The generation skipping tax (GST) is the third of the taxes that make up the transfer tax system along with the Estate Tax and Gift Tax. The tax generally applies to transfers you make to someone who is two or more generations below you and is sometimes called the grandchildren’s tax.
The tax was enacted in 1976, repealed and then replaced in 1986. The purpose of the tax is to ensure that property transfers at each generation pay some form of transfer tax. Key terms are:
- Transferor – The person who makes the transfer of property
- Skip Person – A person who is two or more generations below the transferor, a trust where all of the interests are held by skip persons and a person who is not related to the transferor and is more than 37 1/2 years younger than the transferor
- GST Exemption – The amount of property that can be transferred without incurring a GST tax
- Direct Skip – A transfer to a skip person
- Indirect Skip – A transfer to a GST trust and is subject to a Gift Tax
- Taxable Distribution – A distribution from a trust to a skip person
- Taxable Termination – When an interest in the transferred property passes from the last person who is not a skip person
- Deceased Parent Rule – When a parent of the grandchild dies before a transfer then the grandchild is moved up a level and any transfers to the grandchild do not incur a GST tax
Every taxpayer is entitled to a GST tax exemption that can be used during life or at death. Depending on the type of transfer the exemption is automatically applied or the taxpayer must allocate the exemption. If the transfer is to direct or indirect skips during lifetime then the exemption is automatically allocated unless the taxpayer opts out through an election. If the transfer is not a direct or indirect skip then the taxpayer must allocate their exemption on either a gift or estate tax return. The exemption amounts and tax rates are:
|Year||Maximum Tax Rate||Applicable Exclusion Amount|
The Economic Growth and Tax Reconciliation Act of 2001 (EGGTRA) provided for a gradual decrease in the tax rate and a gradual increase in the exemption amount. Under the terms of EGGTRA it was scheduled to expire December 31, 2010 and as of January 1, 2011 the rates and exclusion amounts were slated to revert back to the 2001 figures. However, due to the newly enacted Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 the maximum rate is 35% and the applicable exclusion is $5,000,000 for years 2011 and 2012.
The GST tax applies to any transfer of property to a skip person unless the deceased parent rule applies. The most common transfer that triggers the tax is a transfer to a grandchild. Additionally, a transfer to a trust will be subject to GST tax if:
- All of the beneficiaries are skip persons or
- A trust that provides for permissible payments to skip persons and does not provide for current payments to non skip persons.
The tax will also apply when there is a distribution from a trust to a skip person or upon a taxable termination when the trust terminates and property is distributed unless only non skip persons receive or have the right to receive the distribution.
The GST tax is complex and any actions taken in furtherance of GST planning and exemption allocations should only be undertaken after consultation with an experienced attorney.