Personal Financial Planning Monthly - Editorial Direction LLC

PERSONAL FINANCIAL PLANNING MONTHLY
estate tax by keeping property out of the taxable
estates of the members of the intermediate generation.
The beneficiary could be trustee, have all the
income, invade the principal for needs, and control
the distribution of the property as long as the beneficiary
did not have a general power of appointment.
Now, the GST tax considerations of such transfers
must also be considered.
There are three situations where GST techniques
are useful. First, where a client stands to inherit a
substantial estate from a parent and already has a
substantial estate of his or her own, a generationskipping
trust would be set up for the parent’s property
for the benefit of the client. Such a trust would
allow the client-beneficiary the use and enjoyment
of the inherited property, together with protection
against creditors, divorce courts, or bankruptcy. The
amount subject to the $1,090,000 GST exemption
will also be excluded from the beneficiary’s already
substantial estate. Although the client’s parent may
pay gift or estate tax, the client does not pay estate
tax or GST tax on the exempt inherited property at
death. Furthermore, it is possible that no estate tax
or GST tax will be paid by the client’s children or
future issue, depending on the term allowed for the
trust.
Second, a generation-skipping trust may be used
where parents wish to minimize transfer taxes in a
child’s estate but still give the child the use and benefit
of the property, or where the parents wish to
protect the property from a spendthrift child, or
from being subject to loss through a child’s divorce
or bankruptcy. In these situations, a generation-skipping
trust would be set up to provide income to the
child for life, but with the principal being preserved
for subsequent distribution to grandchildren. The
trust can continue through the grandchildren’s lives
(and for great-grandchildren as well), avoiding
transfer tax in each generation, subject only to the
limitation on the maximum life of a trust under state
law. In the case of many estates, however, the generation
skip occurs as a result of the death of a member
of the intermediate generation before such
member receives full ownership of the gift or inheritance,
as when a trust is provided for a child until
he or she attains age 30, and that child dies before
attaining age 30, leaving grandchildren surviving.
Third, a client may wish to make direct transfers
to a grandchild or other skip person for the beneficiary’s
education, support, or enjoyment, or in order
to avoid tax in the estate of the intervening generation.
Gifts that immediately benefit grandchildren
will generally be subject to the GST tax unless they
qualify for the $1,090,000 per donor generationskipping
exemption or the $11,000 per donor per
donee annual exclusion.
If combined with a “family bank” or “dynasty
trust,” the GST is the most valuable planning concept
currently available for passing assets to future
generations. Generally, a trust fund is established by
current gift or eventual bequest that will continue
for selected beneficiaries—usually children, grandchildren,
great-grandchildren, and spouses. During
the life of the trust, the beneficiaries’ shares will not
be subject to the wealth transfer tax. The trust can
also be designed to freeze distributions to creditors
or divorcing spouses.
Any gift or estate taxes which become due are
paid, and $1,090,000 or less is transferred in trust to
establish a generation-skipping plan. If the donor’s
spouse consents, as much as $2,180,000 may be
transferred in this fashion. The funds are accumulated
by the trustee and paid to or for the benefit of all
of the donor’s descendants. The effect is to defer for
a considerable amount of time (often well over 100
years) the payment of transfer taxes.
A generation-skipping trust plan designed as a
dynasty trust can permit the trustee to make payments
of income and principal to any member of the
family who needs them. The trust itself is usually
funded with appreciating assets (which can be
leased to beneficiaries at a low rent). Also, the trust
may make tax-free loans to descendants. In these
ways, there can be more accumulation and tax
deferral to benefit future generations.
While such a plan is in place, beneficiaries
should “spend down” other personal assets owned
outside the dynasty trust. Once they deplete their
assets, they can look to the dynasty trust for help. In
this way, they will consume property that would
otherwise be taxable in their estates at their deaths,
which also would be subject to their creditors and,
possibly, the claims of former spouses. Meanwhile
the protected trust fund grows, and their exposed
personal taxable estates get smaller.
Such trusts should not permit any descendant
who is trustee to have the absolute, unfettered
20 November 2002