Should your estate plan include a generation-skipping trust? The answer is… yes! Even if:
If the Internal Revenue Code gives you an exemption that shields your inheritors from estate taxes, why not use it? As long as your estate is passing to people (not charity), then the generation-skipping tax exemption is for you.*
One caveat, however: The name “generation-skipping” is deceiving. It sounds like you are skipping or disinheriting somebody. With a generation-skipping trust, though, this is not what happens. The trust allows you to skip an estate tax at each generation, not skip the generation. It is so advantageous that the federal government limits the amount that can pass to such a trust, yet it is often overlooked in estate plans.
WHAT IS THE GENERATION-SKIPPING TRANSFER TAX?
It is helpful to consider the history of this tax: Congress passed it to close a loophole created by wealthy people leaving inheritances in trust for successive generations—a child’s lifetime, then a grandchild’s lifetime, then a great-grandchild’s lifetime—thus avoiding estate taxes as property is passed from one generation to the next.
In the early days, there were no limits on the amounts that could be left in such trusts. Then things changed: By 1986, Congress had adopted the generation-skipping tax that’s in effect today. It imposes a flat tax, now 40 percent, on generation-skipping transfers that exceed the allowable exemption, currently $5.49 million.
All of this is confusing because the federal estate-tax exemption amount is the same as the generation-skipping tax exemption amount—$5.49 million; but they are different exemptions. When you die, your estate will be subject to an estate tax before your beneficiaries receive their inheritances. The generation-skipping tax exemption allows you to leave a certain amount in trust for your beneficiaries so that these inheritances are not taxed again when the beneficiaries die. Despite talk that both the estate tax and generation-skipping tax might be eliminated, this change does not appear likely.
HOW SHOULD YOU USE THIS EXEMPTION?
A named beneficiary of your estate plan could receive the inheritance in trust—only adding more paragraphs to your living trust. A beneficiary of a lifetime trust can be a trustee, as long as the trust limits principal invasion for certain purposes.
The beneficiary can also have the right to determine future beneficiaries by granting a special power of appointment. Apart from avoiding estate taxes, the trust provides the beneficiary with lifetime protection from spousal or creditor claims. So, regardless of the size of your estate or your relationship to the beneficiaries, you should have a generation-skipping trust in your plan.
Often misunderstood by accountants, financial advisors and even attorneys, the generation-skipping tax exemption is buried in one of the most complex chapters of the Internal Revenue Code, but it has been there for 20 years serving those who are willing to take advantage of it.
*You may also use your generation-skipping tax exemption for lifetime transfers, which offers leveraging of the benefits of using the exemption, but is beyond the scope of this article. The information presented in this publication is made available for general purposes and it is not legal advice nor is it intended to be acted upon as legal advice. There is no attorney-client relationship created between the reader and White Law or any of its representatives. The content of this publication may be changed, improved or updated without notice. The reader should seek a certified attorney licensed to practice law in the relevant state or jurisdiction with respect to addressing any particular issue or idea raised in this publication.