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Before the Tax Reform Act of 1976, taxpayers attempted to create trusts to successively skip the estates of children and grandchildren, thereby not subjecting the trust assets to federal estate taxes for several generations.

To prevent such skipping, a new tax was created in 1976 called the generation-skipping trust tax. In 1986 that tax was repealed retroactively and replaced by a similar tax called the generation-skipping transfer tax.

The generation-skipping transfer tax may not be imposed by (1) placing the property in a trust that is exempt from the generation-skipping tax or (2) causing the trust property to be taxed in the trust beneficiary’s estate for estate tax purposes, thereby obtaining the exemption from tax of the unified credit amount. The first solution is limited to the amount of the generation-skipping exemption for each donor (approximately $11,400,000 in 2019). The second solution is achieved by giving the beneficiary a general power of appointment over the trust property, that is, a right to give the trust property on the beneficiary’s death to anyone the beneficiary chooses.

Gifts to Generation-Skipping Trusts may be made during lifetime or at death.

Characteristics

The Generation-Skipping Trust often provides as follows:

  1. The child for whom the trust is held acts as trustee of their own trust, when they reach a designated age of maturity.
  2. The income of the trust is accumulated and added to principal.
  3. The accumulated income and the principal of the trust may be distributed to the child for whom the trust is established for that child’s health, maintenance, support, and education.
  4. The child has the right to use any residence in the trust rent-free.
  5. The child has a special power of appointment allowing them to designate the beneficiaries of the trust on their death.
  6. If the special power of appointment is not used, the remainder of the trust will be distributed to the child’s descendants, if any, and, if none, then to their parents’ other descendants.
  7. The donor/parents can choose how the income tax burden of the trust will be borne. If a “non-grant-or” form is elected, then the income earned by the trust is typically taxed to either the trust or to the beneficiary. If the “grantor” trust design is selected, then the income earned by the trust is taxed to the donor/parents on their own income tax returns, even though the income remains in the trust.

Advantages

  1. The children retain virtually full control of their trusts during their lifetimes.
  2. None of the assets of the Generation-Skipping Trust are includable in the estate of the child on their death and pass free of estate tax and generation-skipping tax to their children or designated beneficiaries.
  3. The assets of the trust are the separate property of the child and are not as readily commingled with their spouse’s assets.
  4. There is some degree of creditor protection associated with having the property in the trust rather than owned outright.
  5. If the “grantor” trust design is selected, there is a financial benefit to the trust and the donee/child without the parents incurring a gift tax.

Disadvantages

  1. The attorney’s fees for drafting the trust are more expensive than those associated with outright gifts to the child.
  2. There is the additional administrative burden of operating the trust and perhaps preparing accountings.
  3. If the non-grantor design is selected, there is an additional administrative burden of annual income tax returns for the trust and the tax brackets for trusts may result in a high income tax rate for the trust.
  4. If the grantor design is selected, the income tax paid by the parents may be at a higher rate than would have been paid by the trust or the beneficiary, depending upon circumstances. In addition, the amount of income tax payable by the parents may be larger than expected.

Cerity Partners maintains an estate planning glossary that further defines many of the terms used in this memo. If The generation-skipping transfer tax may not be imposed by (1) placing the property in a trust that is exempt from the generation-skipping tax or (2) causing the trust property to be taxed in the trust beneficiary’s estate for estate tax purposes, thereby obtaining the exemption from tax of the unified credit amount.you wish to receive a copy of the glossary, please contact your a member of your wealth management team.


Cerity Partners LLC (“Cerity Partners” is an SEC-registered investment adviser with offices in California, Colorado, Illinois, Massachusetts, Michigan, New York, Ohio and Texas. Registration of an Investment Advisor does not imply any level of skill or training. The foregoing is limited to general information about Cerity Partners’ services, which may not be suitable for everyone. You should not construe the information contained herein as personalized investment, tax, or legal advice. There is no guarantee that the views and opinions expressed in this brochure will come to pass. Before making any decision or taking any action that may affect your finances or your company’s finances, you should consult a qualified professional adviser. The information presented is subject to change without notice and is deemed reliable but is not guaranteed. For information pertaining to the registration status of Cerity Partners, please contact us or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov). For additional information about Cerity Partners, including fees and services, send for our disclosure statement as set forth on Form CRS and ADV Part 2 using the contact information herein. Please read the disclosure statement carefully before you invest or send money. 


Meet the Author

Judith Gordon

Principal

Judy is a Principal based in the Silicon Valley office. She provides consulting advice for private clients and advisors on estate planning, wealth-transfer strategies, d trust and estate administration, and charitable planning. With her extensive law background, Judy works collaboratively with clients and their tax advisors and estate planning attorneys to ensure that their strategies are consistent with their overall financial and estate plans and to manage, preserve, and grow their wealth for their family and philanthropic goals.

Prior to joining Cerity Partners, Judy worked as an Estate Planning Advisor at B|O|S and served as a member of the Financial Planning Team. In this role, Judy helped clients navigate significant life changes, minimize their tax burden, and identify goals and strategies for legacy planning. Prior to joining B|O|S, she enjoyed a 35-year legal career in sophisticated gift and  estate tax planning, charitable planning, and probate and trust administration.

Judy earned her Bachelor of Arts in Psychology from the University of Florida and her Juris Doctor degree from Georgetown University. She also received her Master of Laws from New York University.

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