How Does the Generation-Skipping Transfer Tax Work in Estate Planning?

The generation-skipping transfer tax, also called the generation-skipping tax, can apply when a grandparent leaves assets to a grandchild—skipping over their parents in the line of inheritance. It can also be triggered, when leaving assets to someone who’s at least 37½ years younger than you. If you are thinking about “skipping” any of your heirs when passing on assets, it is important to know what that may mean tax-wise and how to fill out the requisite form. An experienced estate planning attorney can help you and counsel you on the best way to pass along your estate to your beneficiaries.

KAKE.com’s recent article entitled “What Is the Generation-Skipping Transfer Tax?” says the tax code imposes both gift and estate taxes on transfers of assets above certain limits. For 2020, you can exclude gifts of up to $15,000 per person from the gift tax, with the limit twice as much for married couples who file a joint return. Estate tax applies to estates larger than $11,580,000 for 2020, increased to $11,700,000 in 2021.

The gift tax rate can be as high as 40%, and the estate tax is also 40% at the top end. The IRS uses the generation-skipping transfer tax to collect its portion of any wealth that is transferred across families, when not passed directly from parent to child. Assets subject to the generation-skipping tax are taxed at a flat 40% rate.  Note that the GSTT can apply to both direct transfers of assets to your beneficiaries and to assets passing through a trust. A trust can be subject to the GSTT, if all trust beneficiaries are considered to be skip persons who have a direct interest in the trust.

The generation-skipping tax is a separate tax from the estate tax, but it applies alongside it. Similar to the estate tax, this tax begins when an estate’s value exceeds the annual exemption limits. The 40% GSTT would be applied to any transfers of assets above the exempt amount, in addition to the regular 40% estate tax.  That is the way the IRS gets its money on wealth, as it moves from one person to another. If you passed your estate to your child, who then passes it to their child then no GSTT would apply. The IRS would just collect estate taxes from each successive generation. However, if you skip your child and leave assets to your grandchild, it eliminates a link from the taxation chain, and the GSTT lets the IRS replace that link.

You can use your lifetime estate and gift tax exemption limits, which can help to offset how much is owed for the generation-skipping tax. However, any unused portion of the exemption counted toward the generation-skipping tax is lost when you pass away.

If you’d like to minimize estate and gift taxes as much as possible, there are several options. Your experienced estate planning attorney might suggest giving assets to your grandchildren or another generation-skipping person annually, rather than at the end of your life. That’s because you can give up to $15,000 per person each year without incurring gift tax, or up to $30,000 per person if you’re married and file a joint return. Just keep the lifetime exemption limits in mind when planning gifts.

You could also make payments on behalf of a beneficiary to avoid tax. For instance, to help your granddaughter with college costs, any direct payments you make to the school to cover tuition would generally be tax-free. The same is true for direct payments made to healthcare providers, if you’re paying medical expenses on behalf of another.

Another option may be a generation-skipping trust that lets you transfer assets to the trust and pay estate taxes at the time of the transfer. The assets you put into the trust must stay there during the skipped generation’s lifetime. Once they die, the trust assets can be passed on tax-free to the next generation.

There’s also a dynasty trust. This trust can let you pass assets to future generations without triggering estate, gift, or generation-skipping taxes. However, they are meant to be long-term trusts. You can name your children, grandchildren, great-grandchildren and subsequent generations as beneficiaries and the transfer of assets to the trust is irrevocable. Therefore, when you place the assets in the trust, you will not be able to take them back out again. You can see why it’s so important to understand the implications, before creating this type of trust.

The generation-skipping tax can make a big impact on the assets you’re able to leave to heirs. If you’re considering using this type of trust to pass on assets or you’re interested in exploring other ways to transfer assets while minimizing taxes, speak to an experienced estate planning attorney.

Reference: KAKE.com (Feb. 6, 2021) “What Is the Generation-Skipping Transfer Tax?”

 

What Trusts are Available for Estate Planning?

A trust is a legal agreement that has at least three parties. The same person(a) can be in more than one of these roles at the same time. The terms of the trust usually are embodied in a legal document called a trust agreement. Forbes’s recent article entitled “Here’s What You Need To Know About The Most-Popular Estate Planning Trusts” explains that the first party is the person who creates the trust, known as a trustor, grantor, settlor, or creator.

The trustee is the second party to the agreement. This person has legal title to the property in the trust and manages the property, according to the instructions in the trust and state law. The third party is the beneficiary who benefits from the trust. There can be multiple beneficiaries at the same time and there also can be different beneficiaries over time.  The trustee is a fiduciary who must manage the trust property only for the interests of the beneficiaries and consistent with the trust agreement and the law. Although a trust is created when the trust agreement is signed and executed, it isn’t really operational until it’s funded by transferring property to it. An estate planning attorney would be a good trustee as they understand the trusts.

A living trust, also called an inter vivos trust, is a trust that’s created during the trustor’s lifetime. A testamentary trust is created in the trustor’s last will and testament. A trust can be revocable, which means that the trustor can revoke it or modify the terms at any time. An irrevocable trust can’t be changed or revoked.

Assets that are owned by a trust avoid the cost, delay and publicity of probate. However, there are no tax benefits to a revocable living trust. The settlors-trustees are taxed as though they still own the assets. The trust assets are also included in their estates under the federal estate tax.

An irrevocable trust typically is created to reduce income and/or estate taxes. This type of trust can also protect assets from creditors. When assets are transferred to an irrevocable trust, the income and gains are taxed to the trust when they are retained by the trust and taxed to the beneficiaries when distributed to them.

Under the federal estate tax and most state estate taxes, assets that are retitled to an irrevocable trust aren’t part of the grantor’s estate. Transfers to the trust are gifts to the beneficiaries. The grantor’s gift tax annual exclusion and lifetime exemption can be used to avoid gift taxes, until gifts exceed the exclusion and exemption limit.

An irrevocable trust typically is created to reduce income and/or estate taxes. This type of trust can also protect assets from creditors. When assets are transferred to an irrevocable trust, the income and gains are taxed to the trust when they are retained by the trust and taxed to the beneficiaries when distributed to them.

A grantor trust is an income tax term that describes a trust where the grantor is taxed on the income. That’s because he or she retained rights to or benefits of the property. The revocable living trust is an example of a grantor trust.

A trust can be discretionary or nondiscretionary. A trustee of a discretionary trust has the power to make or withhold distributions to beneficiaries as the trustee deems appropriate or in their best interests. In a nondiscretionary trust, the trustee makes distributions according to the directions in the trust agreement.

Another type of trust is a spendthrift trust. This is an irrevocable trust that can be either living or testamentary. The key term restricts limits the beneficiary’s access to the trust principal, and the beneficiary and the beneficiary’s creditors can’t force distributions. The spendthrift provision is used when the settlor is worried that a beneficiary might waste the money or have trouble with creditors. Many states permit spendthrift trusts, but some limit the amount of principal that can be protected, and some do not recognize spendthrift provisions.

Finally, a special needs trust can be used to provide for a person who needs assistance for life. In many cases, it’s a child or sibling of the trust settlor. It can be either living or testamentary. Critical to a special needs trust is it has provisions that make certain the beneficiary can receive financial support from the trust, without being disqualified from federal and state support programs for those with special needs.

For more about trusts and how one may fit into your estate planning, contact an experienced estate planning attorney.

Reference: Forbes (Oct. 26, 2020) “Here’s What You Need To Know About The Most-Popular Estate Planning Trusts”

 

How Can We Do Estate Planning in the Pandemic?

We can see the devastating impact the coronavirus has had on families and the country. However, if we let ourselves dwell on only a few areas of our lives that we can control, the pandemic has given us some estate and financial planning opportunities worth evaluating, says The New Hampshire Business Review’s recent article entitled “Estate planning in a crisis.”

Unified Credit. The unified credit against estate and gift tax is still a valuable estate-reduction tool that will probably be phased out. This credit is the amount that a person can pass to others during life or at death, without generating any estate or gift tax. It is currently $11,580,000 per person. Unless it’s extended, on January 1, 2026, this credit will be reduced to about 50% of what it is today (with adjustments for inflation). It may be wise for a married couple to use at least one available unified credit for a current gift. By leveraging a unified credit with advanced planning discount techniques and potentially reduced asset values, it may provide a very valuable “once in a lifetime” opportunity to reduce future estate tax.

Reduced Valuations. For owners of closely-held companies who’d like to pass their business to the next generation, there’s an opportunity to gift all or part of your business now at a value much less than what it would’ve been before the pandemic. A lower valuation is a big plus when trying to transfer a business to the next generation with the minimum gift and estate taxes.

Taking Advantage of Low Interest Rates. Today’s low rates make several advanced estate planning “discount” techniques more attractive. This includes grantor retained annuity trusts, charitable lead annuity trusts, intra-family loans and intentionally defective grantor trusts. The discount element that many of these techniques use, is tied to the government’s § 7520 rate, which is linked to the one-month average of the market yields from marketable obligations, like T-bills with maturities of three to nine years. For many of these, the lower the Sect. 7520 rate, the better the discount the technique provides.

Estate Planning. Now is the time to contact an experienced estate planning attorney to get your affairs organized

Bargain Price Transfers. The reduced value of stock portfolios and other assets, like real estate, may give you a chance to give at reduced value. Gifting at today’s lower values does present an opportunity to efficiently transfer assets from your estate, and also preserve estate tax credits and exclusions.

 

Reference: New Hampshire Business Review (May 21, 2020) “Estate planning in a crisis”

 

Do You have an Estate Plan Blueprint?

Your assets can go to one of four places: family, friends, charity or the government. You should work with a qualified estate planning attorney to make certain that you have the instructions set up correctly in your will and perhaps a trust and create an estate plan for yourself.

Forbes’s recent article entitled “How To Create An Estate Planning Blueprint” emphasizes that you need to make sure your plan is optimized, so your beneficiaries can sidestep the pain of probate and you can be certain that you make the most of the gifts you plan to leave them.

Let’s look at some tips on how to make sure your estate is as planned as best as it possibly can be.

Conduct Regular Check-ups. You should review your estate plan every few years. Things change, like laws and regulations, family situations, wealth and more. This needs to be reflected in your planning.

Think of the Future. Failing to plan now, can mean headaches in the future for your family after you’re gone.

Look at Your Options. If you and your estate planning attorney decide to set up a trust, know your options and discuss them, along with their tax implications.

Plan Your Charitable Gifts. Ask your estate planning attorney whether lifetime gifting makes sense. The unified exemption amount is at $23.16 million per couple, when it comes to lifetime and at-death gifts. If you have an estate valued in excess of that per-couple threshold, consider making lifetime gifts now before the possible future decrease in this exemption!

Inform Your Beneficiaries of Your Wishes. Let you family know what you’re planning to do with your estate to avoid hurt feelings and fighting after you’re gone. That way, there will be no surprises. You do not need to spell out all the financial details. However, you should provide a general summary of what you anticipate, as well as details about who will be the trustees and executors of your estate.

When planning your estate plan strategy, paying for the services of a legal professional now can help you avoid problems in the future. Work with an experienced estate planning attorney.

Reference: Forbes (April 1, 2020) “How To Create An Estate Planning Blueprint”

 

What’s the Difference Between an Inter Vivos Trust and a Testamentary Trust?

Trusts can be part of your estate planning to transfer assets to your heirs. A trust created while an individual is still alive is an inter vivos trust, while one established upon the death of the individual is a testamentary trust.

Investopedia’s recent article entitled “Inter Vivos Trust vs. Testamentary Trust: What’s the Difference?” explains that an inter vivos or living trust is drafted as either a revocable or irrevocable living trust and allows the individual for whom the document was established to access assets like money, investments and real estate property named in the title of the trust. Living trusts that are revocable have more flexibility than those that are irrevocable. However, assets titled in or made payable to both types of living trusts bypass the probate process once the trust owner dies.

With an inter vivos trust, the assets are titled in the name of the trust by the owner and are used or spent down by him or her, while they’re alive. When the trust owner passes away, the remainder beneficiaries are granted access to the assets which are then managed by a successor trustee.

A testamentary trust (or will trust) is created when a person dies and the trust is set out in their last will and testament. Because the creation of a testamentary trust doesn’t occur until death, it’s irrevocable. The trust is a created by provisions in the will that instruct the executor of the estate to create the trust. After death, the will must go through probate to determine its authenticity before the testamentary trust can be created. After the trust is created, the executor follows the directions in the will to transfer property into the trust.

This type of trust does not protect a person’s assets from the probate process. As a result, distribution of cash, investments, real estate, or other property may not conform to the trust owner’s specific desires. A testamentary trust is designed to accomplish specific planning goals like the following:

  • Preserving property for children from a previous marriage
  • Protecting a spouse’s financial future by giving them lifetime income
  • Leaving funds for a special needs beneficiary
  • Keeping minors from inheriting property outright at age 18 or 21
  • Skipping your surviving spouse as a beneficiary and
  • Making gifts to charities.

Through trust planning, married couples may use of their opportunity for estate tax reduction through the Unified Federal Estate and Gift Tax Exemption. That’s the maximum amount of assets the IRS allows you to transfer tax-free during life or at death. It can be a substantial part of the estate (all of your assets), making this a very good choice for financial planning. Seek out an experienced estate planning attorney to explore and discuss these types of trusts.

Reference: Investopedia (Aug. 30, 2019) “Inter Vivos Trust vs. Testamentary Trust: What’s the Difference?”

 

A 2020 Checklist for an Estate Plan

The beginning of a new year is a perfect time for those who haven’t started the process of getting an estate plan started. For those who already have a plan in place, now is a great time to review these documents to make changes that will reflect the changes in one’s life or family dynamics, as well as changes to state and federal law.

Houston Business Journal’s recent article entitled “An estate planning checklist should be a top New Year’s resolution” says that by partnering with a trusted estate planning attorney, you can check off these four boxes on your list to be certain your current estate plan is optimized for the future.

  1. Compute your financial situation. No matter what your net worth is, nearly everyone has an estate that’s worth protecting. An estate plan formalizes an individual’s wishes and decreases the chances of family fighting and stress.
  2. Get your affairs in order. A will is the heart of the estate plan, and the document that designates beneficiaries beyond the property and accounts that already name them, like life insurance. A will details who gets what and can help simplify the probate process, when the will is administered after your death. Medical questions, provisions for incapacity and end-of-life decisions can also be memorialized in a living will and a medical power of attorney. A financial power of attorney also gives a trusted person the legal authority to act on your behalf, if you become incapacitated.
  3. Know the 2020 estate and gift tax exemptions. The exemption for 2020 is $11.58 million, an increase from $11.4 million in 2019. The exemption eliminates federal estate taxes on amounts under that limit gifted to family members during a person’s lifetime or left to them upon a person’s passing.
  4. Understand when the exemption may decrease. The exemption amount will go up each year until 2025. There was a bit of uncertainty about what would happen to someone who uses the $11.58 million exemption in 2020 and then dies in 2026—when the exemption reverts to the $5 million range. However, the IRS has issued final regulations that will protect individuals who take advantage of the exemption limits through 2025. Gifts will be sheltered by the increased exemption limits, when the gifts are actually made.

It’s a great idea to have a resolution every January to check in with your estate planning attorney to be certain that your plan is set for the year ahead.

Reference: Houston Business Journal (Jan. 1, 2020) “An estate planning checklist should be a top New Year’s resolution”

 

How Will Changes in the Law Impact my Estate Plan?

Wealth Advisor recently published an article—“Tune-Up Your Estate Plan in Light of Changing Conditions”—that asks if your estate plan is still appropriate, in light of several changes in the law.

The federal estate tax gift and estate tax exemption amount is now $11.4 million, indexed for inflation, which is an all-time high. A married couple can transfer twice that amount to children or others, or $22.8 million, without any federal gift and estate tax. The federal exemption amount is also now “portable” between spouses. It means that the first spouse to die, can transfer any unused exemption to the surviving spouse, without the need of a “credit shelter trust.”

Note that the enhanced federal exemption amount is scheduled to “sunset” in 2026, returning back down to $5.6 million (indexed for inflation).

As far as state law changes, the New York estate tax exemption amount is $5.74 million. However, that exemption isn’t portable. The estate tax exemption is also phased out, if your taxable estate is 5% more than that amount. For a New York taxable estate of about $6 million, there’s no exemption and the New York estate tax is about $500,000. The New York estate tax on a $10 million taxable estate is more than $1 million. Since New York has no gift tax, lifetime gifts don’t decrease the estate tax exemption for state tax purposes. However, gifts made within three years of death, would be clawed back under a pending bill.

In New Jersey, they’ve repealed the estate tax but kept the inheritance tax. Connecticut raised its estate and gift tax exemption amount. In the state of Illinois, the estate tax exemption amount is only $4 million and isn’t portable. This makes flexibility in your estate plan very desirable. For residents in the Land of Lincoln (that’s Illinois), the estate tax savings are less dramatic, since the exemption is smaller than in New York, but the potential savings through proper planning are still major.

Another consideration to note includes the fact that surrogate’s courts and probate courts—which have always moved at a snail’s pace—have become even slower.

Some of these changes may impact your current estate plan. You may want to take advantage of the enhanced federal exemption amount, before it goes away.

Talk to an experienced estate planning attorney to see how you can shelter your savings from a state estate tax, if you are married and live in a state with an estate tax like New York, Connecticut, or Illinois. This could save you a lot of money that you can then pass on to your heirs.

Reference: The Wealth Advisor (June 17, 2019) “Tune-Up Your Estate Plan in Light of Changing Conditions”