Articles

ESTATE PLANNING AND THE GST EXEMPTION

General Planning Memorandum

This memorandum provides an overview of the estate planning considerations for generation-skipping transfer ("GST") tax purposes of the so-called "GST exemption". Under tax legislation enacted in 2001, the GST exemption amount is set at $2,000,000 for 2006 through 2008, and $3,500,000 for 2009. The generation-skipping transfer tax under current law is scheduled to be repealed in 2010 but to be reinstated in 2011 (with an exemption limited to $1,000,000). These increases for subsequent years track similar provisions enacted in 2001 for the exemption equivalent for federal estate tax purposes. It is expected that future tax legislation may amend the federal tax law for the later years so as to create a climate of greater certainty and stability for long term estate planning. For purposes of this memorandum, it is assumed (consistent with the current tax law) that the federal estate and generation-skipping transfer tax will in the long term remain in place.

To appreciate the importance of the GST exemption, it is necessary to understand how the GST tax and the estate tax are related. Where no trust arrangement is created for children, an estate plan often provides that a parent's property, after estate taxes, passes outright to children in equal shares. If, at their deaths, the children leave that property to their children, the property is again subject to estate taxes. The GST tax is designed to complement the estate tax by ensuring that property held in trust is taxed at each generation level. The GST exemption, however, allows property placed in trust up to the amount of the available GST exemption amount to avoid being subject to the estate tax or GST tax.[1] As a result, there is no estate or GST tax at the deaths of children (and also possibly grandchildren) with respect to this "GST exempt" property. Appreciation on the property placed in trust also avoids transfer taxation at the death of a child (or grandchild).

A trust utilizing the GST exemption typically provides for pro-rata income distribution among children (or grandchildren). It may also authorize an independent trustee with a broad discretionary power to distribute principal to children or grandchildren during the trust term, in equal or unequal shares, but a child (or grandchild) cannot be given an unrestricted right to withdraw trust principal. A descendant may be given a given a broad testamentary power to appoint the trust property at his or her death, and if desired, the trust may be continued through lives of grandchildren (and possibly longer). For married couples, a properly structured estate plan may take into account utilizing the GST exemptions of both spouses -- a total of $4,000,000 in 2008 under current law. An estate plan of this type will include a trust utilizing the GST exemption of the first to die while still qualifying for the marital deduction.

There are certain refinements in planning for the GST tax. For a New York resident, one consideration is that the GST exemption for New York law purposes is lower than the federal -- $1,250,000 in 2007 and adjusted by an inflation factor in years going forward.[2] Accordingly, separate New York GST tax may be applicable to federal GST exemption trust property at deaths of children with respect to any excess over the applicable lower GST exemption for New York estate tax purposes. [3]

Another concern related to planning for the GST exemption is the subject of appropriate trust provisions for children for dispositions in excess of the GST exemption level. Often trust provisions are established for a child until he or she reaches a certain age -- say, age 35 or 40 -- at which time it is expected that the child will have become sufficiently fiscally responsible to receive a substantial outright inheritance. As an alternate, there may be structured long term trust provisions for this property (which is often referred to as "GST non-exempt property") for the life of a child under trust provisions which may provide for significant flexibility for distribution to the child/beneficiary of a substantial part or all of the GST nonexempt property held in trust as appropriate over time and may grant full testamentary control through a broad power of appointment. The tax reason for a long term trust along these lines for GST nonexempt property is to take into account long term estate planning at a child's death and allow an independent trustee, in exercise of discretion, to take appropriate action so as to reduce to overall combined estate tax and GST tax which may be incurred at the child's death. While it adds an additional level of complexity in estate planning, it is important to give some consideration to the potential long term tax advantage which this may afford, particularly in planning for a substantial estate and/or where trust provisions for a child's lifetime may be appropriate for non-tax reasons.

January 2008

[1]This disposition may be made by a trust established during an individual's lifetime or by a formula disposition tied to the GST exemption amount available at the time of death under an individual's estate plan. Provision is typically made under an individual's estate plan to address the level of GST exemption funding in the event of repeal of the GST tax prior to death.

[2] The inflation factor for 2008 is to be set later in 2008.

[3] The New York State GST tax rate on taxable distributions and terminations is 2.75%, which is 5% of the federal GST tax rate of 55%. The 55% rate is the same as the maximum federal estate tax rate for dates of death before 2002. The New York rate is the maximum allowed as a federal credit for state GST taxes on taxable distributions and terminations from a trust before 2002. Since New York does not conform to the change in the federal rate enacted by the 2001 tax legislation, the NY rate remains at 2.75% without regard to the date of the generation-skipping transfer. Unlike the federal GST tax, there is no NY GST tax on direct skips. However, in calculating the total exemption available to an individual, it is the position of the New York taxing authority that direct skips will be deducted from the exemption amount.