By Elliott Stapleton Estate Planning Cincinnati
GST Tax Implications
The generation-skipping tax (GST) applies to gifts and bequests made to persons in a generation that is two or more generations below the donor’s generation. For example, a grandchild is a skip person for purposes of the GST.
A skip person can be a natural person or a trust if all interests in the trust are held by skip people or if future distributions can only be made to skip people.[1] The GST tax is a separate tax in addition to the gift or estate taxes.
It is calculated based on the amount of the bequest or gift to the skip person less any GST exemption allocated to that gift or bequest. The purpose of the GST is to ensure taxpayers are unable to avoid estate and gift taxes with long-term trusts that benefit multiple generations.[2]
A property interest transferred to a skip person must be includible in the gross estate to be subject to the GST tax. Transfers to charitable remainder trusts and pooled income funds are not subject to the GST tax. There are three forms of GSTs.
A direct skip is a transfer of an interest in property to a skip person that is subject to the gift or estate tax. A taxable termination is a transfer to a skip person upon the end of a trust’s interest in property. A taxable distribution is any distribution from a trust to a skip person that is not a direct skip or taxable termination.[3] Only the tax on a direct skip is reported on Form 706.
For lineal descendants of the decedent or spouse’s grandparents such as nieces, nephews, and cousins, the number of generations from the beneficiary is determined by subtracting the number of generations between the grandparent and the decedent from the number of generations between the grandparent and beneficiary. A spouse of a descendant is assigned the generation of that descendant.
There is no difference for adopted or half-blood relationships. If more than one rule applies, the beneficiary is placed in the youngest applicable generation. If a beneficiary does not fall into the above categories, that person receives a generation according to his or her birth date as shown:
- Decedent’s Generation: Born within 12.5 years;
- First Generation: Born more than 12.5 but not more than 37.5 years;
- Second Generation and Beyond: After 37.5 years, a new generation is created every 25 years.[4]
The GST may not apply to transfers to a decedent’s grandchildren if the children predeceased the decedent. If a beneficiary is a descendant of a parent of the transferor, and the beneficiary’s own parent is deceased when the gift or estate tax is assessed, then the beneficiary is treated as part of the generation directly below the lower of the transferor’s generation or the generation of the youngest living ancestor of the beneficiary who is also a descendant of the transferor’s parent.
This does not apply to a beneficiary who is not a lineal descendant of the transferor. This rule also applies to transfers to trusts. A beneficiary’s parent is treated as having predeceased the transferor if death occurs no more than 90 days after a transfer.[5]
A separate exemption is permitted for the GST tax. The amount exempt from tax is $5,250,000 (2013), $5,340,000 (2014), and $5,430,000. Increases to this amount may be applied during or after the year of increase.
A transferor may allocate as much of his or her exemption to a transfer as desired, but an allocation is irrevocable once made. If the representative fails to allocate direct skips made at death, then default allocation rules will apply.
A trust should specify an inclusion ratio to determine what portion of each future distribution will be covered by the GST exemption and not subject to the GST tax. A transferor should provide for skip persons and nonskip persons in separate trusts with different inclusion ratios to most efficiently allocate the GST exemption.[6]
The GST tax is charged to the property being transferred unless the governing instrument provides otherwise.[7] If a transfer to a trust is subject to the GST tax, the trustee rather than the estate representative is responsible for payment. Schedule R-1 on Form 706 notifies the trustee of GST tax liability.
Direct Skip Person
Only direct skips to trusts includible in the decedent’s gross estate must be reported. Direct skips to an ordinary trust must be reported regardless of the amount, while direct skips to other trusts must exceed $250,000.
An ordinary trust is defined as “an arrangement created by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate court.”[8] If the personal representative is also the trustee, then direct skips are reported on Schedule R.
If you have questions on this legal topic, feel free to contact Elliott Stapleton, a Cincinnati Estate Planning and Probate Attorney – (513) 334-0099 123 Boggs Lane Cincinnati, Ohio 45246.
References:
[1] I.R.C. § 2613.
[2] Scott Blakesley, What is GST and Why Do I Care? Planned Giving Design Center (1999), http://www.pgdc.com/pgdc/what-gst-and-why-do-i-care.
[3] I.R.C. § 2612.
[4] I.R.C. § 2651.
[5] Treas. Reg. § 26.2651-1(a).
[6] Blakesley, supra note 48.
[7] I.R.C. §§ 2631-33.
[8] Treas. Reg. 301.7701-4(a).
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