Generation-Skipping Transfer Tax (GSTT)
The federal generation-skipping transfer tax bans donors from avoiding estate taxes by transferring gifts or inheritances to grandkids instead of children. The generation-skipping transfer tax gives grandkids the same inheritance as their parents.
Before the 1976 generation-skipping transfer tax, affluent people could pass money and property to their grandchildren without paying federal estate taxes. The law addressed the loophole where inheritances might jump generations to avoid double estate taxation.
Understand Generation-Skipping Transfer Tax
A property transfer that skips a generation is subject to the generation-skipping transfer tax (GSTT). The GSTT aims to prevent successive generations from evading inheritance taxes by giving gifts or bequests to grandchildren or great-grandchildren.
Skipping the father generation avoids double estate taxes. The GSTT assures that grandchildren inherit the same assets they inherited from their parents.
The transferor is the gift giver, and the recipient is the skip person. Many individuals use a grandchild as a skip; however, non-family members can skip. Individuals must be 37½ years younger than the transferor to receive a generation-skipping transfer.
The generation-skipping transfer tax applies only if the transfer avoids gift or estate taxes for each generation. The IRS adds a tax to gifts and bequests beyond the estate and lifetime gift exclusion to compensate for missing a generation. It implies the GSTT is only owed when a recipient receives more than the GST estate tax credit.
GSTT direct vs. indirect skips
GST taxes rely on direct or indirect skip transfers. A straight skip is an estate- or gift-taxed property transfer. A grandmother giving property to a grandchild is a straight skip. The transferor or estate pays GST on direct skips.
Transfers with intermediary stages reach people via indirect skips. Taxable termination and distribution are indirect skips.
Skip and non-skip people are involved in taxable terminations. Before the transfer, the principal beneficiary, a non-skip person, will get the property. Transferring to the skip person happens when a non-skip person—usually the transferor’s son’s child—dies.
Taxable terminations include a transferor who creates an income-producing trust for his child. After his death, the transferor’s son’s grandchild would inherit the property, subject to GST.
Taxable distributions are distributions of income or property from a trust to a particular person that are not subject to estate or gift taxes. The beneficiary grandmother’s trust payments to her grandson must pay GST taxes.
How Much Is Generation-Skipping Transfer Tax?
The GSTT has been high, 35%–77%. Since 2014, the 40% rate has been applied; however, the Tax Cuts and Jobs Act has dramatically reduced its impact on estates. In 2022, the federal estate, gift, and GSTT exemption is $12.06 million for individuals ($12.92 million in 2023) and $24.12 million for married couples ($25.84 million in 2023), more than tripling the former $5.49 million limit.
Some states with inheritance taxes also collect generation-skipping transfer taxes.
Only the person’s estate with more than the appropriate exemption is liable to estate tax at death, or GSTT, at that flat rate of 40%. So, only aggregate gifts and bequests to skip people over $12.06 million in 2022 ($12.92 million in 2023) would be liable to the 40% flat generation-skipping transfer tax.
The GSTT is assessed when the gift or property transfer is made; GSTs can occur before or after the transferor’s death. The transferor can give the gift to the skip while she is alive. The transferor’s will may give property to a sick person or form a trust for payouts. Use Form 709 to record GST taxes and transfers involving federal gift taxes.
GST Strategies
Most recipients would escape GST since their estates are worth less than the government estate tax credit. As said, the GSTT exemption is high.
When estate taxes may apply, transferors might construct dynasty trusts to minimize or prevent them with each generational transfer. Parking assets in the trust and making generational payments avoids estate taxes on the transfer.
What Causes Generation-Skipping Transfer Tax?
The generation-skipping transfer tax applies when someone transfers an asset but skips a generation. Example: giving a grandchild a home and skipping their child.
Generation-Skipping Transfer Tax: Who Pays?
Grantors or skipped beneficiaries pay generation-skipping transfer taxes. The donor pays the direct generation-skipping tax, and the skipped recipient pays the indirect one. Most cases include the former.
Tax-Free Gifts for Children in 2022: How Much?
Parental gifts of $16,000 in 2022 are tax-free. The 2023 amount is $17,000 per parent and beneficiary.
Conclusion
- The federal generation-skipping transfer tax (GSTT) applies to property transfers by gift or inheritance to a recipient at least 37½ years younger than the donor.
- The GSTT eliminated the loophole that permitted rich people to give money and property to their grandchildren without paying federal estate taxes.
- GSTT is 40% flat.
- Because the GSTT only applies when the transferred sum surpasses $12.06 million per individual for 2022 and $12.92 million for 2023, most people will never pay it.
