Generation Skipping Tax

Consider this scenario: you make provisions for your children in the event of your death by leaving your estate to them. If you have the good fortune to live until your 90s, and your children are in their 70s, it might not be too long until your children are deceased and your assets pass on to your grandchildren. When this occurs, your estate is taxed twice; once upon transfer to your children, and once again when it passes to your grandchildren. To prevent this double-taxation, some families choose to leave estates directly to the grandchildren. However, the Internal Revenue Service isn't going to let it go without getting their cut of your cash; hence the Generation Skipping Transfer Tax.

What is subject to the Generation Skipping Transfer Tax?
As the Generation Skipping Transfer Tax currently stands, any estate valued at over $2 million is subject to GST at 45 percent, representing the highest possible estate tax rate, when it passes to second-generation or younger recipients. If you leave your estate to your grandchildren or even your great-grandkids, it is subject to the Generation Skipping Tax. When the recipient of the assets is not a direct descendent, the Generation Skipping Tax applies if he or she is more than 37.5 years younger than the donor. However, if the estate is valued at less than $2 million, it is not subject to the Generation Skipping Transfer Tax.

The Generation Skipping Transfer Tax is currently scheduled to phase out on the same timeline as the estate tax, being completely eliminated in 2010. As of 2010, there is no $2 million exemption to the Generation Skipping Tax; it simply doesn't apply at all. However, the law repealing these taxes expires in 2011, so unless Congress extends the exemption, the Generation Skipping Tax rate returns to its pre-2001 levels. The Generation Skipping Transfer Tax is currently scheduled to return to a $1 million exemption in 2011, and a taxable rate of 55 percent.

Who pays the Generation Skipping Transfer Tax?
There are three types of skips under the Generation Skipping Transfer Tax: direct skip, taxable distribution and taxable termination. With a direct skip, where the estate is left directly to the grandchildren or other younger recipients, the donor or the donor's estate via the executor pays the Generation Skipping Transfer Tax. Taxable distribution applies if a donor establishes a trust, which is then subject to Generation Skipping Transfer Taxes paid by the recipient of trust distributions. This only applies if a trustee receives distributions; if the trust just sits there and doesn't pay out to the recipient, taxable distribution does not apply. Taxable termination applies when a trust is terminated and pays out the remainder of its funds. Under taxable termination, the trustee is responsible for paying the Generation Skipping Transfer Tax.