2012 Estate Planning. Martin Inc. Shenkman
with a series of examples. If Clint Eastwood appeared in a remake of a movie called The Good, the Bad and the Ugly: GST Episodes, the script might read as follows.
GOOD EXAMPLE: Tom Taxpayer has a modest estate but is concerned about future estate taxes and consults his CPA, attorney, and wealth manager. It is determined that Tom can gift away $1 million in 2012. The team offers Tom several options ranging from an outright gift, to a simple local trust in Tom’s home state, to a grantor, GST exempt dynasty trust formed in South Dakota. After weighing the pros and cons, Tom opts for the more sophisticated trust. Tom’s children and heirs multiply. The money in the trust was invested wisely. As the generations of family members multiplied, so did the wealth accumulated within Tom’s trust, protected from the beneficiaries’ creditors (including a spouse in divorce) and forever outside the transfer tax system. Generations into the future, Tom’s wealthy descendants all lived happily, safely, and transfer tax free. But alas in our fairy tale land of tax planning, some taxpayers did not fare as well.
BAD EXAMPLE: Tom Taxpayer has a modest estate but is concerned about future estate taxes and consults his CPA, attorney, and wealth manager. It is determined that Tom can gift away $1 million in 2012, but that if the estate tax exemptions remain at $5 million Tom won’t ever have to worry about the estate tax (let’s assume that Tom doesn’t live in a state that has its own estate tax). The team offers Tom several planning options, but Tom opts to wait and see.
In 2013, the estate tax exemption is reduced to $3.5 million and other changes Tom really doesn’t understand are enacted. One of these includes President Obama’s restriction on the number of years for which GST exemption can be allocated to a trust. Tom again consults his advisers and they offer a range of planning options in 2013 from an outright gift, to a simple local trust in Tom’s home state, to a grantor, GST exempt dynasty trust formed in Delaware. After weighing the pros and cons, Tom opts for the more sophisticated trust. Tom’s children and heirs multiply. The money in the trust was invested wisely. As the generations of family members multiplied, so did the wealth accumulated within Tom’s trust, protected from the beneficiaries’ creditors (including a divorced spouse) and forever outside the transfer tax system—or so they all thought. Generations into the future, Tom’s wealthy descendants thought they were going to all live happily ever after, but out of nowhere sprang the Big Bad GST Wolf who exclaimed the GST exemption Tom allocated had reached the maximum term. While Tom’s heirs all lived happily for 90 years, in year 90 Tom’s trust was no longer GST exempt. Shortly thereafter, Tom’s grandchildren died and half of the trust assets were lost to GST taxes. So only half was left even though the number of Tom’s descendants had grown. Then his great-grandchildren died, and half of the remaining half was lost again to such taxes, again even though the number of descendants had again expanded, the wealth shrunk dramatically. And the trust will continue to be eroded as each generation dies.
But some taxpayers did not fare even this well!
UGLY EXAMPLE: Tom Taxpayer has a modest estate but is concerned about future estate taxes and consults only his CPA. It is determined that Tom can gift away $1 million in 2012. The CPA suggests to Tom, “Hey, why spend money on legal fees, your kids are adults. Just write them a check and call it a day.” So Tom, always happy to save legal fees, writes out a check for $500,000 to each of his two children and smiles in anticipation of a simple, cheap, and easy tax savings. Unfortunately, the excitement of saving legal fees proves too much, and Tom dies. Tom’s children use a much older and wiser CPA who informs them of the consequences of the poor advice their father received, of lack of GST planning, and the tax, divorce, and liability protection that was all sacrificed. Tom’s children sue Tom’s CPA for poor advice. While there are some significant issues as to whether the CPA has any responsibility to the children for the poor 2012 planning advice, the claims and suits rage on. And the lawyer for Tom’s CPA and the lawyers for each of Tom’s children bill and bill, and it is they, not Tom’s heirs, who live happily ever after.
GST planning is so integral to 2012 gift transfers, and not only for mega-dollar-value gifts, that you should endeavor to incorporate the possible advantages of the GST planning opportunities available. The reality is that when considering GST planning, many taxpayers will be put off by the complexity and/or cost. But you should stop and consider how the benefits may dramatically outweigh the costs and other negatives.
A Bit of Background
The GST tax has existed since 1986. (There was an earlier version in effect from 1976 to 1986.) It was designed to prevent the wealthiest families from doing an end run around the estate tax. If an individual’s wealth was great enough, without the GST tax he or she could gift or bequeath assets in trust to two, three, and perhaps more generations “down the line” skipping the estate tax on intervening generations. To prevent the possible avoidance of the estate tax, the GST tax was enacted to apply when property transfers skip over a generation for estate tax purposes. Thus, the GST tax is a second layer of transfer tax applied to gifts and bequests that skip a generation. For example, the GST tax may apply if you make a gift to your grandchildren while your child (parent of the grandchildren) is still alive. A gift to a trust to benefit only grandchildren and later descendants could also trigger GST tax (if the trust is created while your child is alive). The planning is arcane and complex even for estate planning specialists; it is likely impenetrable for most taxpayers. But the high hanging fruit can often be the sweetest and worth the stretch to reach it.
GST Rules: Quick Overview
The following is a general background discussion of GST to establish the framework for the 2012 planning discussions that follow in several later chapters. While you might choose to skip the effort to understand GST planning, some sense of the tax and how planning for it commonly is approached will make some of the more dramatic planning recommendations for 2012 more understandable and, perhaps, even more palatable.
The GST tax can apply to a broad range of property transfers, including transfers of property in trust (e.g., a gift to a trust established for a grandchild), life estates (e.g., a child has the right to income from the property for life and on the child’s death a grandchild receives the property), remainder interests (e.g., a grandchild receives the property after the death of a child and the termination of the child’s life estate), and so forth. The real power, however, of GST planning is the allocation of the GST exemption to gifts made to perpetual, flexible trusts that benefit future generations in a manner that maximizes the leverage of assets transferred into the protective trust structure, and the duration for that trust.
For the GST tax to apply, a taxable event must occur. This requires a generation-skipping transfer. The simplest example is when you make a gift to a grandchild. In general, the tax is imposed whenever property passes to or for the benefit of a grandchild or more remote descendants, or to someone assigned to the generation of a grandchild or more remote descendants. It applies, in general, whenever property passes through the generation of children (e.g., a trust for a child which ends in favor of grandchildren) or around the generation of children (e.g., directly to a grandchild) if no estate or gift tax is imposed at the children’s generation. More technically, the GST tax applies when there is a transfer of property (or income from property) to a person who is, or is considered to be, a member of a generation at least two generations below that of the person making the gift. The term “person” in tax speak is broad and includes trusts as well—these people (individuals and trusts)