1. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company1 What is GSTT? Generation Skipping Transfer Tax applies to transfers of property during life or at death to persons determined to be two or more generations below the transferor known as “skip persons,” generally including: –Family members: Grandchildren, great-grandchildren, grand nieces or nephews (and spouses of such family members) –Non-family members: Persons 37.5 years younger than transferor

2. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company2 Tax Implications Each person has a GST tax exemption The GST exemption is: –$2,000,000 (2006 - 2008) –$3,500,000 (2009) –$5,000,000 (2010 2012) –$1,120,000 (plus indexing for inflation after 2003)

3. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company3 The GST tax is calculated by multiplying the GST tax rate by the amount of the GST transfer and the inclusion ratio (based on allocation of GST exemption) The GST tax rate is equal to the highest estate tax rate for the year the transfer is complete: –46% (2006) –45% (2007-2009) –0% (2010) –35% (2011-2012) –55% (2013) Tax Implications (cont’d)

4. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company4 The annual exclusion amount of $13,000 (in 2009 and 2011) applies to present interest gifts to skip parties Both the medical and tuition exemptions are available for transfers made on behalf of skip parties Tax Implications (cont’d)

5. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company5 Client stands to inherit a substantial estate from a parent and already has a substantial estate of his own Parents wish to minimize transfer taxes in a child’s estate but still give the child the use and benefit of the property Parents wish to protect property from a spendthrift child or from being subject to loss through a child’s divorce or bankruptcy Client wishes to make a direct transfer to a grandchild or other skip person for their support or enjoyment When Is The Use Of A Generation Skipping Trust Appropriate?

6. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company6 Trigger: Any gift, establishment of a trust, or transfer of property at death, that will or may benefit a skip person What Are The Requirements For A GST?

7. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company7 A GST trust may be established during life or by a will provision at death There are two trusts established by the will or trust instrument: –GST exempt trust GST exemption is allocated to these assets, so they pass tax-free –GST nonexempt trust How Is It Done?

8. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company8 Related persons are assigned to a generation in reference to the ancestral chain Spouses of the transferor or a decedent are always assigned to the same generation as the transferor or descendant Generation Assignment

9. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company9 Unrelated persons are assigned as follows: –< 12.5 years younger  the same generation as the transferor –12.5 years < unrelated person < 37.5 years  first younger generation –37.5 years < unrelated person < 62.5 years  second younger generation (skip person) –Generation assignments continue in 25 year increments Predeceased parent rule: If an individual’s parent who is a lineal descendent of the transferor is deceased at the time of a transfer from which the individual’s interest is derived, the individual and all succeeding generations move up one generation –Applies to collateral relatives (e.g., nephews and nieces) if transferor had no living descendants at the time of the transfer Generation Assignment

10. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company10 If transferee is an entity (estate, trust, partnership, corporation), individuals who own beneficial interests in the entity are assigned generations Generation Assignment (cont’d)

11. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company11 Skip person = person assigned two or more generations below the transferor A trust may be a skip person if all the beneficiaries holding interests are skip persons Skip Persons

12. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company12 Taxable distribution Taxable termination Direct skip Types of GSTs

13. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company13 Any distribution of income or corpus from a trust to a skip person that is not otherwise subject to gift or estate tax Transferee is obligated to file Form 706GS(D) and pay the tax –Note: If the trust pays the tax for the transferee, the payment will be treated as an additional taxable distribution Taxable Distribution

14. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company14 Taxable amount is what the distributee received, reduced by: –Any expenses incurred by distributee in connection with the determination, collection, or refund of GST tax, and –Any consideration he paid for the distribution Taxable Distribution (cont’d)

15. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company15 Taxable distributions are “tax inclusive” meaning the amount subject to tax includes: –The property, and –The GST tax itself Example: A trustee makes a taxable distribution of $10,000 of trust income to a grandchild in 2009 (assuming a tax inclusion ratio of one), the tax would be $4,500 if paid by the grandchild. Grandchild will net $5,500. Taxable Distribution (cont’d)

16. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company16 A taxable termination occurs by death, lapse of time, release of a power, or otherwise and results in skip persons holding all the interests in the trust The trustee is responsible for filing Form 706GS(T) and paying the tax Taxable amount is the value of all property involved less: –Deduction for any expenses, debts, and taxes (other than GST tax) generated by the property, and –Any consideration paid by the transferee Taxable Termination

17. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company17 Taxable terminations are also “tax inclusive” –Property subject to transfer includes generation skipping tax Example: Grantor placed $1 million into an irrevocable trust for the benefit of her daughter for life, with remainder to her grandson. At the daughter’s death in 2011, a taxable termination occurs. Assuming no exemptions were claimed and the trust has an inclusion ration of one, the tax is: 35% x ($1,000,000 x 1) = $350,000 The $350,000 must be paid out of the property passing to the grandson, so the grandson nets $650,000 Taxable Termination (cont’d)

18. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company18 Transfer subject to an estate or gift tax made to a skip person –Gift from individual to his granddaughter –Gift from individual to a trust where all beneficiaries are skip persons The transferor (donor or decedent) is responsible for the payment of GST tax Taxable amount equals the amount received by transferee, reduced by consideration paid by transferee Direct Skips

19. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company19 Tax on a direct skip is “tax exclusive” meaning tax paid by the transferor or the estate does not include the amount of GST tax Example: A grandfather makes a lifetime gift of $1 million to his grand- daughter in 2011. Assuming an inclusion ration of 1 and no exemptions are available, the grandfather must pay GST tax of: 35% x ($1,000,000 x 1) = $350,000 The tax is paid not out of the gift, but out of additional assets of the grandfather. Granddaughter’s net gift received is the full $1,000,000. Direct Skips (cont’d)

20. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company20 Year 2006 2007 2008 2009 2010 2011 2012 2013 Exemption $2,000,000 $3,500,000 $5,000,000 $1,120,000 Rate 46% 45% 0% 35% 55% Exemptions and Tax Rates

21. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company21 Gifts subject to GST tax which are split by the spouses will be treated as having been made half by each spouse, and each spouse can use some or all of their exemption to avoid the GST tax Gifts of direct payment for donee’s educational or medical expenses are exempt Exemptions and Exclusions

22. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company22 Transfers that pass under annual exclusion (special trust rules) Transfers already subjected to GST tax in which the transferee was in the same or lower generation as the present transferee Unless governing document directs otherwise, GST tax is charged to the property constituting the transfer Exemptions and Exclusions (cont’d)

23. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company23 Step 1ListValue of property transferred$_____ Step 2ListExemption allocated to transfer$_____ Step 3ListState & fed tax paid on transfer$_____ Step 4ListGift or estate tax charitable deductions allowed on transfer$_____ Step 5AddSteps 3 & 4$_____ Step 6 SubtractStep 5 from Step 1$_____ Step 7 DivideStep 2 by Step 6 This is the “applicable fraction” _____ Step 8 SubtractStep 7 from (1) This is the “inclusion ratio” _____ Step 9 MultiplyStep 8 by GST tax rate This is the “applicable rate” _____ Step 10 MultiplyStep 1 by Step 9$_____ Calculating GST Tax: A Simplified Worksheet

24. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company24 Transferor conveyed property worth $500,000 to a GST trust in 2009 and allocated $300,000 of exemption to it. In 2011, when the property was worth $700,000, transferor transferred additional $100,000 in cash to trust and allocated $100,000 of exemption. Calculate the inclusion ratio: 1 - $100,000 + (.600 x $700,000) $100,000 + $700,000 1 - $520,000 =.350 $800,000 Note: The.600 represents the non-tax portion of the trust before the second transfer $300,000 / $500,000 Inclusion Ratio Example =

25. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company25 Type of Who’s Responsible GST Transferfor Payment Taxable DistributionTransferee Taxable TerminationTrustee Direct SkipTransferor Liability For Payment of GST Tax

26. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company26 There are special provisions for the following as they relate to GST transfers: –QTIP property –Taxation of multiple skips –Basis adjustments –Disclaimers –Administration –Return Requirements Trusts can have multiple generation skips IRC Section 303 IRC Section 6166 Special Provisions

27. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company27 GST tax may be imposed in addition to any estate or gift tax due because of the transfer In some cases the total cost of making a property transfer can exceed the value of the gift Trust distributions will be subjected to the tax regardless of whether they are made from income or corpus Planning For GST Tax

28. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company28 Once assets are protected by the exemption, future appreciation is also exempt from GST GST may be allocated by the donor or his executor among any property that is transferred Election is irrevocable GST exemption will be automatically allocated to direct skips during life, unless the donor elects otherwise Allocation of GST Exemption

29. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company29 If total value of the QTIP trust may exceed available GST exemption: Will or trust should provide for division of single QTIP trust into two trusts, exempt and non-exempt, to take advantage of the reverse election “All or nothing election” that must apply to all qualifying property in the trust (exempt trust) QTIP election qualifies the transfer property for the marital deduction in the transferor’s estate, while the reverse QTIP treats the property as part of the transferor’s estate for GST purposes Reverse QTIP Election

30. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company30 Grantor retained income, annuity, and unitrusts where the remainder interests pass to skip persons Transfer may be complete for gift tax purposes, but includable in the transferor’s taxable estate, so that allocation of the GST exemption will be postponed during this “estate tax inclusion period” (ETIP) GRIT’s, GRAT’s & GRUT’s

31. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company31 GST rules postpone allocation of exemption during the ETIP period until: –There is an actual GST transfer, –Transferor dies, or –Property would no longer be included in the transferor’s taxable estate GRIT’s, GRAT’s & GRUT’s (cont’d)

32. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company32 Dynasty Trust to avoid estate and generation skipping taxation on transfers to succeeding generations of skip persons (subject to any applicable rule against perpetuities) Advantage of a Dynasty Trust: $2,000,000 placed into a trust today Growing at annual rate of 4% Over a period of 75 years Will increase to over $37,000,000 Combined with the leverage of a survivorship life insurance policy this tool is even more powerful Multi-Generational Planning

33. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company33 Inclusion ratio for nontaxable gifts is zero Gifts that are not taxable by reason of the gift tax annual exclusion are also exempt from GST including gifts under IRC Sections –2503(b) –2503(c) –2503(e) Exclusion For Nontaxable Gifts

34. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company34 Inclusion ratio for nontaxable gifts to trust are not zero unless: –No portion of the trust could be distributed to a person other than a single beneficiary, and –If that beneficiary dies before the trust terminates, trust assets will be included in beneficiary’s estate Exclusion For Nontaxable Gifts (cont’d)

35. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company35 Compare GST tax cost on direct skip vs. Estate and gift tax cost on transfers to children, who then transfer to grandchildren (Assume a 2009 45% transfer rate) –Gift tax is exclusive of the gift, so a 45% gift tax rate = a tax inclusive rate of 31.034% [45% / (1 + 45%)] –Estate tax is included in the tax base, so the estate tax inclusive rate is 45% –GST tax on taxable distributions and taxable terminations is imposed on the transferee and is tax inclusive at a rate of 45% To Skip Or Not To Skip?

36. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company36 Compare GST tax cost on direct skip vs. estate and gift tax cost on transfers to children, who then transfer to grandchildren (Assume a 2009 45% transfer rate) –GST on direct skips is tax exclusive, resulting in a tax inclusive rate of 31.034% Note: GST on lifetime gifts also considered a taxable gift, so gift tax will be paid on the GST tax. Similarly, a direct skip at death will result in GST tax being paid from assets subject to estate tax. Note: If a lifetime direct skip transfer is made, both gift and GST tax paid will reduce the donor’s taxable estate To Skip Or Not To Skip? (cont’d)

37. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company37 Generally, GST tax applies to transfers made after October 22,1986 Irrevocable trusts grandfathered for GST purposes on September 25, 1985, may become “tainted” by actual or constructive additions –Constructive addition consists of exercise, release, or lapse of a general power of appointment over a portion of the grandfathered trust Other Planning Considerations

38. Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company38 Gift splitting by husbands and wives may not be necessary Transfers from wealthier spouse to less wealthy spouse may not be necessary so that both may utilize their full exemptions Issues In Community Property States