The one-year “repeal” of the estate tax continues to surprise us. One element of this change in the tax law for 2010 is the full repeal of the Generation Skipping Transfer tax (the “GST tax”). And, with 3/4ths of the year gone, it is becoming less likely that Congress will do anything on a retroactive basis to apply the GST tax to transfers that occur in 2010. Estate planning attorneys and other advisors are, therefore, recommending that their clients take advantage of this limited window of GST opportunity.
Unless the law on the books is changed, the GST tax will essentially apply to any large gift made to the donor’s grandchildren or their heirs in 2011 or thereafter. This tax is in addition to any applicable gift or estate tax. Therefore, large gifts to grandchildren (or trusts for their benefit) are often too costly to consider when the GST tax applies.
However, in 2010, direct gifts can be made to grandchildren free of any GST tax. It is important to remember that the transfer would still be subject to the gift tax, but that rate is currently 35% and is scheduled to jump as high as 55% in 2011. Once the gifted asset is in the hands of the grandchild, the asset itself (and any appreciation on that asset) would be outside of the donor’s taxable estate and would avoid inclusion in the taxable estate of the donor’s child (parent of the grandchild).
Our clients often ask if these gifts can be made into trusts for the benefit of grandchildren in 2010. Based on our technical interpretation of the applicable rules and regulations, we believe the answer is no. There is a tremendous amount of uncertainty surrounding this question, but, without more clarity from Congress or the IRS, we feel that there is a substantial risk that the GST tax would apply at some later date to the trust assets. That being said, we are often able to provide our clients with trust-like protections for “direct” gifts to grandchildren which will never be subject to the GST tax.
There is also a significant planning opportunity for trusts already in existence. Trusts often have an ability to make distributions to many generations of family members. If the trust is a “non-exempt” Trust, it will incur a GST tax when the Trustee makes a distribution to anyone other than the oldest generation of beneficiaries. Further, the GST tax will ultimately be imposed on the Trust itself when certain generational interests expire in favor of beneficiaries in lower generations. But, for the remainder of 2010, distributions from otherwise non-exempt trusts can be made to the younger beneficiaries and entirely avoid the GST tax. Large distributions and even full trust liquidations should be carefully considered for “non-exempt” Trusts this year.
To be clear, a retroactive application of the GST tax by Congress would nullify the advantage of many of the strategies discussed in this analysis. But the closer we get to 2011, the more confident we become in these strategies.