Generation-Skipping

You have a living trust. Your trust avoids a probate or a conservatorship. If you are a couple, it also eliminates all capital gain on community property and can double your estate tax exemptions to $4.0 million in 2006-2008. The estate tax exemption is slated to go back down to $1,000,000 in 2011.

However, your living trust is really a plan to make your grandchildren pay unnecessary estate taxes at the death of your children. Please consider the following:

With its 50 percent top rate, the estate tax one of the most expensive taxes. However, the government imposes it on each generation. When you pass away and leave everything to your children, your estate must pay estate taxes. However, when your children pass away, the estate tax is imposed again before anything goes to your grandchildren, even though the property was already taxed when you died.

Let us assume the following: Your child has a net worth of $1,000,000. He or she inherits $500,000 outright from you, and his or her net worth increases to $1,500,000. If he or she had died without the inheritance, his or her estate would have had zero estate tax to pay on $1,000,000 because we will assume the estate tax exemption is $1,000,000 (2011 and beyond). However, the following results at the death of your child with the inheritance from you:

Outright Trust Distribution to Child
Item Amount
Child’s Own Assets $1,000,000
Inheritance from You $500,000
Total Taxable Estate of Child $1,500,000
Estate Taxes Paid by Your Grandchildren $210,000

The key reason why your grandchildren had to pay such estate taxes on your child’s death is because your child had absolute theoretical control over the $500,000 inheritance from you.

On the other hand, please consider the following:

Instead of having the $500,000 go outright to your child you would change your trust to say the $500,000 goes to a trust controlled by your child. Your child would be the trustee of the trust and so control its investments as if he or she owned it outright. Your child as trustee would decide and when and how much to distribute out of the trust to himself or herself. Your child would have the power at his or her death to decide how his or her trust would be distributed among his children, outright or still in trust.

The only powers your child would lack would be the powers to wildly speculate, waste, or give away to non-family members the assets. However, these are things you would not want your child to do anyway.

Your child’s trust would be irrevocable. Hence, it would have the added advantages of being free from his or her creditors, his or her spouse in a divorce, or anyone else trying to seize it.

Consequently when your child passes away, the following would result:

Child Holds Inheritance in Generation Skipping Trust
Item Amount
Child’s Own Assets $1,000,000
$500,000 Inheritance from You Held in Trust.  Amount Taxable by Child’s Estate Tax $0
Total Taxable Estate of Child $1,000,000
Estate Taxes Paid by Your Grandchildren $0

Therefore, through merely adding this additional provision in your living trust you will have saved your child’s children $210,000.

Notwithstanding, this trust for your child has tremendous potential for estate tax avoidance. With proper planning the wealthy could avoid estate tax for many generations. Therefore, Congress placed a limit on the use of generation-skipping trusts by imposing a generation-skipping transfer tax (“GST tax”). The GST tax is imposed on the trust when each generation dies, just as if each generation had received their inheritance outright and paid estate taxes on it. Unfortunately, the GST tax is a very expensive tax–a flat rate of 55 percent. Furthermore, the GST tax is in addition to estate taxes, which can also be as high as 55 percent.

Nevertheless, Congress has given everyone an exemption from the GST tax. ($2,000,000 in 2006-2008) Hence, a couple can presently shelter up to $4,000,000 in generation-skipping trusts free of the GST tax. If properly drafted, the generation-skipping tax exemptions can enable you to create a family “dynasty” trust to last for up to 100 years or more estate tax free! Depending on the size of your children’s estates, the generation-skipping trust can often save your descendants hundreds of thousands, and maybe millions, of dollars in estate taxes.

We typically only charge only an additional $300 to add this provision to your new living trust or to the restatement of your existing living trust we otherwise are preparing for you..

How Can I Find Out More?

To learn more about generation skipping trusts, or if you would like a free consultation to learn if a generation skipping trust should be an added provision to your living trust, please do not hesitate to contact us at (805) 482-2282, or e-mail us at   KGS@Staker.com.

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