The Generation Skipping Transfer Tax Exempt Trust (GST Trust) is an estate planning tool that can be utilized to help reduce the Federal Estate and State Inheritance Taxes that may be paid as assets are passed to surviving family members. A GST Trust can be created under your last will and testament or created as a separate document during your lifetime.
Each individual is given a Generation Skipping Transfer Tax Exemption to be used either during his or her lifetime or at the time of death for assets transferred for gifts to individuals who are more than one generation removed from the person making the gift. The exemption is $1,500,000 as of Jan. 1, 2004. Any amount transferred that is in excess of the exemption will have a Generation Skipping Transfer Tax assessed at a rate as high as 48 percent.
It may be advisable to "skip" a generation by gifting or through will transfers in order to avoid potential double taxation for Pennsylvania Inheritance Tax and Federal Estate Tax purposes. For example, if an individual passes away with $2,000,000 in his estate and has named his daughter as the sole beneficiary, the PA Inheritance Tax will apply on the entire estate and Federal Estate Tax will apply on the assets in excess of $1,500,000. When the daughter passes away at some date in the future and the assets are transferred to her children there is a high likelihood that the same assets that were taxed in her father's estate will again be taxed in her estate. This continuous taxation in successive generations can be crippling to a family's inter-generational wealth transfer.
One strategy for reducing this double taxation is the GST Trust.
Traditionally, the GST Trust has been created under an individual's last will and testament and only becomes an active trust at the time on the date of death. However, individuals are increasingly using their GST exemption and creating GST Trusts during their lifetimes. This allows the trust creator to transfer a portion of his wealth prior to passing away. These lifetime GST Trusts provide the additional benefits of removing the growth of the assets out of the estate of the creator and creditor protection during his or her lifetime.
It is possible to allow for the testator's/creator's children to have use of the assets in the GST Trust during their lifetimes. This is done by applying the GST exemption to a Beneficiary Controlled Trust (BCT Trust).
The BCT Trust will allow the testator's/creator's children to be trustees over the trust and make use of all of the assets within the trust. Provided that the assets remain in the BCT Trust, they will not be taxed in the children's estate and with proper planning can avoid taxation in multiple generations.
The BCT Trust is also great for the children of the grantor because it provides them with increased creditor protection. This allows them to feel more secure that the assets will be safe from divorce, law suits and other individuals or entities attacking the assets.
The GST Trust or direct gifts to grandchildren are often used where the estate of the grandparent is going to be subject to a large tax burden. However, it is also prudent to "Skip" a generation where a parent knows that his or children will have a large estate of their own and therefore the inheritance would only serve to further increase the tax burden in the children's estate.
As you can see, the combination of Pennsylvania Inheritance Taxes, Federal Estate Tax and Creditors can be crippling to the growth of family wealth. Under the right circumstances, the use of the GST Trust will create extreme savings in the transfer tax and creditor protection arena by allowing assets to avoid taxes and creditors. As always, be sure to consult your advisors to determine the best plan for you and your family.
David M. Frees, III and Douglas L. Kaune are local attorneys focusing their practice on estate planning and administration and can be contacted at 610-933-8069.