The Generation-Skipping Transfer Tax is a special tax that covers direct transfers from grandparents to grandchildren. It is a flat tax currently set at 40%. The Generation-Skipping Transfer Tax also covers “skipped persons.” These are gift beneficiaries who are at least 37.5 years younger than the donor of the gift. The Generation-Skipping Transfer Tax was established to close the loophole where donors transfer money directly to grandchildren to avoid being subject to estate tax twice (once when the assets are inherited by the children of the donor, and again when those assets are inherited by the grandchildren of the donor).
Why “skip” and what is a “skipped person”?
The child generation is skipped to avoid the inheritance being subject to taxation when it passes from grandparents to their children, and then from those children to their children. Therefore, the Internal Revenue Code (IRC) has imposed an additional tax on these inheritances since 1976, which was repealed and re-enacted as a flat tax in 1986. It only applies to transfers that occur in the generation-skipping after that date. Old fixed exemptions from the Generation-Skipping Transfer Tax are excluded to offset the estate taxes that could have otherwise been avoided.
Trusts can be “skipped persons” too
The Generation-Skipping Transfer Tax can apply to direct transfers to these beneficiaries and gifts given to them through trusts. Trusts are also considered “skipped persons” in some cases: all beneficiaries of the trust are skipped persons of the donor, or no actions are taken in the income or property for anyone who is not a skipped person.
Exemption for certain grandchildren
Section 2651 (e) of the Internal Revenue Code provides an exemption for grandchildren whose parents predeceased them. In these cases, the children effectively move into their parents’ place in line so that the Generation-Skipping Transfer Tax does not apply to them – thus the gift is not skipped a generation.
Generation-Skipping Transfer Tax Exemption
This exemption is the amount that can be transferred directly to grandchildren or to a Generation-Skipping Trust for the benefit of grandchildren without paying federal Generation-Skipping Transfer Tax. The Generation-Skipping Transfer Tax shares the same lifetime exemption as federal estate and gift taxes, which is very important in the 2022 tax year.
When the Tax Cuts and Jobs Act (TCJA) took effect in 2018, this law effectively increased the exemption to approximately $11.18 million. (The limit is adjusted with inflation, reaching $12.06 million for 2022 and $12.92 million for 2023.) This allows grandparents to give substantial amounts of money and property, although it may not always be the case. The TCJA and most of its provisions expire at the end of 2025 unless Congress takes steps to renew it. The Generation-Skipping Transfer Tax rate remains at 40%.
Married couples can double these exemption amounts, leading to a significant amount of cash and property that can be transferred tax-free. The average taxpayer is unlikely to need to worry about these rules. Those who are concerned should speak to an estate planning attorney for guidance on how to prepare their estates for maximum protection.
Important
The Internal Revenue Code also provides an annual exemption, just as it does in the case of gift taxes. You can give up to $16,000 per person per year starting in 2022 without paying Generation-Skipping Transfer Tax. This amount increases to $17,000 for 2023. Married couples can double this amount as they are eligible to give up to the maximum.
How to
Reporting Generation-Skipping Transfer Taxes
All direct transfers that exceed the annual exclusion must be reported on IRS Form 709, the Gift Tax Return (and Generation-Skipping Transfer Tax). They are entered in Part 2 of Schedule A. If you also enter them in Schedule C of Form 709, they are considered direct transfers and are counted over the years to apply to the lifetime exclusion. Part 3 of Schedule A records indirect transfers.
State Generation-Skipping Transfer Taxes
Many states that collect estate taxes also impose state-level generation-skipping transfer taxes. Check with your state’s tax authority, accountant, or estate planning attorney to find out the rules in your location.
Frequently Asked Questions
If the beneficiary is not related to the person leaving the money, do they have to pay generation-skipping transfer tax?
Yes. If someone leaves money or assets to another person who is at least 37.5 years younger, the generation-skipping transfer tax will be assessed above the exclusion limit.
Can a trust in the generation-skipping transfer tax be broken?
Since a generation-skipping transfer trust is irrevocable, it typically cannot be broken or dissolved.
Who pays the generation-skipping transfer tax?
If the money and assets are in direct generation-skipping transfer tax, the person who establishes the trust (the grandparent, for example) will pay the tax and will set an item for that. If the assets are in indirect generation-skipping transfer tax, the immediate beneficiary (the parent of the skip beneficiary, for example) will not pay taxes on it, but the skip beneficiary (the grandchild, for example) will pay. These taxes can be paid from the proceeds of the estate.
Source: https://www.thebalancemoney.com/exemption-from-generation-skipping-transfer-taxes-3505526
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