1 the teenaged tax comes of age fran m. demaris executive vice president cannon financial institute,...

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The Teenaged Tax Comes of Age

Fran M. DeMaris

Executive Vice President

Cannon Financial Institute, Inc.

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OverviewWhy is it

important?What is the

GSTT?

EffectiveDates

GenerationAssignment

TaxableEvents

Credits,Exclusions,Exemptions

Allocation ofthe

Exemption

FamilyMembers

Non-Family

Members

Skip andNon-skipPersons

Direct SkipTaxable

DistributionTaxable

Termination

GSTTExemption

AnnualExclusion

QualifiedTransfers

InclusionRatio

SplittingTrusts

Generation SkippingTransfer TaxLearning Map

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What is GSTT?

• A Transfer Tax similar to Gift and Estate tax

• Applies when assets are transferred two or more generations below the transferor

• Not unified with Gift and Estate Tax

• Imposed at the maximum estate tax rate (45% in 2008)

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GSTT Exemption and Rates

Year Exemption GST Tax Rate

2001 $1,060,000 55%2002 $1,100,000 50%2003 $1,120,000 49%2004 $1,500,000 48%2005 $1,500,000 47%2006 $2,000,000 46%2007 $2,000,000 45%2008 $2,000,000 45%2009 $3,500,000 45%2010 N/A (Estate & GST Tax Repealed)2011+ $1,000,000 (plus indexing) 55%

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Why GSTT Is Important

• Not Widely, Well Understood

• Millions of Millionaires

• Unintentional skips• Many Existing Plans

Were Created Prior To Enactment Of GSTT

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Two Options

Parent

Child

Grandchild

Estate/Gift$ 2,000,000 41-45%

GSTT$ 2,000,000 45%

Estate/Gift$ 2,000,000

41-45%

Estate/Gift$2,000,000

41-45%

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Effective Dates - When Does GSTT Apply?

• When a generation is “skipped”• When, in a trust or similar arrangement,

interests pass down multiple generations without Estate or Gift tax vesting in each generation

• When a trust has NO GPOA to a beneficiary• All transfers after 10/22/86 and lifetime

transfers after 9/25/85 are subject to GSTT

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When Does GSTT Not Apply

• When trust contains a GPOA to each generation

• When grandfathering rules apply:– Lifetime transfers (gifts) before 9/26/85– Intervivos irrevocable trusts created before

9/26/85– Testamentary irrevocable trusts before 10/22/86– Decedents with revocable plans who have been

incompetent from 10/22/86 until death

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Generation Assignment

GenerationAssignment

FamilyMembers

Non-FamilyMembers

Skip andNon-skipPersons

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Generation Assignment Rules

• Family members assigned by relationship

• Non-family members assigned by relative age to transferor

• Determines relative generation to transferor

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Family Members

• Family Members are assigned generations based on relationship to the transferor

• Spouse is in transferor’s generation

• Adopted children fall into appropriate generation

• Family tree used is from transferor’s grandparents down

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“Family Members”

Spouse

Great-grandchild

Grandchild

Adopted Child

Great-grandchild

Grandchild

Child

Transferor

Etc.

Great- Niece/Nephew

Niece/Nephew

Brother/Sister

Parents

Etc.

Twice Removed

Once Removed

First Cousin

Uncle/Aunt

Grandparents

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Spouse

Great-grandchild

Grandchild

Adopted Child

Great-grandchild

Grandchild

Child

Transferor

Pre-deceased Ancestor Rule

• When a child predeceases the transfer, the more remote descendants all ‘step-up’ a generation

• Applies to issue only, unless transferor has no issue. Then to niece/nephew, etc.

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Pre-deceased Ancestor RuleResults of predeceased child

Spouse

Great-grandchild

Grandchild

Adopted Child

Great-grandchild

Grandchild

Transferor

Etc.

Great Niece/Nephew

Niece/Nephew

Brother/Sister

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Non-Family Members

• Age difference determines “generation” • Each generation deemed to be 25 years• Transferor deemed to be in middle of

his/her generation, thus 12½ years to end of transferor’s generation

• 12½ + 25 = 37½ years• Transfer to non-family member who is

37½ years younger than transferor is a skip

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Generation AssignmentPutting It All Together

“Skip Person”• Family member two

or more generations below transferor

• Non-family member 37½ years younger than transferor

• Trust with only skip person beneficiaries

“Non-skip Person”• Family member within

two generations of transferor

• Non-family member with age within 37½ years of transferor

• Trust with any non-skip person beneficiary

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Types Of Skips

TaxableEvents

Direct SkipTaxable

DistributionTaxable

Termination

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Types of Skips

Direct• Skip takes place

when transfer becomes irrevocable

• GSTT due at same time Gift or Estate tax applies– Direct Skip

Indirect• Skip might or will take

place in the future• Gift or Estate tax due

on initial transfer• GSTT due in future at

occurrence of a taxable event– Taxable Distribution– Taxable Termination

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Direct Skip

• A lifetime or testamentary transfer to a skip person in which only skip person(s) have an interest

• Transferor pays the tax

• Tax reporting is on Form 709 or 706

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Taxable Distribution

• Distribution of funds to a skip person from a trust that has non-skip beneficiaries also

• Recipient skip person pays the tax (may also carry out DNI)

• Tax reporting on Form 706 GS(D) filed by recipient and 706 GS(D)-1 filed by trustee

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Taxable Termination

• Termination of the interest of the last non-skip person beneficiary

• Trustee pays the tax

• Tax reporting on Form 706 GS(T) filed by trustee

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Exemption & Exclusions

Exclusions &Exemption

GSTTExemption

AnnualExclusion

QualifiedTransfers

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Exclusions and Exemption

• Annual Exclusion• Unlimited tuition & medical expense exclusion• GSTT Exemption

($2,000,000 in 2008)

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Annual Exclusion

• Similar to Gift Tax Annual Exclusion• Applies to outright direct skips and direct

skips to a special trust– Income or corpus can be distributed only to the

person benefited by the gift, and– The trust must be includible in the person’s estate

at death [IRC 2642 (c)]

• Beware the application to Crummey trusts

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Different Rules for Gift &GSTT

Gift Tax Annual Exclusion

(Present Interest)•Outright•Simple Trust•Minor’s Trust•Crummey Powers

GSTT Annual Exclusion

(Non-taxable direct skip)• Outright Direct Skip• Direct Skip to “Special

Trust”– One current beneficiary– Includible in his/her

estate

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Exclusion for Qualified Transfers

• Direct payment to the service provider of tuition and medical expenses is exempt (as for Gift Tax)

• Unlimited amount• No relationship need exist• Applies to donor or

distribution from a trust• §2611(b)(1)

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GSTT Exemption

• $2,000,000 (Indexed starting in 1999)• Changed in 2004 to new phased in UCEEA• 2008 Exemption is $2,000,000• Allocated by transferor or personal

representative on Gift or Estate tax return• Irrevocable election• Retroactive allocation allowed for

unnatural order of death• If not allocated, deemed allocation applies

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GSTT Exemption in Past Years

• 1986-1998• 1999• 2000• 2001• 2002• 2003• 2004• 2005• 2006• 2007

• $1,000,000• $1,010,000• $1,030,000• $1,060,000• $1,100,000• $1,120,000• $1,500,000• $1,500,000• $2,000,000• $2,000,000

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Allocation of the Exemption

Allocation ofthe Exemption

GSTTExemption

InclusionRatio

SplittingTrusts

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• Determines the amount (ratio) of the transfer subject to (inclusion) GSTT

• Applies at time of direct skip or for the life of the arrangement for an irrevocable trust

• Can be adjusted for later transfers

Inclusion Ratio

Funded AmountNet

AllocatedExemption1 Ratio Inclusion

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Always, Always, Always split trusts to achieve a zero inclusion ratio!!!

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Why Split Trusts?

• To achieve zero inclusion ratio accounts• Optimizes use of the generation skipping

transfer tax exemption• Fund can then be used for alternate

purposes, have different distribution terms or be distributed last to non-skip persons

• Can optimize tax allocation clauses• Provides specific fund to use for direct skips

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Split Trusts, How?

Formula in documentPower to split

In document Under state law

Qualified Severance

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Qualified Severance

• The division of a single trust and the creation of two or more trusts if:1. The single trust was divided on a

fractional basis, and2. The terms of the new trusts, in the

aggregate, provide for the same succession of interests of beneficiaries as in the original

• Trustee may elect to sever a trust at any time

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“Reverse QTIP” ElectionAn election to determine transferor

QTIP for Gift/Estate Tax • Qualifies for marital

deduction only if elected

• Treats spouse as transferor even though spouse has no GPOA

Reverse QTIP for GSTT• Does not affect estate

tax marital deduction achieved by QTIP election

• Treats decedent as transferor even though assets are included in survivor’s estate

• Enables optimum use of GSTT exemption

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Standard GST Estate Plan

Will or Revocable Living Trust

Second Marital or Survivor’s Trust

Credit Shelter Trust Zero Inclusion Ratio

Reverse QTIP Zero Inclusion Ratio

Surviving Spouse may assign GSTT exemption to his/her assets and second marital trust