Generation-Skipping Transfer Tax

Gift & Estate Planning Concepts: Generation-Skipping Transfer Tax

At a Glance

Estate owners often seek to arrange the disposition of their assets so that death taxes are not levied on each generation. Parents give children a life income interest in a trust, with fairly liberal invasion privileges; at the child's death, the trust continues for grandchildren and perhaps subsequent lineal descendants. By properly arranging the child's interest, they can avoid the federal estate tax when the child dies and the remainder passes to grandchildren.

In order to reduce the loss of estate tax revenue, Congress first enacted a GSTT in 1976 as a sort of "backstop" to the federal estate and gift taxes. After exemptions were applied, the GSTT was intended to prevent the skipping of transfer tax on a generation of heirs through the use of multigenerational trusts where the interests were not sufficiently "robust" to trigger a tax on each passing generation. The original GSTT law went through several alterations, and was eventually replaced by a new GSTT law in 1986.

Taxable Events

At a Glance

The imposition of GSTT is triggered by a "generation-skipping transfer" to a "skip person."

A generation skipping transfer is:

$image\bullet.jpg$ A direct skip,

$image\bullet.jpg$ A taxable termination, or

$image\bullet.jpg$ A taxable distribution.

A "skip person" is defined as:

$image\bullet.jpg$ A lineal descendant, at least two generations below the transferor,

$image\bullet.jpg$ A non-relative, at least 37½ years younger than the transferor, or

$image\bullet.jpg$ A trust, if all interests in the trust are held by skip persons.

Direct Skips

A direct skip occurs when an individual gives assets outright or through a trust to a skip person or persons.

Taxable Terminations

A "taxable termination" occurs upon the termination of an interest in property held in trust (by death, lapse of time, release of power, or otherwise) if:

$image\bullet.jpg$ Immediately after the termination a skip person has an interest in such property or

$image\bullet.jpg$ At any time after the termination, a distribution may be made from the trust to a skip person.

A common example of a taxable termination occurs when a decedent places assets in a trust, with income payable for life to a child, and the remainder to a grandchild. Normally, the child's life estate interest would not be taxable at death. However, the GSTT treats the termination of the child's interest at death as a "taxable termination," i.e. a taxable transfer to the grandchild, triggering the tax.

Taxable Distributions

A "taxable distribution" is a distribution from a trust to a "skip person" that is not classified as a taxable termination or a direct skip.

Taxable distributions can also be a factor for charitable lead trusts. For a discussion of how the generation skipping transfer tax can affect charitable lead trusts, see Other Gifts, the "Effect of the Generation-Skipping Transfer Tax" in the Charitable Lead Trust section.

Exemption

The GSTT laws provide an exemption to shield a portion of generation-skipping transfers from the imposition of tax.

$image\bullet.jpg$ $13,990,000 per transferor (in 2025)—Each transferor may shield up to $13.99 million in either lifetime or death transfers from the imposition of GSTT. Married couples may elect to split the transfer, treating the GST as if being made 50% by each spouse.

$image\bullet.jpg$ Allocation of exemption—The exemption may be allocated to the transferred property at any time before an estate tax return becomes due. Once the allocation election is made, the decision is irrevocable.

Unless the transferor elects otherwise on a gift tax return, any unused GSTT exemption is allocated automatically to direct skip transfers made during life. In addition, the exemption will be deemed allocated to any trust that involves an "indirect skip" during the grantor’s lifetime. Any portion of the exemption that remains unallocated at the transferor's death is first allocated to any direct skips that occurs at his or her death (e.g. a bequest to a grandchild), and then to trusts from which a taxable distribution or taxable termination may occur by virtue of the individual's death. A generation-skipping trust may undergo a "qualified severance" under which it would be split into exempt and non-exempt trusts.

Valuation of a Transfer & the "Inclusion Ratio"

Once a transfer is determined to be a GST, the transferred property must be valued to calculate potential tax liability.

Valuation—Generally, property is valued by using the fair market value at the time of the transfer. However, if the property is transferred at death and the estate elects to use either the alternate valuation date or the special use valuation, that value will be utilized to determine the GSTT liability.

Inclusion Ratio—To determine the amount of GSTT liability, the transferor or his executor must determine the inclusion ratio amount. The inclusion ratio is: (1 - "applicable fraction").

The applicable fraction amount is:

B - (C+ D)

A = the amount of the GSTT exemption allocated

B = the value of the property transferred

C = any federal estate or death taxes actually paid from the property

D = any charitable deductions allowed under the estate and gift tax rules

Any allocation of the GSTT exemption in excess of the amount necessary to reduce the inclusion ratio to zero with respect to a particular transfer is void.

Assignment to Generations

A GST tax will be levied when the transfer is made to a "skip person." A skip person is determined by looking at the generation assignments applicable for family and non-family members.

Family Situations

Generally, the GSTT will be imposed when the transfer is to a family member two or more generations below the transferor. The family member must be a lineal descendant of the transferor's, or his or her spouse's grandparents. For example, a grandnephew, grandson or spouse's grand-nephew would all be classified as two generations below the transferor.

Individuals related by adoption or half-blood are treated in the same way as a whole blood relationship.

Transferor and Spouse - Same Generation

Regardless of the age difference between spouses, a transferor and his or her spouse are treated as on the same generation level.

Predeceased Generation in a Direct Skip

Granddad leaves property in his will to his son, with a remainder to his grandson. Six months later, the son passes away. Subsequently, Granddad passes away a year later, with the property then passing to the grandson in a direct skip. Is this transfer subject to GSTT liability?

The transfer would not be subject to the GSTT, under the "predeceased ancestor rule." The rule pushes any beneficiary up into the generation level of the person who predeceased. Therefore, the grandson would move up into the position of his deceased father, one generation level below his grandfather.

Non-Family Situations

Non-family members are assigned to the same generation if the transferor and transferee are within 12½ years in age. A beneficiary with an age difference from the transferor of between 12½ and 37½ years will be assigned to the second generation. Any transfers between individuals with an age difference of more than 37½ years, will be subject to GSTT liability as a transfer between individuals more than two generations apart. Individuals with an age difference of more than 37½ years will be assigned to generations in 25-year increments.

Deductions

The type of GST determines whether a deduction may be used to reduce GSTT liability. The transferor of a taxable termination may claim a deduction for administration expenses, indebtedness and taxes. Taxable distributions may be reduced by the expenses of determination, collection, or refund of a tax. Finally, direct skips are not eligible for any deductions.

Recall that charitable deductions allowable under federal estate or gift tax rules will be used in the GSTT inclusion ratio in the denominator position.

Computing the GSTT

To compute a transferor's GSTT liability, the applicable tax rate is applied to the result of the inclusion ratio calculation.

Flat 40% rate—Unlike the graduated tax rates used for estate and gift taxes, the GST tax applies a flat rate of 40% to all transfers in excess of the available exemption.

Year	GSTT Flat Rate
2011-2012	35%
2013-2025	40%

State tax credit—The federal GSTT allows a credit for any GST taxes paid to a state. The credit may only be claimed if:

$image\bullet.jpg$ The transfer is not a direct skip, and

$image\bullet.jpg$ The GST occurs at the same time and as a result of the death of an individual.

The amount allowed as a credit must not surpass 5% of the amount of the federal GST tax imposed.

GSTT Return

The party responsible for payment of the GSTT depends upon the type of generation skipping transfer. The following table identifies which individual must pay the GST tax.

Payment Of GSTT Tax Liability
Type of Transfer	Party Responsible for Paying the Tax
Taxable Termination	Trustee
Taxable Distribution	Transferee
Direct Skip (Trust)	Trustee
Direct Skip (Outright transfer)	Transferor

Similarly, the type of transfer determines at what date a GSTT return must be filed with the Internal Revenue Service. With the exception of an outright direct skip, the GSTT return must be filed before the fifteenth day of the fourth month in the year following the taxable year of the transfer. In the case of an outright direct skip transfer, a return must be filed on or before the date for filing the gift or estate tax return.

State GST Taxes

Some states have enacted a Generation Skipping Transfer (GST) tax. However, a majority of these states have statutory language that equates the state GST tax to the maximum federal tax credit for state GST tax paid. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) gradually reduced the federal credit for state GST tax paid, then eliminated the credit altogether in 2005. While many states have GST tax laws on the books, those laws are based on a federal GST tax credit that currently does not exist. Thus, many states currently have no GST tax in effect. However, a few states have de-coupled their state GST tax from the federal credit.

Click here to see whether your state imposes a GST tax.

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