The Generation-Skipping Transfer (GST) tax, in conjunction with the Gift and Estate Tax, is an additional tax imposed on transfers occurring at death or during life. GST applies to a transfer of wealth to recipients that are more than one generation younger (called “skip persons”) than the transferor. A generation can be defined as linear (grandparent to grandchild) or non-linear (age gap greater than 37.5 years). Transfers of property to skip persons that exceed two generations (ex: great-grandchildren) are only taxed once under the GST rules. GST tax was originally created to attempt to avoid affluent families from transferring large amounts of wealth via trusts to benefit multiple generations without paying a transfer tax.
Under current law, the GST tax has the same exemption amount as Estate and Gift Taxes ($12,060,000 for 2022), the same annual gift tax exclusion ($16,000 for 2022), and the same 40% tax rate (maximum Estate tax rate for 2022). Also, any gifts made on behalf of a skip person that is for tuition to qualified educational organizations or for qualified medical expenses are exempt from GST tax (assuming paid directly to the educational institution or medical facility). While there are similarities, there are also differences. For example, portability, which is the ability to transfer unused exemption at death to a spouse, does not apply to GST. In addition, some Crummey trusts are not eligible for the annual exclusion for GST purposes. Finally, and possibly most importantly, there is a concept of allocation of GST exemption. The allocation rules apply to gifts or bequests that are considered indirect skips and can be automatic unless a specific election is made.
GST can be considered direct (outright to skip persons) or indirect (through a trust). An example of a direct gift would be grandma giving her grandson $500,000. In 2022, $16,000 of the direct gift would be considered an annual exclusion gift (for GST purposes, similar to regular gift tax rules). The difference of $484,000 would reduce the $12,060,000 GST exemption available (similar to the gift tax rules). For an indirect skip, things become a bit more complicated due to the complex rules of the GST allocation. To keep the example simple, let’s say grandma gives the same $500,000 to her grandson, but this time via a trust. The trust may or may not meet the requirements for the annual exclusion amount of $16,000 and therefore, the full amount of $500,000 could potentially reduce the $12,060,000 GST exemption available.
GST tax concepts and the application of the rules are complex, but if used properly can provide substantial tax savings on the transfer of wealth to future generations. Conversely, if not applied properly, the allocation rules could result in possible adverse tax results upon transfer. Careful planning and discussions with your tax advisor are highly recommended.