Back to the future tax: what to know about generation-skipping transfer tax.

• Author: Malekhedayat, Julie
• Position: Estate planning

While estate taxes have been a hot topic the last several years and frequently make national headlines, less attention is generally given to the similar generation-skipping transfer (GST) tax. Following are some basics to keep in mind when clients are making gifts, planning their estate or during administration of the estate of a deceased client.

Almost a parallel tax, the easily overlooked GST tax comes into play when assets are transferred during life or at death to "skip persons," typically grandchildren or trusts created for the benefit of grandchildren or future generations. GST tax rules can be complex and far-reaching, providing a powerful tool for estate planning or unpleasant surprises when ignored.

What Is the GST Tax?

Enacted in 1976, then repealed and replaced with a new version in 1986, the generation-skipping transfer tax prevents estate tax savings that could be obtained in the past by transferring assets directly to grandchildren or future generations and skipping the generation directly below the transferor, the child's generation.

Example: Sally has a $9 million estate and, at her death, leaves her entire estate to her daughter Jane. Assuming a $5 million lifetime exemption is in effect in the year of Sally's death, the excess $4 million over the exemption amount is subject to estate tax. When Jane dies several years later, having fully utilized her exemption for lifetime gifting, the S4 million taxable estate she leaves to her daughter Kim (Sally's grandchild) at her death is also subject to estate tax--thereby subjecting the $4 million to estate tax twice, once at each generation below Sally.

Assuming there were no GST tax laws in place, Sally could instead bypass estate tax at Jane's generation by leaving the $4 million taxable portion of her estate directly to her granddaughter Kim, paying the estate tax at only one transfer.

The GST tax laws prevent the estate tax savings in the example above by imposing a generation-skipping transfer tax, in addition to the regular estate tax, when Sally leaves her taxable estate directly to her granddaughter Kim. (An exception may apply when a child pre-deceases the parent, which is discussed later in this article.)

GST Tax Rate, Exemptions and Exclusion

The GST tax is imposed at a flat rate equal to the highest estate tax rate: 40 percent. There is a lifetime GST tax exemption available to each taxpayer equal to the regular estate tax exemption amount, or $5.43 million in 2015...