What is the Worst Tax You Can Imagine?

“I have a GST problem” may sound like a plea for medical attention, but it’s actually a rare – and severe – financial challenge known as generation-skipping transfer tax. Most people never have to worry about GST tax, but here are some signs for caution:

• You plan to make a gift, during life or through your estate plan, to a person who is more than one generation removed from you. What does that mean? Your spouse is always in the same generation as you, even if he or she is significantly younger. A child or niece is only one generation removed from you, so gifts and bequests to these people do not involve a “skip.” But transfers to grandchildren, grandnieces and grandnephews, or to “greats” may trigger GST tax. Certain exceptions may apply; for example, where you transfer funds to a grandchild whose parent has passed away. And transfers to unrelated persons may trigger tax if they are more than 37.5 years younger than you. Ask your advisers for specifics.

• Your lifetime gift to a grandchild or other “skip” person exceeds the $13,000 annual exclusion from gift taxes. Any lifetime gift under $13,000 avoids both gift tax and GST tax.

• Your total generation-skipping transfers, during life or at death, exceed $3,500,000. It’s the $3,500,000 exemption, plus the $13,000 annual tax break, that get most Americans off the hook regarding GST taxes. Married people each receive an exemption, and currently can pass $7,000,000 to grandchildren and others.

If the exclusions and exemptions don’t cover your gifts and bequests, how bad is the tax bite? The current GST tax rate is 45%, and the tax applies to direct gifts and bequests and transfers in trust. Furthermore, the tax is in addition to gift taxes or estate taxes. That all adds up to the most severe tax in America. What can people do who face GST taxes? One idea was made famous by the estate plan of Jacqueline Onassis. When Mrs. Onassis died, several newspapers and magazines made note of the fact that she left the bulk of her estate to a charitable lead trust – an unusual estate planning arrangement that could mean substantial benefit for charitable causes, tremendous savings in federal transfer taxes – including GST tax – and eventual benefit for Mrs. Onassis' grandchildren, although ultimately the trust was never funded.

Interest rates for calculating charitable deductions for lead trusts are currently at some of the most favorable levels in history. Obviously, you should seek out the counsel of your professional financial and estate planning advisers. Note: The GST tax was scheduled to be repealed for one year only in 2010, along with the federal estate tax, but Congress is almost certain to reinstate both of these taxes for 2010 and later years.

Copyright © 2009 by R&R Newkirk. All rights reserved.