This is a big week. The Obama Administration released a report detailing its proposed tax law changes, many of which are slated to take effect at the end of 2012. Among those changes are alterations to the current gift and generation skipping transfer tax rates. Currently, individuals can gift approximately $5 million total in their lifetimes (or in their estates after death) without incurring a tax consequence. That same $5 million limit applies to generation-skipping transfer tax. In other words, there is no tax on generation-skipping gifts up to the $5 million level. Of course there is only one $5 million exclusion. It’s a “unified tax credit.”
An example of a generation-skipping gift is a gift from grandparents to their grandchildren (or an unrelated person who is 37 1/2 years or more younger than the gift giver), even if that gift is give via a trust that distributes the gift long after the grandparents have died.
How Generation Skipping Taxes Work
This is how generation-skipping taxes are assessed: A grandparent creates a trust, names her children as income beneficiaries, and directs that the assets should be distributed to the grandchildren after the child dies. That way, the trust corpus isn’t part of the child’s estate. This worked to avoid taxes until the generation-skipping tax (“GST”) was introduced. The GST basically said, “The IRS is going to tax all distributions from the trust, to the extent that there is no unified credit remaining for the trust creator.”
Lawyers can be pretty clever. When some states did away with the dreaded Rule Against Perpetuities and cleared the way for Dynasty Trusts (trusts that last forever in some circumstances and provide a lot of asset protection), attorneys saw an easy solution to circumventing the generation-skipping transfer tax. They simply created trusts that don’t terminate for many, many years. In Florida, for example, trusts can last up to 360 years. If such a trust is created and the original trust creator’s unified credit is applied to it, money can grow in trust and pass from generation to generation to generation without the burden of estate taxes eating into wealth.
Dynasty Trusts Help Avoid Onerous Taxes
Realizing that families have figured out how to avoid a very onerous tax burden, the Obama Administration has cleverly decided to tax Dynasty Trusts (the kinds of trusts that can last forever in some cases) every 90 years. In effect, this reverses the benefits of creating a Dynasty Trust in the first place. Fortunately, there is still time to create your Dynasty Trust in 2012 and possibly forever avoid these changes in the tax code, since the changes will only affect trusts created in 2013 and beyond.
You can learn more about estate taxes and generation-skipping taxes in IRS publication No. 950.
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