Generation Skipping Transfers

The Three Taxes on a Transfero Gift Tax

• If gift outside annual $14,000 exclusion• If gift outside one time exclusion

o Estate Tax• Excess of estate passed to heirs above

exclusions• Exclusion – Unlimited Marital Deduction• Exclusion – Charitable Deduction

o Generation Skipping Transfer• Additional flat tax on asset transfer

Why tax transfer based on where recipient is on lineage chart or age of recipient?o Moves up the taxes on some assets that transfer at a low

basiso Transfers “skipping” normal lineage against social norm

Skipped Generationo Two types of recipients – non-skip persons and skip personso With a skip person in lineage (see Exhibit 13-2 on page 541)o With a skip person defined by age

• Generation is defined as 25 years• Split for the first pass of transfers (12.5 years either way)• Next generation add 25 years• Skip is thus passing of assets to someone 37.5 years away

Who is in lineage, who is not?o See Exhibit 13-3 on Page 542

• Great Aunts and Uncles – outside lineage• Descendants of Great Aunts and Uncles – outside lineage

o Non-lineage recipients are “skip” persons based on age difference

Other Non-Skip Personso Trusts can be skipped or non-skipped depending on the

beneficiaries of the trust – one non-skipped beneficiary makes trust non-skipped trust

o Predeceased Ancestor (non-skipped person above in lineage is deceased) – Skip person moves up one generation and may become non-skipped person

When does transfer tax applyo Direct transfers to skipped person – direct skip

• Transferee is responsible for tax (40% flat rate)• Trust making transfer, then trustee is responsible for tax

o Taxable Termination• When a non-skipped person dies and the remainder goes to

the skip generation from the original transferee• Trust is typically way – trust maker sets up trust to child

and upon death of child, trust continues to pay or distributes assets to child’s children (grandchildren of trust maker)

o Taxable Distribution• Any distribution from a trust to a skipped person not part of

a taxable termination

Filing Requirementso Inter vivos gifting (while alive) – by April 15 of year

following gifto Direct Skips at Death

• Schedule R or R-1 of Estate Tax form 706• Due nine months after death

o Taxable Distributions• Filed by trustee• Due April 15 of year following distribution

o Taxable Termination• Filed by trustee• Due April 15 of year following distribution

Dynasty Trustso Trust designed to payout to future generations

beyond first in lineo Trust assets are not owned by any beneficiary

• Therefore assets do not “transfer” via estate to each succeeding generation

• No estate transfer – no estate taxo States determine when the assets must “vest” in

a beneficiary for estate purposes• Either 21 Years after death of youngest beneficiary• Or 90 years maximum

Dynasty Trusts -- continuedo Generally family trusts for direct lineage of trust

makero Typically funded with non-real estate propertyo Designates which “state” laws govern trusto Selects trustee (non beneficiary) – usually two

independent trustees• Trustee service limited (must resign at certain age)• Trust protectors named – can remove current trustees• Trustees can terminate (if appropriate), transfer assets

to new dynasty trust (if appropriate) and sell assets

Dynasty Trusts - continuedo Assets of trust are “protected” from creditors

of beneficiaries (again the trustee owns the assets not the beneficiaries)

o Divorced spouse (non beneficiary) cannot claim ownership of trust assets

o Distributed income from trust to beneficiaries is taxed at the beneficiaries income rates and paid by beneficiaries

o Non-distributed income is taxed at the trust and paid by trustee from trust assets

Dynasty Trusts - continuedo To manage long-term trusts with births and deaths

• Sub-generational trusts are made within the larger family trust

• Allows distributions to be allocated per stirpes

o Funding of Trust• Typically personal property only to avoid state

laws on removing real estate from commerce• Often life insurance policy used to fund trust as it

“grows” tax free and tax free upon distribution

Dynasty Trusts - continuedo Termination of a dynasty trust

• Trust typically designed to terminate upon the death of the last lineal descendant

• Trustee usually has power to terminate and distribute assets to beneficiaries

• With no lineal descendants final beneficiary is usually a charity (family foundation for example)

In general dynasty trust is designed to pass on assets (and income from assets) to descendants free of estate, gift, and generations skipping taxes

What are the implications for Financial Planning?o Need to understand that some gifts can incur another

level of taxation• Determined by recipients status• Is significant reduction in “estate”

o Dynasty trusts are very complicated so• Drafting of trust must be done by a qualified expert• State laws can impact the rules of the trust and the assets

placed in the trust• Trustees and Trust Protectors are important consideration

Questions?