This memorandum summarizes the general provisions of the generation-skipping transfer ("GST") tax.
Transfers Subject to the GST Tax
The GST tax is imposed at the highest estate tax rate, which is 55%.
The GST tax was enacted so that all family property would be subject to a tax (whether gift tax, estate tax or GST tax) at least once in each generation. Before the GST tax, it was possible to avoid a tax on each generation in one of two ways: (1) property could be transferred in trust to a child for life, after which the property would pass to the next generation (i.e., grandchildren) without additional gift or estate tax; or (2) property could be transferred directly from a grandparent to a grandchild (outright or in trust) subject only to a single estate or gift tax (a "direct skip"), avoiding taxation on the children's or "middle" generation. In general, the GST tax now applies to these two types of transfers.
- Trusts for Children for Life
If you create a trust for your child's lifetime, you pay a gift or estate tax at the time of creating the trust (subject to your available exemptions and credits). At your child's death, the trust property incurs either estate tax (because the child has sufficient control over the trust to be considered its owner) or GST tax (whenever the estate tax does not apply) before the trust property passes to the next generation. The GST tax does not apply, however, if the property passes to someone in the child's generation, e.g., a sibling; in that case, the GST tax is deferred until the property passes to someone in a lower generation.
- Direct Skip Gifts to Grandchildren
Property that you give directly to a grandchild is subject to an immediate GST tax in addition to any gift tax or estate tax. This GST tax is intended to duplicate the consequences if you gave the property to a child (rather than a grandchild) and your child in turn gave the property to your grandchild. In that two-transfer situation, two taxes would be imposed; consequently, the GST tax adds a second tax to gifts you make directly to your grandchildren.
Exceptions to the GST Tax
The exceptions to the GST tax include the following: (1) trusts created before 1985, including those trusts as extended by exercising powers of appointment; (2) most gifts that are exempt from the gift tax; and (3) transfers, up to a per-person lifetime total of $1,000,000, designated by the transferor as exempt from the GST tax by use of your "GST tax exemption."
- Pre-1985 Exempt Trusts
The GST tax was enacted by Congress in 1986, and it is not applicable to trusts that were irrevocable and in existence on September 25, 1985 (the date on which the 1986 legislation was first introduced in Congress). Trusts in existence before this date are said to be "grandfathered" from the GST tax. This protection from the GST tax applies also to these trusts as they may be extended by exercising powers of appointment, which in some cases may permit these older trusts to be continued for several generations without tax.
- Gifts Exempt From Gift Tax
The GST tax does not apply to gifts that are not subject to the gift tax, which include the following: (1) annual exclusion gifts of up to $10,000 per donee per year (although there are certain technical requirements for gifts in trusts to obtain this exemption from the GST tax), and (2) payments for tuition or medical care paid directly to the school, doctor, hospital, etc. You may make these kinds of gifts to or for a grandchild without paying any GST tax. For more information about the exemptions from gift tax, see our separate memoranda Gift-Giving Tips and Gifts to Minors.
- $1 Million Lifetime Exemption From GST Tax
Each individual has a $1 million lifetime exemption from the GST tax, which may be applied to any combination of gifts during life and at death. For example, at your death you may leave up to $1,000,000 in lifetime trusts for your children. At your children's deaths, the trusts' $1,000,000 (plus any appreciation) may pass to your grandchildren without incurring a GST tax (and without estate tax). Thus, the $1 million exemption provides an estate planning opportunity because you might deliberately leave property in a lifetime trust for a child for tax reasons even if there are no non-tax reasons. In contrast, if you leave this $1,000,000 outright to your children, the $1,000,000 (plus any appreciation) would be included in the children's gross estates and would be reduced by estate taxes as it passes to grandchildren.
Miscellaneous GST Tax Issues
As noted above, gifts made directly to grandchildren are normally treated as "direct skips" and are subject to the GST tax. This rule does not apply, however, if you transfer property to a grandchild after the death of your child who is the parent of that grandchild.
The GST tax also applies to your gifts to or in trust for unrelated individuals. For this purpose unrelated persons belong to a generation determined by their age in relation to your age. A person who is 37-1/2 or more years younger than you is treated as being in your grandchildren's generation.