Would you like to include grandchildren, great grandchildren, or nonrelatives who are significantly younger than you in your estate plan? If so, you’ve got more to consider than gift and estate taxes. The generation-skipping transfer (GST) tax may also apply.
GST Tax Basics
One of the harshest taxes in the Internal Revenue Code, the GST tax is a flat 40% tax on asset transfers that “skip persons”. For example, the tax may apply if you plan to leave assets to grandchildren or other family members who are more than one generation below you. (For non-family members, the tax applies when the heir in question is more than 37 ½ years younger than you.)
Because this tax is calculated in addition to estate and gift taxes, it can significantly impact the amount of wealth you’re able to leave to future generations.
GST Tax Exemption Under the Tax Cuts and Jobs Act
A generous GST tax exemption may fortunately offer some relief. For persons dying after December 31, 2017 and before January 1, 2026, the Tax Cuts and Jobs act adjusts the GST tax exemption amount to an inflation-adjusted $10 million. That totals $13.61 million for 2024.
Unless congress takes action before this time frame ends, the exemption will shrink back to an inflation-adjusted $5 million starting on January 1, 2026.
Of course, taking advantage of this exemption requires careful planning.
For an exemption to apply in some cases, it’s necessary to allocate the exemption to particular assets on a timely filed gift tax return. This is called an affirmative election.
In some cases, the exemption may be allocated automatically unless you opt out. If you prefer to allocate your exemption elsewhere, this can lead to unwanted results.
Reviewing each transfer for potential GST tax liability is a great way to avoid costly mistakes and ensure your exemption is allocated as advantageously as possible.
What transfers are taxable under the GST?
In addition to direct gifts that skip persons, GST tax applies to two types of trust-related transfers:
- Taxable terminations
Trust assets pass to your grandchildren when your child dies and the trust terminates.
- Taxable distributions
Trust income or principal is distributed to a skip person.
Note: Gifts covered by the annual gift tax exclusion aren’t currently subject to the GST tax.
Protections offered by automatic allocation rules
While the automatic allocation rules can be unfavorable if you prefer to allocate your exemption elsewhere, they’re ultimately intended to protect you against unintentional loss of GST tax exemptions.
For instance, your unused GST tax exemption may be automatically applied to a gift to a grandchild or other “skip person” that exceeds the annual gift tax exclusion ﹘without the need to make an allocation on a gift tax return.
The rules’ impact on “GST trusts” are complex. In general, a trust is considered a GST trust if it will likely benefit skip persons or your grandchildren in the future.
In most cases, these automatic allocation rules work favorably and ensure your GST tax exemption is applied where it’s most needed. However, they can also lead to unintended﹘and potentially expensive﹘results in other cases.
Questions? Smolin can help
For many people, the GST tax might not be top of mind right now. After all, the exemption amount is currently high enough that it doesn’t impact most families’ estate plans.
However, the GST tax exemption rate is expected to decrease significantly after 2025 without action from congress.
By choosing to contact your accountant to plan for this tax now, you can avoid unexpected costs and protect the wealth you want to leave to your younger relatives in the future.