Plan carefully to avoid GST tax surprises
It’s crucial to consider and plan for the generation-skipping transfer (GST) tax if you wish to pass along some of your wealth to your grandchildren or great-grandchildren or if your estate plan should benefit them in any way. The GST tax is one of the harshest and most complicated in the tax system since it ensures that money is taxed at every generational level. Furthermore, it’s one of the most misinterpreted.
ABCs of the GST tax
Transfers that skip a generation are subject to the GST tax at a flat 40% rate and any other applicable gift and estate taxes. Transfers to “skip persons,” such as your grandchildren, other relatives who are more than one generation below you, and unrelated individuals under 37.5 years of age, are subject to the tax.
However, there is an exemption for a grandchild whose parent (your child) has already passed away. The grandchild then advances one generation and is no longer a “skip person.”
The lifetime exemption for the GST tax is the same as the lifetime exemption for gift and estate taxes. ($12.92 million for 2023.) However, it operates differently. For instance, the GST tax exemption must be awarded to a transfer to protect it from tax. That is unlike the gift and estate tax exemptions, which automatically protect eligible wealth transfers.
The tax code has automatic allocation criteria to avoid unintentionally losing the exemption. However, relying entirely on them can be risky. For example, the exemption may only sometimes apply to transfers that could result in high GST charges. Others automatically distribute the exception to transfers that aren’t likely to use it, wasting the exemption funds.
Three types of GST tax triggers
Three types of transfers may trigger GST taxes:
- “Direct skips” — Transfers to a skip person made directly and subject to federal gift and estate taxes.
- Taxable distributions — Trust distributions to a skip person.
- Taxable terminations — For example, suppose you create a trust with your children as beneficiaries. In that case, there will be a taxable termination when the final beneficiary passes away. The trust’s assets are then transferred to your grandchildren.
The GST tax does not apply to transfers that you allocate your GST tax exemption. Additionally, you can transfer up to $17,000 per year to any other persons without incurring GST tax or exhausting any of your GST tax exemption because of the GST tax annual exclusion, which is comparable to the gift tax annual exclusion. But remember that transactions made in trust only qualify for the exclusion if it meets specific conditions.
Make sure to appropriately distribute your GST tax exemption if your estate plan includes giving sizeable gifts to your grandkids or other young individuals, whether outright or in trust. We can assist you in developing a plan that takes advantage of the exemption and reduces your GST tax liability. Contact our RRBB accountants and advisors if you have further questions.
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