What Is the “Generation Skipping” Tax?

Trying to figure out the best way to pass on your wealth to the next generation?  If so, you need to be familiar with the “generation skipping” tax.  This tax is assessed by the IRS on any property that is passed on to a generation that is two or more generations below you.  In other words, when you pass property on to your grandchildren, as opposed to your children, the IRS will assess a tax on that property transfer.  The tax also applies to transferring any part of your estate to someone who is unrelated to you, and who is 37 ½ years or more younger than you.

Some people feel this tax signifies the lawmaker’s belief that family wealth should only trickle down from one generation to the next.  Or, it may just be a way to prevent taxpayers from avoiding taxes by “skipping” a generation.  The generation skipping tax does close the obvious loophole in estate tax law, and ensures that taxes will be paid at each generational level.  The reality is that, many well-meaning individuals choose to assist their grandchildren in paying for expenses, such as college.  If they choose to do so, the tax rate will be 40%.  The question then becomes, is there any way to avoid the generation skipping tax?

There are exemptions

The current exemption is $5.34 million.  However, it has not always been so.  In 2009, the federal government first created this exemption for property transfers up to $3.5 million. The tax was repealed in 2010, but then reinstated in 2011 and increased to $5 million.

Can I plan for this tax?

Yes.  There are specific estate planning tools designed to eliminate estate taxes at each generational level.  A Generation Skipping Trust, also known as a “dynasty trust,” is an irrevocable trust created to deal specifically with this tax.

A Generation Skipping Trust is intended to avoid, or at least minimize, estate taxes on transfer to subsequent generations, by holding the assets in trust and distributing the funds in a pre-defined way to each successive generation.  Using this method, the entire amount of the trust will be protected from estate taxes with each passing generation.  It is important to recognize that Generation Skipping Trusts are not just for wealthy families, but can provide a huge benefit for nearly everyone.

Another option is transferring assets to your grandchildren as gifts.  This can, not only, potentially reduce the size of your estate, but also reduce the tax that must be paid upon your death. Grandparents can give their grandchildren up to $14,000 a year without having to report the gift.  The money could also be placed in a gift trust.  Although you can make an outright gift, pay health care or education expenses directly or put the money in a custodial account, putting the money into a trust has some major advantages that you should discuss with your estate planning attorney.

Generation skipping trusts can be complicated legal documents, which should be drafted by a competent, experienced Arkansas estate planning attorney.  If you have questions regarding estate taxes, trusts or any other estate planning needs, please contact Wilcox Attorneys, PA online, or by calling us at (479) 443-0062.

To learn more, please download our free Arkansas Generation Skipping Tax here.