Planning For Generation Skipping Transfer Tax Exemption
This article addresses one of these "mysterious" areas of estate planning that is
often  referred  to  as  GST  (Generation  Skipping  Transfer).  Actually,  this  area
involves the concept of planning over several generations, and is based on the
reality  that  estate  planning  cannot  focus  on  a  single  client  or  a  single
generation.  Estate  planners  always  need to  be  aware  of  how  actions  of  prior
generations will affect the current generation, and how the actions of the current
generation  will  affect  future  generations.  The  proper  term  for  this  kind  of
planning is probably something like "multiple generation planning". However,
the  terms  generation  skipping  and  GST  are  used  quite  often  because  of  the
specific tax rules that operate to control multiple generation plans (and because
planners are always looking for shorter ways to refer to ideas).
The Federal Generation Skipping Tax
The  current  federal  Generation  Skipping  Transfer  Tax  (GST  Tax)  came  into
existence  with  the  Tax  Reform  Act  of  1986  (the  original  1976  version  was
repealed  retroactively.  Thank  goodness  it  was  an  unbelievable  mess.).
Basically,  the  federal  "death" tax imposes a  tax  on  the  transfer  of  assets  during life and at  death in excess of the "unified credit".  The credit was raised to $5.25 million under the 2012 American Taxpayer Relief Act, and is indexed to increase for inflation for every year.  The credit during 2016 is $5.45 million.  This federal tax (40%) is imposed on non-exempt gifts which taxpayers make in excess of the credit.  Similarly, the federal GST Tax is  designed  to  make  sure  that  taxpayers  do  not  avoid  the  estate  and  gift  tax
through the  use  of long-term trusts,  and to  ensure there  will  be  a tax  paid  at each generation.  The GST credit amount is the same as the unified credit, $5.45 million, and is also indexed for inflation.
The  primary  target  of  the  GST  Tax  is  the  typical  generation  skipping  trust
(sometimes called a GST Trust or Dynasty Trust), which provides distributions
for  the  benefit  of  a  child  for  life  with  the  remainder  continuing  on  for  the
grandchildren (or more remote descendants). Under the current estate tax rules,
the trust assets would  not  be taxed at the child's  death  because the child  does
not  have  sufficient  powers  over the trust to cause the assets to  be included in
the child's estate. In this context, the reference to generation skipping does not
mean that the economic benefits of the trust "skip" the children, but simply that
the estate transfer tax is  "skipped" at the  death  of the children. The GST Tax
was  established to  prevent this type  of tax  "skipping"  (at least  above  certain
limits, as described below).
In the  case  of the typical  GST  Trust, the  GST  Tax  would  be imposed  at the
death of the child, when the assets continue  for the grandchildren  (but only if
the assets of the trust are not otherwise subject to estate tax at the child's death).
The  GST  Tax  also  applies  to  direct  transfers  to  grandchildren  that  would
otherwise avoid the GST Tax because no trust is involved.
Rate and Specific Application
When the GST Tax applies, the rate of tax is a flat rate equal to the maximum
estate tax  rate  (currently  40%).  [IRC  §  2641] However,  unlike the  estate  and
gift tax, there are no lower rate brackets applicable to the GST Tax.
Specifically,  the  GST  Tax  is  applied  in  each  occurrence  of  a  Direct  Skip,
Taxable Termination, or Taxable Distribution. 
Direct  Skip:  A direct skip occurs whenever a transfer is made to a "skip person"
with no intermediate benefit to a non-skip person. A skip person is anyone
assigned to a generation  that  is  two  or  more  generations  below  the 
transferor's  assigned generation (the most common example of a skip person
is a grandchild). A trust can also be a skip person if all the beneficiaries are skip
Taxable  Termination: A taxable termination  occurs  through  a  trust  when  the
interest  of  a non-skip  person  terminates  and  there  are  no  more  non-skip 
persons  still holding  an  interest.  For  example,  upon  the  death  of  a 
child/beneficiary  if, after the child's death, the only beneficiaries are grandchildren.
Taxable Distribution: A taxable distribution occurs whenever a distribution is made
from a trust to a skip person. However, a taxable distribution does not occur if the
event can be classified as a direct skip or a taxable termination.
To  determine  if  a  person  is  or  is  not  a  skip  person  for  GST  Tax  purposes,
everyone is assigned to a specific generation on the basis of: 1) lineal descent
(if applicable); or  2) an implied  generation assignment based  on each  25-year
age group (for example, a person born more than 12 _ years but less than 37 _
years  after the transferor will  be  deemed to  be in the  generation immediately
below  the  transferor).  [IRC  §  2651]  In  the  case  of  lineal  descendants,  the
spouse  of  a  descendant  is  deemed  to  be  in  the  same  generation  as  such
descendant. [IRC § 2651(c)]
There is also the "move up rule," which provides that at the time of any transfer
to  a  skip  person, if the  parent  of the  skip  person  (who is  a  descendant  of the
donor) is not living, then the transfer will not be deemed a direct skip because
the skip person is "moved up" to the generation of his or her deceased parent.
[IRC  §  2612(c)(2)] The move-up  rule  does  not apply if the  non-skip  person is
only  deemed  to  have  predeceased  the  transferor  as  a  result  of  a  qualified
Exclusions from the GST Tax
The GST Tax does not apply to transfers made prior to September 25, 1985-so
that  an  irrevocable  trust  created  before  September  25,  1985  is  considered
"grandfathered"  for  GST  Tax  purposes  (distributions  from  the  trust  are
generally not subject to the GST Tax). In addition, the GST Tax does not apply
to any transfer under a will or revocable trust if the will or trust was executed
before October 22, 1986, and the decedent died before January 1, 1987. (This is
becoming less and less significant as the years  roll on.) However, if additions
are  made  to  a  grandfathered  trust,  the  trust  becomes  partially  taxable  in  the
future except to the extent the GST Exemption (described below) is allocated to
the additional transfer.
In addition, if a transfer is not subject to gift tax because it is within the $10,000
annual  exclusion  amount,  the  GST  Tax  will  not  apply.  [IRC  §  2611(b)(2)]
However, as a  result of the Technical Corrections and Miscellaneous Revenue
Act  of  1988  (TAMRA),  this  exception  for  nontaxable  transfers  is  limited  to
transfers that are direct skips; and for this purpose, a gift to a trust will only be a
direct skip if: 1) the trust is for only one beneficiary who is a skip person; 2) no
one other than the beneficiary can receive distributions during the beneficiary's
lifetime;  and  3)  if  the  beneficiary  dies  before  the  trust  terminates,  the  trust
estate must  be included in the  beneficiary's estate  for tax  purposes. What this
means is that transfers to trusts that qualify for the gift tax annual exclusion as a
result  of  withdrawal  rights  (sometimes  known  as Crummey  Powers)  will  not
qualify  for  the  GST  annual  exclusion  unless  the  trust  also  meets  the
requirements detailed above.
Finally,  transfers  made  directly  to  education  institutions  (for  tuition)  or
healthcare providers on behalf of a donee, which are therefore exempt from gift
tax under IRC § 2503(e), are excluded from the GST Tax. [IRC § 2611(b)(2)]
$1,000,000 GST Exemption
One  of  the  most  important  aspects  of  the  GST  Tax  is  the  $1,000,000  GST
Exemption  that  is  available  to  each  individual.  This  is  commonly  called  the
GST  Exemption.  (Note:  As  a  result  of  recent  changes  in  the  tax  laws,  this
$1,000,000 is indexed  for inflation, and is actually $1,010,000 in 1999, but is
still often referred to as the $1,000,000 GST Exemption.) Because of this GST
Exemption, each person has the ability to transfer up to $1,010,000 (determined
at  the  time  the  exemption is  allocated) in  a  manner that  would  otherwise  be
subject to the GST Tax. [IRC § 2631(a)] This amount can be used for lifetime
gifts, and any  portion  of the GST Exemption  not  used  during lifetime will  be
applied to assets passing at death.
The GST Exemption can  be allocated in any manner chosen  by the transferor
(or the decedent's personal representative). [IRC § 2632(a)] Normally, the GST
Exemption  will  not  be  allocated  without  affirmative  action  of  the  transferor.
However,  the  GST  Exemption  will  be  automatically  applied  to  direct  skips
unless the transferor elects not to use the GST Exemption. [IRC § 2632(b)]
Any  portion  of the GST Exemption  unused at  death, and  not allocated  by the
decedent's  personal  representative  (sometimes  called  the  executor),  will  be
automatically  allocated  to  direct  skips  occurring  at  death,  and  then  any
remaining GST Exemption will be allocated to trusts with respect to which the
decedent  is  the  transferor,  and  as  to  which  taxable  distributions  or  taxable
terminations may occur.
Reverse QTIP Election.  Married  couples  can  make  use  of  a  special  IRC  §
2652(a)(3) election (reverse QTIP election) that allows the full use of the GST
Exemption for both spouses, even if the unlimited marital deduction is utilized.
Normally,  assets in  a  Qualified  Terminable  Interest  Property  (QTIP) Marital
Trust are deemed to pass from the surviving spouse (and could only utilize the
GST  Exemption  of  the  surviving  spouse).  The  IRC  §  2652(a)(3)  election
reverses this presumption so that,  for GST Tax purposes only, the QTIP Trust
assets are  deemed to  pass  from the  first  spouse  (and therefore will  utilize the
first spouse's GST Exemption).
ETIP Rules.  No GST Exemption can  be allocated to a transfer to which the
transferor has retained certain rights or interests that would cause the assets to
be included in the transferor's estate for estate tax purposes under IRC §§ 2036,
2037, 2038, 2041, and 2042 (but not IRC § 2035). This is known as the Estate
Tax Inclusion Period (ETIP), which continues until the assets of the trust would
no longer be included in the transferor's estate under the above Code sections.
Allocation to Lifetime Gifts . If an allocation of GST Exemption is made on a
timely  filed  gift  tax  return  (including  extensions),  the  allocation  is  effective
from the date of the gift (even if the value has since changed). An allocation of
GST Exemption made after the due date for the gift tax return must be based on
the current value of the asset (although the value at the beginning of the month
may  be  used instead,  unless the  grantor  has  died).  The  Treasury Regulations
also confirm that if an allocation of GST Exemption is made for an irrevocable
life insurance trust, the GST Tax status of the trust continues after the grantor's
death,  even  if  the  grantor  dies  within  three  years  and  the  trust  assets  (the
insurance  policy)  are  included  in  the  Grantor's  estate  for  federal  estate  tax
Inclusion Ratios
Every  trust  has  an  inclusion  ratio  that  determines  the  portion  of  each  future
distribution or termination that will be subjected to the GST Tax. [IRC § 2642]
For example, an inclusion ratio of "zero" means that the trust is totally exempt
from  the  GST  Tax;  an  inclusion  ratio  of  "one"  means  that  all  taxable
distributions and taxable terminations will be fully subject to the GST Tax; and
an  inclusion  ratio  of  _  means  that  one-half  of  all  taxable  distributions  and
taxable terminations will result in a GST Tax.
The inclusion ratio for a trust is initially determined by calculating the portion
of the transfer that is not covered by the GST Exemption, or an exclusion, and
dividing this amount by the value of the entire transfer. For example, if a person
transfers $1,500,000 into a  generation  skipping trust and allocates  $1,000,000
of GST Exemption, the inclusion ratio would be:
                        $500,000 / $1,500,000 = 1/3
Subsequent transfers to an existing trust may affect the trust's inclusion ratio. If
sufficient GST Exemption is allocated to the subsequent transfer, the trust will
retain its zero inclusion ratio. It is advisable not to make additions to an existing
trust in amounts that exceed the available GST Exemption. However, if there is
not sufficient GST Exemption remaining, the inclusion ratio is redetermined as
First,  the  nonexempt  portion  of  the  trust  (prior  to  the  new  transfer)  is
determined  by  multiplying  the  pretransfer  value  of  the  trust  assets  by  the
existing inclusion ratio.
Second,  the  value  of  this  nonexempt  portion  is  added  to  the  portion  of  the
new transfer that is not covered by a GST Exemption or exclusion.
Third, this total of the nonexempt amount is divided by the total value of      the
trust estate immediately following the new transfer.
For example, if an existing trust with an inclusion  ratio of 2/3 has trust assets
valued  at  $750,000  (meaning that  $500,000 is  currently  not  covered  by  GST
Exemption), and if an additional  $500,000 is transferred to the trust,  but  only
$250,000 of GST Exemption is allocated to the transfer, then the new inclusion
ratio for the trust will be determined as follows:
($500,000 + $250,000) / $1,250,000 = 3/5
The  Treasury Regulations include  elaborate  rules  as to  when trusts  or  shares
will be treated as separate for purposes of the inclusion ratio. Extreme caution
is  needed  when,  following  the  Grantor's  death,  a  trust  is  to  be  divided  into
exempt  and  nonexempt trusts  for GST Tax  purposes. This is  particularly true
when the  division is  created  by  means  of  a  pecuniary  amount  passing to the
nonexempt trust with the remainder becoming the GST exempt trust. Generally,
when such a pecuniary amount is funded, it must be done within 15 months, or
carry with it appropriate interest to compensate  for the  delay in  funding.  It is
also important that a trust is  divided  before any GST Exemption is allocated.
For  example, if there is  a  $500,000 trust that  has  an inclusion  ratio  of  _, the
Regulations  do  not  allow this trust to  be  divided into  a  $250,000 trust with a
"zero" inclusion  ratio and  a  $250,000 trust with  a  "one" inclusion  ratio  (even
though  such  result  sounds  quite  logical).  According  to  the  Regulations,  a
division of this trust would result in two $250,000 trusts, each of which would
still have an inclusion ratio of _.
General Planning Strategies
If the total value of the combined estates of a husband and wife is not expected
to exceed $1,000,000, then the GST Tax will not be a direct concern. However,
if children have sizeable estates, it may be beneficial to have some or all of the
parents'  estate  put into  GST  Trusts,  or  be  given to  grandchildren  outright, to
avoid  unnecessarily  increasing  the  children's  taxable  estates.  To  the  extent
possible,  an  estate  plan  for  the  parents  should  consider  the  planning
opportunities for children that may be lost once assets are distributed outright to
the children.
If  the  total  value  of  the  combined  estates  of  a  husband  and  wife  is  over
$1,000,000, but is not expected to exceed $2,000,000, then the GST Tax can be
avoided,  but  special  planning  may  be  necessary  (using  the  reverse  QTIP
election) to ensure that both spouses can use the $1,000,000 GST Exemption.
If the total  value  of the combined estates  of a  husband and wife  substantially
exceed $2,000,000, then more sophisticated GST planning should be discussed,
including the use of the GST Exemptions during life.
To the maximum extent possible, it is important to make sure that each trust is
either fully exempt or fully nonexempt; otherwise, it will be impossible to make
the most efficient  use  of the exempt trusts.  If a trust  has an inclusion  ratio  of
something  other  than  one  or  zero,  there  is  no  efficient  method  to  make
distributions, because either: 1) a distribution is made to a skip person that will
result in the payment of some GST Tax; or 2) a distribution will be made to a
non-skip  person  that  will  result  in  wasting  a  portion  of  the  GST  Exemption
previously allocated.
Generally  speaking,  trusts  with  inclusion  ratios  of  one  should  be  used  for
Non-skip  persons  (or  be included in the  estates  of  non-skip  persons)  and trusts
with a zero inclusion ratio should be used for skip persons or accumulated for
future generations. Once the trusts have been carefully divided into exempt and
nonexempt, distributions should be made to non-skip persons out of nonexempt
trusts and distributions should be made to skip persons out of exempt trusts.
This  article  summarizes  the  basic  concepts  and  considerations  involved  in
planning  for  and  around the  GST  Tax,  but there is much more that  could  be
said.  This  is  one  area  where  the  inexperienced  and/or  untrained  professional
should  not  venture  without the  guide  of  an  expert  who  has  been there  many
times before. But, hopefully, you now have some general information that will
permit  you  to  participate  in  the  discussions  and  provide  a  roadmap  to  the
mysterious land of GST.