What Is The Generation Skipping Transfer Tax and How Does it Affect my Estate In Tennessee?

The Generation Skipping Transfer Tax is a federal tax that is imposed on those estates that leave a gift directly to their grandchildren, i.e., skip the next generation. For example, John died leaving behind 2 children and 3 grandchildren. At John’s death, he leaves a $1 million gift directly to each grandchild. This is an example of generation skipping and an estate gift that would be subject to the generation skipping transfer tax. 

However, what does the generation skipping transfer tax mean for most estates in Tennessee? Well, honestly, it doesn’t mean much for most Tennessee families. Specifically, the Generation Skipping Transfer Tax is only going to apply, just like the Federal Estate Tax, in about 1% of estates. The Generation Skipping Transfer Tax only applies to transfers that skip a generation in excess of $5.43 million. However, if you do make a gift to a grandchild that skips a generation in excess of $5.43 million, then that gift in excess of $5.43 million will be subject to the GST tax, which also has a top rate of 40%. 

Now, let’s assume that you do have a very large estate that will be subject to both the federal estate tax and the generation skipping transfer tax. Is there anything that you can do to prevent and/or minimize these potential tax obligations for your family at your death? 

One estate planning and tax planning technique is called a Dynasty Trust or a Generation Skipping Transfer Tax Trust. This type of trust is potentially infinite in duration, meaning, that this type of trust could last to serve your great-grandchildren or even your great-great grandchildren. The primary benefit of this type of trust is that this type of trust is designed so that the grantor/settlor of the trust would be the only one to be subject to estate tax and/or generation skipping transfer tax. 

For example, let’s say John and Jane have $25 million in gross assets that they will be passing to their loved ones at their death. Specifically, when John dies, he will be leaving all of his assets, through his trust, to Jane, in the amount of $25 million. Now, when Jane dies, she plans on leaving the first $10 million to her two children in equal shares, but plans on leaving the remain $15 million to her grandchildren in equal shares. However, John and Jane had a QTIP trust and engaged in proper estate and tax planning. Therefore, only $14.5 million of the estate was subject to the federal estate tax at Jane’s death. (John and Jane used the QTIP trust in order to maximize their federal estate tax exemption to $10.5 million exemption). 

However, when Jane died, although only $14.5 million was subject to the federal estate tax, Jane’s grandchildren also had to pay tax on the $15 million gift from Jane. Under the Generation Skipping Transfer Tax, gifts in excess of $5.43 million are taxed at the top rate of 40%. Therefore, Jane’s family would be subject to the both the federal estate tax and the generation skipping transfer tax. In addition, each succeeding generation that passes those assets at death would be subject to the federal estate tax and generation skipping transfer tax for the succeeding generation. 

However, John and Jane could establish the Dynasty Trust described above, and if they did, only the grantor would be subject to the estate tax and generation skipping transfer tax. In this example, only John and Jane would be subject to the estate tax. However, each succeeding generation would avoid the continuing estate tax and generation skipping transfer tax liabilities as those assets were later transferred to the grandchildren, great-grandchildren, great-great grandchildren, etc. 

Although, it needs to be emphasized that Dynasty Trusts are a very complex and specific area of estate planning and should only be considered following detailed and continued discussions with a knowledgeable and experienced estate planning attorney.