The Door Remains Open — for Now
Take Advantage of the Repeal of the Generation-skipping TaxDec. 31, 2010 may be the last time, ever, to make large gifts to grandchildren without having the gifts carry a 55% tax burden.
No, this is not about grandparents giving birthday, holiday, or other small gifts, because gifts with a combined value of $13,000 annually generally carry no tax, even when made to grandchildren. The $13,000 exception (called the annual exclusion) makes a gift of the latest gaming device or even a car to a grandchild free from tax, unless the gaming device comes wrapped in a house or the car is a Telsa Roadster.
Before this year, big gifts or, more often, an interest in a trust that holds an appreciating asset (an interest in a business venture or the family lake house) carried the full 55% tax burden when received by a grandchild. However, the tax could be zero if the gift is made before the end of this year.
This year only, a high-value asset may be given to a grandchild or placed in a trust for grandchildren and later generations, and avoid the 55% generation-skipping tax (GST), regardless of when the asset is distributed.
Since it was enacted in 1986, the GST has been due whenever valuable assets are distributed to persons at least two generations younger than the person who made the transfer initially. But not this year. The GST is repealed, and the impact of repeal can be huge. For example, assume Grandpa funds a trust with $1 million of GrowthCo stock on Dec. 15, 2010, the trust stays in place for 20 years, and assume that in the next 20 years the GrowthCo stock increases in value to $10 million. In year 20, when the GrowthCo stock is distributed to grandchildren, the distribution may be subject to some other taxes, but no GST will be due.
If Grandpa waits until Jan. 1, 2011 to establish the same trust with the same $1 million of GrowthCo stock, when the stock is distributed in 20 years it will be subject to a 55% GST, $5.5 million in tax. The $1 million of GrowthCo stock staying in the same trust for the same 20 years, appreciated to the same $10 million of value, will yield only $4.5 million to the grandchildren, and the federal government will get the $5.5 million difference.
The same gift made before the end of 2010 would yield the full $10 million. The only difference between the two is the application of the GST to the trust established on or after Jan. 1, 2011.
The GST is a tax that sits on top of the better-known federal estate- and gift-tax structures. The estate and gift taxes are essentially taxes on the privilege of distributing accumulated wealth. Wealth distributed during life is a taxable gift unless there is an exemption. Wealth distributed at death is subject to the estate tax, again after exemptions. The rates for the estate and gift taxes are essentially the same. The GST rate is the maximum estate-tax rate applicable when the tax is due: 45% last year, zero this year, and back to 55% next year.
Most of the popular press has focused on the temporary repeal of the estate tax in the year 2010. George Steinbrenner has been called a master tax planner for having avoided the estate tax. Unfortunately, this level of planning requires that one die in 2010. The press does not often say that the gift tax remains in effect in the year 2010. Nor do they mention the $1 million lifetime exemption from the gift tax.
At its simplest, the generation-skipping tax can be understood as a tax levied on the privilege of passing assets that skip over an entire generation. It can be illustrated by a couple of examples from 2009, before the temporary repeal. If Grandpa gave his granddaughter the $2.5 million lake house in 2009, he made what the tax law calls a ‘direct skip.’ Up until the end of 2009, Grandpa’s gift would have been subject to the gift tax when made (or would use up some of his $1 million exemption), and it would also be a subject to the GST, which was at 45% in 2009. If instead, again in 2009, Grandpa put the lake house in trust for the grandchildren, the gift to the trust would have been subject to the gift tax when the gift was made, but also subject to the GST, not at funding in 2009, but when the lake house is distributed to the grandchildren out of the trust (what your tax advisors would call a taxable termination or distribution), and using the value of the asset at distribution.
If the lake house was valued at $2.5 million in 2009 on the date of the gift, the gift tax would be paid or the exemption used at that time. The trust might provide that the house would be held for grandchildren for 20 years. If the house appreciates to $10 million in those 20 years, then on distribution to grandchildren (the taxable termination or distribution), the GST will apply at the maximum estate tax rate. At next year’s rate of 55%, the $10 million distribution would carry with it a GST liability of $5.5 million.
Like the estate tax, the generation-skipping tax is repealed for the year 2010 only. The law simply says that the GST “shall not apply to generation-skipping transfers after Dec. 31, 2009.” This opens a door for a few more weeks that has been closed since 1986.
The GST repeal effectively permits large amounts of value to be placed in trust for later generations without the later application of the GST. For the first nine months of 2010, most tax practitioners believed that Congress would act to close this substantial loophole and re-impose the GST effective as of Jan. 1, 2010. Now, as the year winds down, it appears increasingly less likely that Congress will act at all, and even if it was to act, constitutional challenges might prevent a reinstitution of the GST effective Jan. 1, 2010.
Nonetheless, making a generation-skipping trust gift on the belief that Congress won’t create a retroactive application of this tax requires some nerve, but unlike George Steinbrenner, you don’t have to die to try it. This is a door open only until Dec. 31, 2010, and it is unlikely that Congress will ever leave it open again.
Timothy P. Mulhern, Esq. is a partner at Springfield-based Shatz, Schwartz and Fentin, P.C., providing tax and business legal services since 1979; (413) 737-1131; [email protected]