Many people are aware of the federal gift tax and the federal estate tax (sometimes referred to as the ‘death tax’). These are the transfer taxes which are imposed on transfers during life, by gift, or at death. In 2019, a U.S. Citizen may transfer assets valued of up to $11,400,000 during their lifetime or, to the extent not used during lifetime, upon their death without paying a gift or estate tax. The third federal transfer tax, the Generation-skipping Transfer Tax (“GST”), is often overlooked but may be of significant importance. The applicable exclusion amount for GST purposes in 2019 is also $11,400,000 per U.S. Citizen. Unlike the treatment of the gift and estate exclusion, the GST exclusion is separate and distinct and may result in significant liability.
A bit of background is warranted with respect to the Generation-skipping Transfer Tax. Since the implementation of federal transfers tax there has generally been a gift tax imposed on lifetime transfers and an estate tax imposed on transfers occurring at death. To the extent each generation pays federal transfer taxes, wealthy individuals chose to “skip” generations for transfer tax purposes, and avoid the tax at each generation. Imagine a parent simply giving their assets to grandchildren and skipping their children to avoid transfer taxes at their children’s generational lever. In 1976, the Generation-skipping Transfer Tax was created and provided that transfers to beneficiaries more than a generation below the transferor would be treated to an additional tax at the highest tax rates.
Like the exclusion amount granted for gift and estate tax purposes, the GST exclusion amount is the amount you can transfer (whether outright or in trust) to a grandchild, an even younger descendant, or an unrelated individual who is 37½ years younger than the person making the transfer, without incurring a GST tax. While the GST tax is separate and distinct from the gift and estate tax, if you exhaust your GST exclusion, you will have also exhausted your gift and likely the estate tax exclusion amount. The GST tax rate above the exemption is the maximum estate tax rate – presently 40% and historically as much as 55% – and imposed in addition to gift and estate taxes.
It is critical to note, that while a spouse may transfer any unused federal estate tax exemption at their death – often referred to as “spousal portability – to their surviving U.S. citizen spouse, unused GST exemption may NOT be transferred to their surviving spouse.
What does that mean? Presently, the applicable exclusion amounts are high, and will not apply to many U.S. Citizens. However, the current exclusion amounts are set to sunset in 2026, pursuant to the Tax Cuts and Jobs Act of 2017, and may be reduced even sooner. If an individual does not take advantage of their GST tax exemption during their life or at their death, it will be lost. This could result in your grandkids paying unnecessary transfer taxes – and who wants to make Uncle Sam a beneficiary?