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Your estate plan includes maximum flexibility by providing the entire estate of the first decedent to the surviving spouse during their lifetime. With the availability of portability, there is no need to create and fund a family trust upon the first spouse’s death, which otherwise would not be directly accessible by the surviving spouse. However, you should be aware that the Generation Skipping Transfer Tax Exemption is not portable like the estate tax exclusion and could have a major impact to your estate.

Generation Skipping Transfer Tax. The generation skipping transfer tax is imposed on transfer of property that skips generation. Each person is allowed an amount of lifetime exemption from tax, which is indexed for inflation. Every generation-skipping transfer is subject to the generation-skipping transfer (GST) tax, which takes one of three forms: direct skip, taxable termination or taxable distribution. A direct skip is a transfer to a skip person that is also subject to estate or gift tax. A skip person is two generations or more younger than the transferor. The best example of a direct skip is a grandparent making a gift to his grandchild. Deceased parents are ignored for lineal descendants and for other descendants if the transferor has no living lineal descendants at the time of the transfer. The tax applies to all generation-skipping transfers made after October 22, 1986 and the basic exclusion amount is $5 million of direct skip transfers.

Taxable termination. A taxable termination occurs when an interest in property held in trust terminates and the trust property is held for or distributed to a skip person. A taxable distribution is any distribution from a trust, including a distribution of income, that is not a taxable termination or direct skip.

Tax. The tax is computed by finding the taxable amount of the transfer and multiplying it by the applicable rate. The applicable rate is the product of the highest estate and gift tax rate multiplied by the inclusion ratio for the transfer. The inclusion ratio is found by allocating all or a portion of the transferor’s lifetime exemption to the transfer. It is allocated first to lifetime direct skips, but the transferor may elect his own allocation. The exemption will be equal to the applicable exclusion amount.

Tax Return & Payment. The executor must file the return and pay the tax for direct skips occurring at death. The transferor is responsible for filing the return and paying the tax on lifetime direct skips. The trustee is responsible for filing the return and paying the tax on taxable terminations. The transferee is responsible for paying the tax and filing the return for taxable distributions.

To learn more about the generation skipping tax and how it affects your estate, please do not hesitate to contact your L&B professional at (858) 558-9200.

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