What is the Generation-Skipping Tax?

Jodee Redmond

People who have accumulated a sizable estate and who want to reduce the amount of tax payable when their assets are transferred may consider leaving their property to their grandchildren directly or setting up a trust to benefit their children and grandchildren. The generation-skipping tax is imposed when these types of actions are taken to avoid paying a gift tax or estate tax on the assets involved. The tax may be imposed when the recipient of the gift or the beneficiary of the trust is not a relative and is more than 37 years and six months younger than the person making the gift or setting up the trust. It also applies to relatives who are at least one generation younger than the donor.

Grandchildren receive the wealth and estate of a grantor in a generation-skipping trust.
Grandchildren receive the wealth and estate of a grantor in a generation-skipping trust.

The generation-skipping tax first became law in the United States in 1976. Under the legislation of the time, the government chose to levy a tax equal to the amount of gift or estate tax that the donor was attempting to avoid paying. This measure meant that complicated calculations were needed to determine how much, if any, tax the beneficiaries of a large estate were responsible for remitting to the United States Internal Revenue Service.

In 1986, the generation-skipping tax bill of 1976 was replaced with an updated version that was easier to understand. The new version imposed a flat rate tax payable on gifts or property received through an inheritance. The highest marginal estate and gift tax payable as of the date the gift or the bequest was made is used to determine the amount payable.

The generation-skipping tax law also includes personal exemptions which reduce the amount of tax liability. As of 2009, each taxpayer is given an exemption equal to $3.5 million US Dollars (USD), which means the total amount that a married couple may transfer without the gift or property in a trust being subject to the tax is $7 million USD. The tax rate is set at 45 percent.

The current generation-skipping tax law is set to expire in the year 2011. Unless the United States Congress successfully passes an amendment, the personal exemption amount of the current law will be reduced to $1 million USD per person. To find out more about this tax and to determine the best way to set up a trust or transfer property to grandchildren, consult an attorney experienced in estate matters. He or she will be able to offer personalized advice for the client's situation.

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