A Generation-Skipping Transfer Tax is imposed on gifts or bequests that "skip" a generation – for example, from grandparents to grandchildren. The following example illustrates figures for death occurring in any year after 2010.

 

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The current generation-skipping transfer tax was part of the Tax Reform Act of 1986. This tax imposes a generation-skipping transfer tax on (1) transfers under trusts having beneficiaries in more than one generation below that of the transferor; and (2) direct transfers to beneficiaries more than one generation below that of the transferor.

 

In general, the person liable for paying the tax is the person who is liable for filing the return. The return is due on or prior to the date the estate or gift tax return is due and becomes part of the applicable return:

Liability for the Tax

• For taxable distributions, the transferee pays the tax.
• For taxable termination or direct skip by a trust, the trustee pays the tax.
• For direct skips, the person making the transfer pays the tax

   

Generation-Skipping Transfers

 

Generation-skipping transfers (GSTs) include:

• Taxable terminations
• Taxable distributions
• Direct skips

   

Taxable distributions and terminations involve transfers from, or terminations of interests in, trusts. The term trust includes any arrangement (other than an estate) which, although not a trust, has substantially the same effect as a trust. Examples of these arrangements include life estates and remainders, estates for years, and insurance and annuity contracts. For these purposes, the term trustee means the person in actual or constructive possession of the property subject to such arrangement.

 

Exemptions from GST Tax A GST tax does not apply to any inter vivos transfer that is exempt from gift tax due to either the annual exclusion or the special exclusion for certain tuition and medical expense payments.

 

GST Tax Exemption Every individual is allowed a generation-skipping transfer tax exemption. This is allocated by the transferor to any generation-skipping transfers. Once an allocation is made, it is irrevocable. The spouse of a married transferor may elect to treat one half of the transfer as though made by each spouse.

 

Taxable Termination A taxable termination is the termination by death, lapse of time, or release of power of an interest in a trust if, after that termination, all interests in the trust are held by generation-skipping beneficiaries. A person has an interest in the property in trust if he or she has a present right to income or corpus from the trust.

 

Taxable Distribution A taxable distribution is any distribution from a trust to a skip person. The distribution is subject to tax whether it comes out of trust income or trust corpus. If the distribution is from trust income, an income tax deduction is allowed for any GST imposed.

 

Direct Skip A direct skip is an outright transfer to or a transfer in trust for the benefit of a skip person. A direct skip is a transfer of an interest in property which is a taxable gift or is includable in the estate of the transferor. An example is a gift from a grandparent to his grandchild, or to a trust for the grandchild’s benefit.

 

Skip person

• A person two or more generations below that of the transferor, or
• A trust whereby
• • skip persons hold all interests in the trust, or
  • the trust only makes future distributions to skip persons and no person holds an interest in the trust.

 

Determination of Generations

Family lines determine generations, but if not related, the dates of birth are used.

 

Lineal Descendants

Starting with the grandparents of the transferor, each generation is assigned a number. The difference in the assigned numbers of the descendant and the transferor determines the generation of a descendant. Anyone who has been married to a person is assigned to the same generation. Present and former spouses of the transferor are assigned to the same generation as the transferor. Half-blood or legal adoptions are treated the same as full-blood.

 

Example: A husband, wife, their brothers and sisters and their spouses would be in one generation; their children, including legally adopted children, would be the first younger generation; the grandchildren would be in the second younger generation, and so forth.

 

Persons not lineal Descendants

Persons not more than 12½ years younger than the transferor are considered in the same generation as the transferor. Persons more than 12½ years younger than the transferor but not more than 37½ years younger are considered the same as the transferor’s children (first younger generation). Subsequent generations are measured from the transferor’s birth date every 25 years.

 

Special Descendants Rules

Persons eligible for more than one class are assigned the youngest class possible. For direct skips, if the parent of the transferor’s grandchild is deceased, the grandchild is moved up a generation and treated as the child of the transferor instead of the grandchild.

 

Computation of Tax

The generation-skipping transfer tax equals the taxable amount times the maximum federal estate tax rate times the inclusion ratio for the transfer.

 

Taxable Amount

• For taxable distributions, the taxable amount equals the value of the property received by the transferee reduced by any expenses incurred in connection with the determination, collection, or refund of the GST tax. If the trustee pays any portion of the tax, that amount is treated as an additional taxable distribution.
• For taxable terminations, the taxable amount equals the value of the property in which the interest terminates reduced by any expenses, indebtedness, and taxes similar to those expenses under section 2053.
• For direct skips, the taxable amount equals the value of the property received by the transferee.

   

Maximum Federal Estate Tax Rate

The maximum federal estate tax rate is currently set at 55%. Consult your tax advisor to verify this amount.

 

Inclusion ratio

The Inclusion Ratio is the excess of 1 over the applicable fraction. The applicable fraction is for the amount of the direct skip or for the trust from which the transfer is made.

 

Applicable fraction

The numerator is the amount of the GST exemption allowed to the trust or to the property transferred in a direct skip. The denominator is the value of property transferred to the trust or involved in the direct skip reduced by the sum of any federal estate tax or state death tax attributable to the property that is actually recovered from the trust and the charitable deduction allowed for this property under the estate and gift tax regulations.

 

Applicable Fraction

=

Amount of GST exemption allocated to trust or property

(Value of property transferred)

–

(State & federal estate taxes)

+

Charitable deductions allowed under Secs. 2055 & 2522)

 

Example: When Tom Brown died in 1992, $2,000,000 was transferred to a trust for the benefit of his grandchildren. At the time of the transfer, the entire $1,000,000 GST exemption is allocated to the trust. There are no estate or death taxes and no charitable deductions. The calculation of the GST tax is figured as follows:

 

 

Applicable Fraction

=

$1,000,000 $2,000,000

=

Inclusion Ratios	=	minus 1/2 = 1/2 (or .5)
GST Tax Rate	=	.5 multiplied by 55% = 27.5%

 

Credits

A credit is allowed against the GST tax for the GST tax actually paid to any state or the District of Columbia in respect to any property included in the generation-skipping transfer if this transfer occurs at the same time as, or as a result of, the death of the transferor. However, the amount allowed as a credit is limited to 5% of the amount of the GST tax imposed on the transfer.

 

Valuation

Generally, property is valued as of the time of the generation-skipping transfer. The value of the transferred property is reduced by the amount of any consideration provided by the transferee. The following rules apply:

• Direct Skips – Direct skip property that is included in the transferor’s gross estate is valued the same as for estate tax valuation purposes. If the estate uses the alternate or special-use valuation, the same value is used for GST tax liability.
• Taxable terminations – If taxable terminations occur at the same time as, and as a result of, an individual’s death, an election may be made to value all property included in the termination using the alternate valuation method.
• QTIP Trusts – If the value of a qualified terminal interest property (QTIP) is included in the gross estate of a spouse under section 2044, and if the spouse is the transferor of the property, the value of the property for GST purposes is its value for estate purposes.

 

 

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