For families with a high net worth, inheritance and estate planning can be complex.
Fortunately, with the assistance of a knowledgeable estate planning attorney, there are a number of ways for these families to provide a financial legacy for descendants in a tax-advantageous way.
One such estate planning tool is a generation-skipping trust (GST). When properly configured, a GST can distribute wealth to more than one generation and avoid the lion’s share of, or in some cases all, of the tax liability that would otherwise exist.
Although there is no inheritance tax or estate tax in the State of Florida, it is important to note that the estate of a deceased person could still owe federal inheritance taxes if the value of the estate exceeds the lifetime limit set by the IRS. The current federal limit is $12.06 million as of 2022. A GST is one way to avoid a large portion of that tax liability.
What is a Trust?
Before delving into the details of what a GST is, it is worth looking at what a trust is in the most general sense.
Trusts are legal entities that allow assets to be distributed to beneficiaries, usually after the death or incapacitation of the person setting up the trust. The person setting up the trust is called the grantor. In many cases, trusts are set up with the beneficiaries being in the next generation after the grantor (usually the grantor’s children, nieces or nephews).
What is a Generation-Skipping Trust?
GSTs are legally binding trust agreements with an important difference. Instead of assets being passed down to the next generation as would be the case with a normal trust, the assets in a GST are passed down to the grantor’s grandchildren, effectively “skipping” the generation directly after the grantor.
When correctly set up and maintained, a generation-skipping trust can be a very powerful tool for reducing inheritance tax and gift tax liability and thus they help preserve wealth for future generations.
The language of the law allows for anyone at least 37½ years younger to be beneficiaries, bypassing the next generation of most grantors. In skipping the children of the grantor, a GST avoids the estate taxes that would otherwise be due to the next generation.
Although grandchildren are the most common beneficiaries, the recipient of the assets in a GST doesn’t have to be a direct descendant. In fact, the beneficiary can be anybody who is at least 37½ years younger than the grantor and not a spouse or ex-spouse. Typical cases also include grandnieces and nephews. However, beneficiaries can also be younger people who are not directly related in any way to the grantor in any way, if the grantor so wishes.
When correctly set up and maintained, a generation-skipping trust can be a very powerful tool for reducing inheritance tax
Generation-skipping trusts are designed to transfer wealth to at least the second generation after the grantor, but can still provide some financial benefits to the next generation (ie: the grantor’s children). This is the case because the grantor can give his or her children access to rents, interest, dividends and other income generated by the trust’s assets while still leaving the assets themselves in trust for grandchildren.
Tax Treatment of GSTs
Despite the tax advantages to generation-skipping trusts, the instrument is still subject to a transfer tax. The rate of this tax has varied from year to year, reaching as high as 55% in 2001 and as low as 0% in the period following 2010.
Since then, the American Taxpayer Relief Act of 2012 created a permanent GST tax exemption of $5 million tax. Grantors thus transferring less than $5 million to their second-generation pay no tax on the amount passed on. In 2018, the Tax Cuts and Jobs Act (TCJA) increased this estate tax exemption from $5 to $11.2 million for single grantors ($22.4 million for married couples). A key provision in the Act is that the exemption amounts are indexed for inflation. With current inflation at 7%, the actual exemption for 2022 is $12.06 million.
However, this exemption is temporary, only set to be effective through 2025 unless extended by Congress. Still, those passing on more than $12.06 million create double tax liability, with amounts after the exemption being subject to both a 40% inheritance tax and a 40% generation-skipping transfer tax.
South Florida Law
Are you considering setting up a generation-skipping trust to pass on your legacy in a tax-advantaged manner? If so, South Florida Law has the expertise and experience to:
- Ensure that your future generations (or other beneficiaries) receive the assets and income from the GST in the manner that you intend.
- Create and maintain a GST, navigating the complexities that include reporting requirements and other and other regulatory compliance activities.
- Work with your CPA and other professionals to manage and administrate the GST to prevent tax-related losses.
South Florida Law, PLLC is a law firm with estate planning professionals licensed to practice law in the State of Florida. Are you a Florida resident considering setting up a generation-skipping trust? If so, contact South Florida Law today using our contact form or by phone (954) 900-8885.