Category: GST tax

It is important to talk to your children about your estate planning

The Generation-Skipping Tax Can Make A Big Impact

The generation-skipping tax can make a big impact on the assets you’re able to leave to heirs. The generation-skipping transfer tax, also called the generation-skipping tax, can apply when a grandparent leaves assets to a grandchild—skipping over their parents in the line of inheritance. It can also be triggered, when leaving assets to someone who’s at least 37½ years younger than you. If you are thinking about “skipping” any of your heirs when passing on assets, it is important to know what that may mean tax-wise and how to fill out the requisite form. An experienced estate planning attorney can help you and counsel you on the best way to pass along your estate to your beneficiaries.

KAKE.com’s recent article entitled “What Is the Generation-Skipping Transfer Tax?” says the tax code imposes both gift and estate taxes on transfers of assets above certain limits. For 2020, you can exclude gifts of up to $15,000 per person from the gift tax, with the limit twice as much for married couples who file a joint return. Estate tax applies to estates larger than $11,580,000 for 2020, increased to $11,700,000 in 2021.

The gift tax rate can be as high as 40%, and the estate tax is also 40% at the top end. The IRS uses the generation-skipping transfer tax to collect its portion of any wealth that is transferred across families, when not passed directly from parent to child. Assets subject to the generation-skipping tax are taxed at a flat 40% rate.

Note that the GSTT can apply to both direct transfers of assets to your beneficiaries and to assets passing through a trust. A trust can be subject to the GSTT, if all trust beneficiaries are considered to be skip persons who have a direct interest in the trust.

The generation-skipping tax is a separate tax from the estate tax, but it applies alongside it. Similar to the estate tax, this tax begins when an estate’s value exceeds the annual exemption limits. The 40% GSTT would be applied to any transfers of assets above the exempt amount, in addition to the regular 40% estate tax.

That is the way the IRS gets its money on wealth, as it moves from one person to another. If you passed your estate to your child, who then passes it to their child then no GSTT would apply. The IRS would just collect estate taxes from each successive generation. However, if you skip your child and leave assets to your grandchild, it eliminates a link from the taxation chain, and the GSTT lets the IRS replace that link.

You can use your lifetime estate and gift tax exemption limits, which can help to offset how much is owed for the generation-skipping tax. However, any unused portion of the exemption counted toward the generation-skipping tax is lost when you pass away.

If you’d like to minimize estate and gift taxes as much as possible, there are several options. Your experienced estate planning attorney might suggest giving assets to your grandchildren or another generation-skipping person annually, rather than at the end of your life. That’s because you can give up to $15,000 per person each year without incurring gift tax, or up to $30,000 per person if you’re married and file a joint return. Just keep the lifetime exemption limits in mind when planning gifts.

You could also make payments on behalf of a beneficiary to avoid tax. For instance, to help your granddaughter with college costs, any direct payments you make to the school to cover tuition would generally be tax-free. The same is true for direct payments made to healthcare providers, if you’re paying medical expenses on behalf of another.

Another option may be a generation-skipping trust that lets you transfer assets to the trust and pay estate taxes at the time of the transfer. The assets you put into the trust must stay there during the skipped generation’s lifetime. Once they die, the trust assets can be passed on tax-free to the next generation.

There’s also a dynasty trust. This trust can let you pass assets to future generations without triggering estate, gift, or generation-skipping taxes. However, they are meant to be long-term trusts. You can name your children, grandchildren, great-grandchildren and subsequent generations as beneficiaries and the transfer of assets to the trust is irrevocable. Therefore, when you place the assets in the trust, you will not be able to take them back out again. You can see why it’s so important to understand the implications, before creating this type of trust.

The generation-skipping tax can make a big impact on the assets you’re able to leave to heirs. If you’re considering using this type of trust to pass on assets or you’re interested in exploring other ways to transfer assets while minimizing taxes, speak to an experienced estate planning attorney. If you would like to learn more about GSTT and other estate tax issues, please visit our previous posts.

Reference: KAKE.com (Feb. 6, 2021) “What Is the Generation-Skipping Transfer Tax?”

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Implementing Succession Plans Before Year Ends

Anyone with a taxable estate that includes an operating business should be looking into the efficacy of making gifts in 2020 to take advantage of a unique set of circumstances, advises the article “Why Now is the Right Time to Execute Succession Plans” from Worth. This could include implementing succession plans before the year ends.

The federal exemption from transfer taxes is at a historically high level. Individuals may transfer up to $11.58 million of assets during their lifetime without incurring federal gift, estate or generation skipping transfer tax (GST). The current maximum federal gift and estate tax rate and the current maximum federal GST tax rate is now 40 percent. As the law stands now, this amount is not scheduled to be reduced until the end of 2025, but whether that will remain is anyone’s guess.

The IRS has stated that it will not attempt a claw back of taxes if the exemption amount decreases soon, so taxpayers who put off taking action before December 31, 2020 will miss out.

Lower Value Another Incentive to Develop a Succession Plan

It is important not forget the impact of the global pandemic. Valuations in some parts of public markets continue to be high, but many private companies have lost a lot of value. The lower appraised values can be beneficial for succession planning. If a business owner is willing to transfer all or a portion of the private company to successive generations now, that lowered appraisal value means that more wealth can be shifted. There is the possibility of growth in the future, free of gift, estate, or GST tax.

How Do Interest Rates Impact Succession Plans?

Many strategies used to transfer assets between generations are based on interest rates which are near the lowest they have ever been. Every month, the IRS releases the updated Section 7520 and Applicable Federal Rates (AFR). These are the rates used for transfer techniques like GRATs and intra-family loans. In October, the 7520 rate was 40 basis points (“bps”), and the Mid-Term Annual AFR, used for loans with terms of three to nine years was 39 bps.

Succession Plans Take Time to Create

This unique combination of exemptions, low business valuations and low interest rates is likely to lead many business owners to their estate planning attorney’s offices to implement succession plans before the calendar years ends. The smart move is to contact your estate planning attorney, CPA, and financial advisor as soon as possible to discuss options, and get succession plans going. There will likely be a more-than-usual last minute rush to complete many financial and legal tasks this December, and getting started as early as possible will make it more likely that your succession plan can be completed before December 31, 2020.

If you would like to learn more about gifting, and other means of reducing estate taxes, please visit our previous posts. 

Reference: Worth (Nov. 2, 2020) “Why Now is the Right Time to Execute Succession Plans”

 

 

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Federal Estate Tax Exemption is set to Sunset

In 2018, the Tax Cuts and Jobs Act (TCJA) doubled the lifetime gift, estate and generation-skipping tax exemption to $11.18 million from $5.6 million. With adjustments for inflation, that exemption in 2020 is $11.58 million, the highest it’s ever been, reports the article “Federal Estate Tax Exemption Is Set to Expire—Are You Prepared?” from Kiplinger. However, this won’t last forever. There’s a limited time to this historically high exemption. The window for planning may be closing soon. The federal estate tax exemption is set to sunset at the end of 2025, but the impact of a global pandemic and the presidential election will likely accelerate the rollback.

As of this writing, many states have already eliminated their state estate taxes, although 17 states and the District of Columbia still have them. The estate planning environment has changed greatly over the last decade. However, for families with large assets, and for those whose assets may reach Biden’s proposed and far lower estate tax exemption, the time to plan is now.

Gifting Assets Now to Reduce Estate Taxes. The IRS has stated that there will be no claw back on lifetime gifts, so any gifts made under the current exemption will not be subject to estate taxes in the future, even if the exemption is reduced.

Keep in mind that when gifting assets, to make a gift complete for estate tax purposes, you must relinquish ownership, control and use of the assets. If that is a concern, married couples can use the Spousal Lifetime Access Trust or SLAT option: an irrevocable trust created by one spouse for the benefit of the other. Just be mindful when funding irrevocable trusts of gifting any low cost-basis assets. If the trust holds assets that appreciate while in the trust for extended periods of time, beneficiaries could be hit with tax burdens.

Take Advantage of Lower Valuations and Low Interest Rates. The value of many securities and businesses have been impacted by the pandemic, which could make this a good time to consider gifting or transferring assets out of your estate. Lower valuations allow a greater portion of assets to be transferred out of the estate, thereby reducing the size of the estate tax.

With interest rates at historical lows, intra-family loans may be an effective wealth-transfer strategy, letting family members make loans to each other without triggering gift taxes. Intra-family loans use the IRS’ Applicable Federal Rate–now at a record low of between 0.14%-1.12%, depending upon the length of the loan. These loans work best when borrowed funds are invested and the rate of return earned on the invested loan proceeds exceeds the loan interest rate.

Avoid Last-Minute Rush by Starting Now. This type of estate planning takes time. The more time you have to plan with your estate planning attorney, the less likely you are to run into challenges and hurdles that can waste valuable time. When estate tax laws change, estate planning attorneys get busy. Creating a thoughtful plan now may also help prevent mistakes, including triggering the reciprocal trust doctrine or the step transaction doctrine. Planning for asset protection and distribution allows families to control how assets are distributed for many generations and to create a lasting legacy. Take the time to consider your planning before federal estate tax exemption is set to sunset.

If you would like to learn more about exemptions and gifting, please visit our previous posts.

Reference: Kiplinger (Oct. 14, 2020) “Federal Estate Tax Exemption Is Set to Expire—Are You Prepared?”

 

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Make the Most of Exemptions in Gifting

The time period available to take advantage of the high transfer tax exemption has driven many to make or give more serious thought to making large gifts, while exemptions are certain. However, not everyone is ready or able to give away large amounts of wealth, in case they may be needed in the future. For those who are concerned about needing these assets, there are some strategies that can allow you to make the most of exemptions in gifting, reports the article “Five Ways to Build Flexibility Into Your Gift Planning” from Financial Advisor Magazine.

Spousal Lifetime Access Trust, or SLAT, is one option for married couplies. This is a type of irrevocable trust that includes the grantor’s spouse as one of the beneficiaries. The couple can enjoy the gift tax exemption, because the trust is funded while one spouse is living, but they can also have access to the trust’s assets because the grantor’s spouse may receive both income and principal distributions. A few things to keep in mind when discussing this with your estate planning attorney:

  • If both spouses want to create a SLAT, be careful not to make the trusts identical to one another. If they are created at the same time, funded with the same amount of assets and contain the same terms, it is possible they will not withstand scrutiny.
  • The term “spouse” has some flexibility. The spouse could be the current spouse, the current spouse and a future spouse, or a future spouse for someone who is not yet married.

Special Power of Appointment is a power granted to a person to direct trust assets to a specified person or class of people (other than the power holder, the estate of the power holder or the creditors of either one). The power holder may direct distributions to one or more people, change the beneficiaries of the trust and/or change the terms of the trust, as long as the changes are consistent with the power of appointment. Note the following:

  • The permissible appointees of a power of appointment can be broad or narrow, and the grantor may even be a permissible appointee for outright distributions.
  • If the grantor is a permissible appointee, special care must be taken when naming the power holder(s) to avoid any challenge that the trust was always intended for the grantor. The trust may need to have multiple power holders, or a third party, to agree to any distributions.

A Trust Protector is a person who has powers over the trust but is not a trustee. This is an increasingly popular option, as the trust protector has the ability to address issues and solve problems that were not anticipated when the trust was created. The Trust Protector may often remove or replace trustees, make changes to beneficiaries, divide the trust, change administrative provisions, or change trust situs.

A Disclaimer is used when a gift recipient renounces part or all of a gift transferred to them. When a gift is made to a trust, the trust instrument is used to specify how the assets are to pass, in the event of a disclaimer. If the grantor makes a gift to the trust but is then concerned that the gift is unnecessary or the grantor might need the assets back, the trust can provide that the assets revert to the grantor in the event of the disclaimer.

Planning with Promissory Notes is another way to include flexibility in the timing, implementation and amount of gift planning. An asset is sold by the grantor to a grantor trust in exchange for a promissory note. There are no income tax consequences, as the sale is to a grantor trust. If the sale is for full market value, there is no gift. The grantor gets to decide when, and if, to make a gift with the promissory note.

Speak with your estate planning attorney to determine which, if any, of these strategies is the right fit for you and your family. While it is impossible to know exactly when and how the federal exemptions will change, there are many different tools that can be used while waiting for any changes.

If you would like to learn more about gifting, please visit our previous posts.

Reference: Financial Advisor Magazine (Sep. 10, 2020) “Five Ways to Build Flexibility Into Your Gift Planning”

 

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Take Advantage of Tax Laws Now

The pundits are saying that the if Democrats win the White House and possibly Congress, expect changes to income, gift generation skipping transfer and estate taxes. This recent article from Forbes says that you should take advantage of tax laws now.

Since 2000, the estate and gift tax exemption has taken a leap from $675,000 and a top marginal rate of 55% to an exemption of $11.58 million and a top marginal rate of 40%. However, it’s not permanent. If Congress does nothing, the tax laws go back in 2026 to a $5.6 million exemption and a top marginal rate of 55%. The expectation is that if Biden wins in November, and if Congress enacts the changes published in his tax plan, the exemption will fall to $3.5 million, and the top marginal rate will jump to 70%.

The current exemption and tax rate may be as good as it gets.

If you make a taxable gift today, you can effectively make the current tax laws permanent for you and your family. The gift will be reported in the year it is made, and the tax laws that are in effect when the gift is made will permanently applicable. Even if the tax laws change in the future, which is always a possibility, there have been proposed regulations published by the IRS that say the new tax laws will not be imposed on taxable gifts made in prior years.

Let’s say you make an outright taxable gift today of $11.58 million, or $23.16 million for a married couple. That gift amount, and any income and appreciation from the date of the gift to the date of death will not be taxed later in your estate. The higher $11.58 million exemption from the Generation Skipping Transfer Tax (GSTT) can also be applied to these gifts.

Of course, you’ll need to have enough assets to make a gift and still be financially secure. Don’t give a gift, if it means you won’t be able to support your spouse and family. To take advantage of the current tax laws now, you’ll need to make a gift that exceeds the reversionary exemption of $3.5 million. One way to do this is to have each spouse make a gift of the exemption amount to a Spousal Lifetime Access Trust (SLAT), a trust for the benefit of the other spouse for that spouse’s lifetime.

Be mindful that such a trust may draw attention from the IRS, because when two people make gifts to trusts for each other, which leaves each of them in the same economic position, the gifts are ignored and the assets in the trusts are included in their estate. The courts have ruled, however, that if the trusts are different from each other, based on the provisions in the trusts, state laws and even the timing of the creation and funding of the trusts may be acceptable.

These types of trusts need to be properly administered and aligned with the overall estate plan. Who will inherit the assets, and under what terms?

A word of caution: these are complex trusts and take time to create. Time may be running out. Take advantage of the tax laws now and speak with a skilled estate planning attorney. To learn more about the effects of tax law on estate planning, please view our previous posts here.

Reference: Forbes (July 17, 2020) “Use It Or Lose It: Locking In the $11.58 Million Unified Credit”

 

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Intentionally Defective Grantor Trusts

Using trusts as part of an estate plan creates many benefits, including minimizing estate taxes. One type of trust is known as an “intentionally defective grantor trust,” or IDGT. How does a intentionally defective grantor trust work? It’s a type of irrevocable trust used to limit tax liability when transferring wealth to heirs, as reported in the recent article “Intentionally Defective Grantor Trust (IDGT)” from Yahoo! Finance. It’s good to understand the details, so you can decide if an IDGT will help your family.

An irrevocable trust is one that can’t be changed once it’s created. Once assets are transferred into the trust, they can’t be transferred back out again, and the terms of the trust can’t be changed.  You will want to talk with your estate planning attorney in detail about the use of the IDGT, before it is created.

An IDGT allows you to permanently remove assets from your estate. The assets are then managed by a trustee, who is a fiduciary and is responsible for managing the trust for the beneficiaries. All of this is written down in the trust documents.

However, what makes an IDGT trust different, is how assets are treated for tax purposes. The IDGT lets you transfer assets outside of your estate, which lets you avoid paying estate and gift taxes on the assets.

The intentionally defective grantor trust gets its “defective” name from its structure, which is an intentional flaw designed to provide tax benefits for the trust grantor—the person who creates the trust—and their beneficiaries. The trust is defective because the grantor still pays income taxes on the income generated by the trust, even though the assets are no longer part of the estate. It seems like that would be a mistake, hence the term “defective.”

However, there’s a reason for that. The creation of an IDGT trust freezes the assets in the trust. Since it is irrevocable, the assets stay in the trust until the owner dies. During the owner’s lifetime, the assets can continue to appreciate in value and are free from any transfer taxes. The owner pays taxes on the assets while they are living, and children or grandchildren don’t get stuck with paying the taxes after the owner dies. Typically, no estate tax applies on death with an IDGT.

Whether there is a gift tax upon the owner’s death will depend upon the value of the assets in the trust and whether the owner has used up his or her lifetime generation-skipping tax exemption limit.

Your estate planning attorney can help establish an IDGT, which should be created to work with the rest of your estate plan. Be aware of any exceptions that might alter the trust’s status or result in assets being lumped in with your estate. Funding the IDGT also takes careful planning. The trust may be funded with an irrevocable gift of assets, or assets can be sold to the trust. Your attorney will be able to make recommendations, based on your specific situation.

Reference: Yahoo! Finance (June 3, 2020) “Intentionally Defective Grantor Trust (IDGT)”

 

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What Does Recent Legislation Mean for the Generation-Skipping Transfer Tax (GSTT) Exemption?

Congress has made some significant changes through the planned sunset of the Tax Cuts and Jobs Act (TCJA) increased exemptions and through the recent changes to retirement planning in the Secure Act.

Think Advisor’s recent article entitled, “Estate Planning Tips and Updates,” looks at some of the most notable of these.

  1. Increased Estate Tax Exemption Amounts. The current applicable exemption amount of $11.58 million each (or $23.16 million for a married couple) lets many people totally avoid transfer taxes. However, the applicable exclusion amount reverts to its prior inflation adjusted amount in 2026. Therefore, if you have a gross estate of $11 million and previously made, say, $7 million of gifts, the rules eliminate any claw back of those gifts, if death occurs in 2026. However, you have no applicable exclusion amount remaining, says the IRS. As a result, after the sunset, you have a gross estate of $4 million and no remaining exemption. With this example, you’d be wise to consider implementing one or more strategies, including gifts and sales to grantor trusts, before the end of 2025 to be certain you fully use the disappearing exemption.
  2. The Increased Generation-Skipping Transfer Tax (GSTT) Exemption. The TCJA also upped the GSTT exemption to $11.58 million each. This allows many people to exempt transfers for several generations, if not in perpetuity, under the laws of certain states. However, they must intentionally draft trusts to establish legal situs in states like Nevada to leverage longer perpetuities periods. This will result in avoiding additional estate, gift and GSTT taxes for longer periods, normally a net positive.
  3. Annual Exclusion Gifts. Regardless of the increased exemption amounts, continued annual exclusion gifts (currently $15,000) are still going to be a crucial component of most estate tax reduction planning, removing the amount of the gift and its future appreciation. The tax-exclusive nature of the gift tax makes gifts more tax-efficient.
  4. Basis Harvesting. The increased exemption amounts often will result in some people with previous trust planning no longer having estate tax issues. These people could look at reforming, amending, or decanting an existing trust to add older generations in a manner to cause inclusion in their estates. This inclusion triggers the basis step-up rules in the code and may dramatically reduce taxes upon a liquidity event, like the sale of a business interest previously gifted or sold over to the trust.
  5. Secure Act Age Changes. For those born after July 1, 1949, the Act raises the beginning age for minimum distributions (RMDs) to 72.
  6. Employer Inducements. The Act increases the current $500 credit for setting up a retirement plan to $5,000 in some situations and provides a $500 credit for three years to encourage the use of auto-enrollment.
  7. Inherited IRAs. The Act substantially restricts the use of “stretch” IRAs. For deaths after December 31, 2019, a recipient of an IRA from the deceased must generally take distributions from the IRA over no more than a 10-year period. However, the new rules exempt accounts inherited by a spouse, a minor child, a disabled or chronically ill person, or anyone less than 10 years younger than the deceased account owner.
  8. Annuities. The “stretch” IRA provisions also apply to annuities with one important exception. Annuities making payments before January 1, 2020, may still pay out over two lives. The new law encourages greater investment in annuities through 401(k) plans, and especially plans offered by smaller businesses, by decreasing the risk associated with offering annuities. As a result, employers offering annuities as investments won’t have fiduciary duties as to those potential annuity investments, assuming they choose an issuer in good standing with the applicable state insurance commission. The Secure Act also offers portability for annuities, if you change jobs. This is a direct transfer between retirement plans.

Reference: Think Advisor (March 25, 2020) “Estate Planning Tips and Updates

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C19 UPDATE: IRS Postpones Gift and GST Tax Filing Deadline to July 15

The IRS has expanded the list of deadline extensions for federal taxes and tax returns to include gift and generation-skipping transfer (GST) tax returns. An earlier notice had applied only to federal income tax returns and payments (including self-employment tax payments) due April 15, 2020, for 2019 tax years, and to estimated income tax payments due April 15, 2020, for 2020 tax years.

Notice 2020-20 updates earlier guidance to include the gift and GST deadline extensions.

What Are Gift and GST Taxes?

Gift Taxes. The Internal Revenue Code imposes a gift tax on property or cash you give to any one person, but only if the value of the gift exceeds a certain threshold called the annual gift tax exclusion, currently $15,000 per person. You can give away the amount of the exclusion each year without incurring a tax. The giver is responsible for paying this tax, not the recipient.

GST Taxes. The generation-skipping transfer (GST) tax can be incurred when grandparents directly transfer money or property to their grandchildren without first leaving it to their parents. These types of transfers share the same lifetime exemption as the federal estate and gift taxes, and are also subject to an annual exclusion limit of $15,000 per person.

Resource: Financial Planning, IRS postpones deadline for gift and GST taxes due to coronavirus, https://www.financial-planning.com/news/irs-offers-relief-on-gift-and-generation-skipping-transfer-taxes-due-to-coronavirus

 

Information in our blogs is very general in nature and should not be acted upon without first consulting with an attorney. Please feel free to contact The Wiewel Law Firm to schedule a complimentary consultation.
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