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The GST Tax on Non-Exempt Trusts: What Your Family Needs to Know

April 21, 2020

If you’ve put any thought into estate planning, you’ve no doubt run into the acronym GST. It stands for “generation-skipping transfer,” and it applies when grandparents leave money to their grandchildren without first willing the money to the parents in between. Unfortunately, the tax policies around this process aren’t always straightforward. Here’s what you need to know.

What You Need to Know About a GST

If you want to leave assets to your grandchildren directly, skipping two rounds of estate tax and transferring the wealth more quickly than if you left it to your children first, a GST is what you’re looking for. You don’t even have to leave the money to your biological grandchildren — anyone at least 37.5 years younger than you (called a “skip person”) qualifies for a GST.

It’s worth noting that a GST is still subject to taxation if the amount exceeds a threshold that changes every year — in 2020, that threshold is $11.58 million. But here’s the rub: the threshold applies to the entire estate, not each individual inheritance.

So What is the GSTT?

The GSTT is the Generation-Skipping Transfer Tax, and it applies to any transfer of property, by inheritance or by gift, from one person to a person who’s at least 37.5 years younger than them.

The GSTT was created to close a loophole that allowed grandparents to skip a generation with their inheritance, thus avoiding estate tax entirely. It’s a flat 40 percent, which sounds high, but it only applies to amounts higher than the $11.58 million (in 2020) threshold.

What Not to Do

Imagine a hypothetical deceased person (let’s call them DP) who’s done very well for themselves, then dies. They have an estate of $48 million. They didn’t plan their estate very well beyond a simple will, disbursed in the following order:

  • Their daughter gets $12 million
  • Their grandson gets $12 million
  • Their son gets $12 million
  • Their granddaughter gets $12 million

Here’s how that shakes out when the IRS comes to collect:

  • The daughter’s 12 million is all but exempt from the estate tax, since only the remaining $420,000 over the cap is taxable. She pays a 40 percent estate tax on the rest of the money and inherits a total of $11,832,000. But this uses up the entire estate tax exemption.
  • The grandson’s inheritance isn’t exempt from the estate tax, since the daughter already used up the exemption. He’s two generations removed from DP, so the GSTT would apply, but the exemption hasn’t been used yet. He pays 40 percent estate tax on the entire amount, plus 40 percent GSTT on the $420,000 in excess of the GSTT exemption, for a total inheritance of $7,032,000.
  • The son doesn’t pay the GSTT since he’s only one generation removed, but he has to pay the 40 percent estate tax on the full amount since the daughter already used up the entire exemption. He inherits $7,200,000.
  • The granddaughter gets the shortest end of the stick. She pays the full 40 percent estate tax (since the daughter used up that exemption) and the full 40 percent GSTT (since the grandson used up that exemption) for a total of 80 percent tax. She inherits $2,400,000.

So what seemed like a fair division of DP’s estate turns out to be far from it, thanks to sloppy estate planning. This person could have structured the estate in such a way that the grandchildren got their money first, thus avoiding the double tax on the granddaughter. They could have put the money in a trust (or series of trusts) and named their descendants as trustees. But as is, they subjected their beneficiaries to the full force of the tax code.

Direct and Indirect Skips

A direct skip is pretty straightforward — a grandparent gifts property directly to their grandchild. In that case, the transferor (or their estate) is responsible for paying the GST tax that applies.

An indirect skip is what it sounds like — a transfer that has another step in between the donor and the skip person. There are two types of indirect skips:

  • A taxable termination involves a skip person and a non-skip person. The money goes from the donor to the non-skip person (often the donor’s child) and then passes on to the skip person when the non-skip person dies. In that case, only the assets that are left to pass on to the skip person are taxed.
  • A taxable distribution is any income or property that’s not already subject to either estate tax or gift tax. If you establish a trust that makes payments to your grandson, then the payments are subject to GST taxes.

GSTT Strategies

The GSTT exemption is high enough that a lot of beneficiaries won’t even run into it. And even In cases where your descendants are likely to pay the GSTT, there are still ways around it. One option is a dynasty trust, which makes specified distributions to each generation, avoiding estate taxes entirely. You have plenty of options, in fact, but only if you plan ahead.

Talk to First Western Trust

Estate planning isn’t always easy to wrap your head around, so it’s best to talk to a financial advisor with the expertise and experience to craft a plan that’s tailored to the exact goals and priorities that are most important to you. That’s exactly what we offer at First Western Trust. We know that there’s more to your wealth than the bottom line on your balance sheet — your business, your family, your lifestyle, and your legacy — and we’re here to make sure you achieve everything you’re looking for. Get in touch today.

*This post is not intended as tax advice, consult a qualified tax advisor for your situation.

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