UNDERSTANDING GENERATION SKIPPING TRANSFER TAX
By: Lawrence M. Fuchs, Esq.
The purpose of the Generation Skipping Transfer Tax (GST) is for the government to collect a Transfer Tax at every generation. Congress decided that if a parent elected to skip a generation by leaving property to grandchildren or great-grandchildren, the government would be denied the tax revenue on the transfer to the children. Consequently, the GST imposed on the transfer to the grandchild as though it went to the child first. So, in effect, the transfer that skips a generation is taxed two times.
The GST Law is one of the most complex and confusing sections of the Internal Revenue Code.
These are the transfers that are subject to the GST:
(1) Direct Skip. A transfer to someone who is two or more generations below that of the transferor is considered a "Skip Person". A Direct Skip takes place when a grandparent makes a gift to a grandchild. The amount subject to the GST is the value of the property received by the grandchild. The grandparent who makes this transfer is liable for any GST. The grandparent's payment of the GST is also a gift which could cause additional tax. Note, however, that a transfer from the grandparent to a grandchild will NOT be a Direct Skip if at the time of the transfer, the grandchild's parent is deceased.
(2) Taxable Termination. This occurs when a trust beneficiary's interest terminates and a "Non-Skip Person" has no interest in the Trust. So, for example, if the grandparent created a Trust for the benefit of his child for life and upon the child's death, to the grandchild, a taxable termination occurs when the child dies because the child's interest in the Trust terminates and only a Skip Person (that is the grandchild) has an interest in the Trust. The amount subject to the GST is the value of the property at the time of the termination, that is the child's death, and the liability for any GST falls on the Trustee and not the grandparent.
(3) Taxable Distribution. This would be any trust distribution to a Skip Person other than a Taxable Termination or Direct Skip, discussed above. This is illustrated where the grandparent sets up a Trust and allows the Trustee to make a distribution to a variety of family members including children and/or grandchildren. If and when a distribution is made to a grandchild, the distribution is a Taxable Distribution. It is the value of the property received and, in this case, the tax liability would fall upon the Skip Person Transferee. In the event the Trustee of the Trust pays the Skip Person Transferee's tax liability, that payment is also created as a Taxable Distribution.