Webinar Transcript (9/19/2024): "Generation-Skipping Transfer Tax Tricks and Traps”
Host: Jonathan I. Shenkman, President & Chief Investment Officer of ParkBridge Wealth Management (Contact: jonathan@parkbridgewealth.com)
Speaker: Bruce D. Steiner, Esq., Of Counsel, Kleinberg Kaplan, Wolff & Cohen, P.C. (Contact: bsteiner@kkwc.com)
Jonathan Shenkman: Good morning and welcome to the Park Bridge Wealth Management Fall Webinar Series. This program is entitled "Generation Skipping Transfer Tax Tricks and Traps." As always, my name is Jonathan Shenkman. I'm the President and Chief Investment Officer of Park Bridge Wealth Management. In that role I serve in a fiduciary capacity to help my clients achieve their financial objectives.
Jonathan Shenkman: The goal of my program is to help bring professionals together to help them better serve their clients. This is done by educating attendees on the latest topics in wealth planning and by encouraging collaboration between a client's attorney, CPA, and financial advisor where appropriate. My practice focuses on working with high net worth families, businesses, and not-for-profits. I manage individual investment portfolios, trust accounts, corporate retirement plans and endowments to help my clients achieve their financial goals.
Jonathan Shenkman: In addition to the 20 or so events I run every year, I also do a fair amount of writing on the topics of investing and financial planning, and you can read my work in a variety of periodicals including Barron's, CNBC, Forbes, Kiplinger, the Wall Street Journal and Trusts and Estates Magazine to name just a few. You can see all my work on my website at Parkbridgewealth.com/articles, or by following me on social media at Jonathan on Money.
Jonathan Shenkman: Additionally, you can check out my weekly podcast which is also called Jonathan on Money, and you can listen to that on Apple, Spotify or wherever you get your podcasts.
Jonathan Shenkman: Today we're privileged to hear from Bruce Steiner, who's of counsel at Kleinberg Kaplan, based in New York. Bruce has over 40 years of experience in the areas of taxation, estate planning, business succession planning and estate and trust administration. He's a frequent lecturer at continuing education programs for bar associations, CPAs and other professionals.
Jonathan Shenkman: He's co-author of CCH's Roth IRA Answer Book. Bruce has become a regular on my webinars, and his partnership and insights are always appreciated. Today Bruce will be speaking about generation skipping transfer tax tricks and traps. And with that introduction I'll now turn the program over to Bruce.
Bruce Steiner: Thank you, Jonathan, and thank you for having me back. It's always a pleasure to be on your program. We're going to talk about the generation skipping transfer tax.
Bruce Steiner: Which is incredibly complicated. You could even write a book about it. Someone already has.
Bruce Steiner: We're going to try to just touch on the high points to give people a general understanding of it without getting too deep into the weeds, because you can always go research things that come up as they do.
Bruce Steiner: So we've always had an estate tax for a long time. We had an estate tax and we had a gift tax.
Bruce Steiner: But it had a huge loophole. Professor George Cooper wrote an article in the Columbia Law Review on it.
Bruce Steiner: Basically he pointed out that the very, very wealthiest families would leave money in trust. The trust would go for the children, and then, after the children were not around, it went on for the grandchildren, and it went on for the great grandchildren. It could go on for as long as the perpetuities period. A trust could last for about 90 or so years at that time. Nowadays, in about half the states it can run for much longer, or even for an unlimited period of time.
Bruce Steiner: So when the original transferor made a gift or died, there was an estate tax or there was a gift tax, but as the money wended its way down the generations there were no further transfer taxes, and Congress said, "Hey, wait a minute. You know this is a big loophole." These mega wealthy families avoided the transfer taxes at each generation that the people with less sophisticated advice had to pay every generation. You left money to your kids.
Bruce Steiner: And not only did you pay estate tax when they died, they paid estate tax, and then they left it to the grandchildren, and when the grandchildren died they paid estate tax, and so on. So in 1976 Congress enacted a generation skipping transfer tax. The drafting wasn't very good. In 1986 they repealed that retroactively, and they enacted the current version of the generation skipping transfer tax.
Bruce Steiner: Which is still approximately what it was when it was first enacted with a few little tweaks.
Bruce Steiner: And it's been almost 40 years since then. So we're going to start to see the tax apply. We're going to see people who died after 1986, who left money in trust for their kids, and then their kids are going to start to die. And 40 years is even more than an average generation.
Bruce Steiner: And we'll start seeing people have to deal with this tax that so many people ignored or pretended, or didn't want to learn about because it was too complicated. Well, now we have to learn about it. We have to know a little bit about how it works. We can go look up the details as we need to, but we need to in general understand how it works.
Bruce Steiner: There are 3 things that are subject to the GST tax.
Bruce Steiner: The first is called a direct skip. I give or leave money to, or in trust for, my grandchild. That's a direct skip. I skipped over my child, and I left the money to my grandchild, or in trust for my grandchild, and that is taxable.
Bruce Steiner: The next thing that's taxable is a taxable distribution. I create a trust for my child, and my child's issue. Issue means descendants.
Bruce Steiner: And the trustee distributes money to a grandchild. Maybe the grandchild needs money to go to school or buy a car or start a business - whatever. That's called a taxable distribution. The money went to somebody below the child level, somebody 2 generations down.
Bruce Steiner: The 3rd thing that's taxable is what's called a taxable termination. I give or leave money in trust for my child.
Bruce Steiner: Child dies. And now the trust assets pass to, or more often in further trust for the child's issue. Generally the grandchildren.
Bruce Steiner: That's called a taxable termination, because the child's interest ended and the money went to or in trust for the grandchildren.
Bruce Steiner: Each of those things triggers a generation skipping transfer tax.
Bruce Steiner: The tax rate is equal to the highest estate tax rate. For a long time it was 55%. Now it's 40%.
Bruce Steiner: There is no state GST tax. So if you live in a state that has a state estate tax, such as New York or Connecticut, or Massachusetts or whatnot - there's about a third of them that do.
Bruce Steiner: You're paying an estate tax of around 50% at the top rate.
Bruce Steiner: Whereas a GST tax is only 40%, so it's cheaper to pay GST tax than to pay estate tax. It's also cheaper for a few other reasons as well.
Bruce Steiner: Everyone has a GST exemption, and it's equal to the estate and gift tax exclusion amount, which is presently $13,610,000.
Bruce Steiner: So for most people, estate and gift and GST taxes are pretty irrelevant. There's only a small number of people who pay these taxes or have to think about them, but those are the clients we spend the most time thinking about and working on their matters.
Bruce Steiner: Remember that the exemption is scheduled to revert to half of its current level in 2026. That would be about 6.8 million dollars. It's either 6.8 or 6,810,000. I don't remember how the rounding convention works.
Bruce Steiner: No one knows what Congress is going to do between now and then. We don't know who's going to control the Senate. We don't know who's going to control the House. We don't know who's going to be President, and until a couple of months ago I used to say to people, "We don't even know who the nominees are going to be." And I was right. We didn't know who the nominees were going to be. Now we know.
Bruce Steiner: So what you may want to do in the same way that you may want to use your estate and gift tax exclusion amount before it possibly drops, you may want to use your GST exemption now, in case it reverts, as is scheduled.
Bruce Steiner: A big difference between the estate tax and the GST tax: We all know about portability for the estate tax. I die. I leave my estate to my spouse. She inherits my estate tax exclusion amount, and now has 13,610,000 plus her own, either 13 plus million or her own, about 7 million, depending on what Congress does.
Bruce Steiner: There is no portability for the GST exemption. If I don't use it, if I leave my estate to my spouse, she inherits my estate tax exclusion amount, but does not inherit my GST exemption. So for people who need or want to have 2 GST exemptions, they need to arrange for the first spouse to use it by giving or leaving assets either to a grandchild, or more likely in trust in some way.
Bruce Steiner: And, unlike the gift tax exclusion amount which gets allocated to the first gifts that you make - in other words, I can't say I'm giving away 13 million dollars today paying, and I want to pay the tax on it and save my exclusion for next year's gift - the GST exemption allocation is optional. I can apply it to a transfer today, or I can not apply it and save it for a transfer tomorrow. We'll get into how you decide that in a little bit. In fact, now.
Bruce Steiner: So you have to think about whether you want the trust to be exempt. If I'm giving money in trust, and I expect it will be used for the child, I don't want that one to be exempt. I want to save my exemption for the next thing that I do, but if I expect it to be accumulated for later use for the grandchildren or younger, then I want to allocate exemption to it, because once I allocate exemption to it, I give away a million dollars, and I allocate a million dollars of exemption. If that trust grows to 100 million, it's all exempt.
Bruce Steiner: So do I expect that gift to grow in value? What is the thing I'm giving away? Of course, if I really knew which was going to grow in value and which wasn't, I'd sell all the ones that aren't going to grow, and I'd buy more of the ones that are going to grow. Maybe, Jonathan, you can help me figure out which are which. So I'd only have ones that are going to go up.
Bruce Steiner: But sometimes with a gift, you know, you're giving away something that you really can think has more potential than that.
Bruce Steiner: So some examples of how it works. I give away $100,000 to a trust for my child and my child's issue.
Bruce Steiner: I file a timely gift tax return, and I allocate $100,000 of GST exemption to the trust.
Bruce Steiner: And ignoring any subsequent contributions, that trust is forever exempt. The distributions out of the trust are forever exempt.
Bruce Steiner: Now let's say I didn't allocate to that gift.
Bruce Steiner: And next year, when the value is $200,000, I can still make it exempt. But I have to allocate 200,000 of exemption to exempt the trust.
Bruce Steiner: Or I can elect that no exemption be allocated. I can elect non-allocation, and we'll get into why it is I want to elect one way or the other way right now.
Bruce Steiner: So there are default allocation rules. In some cases the exemption is automatically allocated, unless you elect not to have allocation. In other cases exemption is not allocated unless you elect to allocate, and you can elect for just one year, or you can make an election that's good for both the current year and all future years, until you change your election.
Bruce Steiner: And those rules are in section 2632.
Bruce Steiner: What I urge everyone to do when you're making a gift in trust: on your gift tax return, elect allocation or elect non-allocation, because those default rules are very complicated, and you can easily slip up.
Bruce Steiner: A couple of examples. One is, there's no default allocation if there's a hanging Crummey power in excess of the annual exclusion. For example, I give $20,000 to a trust for my child, and the child has an $18,000 withdrawal power to qualify for the gift tax annual exclusion.
Bruce Steiner: And then, if the child doesn't exercise the power which Crummey powers are rarely exercised, $18,000 lapses, $2,000 carries over to the next year.
Bruce Steiner: You have no default allocation. We really have to be careful with insurance trusts. You could have a default allocation in some years, and not in other years. And you really don't want an insurance trust that is partially exempt and partially non-exempt, because you have so many gifts to the trust, because every year you're paying a premium, and if you get 2 policies that have different premium dates, you may have more than one premium payment every year, and you have to recalculate the exempt portion of the trust every time you pay a premium on one of those policies. It is a nightmare. Make your insurance trust exempt or not exempt, completely one or the other.
Bruce Steiner: Be further careful. There were no default allocations before 2001. So if anyone has an insurance trust that predates 2001, I urge you to examine it now. It's going to be a lot of work to fix it, but it will be several times a lot of work to go fix it later, or to go figure out what you have when the person dies, and there are probably more old insurance trusts than new insurance trusts, because years ago, when the estate tax exemption was $675,000 in 2001, just about every upper middle class client was rich enough to pay estate tax and poor enough to need life insurance, and they all ended up with an insurance trust. They came in for a will. They knew about credit shelter trusts. And then you ended up doing also an insurance trust. So if some of those are still around, take a look at them now. It's going to be a lot of work, but it's going to be more work later.
Bruce Steiner: The annual exclusion. We all know about the gift tax annual exclusion. Presently $18,000. There used to be an annual exclusion for Crummey powers, also for GST purposes until the end of March of 1988.
Bruce Steiner: And now under the Technical Corrections Act of 1988, there are no more annual exclusions for Crummey powers for the GST tax.
Bruce Steiner: With one little exception, a 1 beneficiary trust that's included in the beneficiary's estate. So we often sometimes create trusts for grandchildren that are included in the grandchild's estate, and therefore we get the annual exclusion for GST as well as for gift tax.
Bruce Steiner: And sometimes we don't want it included in the beneficiary's estate, and we're willing to use some GST exemption on the trust, even though it's covered by the Crummey power for gift tax.
Bruce Steiner: You want to track the allocation of the GST exemption to trusts, even if there's no taxable gift.
Bruce Steiner: And even if there's an automatic allocation of GST exemption. And even if it's within the gift tax annual exclusion. I think it's helpful to file gift tax returns to track the allocation, because when somebody dies and you've got existing trusts and you're trying to figure out whether they're GST exempt or whether they're not, or whether they're partially exempt and how much exemption you've used, it's a whole lot easier if there's a paper trail of gift tax returns.
Bruce Steiner: You may not allocate GST exemption during what's called an estate tax inclusion period, an ETIP. That's the period of time when the trust would be in your estate if you died. And that's QUERTs, your qualified personal residence trust, and it's your GRATs. Nowadays, I think there are more GRATs than QUERTs. But pre-mid 1990s, it was the other way around. There were more QUERTs floating around.
Bruce Steiner: You may allocate GST exemption or have a default allocation when that ETIP ends, when the QUERT retained term ends, when the GRAT annuity term ends, and just be careful. There's likely to be a default allocation at that point, and you may want allocation. You may want non-allocation.
Bruce Steiner: So check and see what the default rule is, and if the default is allocation, or if you elect allocation, show the allocation on the return for that year, because otherwise somebody's got to go back and figure it out. You have a QUERT that ended in this default allocation and person dies 20 years later, and then you have to go get an appraisal of what that property was worth 20 years ago, when the retained term of the QUERT ended.
Bruce Steiner: Insurance trusts are incredibly complicated. There's often a default allocation beginning in 2001 unless you've got hanging Crummey powers that are in excess of the annual exclusion, and there was no default allocation before 2001. You may want to - you probably want to make the trust fully exempt or not spend any more annual GST exemption on it one way or the other. So you've got to go get the premium payment history or the contribution history for those who had the trust have its own separate bank account, and have the insured put money into the trust account, and had the trustee pay the premiums. Then you've got to value the trust as of each premium payment or contribution. It's not easy. But you've got to do it.
Bruce Steiner: If you miss something, you can apply for a private letter ruling to either make what we colloquially call a late GST exemption allocation. It's actually a ruling allowing an extension of time to make the election. So if you get the ruling, it would become a timely election, or you can extend the time to elect not to have automatic allocation. Sometimes you don't want to automatically allocate to something. So if you have a trust that's GST status is messed up, you can apply for a PLR. We've actually gotten private letter rulings on GST exemption allocations. We had, I think we had one where there wouldn't have been a default allocation, and the lawyer thought the accountant was doing it. The accountant thought the lawyer was doing it. In reality, I think at least one of them didn't even know there was such a thing, and we got that ruling.
Bruce Steiner: Allocation at death. So if the decedent has any remaining GST exemption as of death because he or she didn't use it all during lifetime, the executor can allocate where it goes. Maybe there are several trusts created either during lifetime that are not fully exempt or created under the will. Maybe there's a credit shelter trust. Maybe there's a marital trust. Maybe there's a trust for somebody else, and you can allocate it wherever you want, and there's a series of default allocation rules that say where it goes if you don't. You don't want to rely on the default allocation rules.
Bruce Steiner: Show it on the estate tax return on Schedule R, so that down the road, when somebody is wondering they can pull up the estate tax return and see what happened.
Bruce Steiner: There is no portability for the GST exemption. So what do you do?
Bruce Steiner: Well, you might have a credit shelter trust, and that has the benefit of there's no leakage of income. In a marital trust all the income gets paid to the spouse and thrown into the spouse's estate. In a credit shelter trust, there's no leakage, but there's no basis step up when the surviving spouse dies.
Bruce Steiner: And the other possibility is you can use a marital trust. You can sacrifice your credit shelter and leave what you want in a marital trust and elect QTIP. There's portability for estate and gift tax, and then you can make what's called a reverse QTIP election, and treat the deceased spouse as the transferor and use the decedent's GST exemption on that QTIP trust, and that gets you the benefit of another basis step up when the spouse dies, and the drawback is, the income gets thrown into the spouse's estate. So in estates that aren't that big, you might leave the estate not in a credit shelter trust, but you might leave it in a QTIP trust if you want to get 2 GST exemptions and portability gets you two estate tax exclusion amounts. So that's a possibility that sometimes makes sense.
Bruce Steiner: The amount of tax is different. And we said that in the same way that the gift tax is cheaper than the estate tax, because the gift tax that you pay is removed from your estate, and not subject to estate tax unless you die within 3 years.
Bruce Steiner: Whereas the estate tax is on the full amount of the estate, including the amount that you pay in estate tax. So on a direct skip during lifetime, the tax, there's a gift tax on the gift, and there's a gift tax on the GST tax, and the result is that if you make a direct skip during lifetime your donee gets about half, and the government gets about half.
Bruce Steiner: In a direct skip at death, I leave money to my grandchild. There's a GST tax on the net after the estate tax. So the government gets a little more than half, and the grandchild gets a little less than half.
Bruce Steiner: A taxable termination, meaning I left money in trust for child, and then to grandchild. The government gets yet a little bit more, and the grandchild gets yet a little bit less.
Bruce Steiner: There's a wonderful, wonderful planning opportunity. If this is the one thing that you take away from this, this is the one thing to focus on. You can get 2 for the price of one.
Bruce Steiner: If I create a trust for child and child's issue, and it's a GST taxable trust, because I've already used up my GST exemption, and some people say, well above the GST exemption, just give it to the child outright, and let it be in the child's estate, which works wonderfully if the child is not otherwise going to have a taxable estate. But when you're dealing with wealthier families, everybody's going to have a taxable estate. I leave money in trust for the child, and the child then appoints it in further trust for the child's grandchildren, not the original decedent's grandchildren. Child appoints it down 2 generations to the child's grandchildren.
Bruce Steiner: Or, if the child lives to be 90 years old, in trust for the child's great grandchildren, I got to drop it down 2 generations, occasionally 3 generations at the price of only one GST tax. There's only one tax, even if it drops 2 generations at a time.
Bruce Steiner: Same way, as if I leave money to my great grandchildren instead of my grandchildren. There's only one GST tax, even though it dropped 2. You will probably have opportunities to do this. If you have clients who are beneficiaries of trusts that are subject to GST tax, have your client appoint that money in trust for your client's grandchildren, and you will avoid a level of transfer tax, and your client will be thrilled, or your client's grandchildren will be thrilled that you came up with this brilliant idea.
Bruce Steiner: So what is the planning for GST taxable estates. You can throw it into the child's estate and that will subject it to a 50% rather than a 40% tax in states that have their own state estate tax, but it takes advantage of the child's estate tax exclusion amount if the child doesn't have enough assets to fill it up, and the child can leave it to the spouse, or in trust for the child's spouse to use the spouse's exclusion amount.
Bruce Steiner: The other choice for GST taxable assets is you leave it in trust, and you skip estate tax in the child's estate. You skip state estate tax in the child's estate because there's no state GST tax.
Bruce Steiner: You give up the use of the child's estate tax exclusion amount. The child can defer the GST tax by appointing it in further trust for the child's spouse, and it does not have to be a QTIP trust. It can be a discretionary trust, so there's no leakage, and then the child can appoint it down more than one generation.
Bruce Steiner: Some other solutions. You can give the child a formula general power of appointment over the GST taxable portion to the extent it will reduce the transfer tax. Those formula provisions are incredibly difficult to draft. Most of the time when people draft them, the formula does not work, although they didn't realize it didn't work.
Bruce Steiner: The other choice is, you can give the trustees other than the child, or maybe other than somebody who's a beneficiary, the power to give the child a general power of appointment, and that lets you wait and see. The drawback - the complexity rather than a drawback - is, it requires the trustee to monitor it from time to time.
Bruce Steiner: There had been a question. Dave Kornfeld from St. Louis raised the question as to whether if the trustee can give the child a general power, whether the child already has a general power.
Bruce Steiner: But it's been 40 years, and the government has never raised this issue. And now that decanting is well accepted - decanting is really the same thing. You can decant and confer powers of appointment. That appears to no longer be a concern, and is probably the better solution. And, in fact, in every will we draft, we say that trustees may grant or take away general powers.
Bruce Steiner: And that, I think, is it. That's our half hour. I hope everyone got a little overview of the GST tax. It's just an overview. We couldn't possibly, without a full whole day go into all the complexities of it.
Bruce Steiner: Great, thank you.
Jonathan Shenkman: Thank you so much, Bruce, for those informative comments. Obviously, if anyone has any questions, new business opportunities or any other issues they'd like to discuss, you can feel free to reach out directly to Bruce or myself where appropriate. I'll be sure to include his contact information in the follow up email to this program. As I mentioned at the onset, the goal of these programs is to stay up to date on timely wealth management related topics, and to collaborate where appropriate.
Jonathan Shenkman: I think we can all agree that the clients who are best prepared are the ones who are served by a team of knowledgeable advisors. Three more quick items before I let you go. First, my fall webinar series continues on October 15th on the topic of International Estate Planning Traps for the Unwary featuring Kay Eli Akavon, who's a partner at Grant, Herman, Schwartz and Klinger, based in New York. And I'll send out an invitation to this program in the coming days.
Jonathan Shenkman: In the meantime, if you have a friend, colleague, or client who would like to be notified of my upcoming webinars, they can email me with the word "webinar" in the subject line, and I'll be sure to add them to my webinar distribution list. And my email is Jonathan@Parkbridgewealth.com.
Jonathan Shenkman: Second, you can follow all my work on X, Instagram and Jonathan on Money. You can also listen to my weekly podcast also called Jonathan on Money, which is available on Apple, Spotify or wherever you get your podcasts. And you can watch my daily financial planning videos by following me on YouTube, at Jonathan on Money as well. And third, please take 30 seconds to fill out my survey at the end of this program. It helps me improve my webinars and provide timely and interesting content to attendees.
Jonathan Shenkman: And I thank you in advance for that. And with that this concludes today's session. Please stay safe and healthy, and have a wonderful day, everybody.