What is the generation skipping tax (GST)?
The generation skipping tax (GST), created in 1986 by the IRS Tax Reform Act, taxes gifts and inheritances that are given to skipped generations in the same way that gifts and inheritances are taxed that are given to the immediate heirs. The reason that the IRS felt compelled to add this tax requirement is to reduce people’s ability to form dynastic trusts with gifts being given to unborn great-great grandchildren.
The rule in general states that any gift given to a skip person must have not only the standard gift or inheritance tax (depending on when the gift was given), but also an additional tax that is set to the highest inheritance bracket at the time of the gift. This causes most givers to pay equivalent to the gift or often more than the gift itself in taxes.
Who Are Skippers?
According to the IRS Rules, any relative that is more than one generation away from the giver is considered a skip person. This includes grandchildren, great grandchildren and great nieces and nephews. However, if the person you are gifting is an orphan, then they move up one space and are no longer considered a skip person. So, leaving an entire estate to a granddaughter whose parents are deceased will not incur a GST tax. These same rules also apply for relatives by marriage.
Unrelated people also fall under the GST tax rules. If the unrelated person is more than 37 years younger than the giver, then this person is considered a skip person and the GST tax may apply. GST tax does not apply to charities, no matter how young the charity is.
Are There Exceptions?
There are two exceptions to the GST tax rule. One exception is gifts given to minors within a "Crummey" trust. The other exception is gifts given for the medical care or education of another. A "Crummey" trust can be drafted by an attorney with the proper restrictions and instructions included. Crummey trusts are unlimited, so you can make one for every grandchild and great grandchild if you so desire. When giving gifts for the purpose of medical care or education, the funds may be paid directly to the specific institution. So, you can pay for your grandson’s college education or even your great grandson’s private preschool and there are no required GST taxes.
GST Tax and Gifts
Gifts are defined by the IRS as large amounts of money given while still alive. Both gifts and generation skipping gifts have an annual exclusion amount which is a set amount that you can give out each year without paying any taxes. For example, the annual exclusion amount for gifts and GST is $15,000 per recipient in 2018 and 2019 ($14,000 in 2017) . Additionally, married couples can engage in the practice of “joint giving” and give a tax-free amount of $30,000 to an unlimited number of recipients. If you exceed those thresholds, you would wind up owing a tax of up to 40% (the GST top tax rate is the same as the gift tax rate).
GST Tax and Inheritances
GST inheritances also incur taxes, but have greater leeway in amount. The 2017 Tax Cuts and Jobs Act doubled the total estate and GST lifetime exemption amount (indexed for inflation) to $11.2 million for individuals and $22.4 million for a married couple in 2018. The corresponding inflation-adjusted 2019 figures are $11.4 million for individuals and $22.8 million for a married couple. (In 2026, under the 2017 Tax Act, these exemption amounts will return to the 2017 figures of $5.49 million for an individual and $10.9 million for married couples.) This means that so long as your estate before 2025 year end is below the basic exclusion amount in the year of death -- which figure is adjusted annually for inflation -- and you have not previously given away and gifts, then you are clear to give away your estate without any tax consequences. Above this amount, all funds are taxed using both estate taxes and GST taxes.