What is the Generation-Skipping Transfer Tax (GSTT)?

You can’t just give away piles of money to the grandkids and skip out on taxes – understand the GSTT and how it works.

At Strohmeyer Law, we’re dedicated to helping our clients leave No Unfinished Business®. Let’s demystify the world of wealth transfer taxes, focusing on the Generation Skipping Transfer (GST) tax.

1. A Brief History of Wealth Transfer Taxes

Before diving into the GST tax, it’s crucial to understand its predecessors: the estate and gift taxes.

Estate Tax: Originated as a means to tax individuals who, upon their death, had vast amounts of assets. The goal was to assess what one owned at death, calculate the tax, and levy it based on the remaining amount.
Gift Tax: Noticing that individuals began gifting their possessions before death to evade the estate tax, Congress introduced the gift tax a decade later. This tax ensures that if you gift too much during your lifetime, you’re still taxed.

2. The Unified Credit Amount: Estate & Gift Tax Interlinked

Both the estate and gift taxes use a unified credit amount, which is essentially the exemption amount. In 2023, this exemption stands at $12.92 million per person. Using up this credit during your lifetime reduces what you have left for estate tax after death. For instance, gifting $1 million in 2023 reduces your exemption to $11.92 million for estate tax purposes.

3. Enter: The GST Tax

The GST tax acts as a safeguard against evasion of the estate and gift taxes. It primarily targets situations where:

An individual skips a generation in the wealth transfer, i.e., directly giving assets to their grandchildren, thereby bypassing their children and the tax that would have been levied in their generation.
The recipient is not a direct descendant, and the generational gap is calculated based on the age difference.

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4. GST Tax Mechanics

The GST tax’s primary function is to replicate the estate or gift tax that would’ve been charged if the assets had been transferred to the immediate next generation. The GST exemption, like the estate and gift tax, stands at $12.92 million per person in 2023, and it’s inflation-adjusted.

Unlike the combined exemption for the estate and gift tax, the GST exemption is more intricate. When considering gift tax, the GST tax is also taken into account. So, a taxable gift to a grandchild might require using a part of the GST exemption to avoid the GST tax on top of the gift tax.

Conclusion

In essence, the GST tax – or Generation Skipping Transfer tax – serves as a backup to both the estate and gift tax. It’s designed to replicate the tax that would’ve been imposed on your children’s generation if you’d transferred wealth directly to them rather than to your grandchildren. Proper planning and understanding are key to navigating these complex wealth transfer taxes.