The Generation Skipping Tax - A Loophole Cover of Estate and Gift Taxes
by Shane Flait ©2011 

The generation-skipping (transfer) tax (GST) taxes anything you directly leave or gift to a person two or more generations below you – typically your grandchildren. Why it’s there and its 2011, 2012 taxation rates are what this article addresses.  

Why it’s there

The government wants a share of your wealth. One way to take its share is to tax whatever wealth you transfer to another. You do this by gifting someone or by dying whereby everything you control or own – i.e. your estate - is taxed before it’s transferred to the beneficiaries of your estate. These two types of transfers are taxed as a Gift Tax (GT) and Estate Tax (ET).

When some people gifted wealth to their grandchildren – i.e. to persons two generations removed – instead of first to their own children, the government felt it was losing out on taxing that wealth at the intermediate generation – i.e. at their children’s level. That’s because it would have to wait until those grandchildren died – and not just the children to die – to collect estate tax of that wealth.  

So, the government dreamt up the generation-skipping tax to make up for the ‘estate tax’ they’d miss-out on at the intermediate generation when you directly gift your grand children. The GST attempts to make you pay the same amount of tax that you'd have owed if you had not made transfers that skip a generation.

How the ET and GT are imposed for 2011 and 2012

For the years 2011 and 2012, both the ET and GT are imposed respectively on the value of your estate when you die as well as the value of all the gifts you made during your life. Presently both those taxes exempt the first $5 million respectively of your estate’s value and the total gift amount. Any amount in excess of this exemption is taxed at a flat 35%.

Incidentally, the first $13,000 you gift to anyone annually is also exempt from gift taxes and exempt from being counted toward your total gift tax amount during your lifetime. But, of course, you must make that annual gift to take advantage of this annual gift tax exclusion; it’s not something you can accumulate in arrears. The amount in excess of your annual exclusion is accumulated throughout your life to give your total gift amount that’s subject to the GT and its $5 million exemption when you di

How the GST is imposed for 2011 and 2012

Now the GST applies to those transfers during your life or at your death by either gift or inheritance to persons two generations removed from you. This GST is imposed in addition to any gift or estate tax that may be imposed at that time. For the present it too has a $5 million exemption level with a GST rate of 35% on any amount in excess of this.  So you can see it’s going after the ‘estate tax’ of the intermediate generation that doesn’t get that wealth.

But when the GST is imposed depends on the nature of the transfer

Direct transfer: In the case of a direct transfer to a person two generations removed (i.e. that bypass the intermediate generation) the GST is taxed at the time of transfer. As an example, if your will creates a trust to receive wealth for your grandchildren at the time of your death, the GST is imposed when you die.

Indirect transfer through a trust: if you create a trust whose income is for the benefit of your children during their lifetime with the trust property passing to the next generation – your grandchildren – the GST is imposed when the children die and the trust property passes on.

Exception: In the case where the intermediate generation – your child – predeceases you, no GST is imposed since your child wouldn’t have inherited your wealth.

To be clear, the GST applies to nonrelatives too. Technically, a generation exists every 37½ years. So allocating a transfer to a nonrelative that amount younger than you is considered skipping a generation.

What happens after 2012?

As it stands now in 2011, the law causes the Transfer taxes to revert to their 2001 levels after 2012.

 

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Shane Flait is a writer and educator. Get more info at www.EasyRetirementKnowHow.com