Estate planning requires more than simply writing a will. For many people, estate planning is about building a long-lasting legacy. However, estate taxes can strip away much of your hard-earned wealth before your heirs ever get it. In the past, people tried to ease their loved ones’ tax obligation by intentionally “skipping” a generation. While this strategy still has benefits, it has important estate planning and tax implications, too.
The Generation-Skipping Transfer (GST) Tax
People sometimes try to reduce their family’s tax obligation by taking certain steps intended to circumvent federally imposed estate taxes. A historically popular strategy for this has been the generation-skipping tax (GST).
In a GST, a grandparent will transfer assets directly to their grandchildren—effectively “skipping” their children.
Ideally, this prevents estate taxes from being levied twice: first, when assets move from a grandparent to their child, and then again when assets move from the child to grandchild.
But, between the 1970s and 1980s, the Internal Revenue Service began closing loop-holes in the federal tax code. Now, federal statutes ensure that generation-skipping transfers are taxed, too.
Using a Trust as an Alternative
A generation-skipping trust can provide an ideal solution to federally imposed taxes. And, while California does not have a state-imposed estate tax, you may need a trust if you hold assets in any states that do.
A generation-skipping trust lets you transfer assets—such as a home, business, or stocks—into the control of an irrevocable trust. Once the trust has these assets, they will no longer be considered part of your taxable estate.
Such trusts allow you to name anyone at least 37.5 years younger than you as a beneficiary, including your grandchildren and other family members.
However, your own children can benefit from the trust, too. If the trust is generating returns or income, your children may be named as beneficiaries. Once they pass away, the trust will exist for the exclusive benefit of your grandchildren or other named heirs.
While generation-skipping trusts are still subject to federal tax, the fact that their benefits are only fully disbursed to your “generation-skipped” beneficiaries means that taxes are only levied once.
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