Gifts to Grandchildren.. Watch out. There is ANOTHER Tax to Consider!

While we may have heard of the estate tax and, of course, the income tax, many of us have never heard of the generation transfer skipping tax (GSTT). This tax is imposed on gifts to grandchildren and was imposed to prevent very wealthy families from keeping assets in a trust and never exposing the assets of the trust to an estate tax (because at each generation the generation did not have to include those assets in their estate when such generation died).

For example Ford creates a trust that lasts for 360 years and provides that all income to each child, grandchild, great grandchild, etc for as long as the trust lasts (360 years). The grandchild, great grandchild, etc only has a right to income and therefore, under tax law, the assets are not included in that person’s estate for estate tax purposes. At each generation’s death Congress is losing a lot of money.

Congress determined that assets should be taxed at each generation and, if not, a GSTT is imposed at the highest estate tax rate. GOOD NEWS…there are exemptions, one of which is currently 5.340 million dollars and most of us can breathe a sigh of relief. However, that exemption may be inadvertently allocated in a way that you don’t want it to be allocated and you can waste a tremendous amount of money. Private Letter Ruling 201407001, illustrates what can happen.

An individual  created a trust which did not “need” any allocation of the GSTT exemption (all assets were going to be taxed at a child’s death). The attorney told the CPA to file a gift tax return and state on the gift tax return that the GST exemption should NOT be allocated because automatic allocations are made to certain trusts which could waste the exemption. The CPA did NOT affirmatively state that a GSTT exemption should NOT be allocated.  When the attorney discovered that the CPA did not elect OUT of the allocation of exemption, and the exemption was needlessly allocated (and wasted) the donor was not too happy.

The attorney applied for this private letter ruling and the IRS said that is okay, you can fix this mess as long as you fix it within 120 of the date of the private letter ruling. Obviously this is NOT a good way to proceed as a private letter ruling can cost as much as $10,000, not including attorney fees and costs.

ADVICE: ALWAYS, when discussing the GSTT, hire someone who is knowledgeable in this area and most importantly FOLLOW UP to make sure that what should be done is done.