While there are numerous ways in which one can pass assets to family members or following generations, a generation-skipping trust allows a beneficiary—or otherwise called a trustor or grantor—the ability to pass all assets onto the next generation by "skipping" the consecutive generation tax–free. This form of trust is most often utilized for relatives who are at least 37.5 years younger than you. They often include a beneficiary such as a friend, grand–child, or niece/nephew (excluding a spouse or ex-spouse).
What is a Generation-Skipping Trust?
A generation-skipping trust is an established trust that names a beneficiary who has to be at least 37.5 years younger than the settlor. A generation-skipping trust can be established by a settlor, as part of a complete estate plan to reduce tax obligation.
A settlor, for example, might leave an inheritance to a grandchild without ever transferring ownership of the assets to the child's parents. The assets flow tax–free to the recipient upon an individual’s death from the consecutive generation.
How a Generation-Skipping Trust Works
Generation-skipping trust laws provide precise requirements for who can be designated as the "skip person," according to the United States Code. According to these laws, the skip person, or beneficiary, must be “a natural person allocated to a generation 2 or more generations below the transferor's generation assignment.”
Three Things to Consider when Creating a Generation-Skipping Trust
- First, the federal GST exemption level was raised to $11.4 million in 2019 and $11.58 million in 2020, after being adjusted for inflation. This implies that you are eligible for a lifelong generation-skipping tax exemption on property transfers up to that amount. There are twelve states who additionally have their own inheritance tax, which applies to smaller estates in some cases. When someone leaves an estate to their child, who then leaves the estate to their offspring, the estate taxes are levied twice. One of these transactions and estate tax assessments is avoided by using a generation-skipping trust.
- As long as the original assets stay in the trust for the deceased person, there is no restriction prohibiting the following generation from obtaining earnings on assets. The trust can also be set up for them to obtain a voice in future beneficiaries' rights and interests. When your children pass away, the assets will transfer to the beneficiaries.
- It is not necessary for the recipient to be blood related. A generation-skipping trust solely requires that the trust is created for a beneficiary who is at least 37 1/2 years younger than the deceased individual.
Generation-Skipping Trust and Taxes
“Congress created the generation-skipping transfer (GST) tax and connected all three taxes [estate, gift, and generation-skipping transfer taxes] into a single estate and gift tax,” according to the Tax Policy Center, with the objective of eliminating the estate tax loophole.
Accordingly, by moving assets to the trust that falls under the exemption amount, the trust can be established to take advantage of the GST tax exemption. If the assets appreciate in value, the proceeds can be distributed to the trust's beneficiaries. Furthermore, because the trust is unchangeable, your estate will be free from paying GST even if the value of the assets exceeds the exemption limit. This is also true for any asset appreciation because all profits are transferred directly to beneficiaries. This means you will not have to pay the generation-skipping transfer tax if the value of the trust's assets totals to an amount exceeding the exemption maximum.
The estate tax exemption was increased through 2026 by the Tax Cuts and Jobs Act, which was passed into law in 2017. Because of the large barrier, most people will not be subject to the generation-skipping transfer tax. However, 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.
The individual gift tax for 2019 was $11.4 million. As a result, you and your spouse will be able to exchange $11.4 million over the course of your lives. Through 2025, the yearly lifetime gift tax exemption has been raised by the Tax Cuts and Jobs Act of 2017. The gift tax increased to $11.58 million per person in 2020.
Determining Whether a Generation-Skipping Trust is Right For You
Since a generation-skipping trust is a complex legal structure, it is a good idea to think about it as soon as possible—preferably when you are starting to plan your retirement.
A generation-skipping trust is an excellent concept for capital preservation if you have a significant estate that is likely to be affected by the federal estate tax, and where, barring any catastrophic circumstances, your children will also have to pay the estate tax. It can also prove to be a sufficient resource in preserving your personal assets to those you wish to desire. Nonetheless, you must keep in mind that trusts are irreversible.
If you are in need of a highly qualified and experienced attorney for advice on how to build a trust, please contact the Law Office of Inna Fershteyn at (718) 333-2394 to have all of your authorization questions answered.