The ability to provide a financial gift to future generations is one of the most satisfying benefits of wealth. It pays to know how to make that gesture while minimizing taxes
It’s important to understand the GST tax (Generation-Skipping Transfer tax) in the context of the Tax Cuts and Jobs Act (TCJA). Since it’s passing, the TCJA has led to significant changes in several tax areas, with the GST faring better than most. The GST happens when grandparents pass money or property straight to their grandkids, not leaving it to the parents of those grandchildren first.
There is a generation-skipping tax exemption that was roughly doubled with the recent tax law, however, and it’s similar in principle to the exemption for estate taxes and gift taxes—so much so, that it shared the same cap of $11.18 million as of 2018.
We say “shared” because that number increases along with inflation. Any individual wishing to pass wealth or property along by skipping a generation (and provided this takes place after December 31, 2018, and before January 1, 2026) can now give $11.58M without incurring gift or GST tax, as of 1/1/2020. Married couples wishing to do the same simply double that figure.
It’s also important to note that while many do choose to pass wealth along to a generationally removed family member such as their grandchild or great-grandchild, any non-spousal family member or even a non-related person can receive the wealth, as long as they are 37.5 years younger than the party providing it. In either case, the individual receiving the money is commonly referred to as a “skip person.”
Since GST taxes are inclusive along with any federal estate or gift taxes that may apply, knowing ways to minimize or remove this tax means more wealth for your beneficiaries.
The current rate of GST taxation
The GST tax rate moved upwards from 35 percent to 40 percent in 2013 and has stayed at 40 percent since. That’s certainly a significant amount, but it’s positively offset by the larger figures that can be passed tax-exempt to future generations.
If there’s no move from Congress to extend the current provisions of TCJA, those exemption limits of over $11 million for individuals and more than $22 million for married couples will drop to pre-2014 levels (adjusted for inflation) on January 1, 2026—which will effectively halve them in each case.
This means that families with sufficient wealth that can afford to make significant gifts can only plan to ensure their chosen recipients benefit from a larger, tax-free amount within the coming six-year window.
What can be done to minimize the GST?
An Annual Exclusion to the GST tax is also offered by the Internal Revenue Code. This figure was $15,000 for 2019 and will remain the same for 2020; again, this can become $30,000 if a married couple is the transferors. This sum will completely avoid the GST tax and lifetime exemptions.
The GST tax also does not apply if a grandparent chooses to pay the entirety of a grandchild’s tuition fees directly to the educational institution; the same applies to medical expenses which must be paid directly to the facility in order to avoid GST.
An important note on the educational front is that only the tuition expenses are exempt for GST purposes. The cost of residence, supplies, and materials are a separate issue. Alternatively, any grandparent or grandparents contributing to their grandchild’s 529 college plan can give more than the $15,000 or $30,000 annual exclusion and avoid the GST tax. They may do so providing their total gifts do not exceed the lifetime exemption limit of the year in question.
How trusts factor into the GST
The annual GST tax exclusion may also apply if the gift is made in trust. Under these circumstances, the trust must benefit only the skip person and only if it is set up so that any assets benefitting that person are included in the estate.
Typically, generation-skipping gifts are made to Dynasty Trusts that allow for the trust to function in perpetuity, with trust assets permanently removed from estate taxation. It is important to note that Dynasty Trusts must be set up in states whose laws allow them.
Connecticut, for example, made changes to its laws that became effective in 2020 which allow Dynasty Trusts for the first time (although they are limited in scope to 800 years), whereas some states allow Dynasty Trusts to remain in perpetuity. (Those domiciled in Connecticut should also be aware that the state has its own gift tax, with exemption levels that are currently less than the Federal exemptions, and they should seek the advice of Trust & Estate counsel and their financial advisor before making a large gift).
If properly structured, all trust assets can be exempt from the GST tax, meaning that the initial sum and all future growth of those assets can escape taxation. Taking great care when establishing a trust should involve working with experienced professionals who will take the unique combination of your wealth, family situation, and personal wishes into account.
Lindberg & Ripple offer customized wealth management, investment, and insurance solutions to wealthy families and successful businesses. We help our clients craft a comprehensive wealth planning model to achieve their financial goals with minimum fuss and maximum savings. To learn more, connect with us at our Connecticut or Florida offices or complete our contact form.