Individuals hoping to leave behind a legacy of generational wealth for their families to enjoy are often frustrated by the complexities of federal wealth transfer taxes. Those who live in states, like Minnesota, that impose their own estate taxes can face an additional layer of considerations that demand careful navigation. Although many estate planners in this type of situation aim to avoid some of the potential impacts of estate taxes by taking advantage of their lifetime generation skipping transfer tax exemption to pass their assets across generations, making the most of these strategies requires detailed knowledge of tax laws and their implications. A consultation with an experienced estate planning attorney may help you to maximize the potential benefits of your generation skipping transfer tax exemption, for yourself and your loved ones. Call the Roulet Law Firm, P.A. today at (941) 909-4644 in Florida or (763) 420-5087 in Minnesota to connect with a member of our experienced and knowledgeable tax and estate planning team. Or you can fill out the contact form on this page and a member of our team will reach out to you to schedule your consultation.
Wealth Transfer Taxes & Estate Planning: Overview
One of the main purposes of estate planning, for many people, is to ensure the orderly transfer of the property they leave behind at their deaths to family members, friends, favorite charities, or other beneficiaries, as indicated in the deceased person’s estate planning documents. Although the scope of the potential beneficiaries an individual may choose to designate in a formal document such as a Last Will and Testament is quite broad, the overwhelming majority of bequests or devises (the gifts left by a decedent in his or her Will may go by a few different names, depending on the type of property transferred and the statutory language employed in the testator’s home state) are directed to family members; the most common beneficiary designations tend to be the testator’s own spouse or children.
Wealth Transfer vs. Capital Gains
In families of modest means, the property that is transferred via Will or trust upon one member’s death typically consists of the funds remaining in the decedent’s retirement or savings accounts, together with the individual’s personal belongings (often of greater sentimental than fiscal value) and perhaps some interest in real estate, likely in the form of a family home. Most of these assets will have been already subject to taxes in one form or another – savings will often have been taxed as earned income during the individual’s working years, and personal property will in many cases have been subject to sales taxes when the items were purchased (with taxed income).
Wealthier individuals, however, often hold much of their net worth in the form of stocks or investment accounts – types of assets that are typically taxed only when the owner “realizes” a gain, usually by trading or selling the asset in question. When assets of this type are transferred via a transaction such as a sale or trade, the increase in value is generally subject to a capital gains tax. When the same kinds of assets are transferred in the form of an inheritance, a new owner increases their total wealth by the assets’ current combined value, rather than by their initial cost of acquisition – even though, in the strictest sense, there is no transaction on which either decedent or beneficiary “realizes” the capital gains.
Estate Taxes and Unrealized Gains
Although they generally apply to the total of a decedent’s gross estate, or to all of the inheritance designated for a specific beneficiary, wealth transfer taxes like the federal estate tax or the inheritance taxes imposed by some states derive much of their impetus from the administrative need to account for transfers of wealth that could otherwise change hands indefinitely without ever generating tax revenue. The relatively high exemption threshold the Internal Revenue Service (IRS) describes for the federal estate tax reflects the practical reality that these taxes are intended, in part, to capture tax on types of assets that are predominantly held by high-net-worth individuals and that are not generally subject to the types of taxes (particularly earned income taxes) that tend to affect a greater proportion of lower-income individual’s total wealth.
What Is the Generation Skipping Transfer Tax?
Cornell Law School’s Legal Information Institute (LII) explains that, prior to the creation of the Generation Skipping Transfer Tax (GSTT), many high-net-worth families took advantage of a “loophole” created by estate tax thresholds and gift tax exemptions to transfer assets across generations. By transferring substantial assets as gifts during their own lifetime, or placing them in an irrevocable Generation-Skipping Trust (GST), wealthy individuals could often reduce the taxes that would be imposed on their estates.
Transferring those assets not to their children, but to their grandchildren, could prevent those assets from being subject to estate tax twice – on transfer from individual to child, and again on transfer from child (now parent) to grandchild (now child). In addition, those families who created GSTs could often set the terms of the trust so that the first generation (grandparents) and second generation (parents) would be eligible to benefit indirectly from trust income throughout their lifetimes, even though the third generation (grandchildren) might be trust’s primary beneficiaries. The GSTT was created to close the generation-skipping loophole by creating a tax that would apply on the transfer of assets (via trust or gift) that skipped a generation in this way.
What Is the GSTT Exemption?
The GSTT is assessed separately from, and in addition to, any applicable estate tax. Owing to the fact that generation-skipping transfers are themselves a strategy employed largely among high net worth families looking for ways to minimize estate tax liability, many bequests run the risk of being subject to both GSTT and estate tax. As the GSTT is generally charged at the highest federal estate tax rate, this could result in a substantial reduction in generational wealth as the assets change hands.
Annual and Lifetime Exclusions
Fortunately for high-net-worth individuals crafting their estate plans, each United States taxpayer is entitled to a substantial lifetime gift tax exemption – up to $13.61 million per donor in 2024, according to the Tax Policy Center. The lifetime gift tax exemption does also count against the estate tax exemption (that is, each individual’s total lifetime exemptions, for estate and gift taxes combined, cannot exceed the threshold amount that applies to the tax year in which the individual passes away); however, because each individual donor is also entitled to an annual gift tax exclusion, whose amounts do not count toward his or her lifetime gift tax exemption, estate planners who are concerned about the potential for a “double-jeopardy” tax scenario on the transfer of their wealth can put themselves in a position to maximize their generation-skipping transfer tax exemption by transferring assets to their children or grandchildren (or other donees) gradually, during their own lifetimes.
Generation skipping Transfer Tax Exemption Allocations
Generally speaking, a portion of an individual’s lifetime GSTT exemption equivalent to the asset value transferred will be automatically allocated to a “direct skip” transfer, unless the individual elects to opt out of the automatic allocation. A transfer is a “direct skip” if any of the following apply:
- The recipient or beneficiary is a family member more than one generation removed from the donor or decedent
- The recipient or beneficiary is at least 37.5 years younger than the donor or decedent
- The gift is made to a trust whose principal beneficiaries would all qualify as “skip persons” under one of the two preceding criteria
In most instances, the direct skip allocation of the generation-skipping transfer tax exemption works well to preserve a family’s generational wealth. However, in certain circumstances an individual may wish to elect not to use some or all of his or her lifetime GSTT exemption on a specific transfer. In that instance, the individual will wish to use IRS Form 709 or 706 (or direct the Executor of his or her estate to do so via Will). An experienced Florida or Minnesota estate planning attorney with Roulet Law Firm, P.A. may be able to assist you in determining whether accepting automatic allocation of your generation skipping transfer tax exclusion is likely to be an efficient strategy for maximizing the benefits of your GSTT exemption.
Using a Trust To Maximize GSTT Exemption Benefits
One of the most common ways to maximize generation-skipping transfer tax exemptions is by setting up a classic generation-skipping trust, establishing directives for the trustee that allow one’s children to benefit indirectly from the income generated by the trust, and setting the trust up so that its accumulated interest continues to add value to the trust as it transfers over successive generations. This strategy can be especially helpful when the trust contains assets, such as financial accounts or investment portfolios, that are susceptible to additional contributions over time, as these incremental increases enable a wealthy individual to take advantage of the annual gift exclusion without encroaching on their lifetime exemptions.
Call an Estate Planning Attorney To Learn More About the Generation Skipping Transfer Tax Exemption
Managing complex assets can be challenging. For families seeking to create, and preserve, generational wealth, effectively utilizing such tools as the generation skipping transfer tax exemption is essential to achieving individual and shared goals. Thanks to the complexities of ever-changing tax regulations and the potentially devastating impacts of double taxation on transfers to “skip” persons, many high-net-worth individuals prefer to seek the assistance of an estate planning attorney who has experience in advanced wealth transfer strategies. Florida and Minnesota residents can schedule their consultations with the knowledgeable and experienced estate planning team at Roulet Law Firm, P.A. by calling (941) 909-4644 in Florida or (763) 420-5087 in Minnesota. Or you can fill out the contact form on this page and a member of our team will reach out to you to schedule your consultation.
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