A generation-skipping trust is one in which the beneficiary is a grandchild, great-niece or great-nephew, or anybody who is at least 37.5 years younger than the settlor. A generation-skipping trust is designed to avoid one round of estate tax.
When passing on assets to heirs, generation-skipping trusts provide tax benefits by allowing you to skip a generation. A settlor may, for example, give an inheritance to a grandchild without ever transferring ownership of the assets to the child’s parents. The assets flow tax-free to the beneficiary at the death of the skipped generation.
Generation-skipping trusts are not only for grandparents and grandchildren. With the exception of spouses and ex-spouses, they may be set up for a number of relationships.
What Is a Generation-Skipping Trust?
A generation-skipping trust is classified as an irrevocable trust that names a beneficiary who is at least 37.5 years younger in age than the settlor. A generation-skipping trust may be established by a settlor, also known as a trustor or grantor, as part of a thorough estate plan to reduce the tax burden.
Because a generation-skipping trust is a difficult legal structure, it is a good idea to consider it as soon as possible – ideally, when you are starting to plan your retirement.
How Does It Work?
Generation-skipping trust laws provide particular limitations for who may be designated as the “skip person,” according to the United States Code. According to these laws, the beneficiary or skip person must be a natural person assigned to a generation at least two or more generations below the transferor’s generation assignment.
Generation-skipping trusts enable the settlor to avoid estate taxes that would be imposed if the assets were transferred to the offspring or the next generation.
If you are considering establishing a generation-skipping trust, there are a few things to consider.
First, the federal GST exemption was raised to $11.4 million and $11.58 million in 2019 and 2020, respectively, after being updated for inflation. This factor implies that you are eligible for a lifelong generation-skipping tax exemption on property transfers up to that amount.
Second, as long as the original assets stay in the skip person’s trust, there is no regulation prohibiting the following generation from accessing profits on assets.
Finally, the person who receives the beneficiary does not have to be blood-related. A generation-skipping trust may be designated as the beneficiary by anybody who is at least 37 12 years younger than you.
Taxes and the Generation-Skipping Trust
Congress enacted the GST tax (generation-skipping transfer tax) and linked all three taxes (gift, estate, and generation-skipping transfer taxes) into a consolidated estate and gift tax, according to the Tax Policy Center, with the purpose of addressing the estate tax loophole.
As a consequence, distributions from generation-skipping trusts that exceed the exemption level are subject to the federal tax code’s 40% GST tax, as well as any state inheritance or estate taxes that may apply.
If the value of the trust’s assets falls below the exemption limit, however, no taxes are due. This is also accurate for any asset appreciation since all benefits flow straight to the beneficiaries. This implies you will not have to pay the generation-skipping transfer tax if the value of the trust’s assets rises over the exemption level.
The estate tax exemption was quadrupled through 2026 by the Tax Cuts and Jobs Act, which was passed into law in 2017. Because of the large barrier, most persons will not be liable to pay the generation-skipping transfer tax. Nevertheless, beneficiaries who receive assets in excess of the $11.58 million inflation-indexed exemption would be subject to a 40% top tax rate on the taxable amount.
Tax on gifts
The gift tax for 2019 was $11.4 million per person. As a result, you and your spouse would be able to give each other $11.4 million in your lifetime. The yearly lifetime gift tax exemption is doubled until 2025, according to the Tax Cuts and Jobs Act of 2017. The gift tax will rise to $11.58 million per person in 2020. To find the most tax-efficient manner to gift your belongings, consult a tax specialist.