In many instances, money that is passed down from one generation to the next is taxed heavily by the federal government, which can feel like an unfair burden for heirs. However, there is a way around this in the world of New York estate planning because of something called the generation-skipping transfer tax.
This article will explore what the generation-skipping tax is and how it works in the estate planning process.
What Is Generation-Skipping Tax?
A generation-skipping transfer (GST) is a legal way to transfer money or property to someone who is two generations below the grantor. It can be an inheritance or a gift, and it is a way to avoid double estate taxation when the grantor passes away.
Why Congress Approved the GST Exemption
The first version of this tax law was introduced in Congress in 1976 “to remedy the perceived abuse of using a trust to benefit several generations while avoiding federal estate tax during the term of the trust.” Before this law, wealthy people could bequeath money to their grandchildren without paying federal taxes.
A revised generation-skipping transfer tax law was enacted in 1986, and now, it is established that a tax is only due when someone receives an amount in excess of the GST estate tax credit. Amounts in excess are assessed at a flat rate. Overall, the purpose of this exemption is to avoid being taxed once when money passes from grandparent to parent and then a second time later from parent to grandchild.
How the Generation-Skipping Tax Exemption Works
There are often changes to the exemption amounts, tax rate, and allocations for GSTT. Direct skips transfer directly to a skip person, such as when a grandparent writes a check to a grandchild. Direct skips can also happen upon death. There are exceptions for grandchildren whose parents have died before them, as the tax exemption does not apply to them since money is not skipping a generation.
GSTT Considerations for Estate Planning
Careful estate planning is necessary to help you make the most of your generation-skipping tax exemption and be able to pass the most amount of money possible to your heirs. However, it’s important to note that a skip person does not necessarily have to be a grandchild and that any non-spousal family member who is at least 37.5 years younger than the transfer can be the recipient.
Setting Up a Generation-Skipping Transfer Trust
One option to consider is to set up a generation-skipping transfer trust to reduce the effects of the tax with a generational transfer. You can choose to put your assets in a trust, which can serve as the “skip person.” This trust is a legally binding agreement and wealth-preservation tool that specifies assets to be passed down to your grandchildren rather than children, meaning that your children never have access to the assets.
Navigating the complexities of the GSTT is a challenge and best left to legal professionals who understand this tax law well and can make it work in your best interests.
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