Tuesday, December 21, 2010

Generation Skipping Tax - Urgent

We will be posting a summary of The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (hereinafter referred to as the "Act."  However, there is one provision that requires immediate attention regarding the Generation Skipping Transfer Tax (GST).

As you know, this Act extends the Bush Tax cuts for two years (2011 and 2012).  In addition, it reinstates the Estate, Gift and Generation Skipping Taxes.

The GST has been reinstated retroactively to January 1, 2010.  However, the Act states that for 2010 the tax rate is zero.  The gift tax exemption has been increased from $1 million to $5 million effective for gifts made on or after January 1, 2011 and before January 1, 2013.

A transfer to a trust for the benefit of a grandchild is treated as a direct skip and subject to the GST.  Therefore, a very wealthy taxpayer could establish a trust for a grandchild, before January 1, 2011, that would be GST tax-free (as a result of the zero tax rate) and which will never be subject to the GST, in later years, when distributions are made to that grandchild.

Example: William Wealthy sets up a trust for the benefit of his granddaughter, Wendy, in the amount of $10 million.  This transfer will create a generation skipping transfer of $5 million ($10 million minus the $5 million exemption).  Due to the fact that 2010 generation skipping transfers are subject to a zero tax rate no tax will be paid.

However, for 2010 this will be treated as a $9 million taxable gift (assuming that the taxpayer has not previously taken advantage of the 2010 exemption of $1 million).  This will create a gift tax exposure of $3.15 million ($9 million times the 35% gift tax rate).

While many taxpayers have no tolerance for the payment of any tax, please understand that the $10 million gifted will grow estate and GST tax-free.  In addition, if the grandfather lives for 3 years the gift tax paid is out of his estate and regardless of when he dies the growth in value of the $10 million that he gifted is also removed from his estate.

Clearly this is a technique that is only available to our weathiest clients who understand the benefits to be derived and have the tolerance for the payment of the gift tax.

To take advantage of this technique time is critical.  The trust must be established and the gift into the trust must be made on or before December 31, 2010.   If you require more information or assistance in this regard please contact Neil or me.

Bob Katz