Let me tell you the story of John Doe. John had been very blessed throughout his life. John had two wonderful children from a prior marriage and three wonderful grandchildren. In John's professional life, he had been extremely blessed. Through his various business dealings he had created a wealth totaling $24 million. As John became older he noticed a need to plan his estate. He told the attorney that he wanted to leave 1/3 of his wealth to his 2nd wife, 1/3 to his children, and 1/3 to his grandchildren. He said, he felt that this would be the most fair way to distribute his estate and what he wanted to leave behind as his legacy.
The unfortunate day came when John died. When it came time to settle the estate, the family was shocked to learn that there was $2,008,000 in taxes that were due to the IRS. John's family was very angry and confused.
In addition to the often misunderstood Federal Estate and Gift Tax, there is also the Generation-Skipping Transfer Tax. This is a tax that is assessed when you leave assets at death by skipping a generation (leaving assets to grandchildren for example). When John left 1/3 of his estate ($8,000,000) to his grandchildren, the assets were going to be subject to the generation-skipping transfer tax.
Under the IRS code, there is a $5.49 million exemption from the generation-skipping transfer tax. Anything over this amount passed at death is taxed at 40%. Therefore, when John gave $8 million to his grandchildren at his death, $2,510,000 ($8 million minus $5.49 million) would be taxed at 40%. In addition, John also gave $8 million to his children at death. Unfortunately for John, there is only a $5.49 million exemption from the federal estate tax. Therefore, any amount over is taxed at 40% as well. As a result, John's estate was responsible for another $1,004,000 in taxes being due to the IRS.
Finally, the $8 million that he left to his second wife, Jane, passed to her tax free. There is an unlimited marital exemption from the estate tax. Therefore, you can leave an unlimited amount to a spouse without incurring any tax.
The unfortunate aspect of this story was that all of these taxes being due were completely avoidable. Had John set up a comprehensive strategy that included an irrevocable trust for the benefit of his wife, a generation-skipping trust for the benefit of his children, and separate trust for the benefit of his children, no taxes would have been due at his death, but instead deferred until the death of his second wife. In addition, Jane would have been able to use John's exemption and turn the $5.49 million estate tax exemption into a $10.98 million estate tax exemption!
If you have a taxable estate and you are considering leaving assets to a grandchild at your death, please make sure that you speak with an experienced trusts, estates, and tax attorney to ensure that you do not make any taxable errors with your planning.
As always, if you have any questions please call us at (615) 472-2482, we are here to help!