The generation-skipping transfer (GST) tax was first enacted by Congress in 1976. The history of GST, why it was created, its impact, the changes made by the Trump administration, and the proposed changes by Joe Biden and Kamala Harris have been discussed in the following brief.
- The generation-skipping transfer (GST) tax was enacted by Congress in 1976 to prevent wealthy individuals from avoiding federal estate tax. Prior to its introduction, wealthy people were legally allowed to bequeath property and gift money to their grandchildren without incurring federal estate taxes. Therefore, inheritances often skipped a generation to avoid double estate taxation.
- Consequently, Congress enacted legislation to close the loophole. The GST ensures that grandchildren will have the same value of assets if the inheritance came directly from their parents.
- There has not been any enactment of the tax code since the 1986 Tax Reform Act, which was made law in October, 1986.
- A GST of 40% is imposed on transfers that are made to remote descendants and grandchildren that are in excess of the exemption amount.
- The GST applies to transfers to people who are more than one generation away. These are mostly grandchildren and great-grandchildren. However, it also applies to unrelated people who are 37.5 years younger or more than the transferor.
- The GST has exemption limits. As of 2018, the exemptions were $11.8 million per person and $23.6 million for married couples. Therefore, an individual can transfer property with value that does not exceed the exemption among without pay any transfer tax. It is noteworthy that “any portion of the exemption used during lifetime reduces the amount of exemption available at death for estate tax purposes.”
- In addition, the tax exempts grandchildren whose parents died. In this case, the grandchildren take the place of their parents, which means that they are not skipping a generation. However, regular federal estate tax is still imposed.
Initial Impact of the GST
- GST led to the taxation of wealthy families that were previously not subject to federal estate tax and could transfer a lot of wealth between generations without being taxed.
- In addition, GST saw fewer wealthy families paying less estate tax compared to wealthy families.
- It is noteworthy that the initial GST that Congress enacted received a lot of criticism and was repealed through the Tax Reform Act of 1996.
- “The 1986 Act imposed a tax equal to the highest estate tax rate on any generation-skipping transfer, with a $1 million exemption per tax payer.”
- The exemption was indexed for inflation in 1995 in $10,000 increments. Also, in 2001, there was another increment to the exemption that saw it match the estate tax exemption. The change was included in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).
- As of 2009, the GST exemption was $3.5 million.
- Furthermore, the GST tax exemption led to the creation of dynastic trusts. Also, states that did not have any Rule Against Perpetuities (RAP) and no income tax on trusts became attractive places for settlers who wanted to establish their trusts.
- GST tax exemptions resulted in “a substantial increase in the establishment of generation skipping trusts…over what would occur in the absence of any generation skipping transfer tax at all.”
Changes Made to the GST under Trump
- The Trump administration made indirect changes to the GST. The federal generation-skipping transfer tax was not expressly amended under the 2017 Tax Act. However, it is noteworthy that the Act increased federal estate tax exemption to $10 million from $5 million. Under the Trump administration, the exemption will continue until 2025.
- “The generation-skipping transfer tax exemption is defined in the Federal Tax Code as an amount equal to the federal estate tax exemption, and therefore the increase to the estate tax exemption likely applies to the generation-skipping transfer exemption as well.” Consequently, the GST exemption for individuals was adjusted to that amount and then indexed for inflation.
- According to the Tax Policy Center, the Trump administration had intentions of permanently extending the Tax Cuts and Jobs Act of 2017, which would prolong the estate tax provisions that are scheduled to expire in 2025. Therefore, the GST tax exemption would be at $11.8 million for a long time.
Changes to the GST Proposed By Biden
- Former Vice President Biden’s economic plan is centered on the wealthiest Americans shouldering a larger percentage of the tax burden including increasing federal estate taxes “back to the historical norm.”
- It is noteworthy that the Biden has not mentioned any specific numbers. However, it is expected that the exemptions could be much lower than what they currently are.
- The estate tax exemption in 2001 was $650,000 and the top marginal rate was 55%. By the end of 2012, the estate tax exemption was made to “decrease to $1,000,000 per taxpayer before Congress passed last-minute legislation to retain the $5,000,000 exemption.” In addition, the second Obama administration had proposed to reduce the amount to $3,500,000.
- Taking into account the current political climate, it would not be surprising if the exemption levels were reduced to what they were in 2017 ($5,000,000 per person) or lower.
- Biden has suggested that the exemption for generation-skipping transfer tax could be reduced to as low as $3,500,000 per person with a top marginal rate of 70%.
- Moreover, Biden during his campaigns proposed that he would increase estate tax, which would also increase the GST tax rate.
- If the Democratic Party gained control of all branches of the government, there is a high likelihood that a new congress and president will speed up the reduction of exemption amounts.
- There are speculations that such reductions, even if they are passed in mid-2021, could be retroactively implemented as soon as January 1, 2021.
- If Kamala Harris takes over after Biden, there is a high chance that there will be a reduction in exemption amounts and an increase in the top marginal rate of GST tax.
- Kamala Harris has previously assured Americans that they will not experience an increase in taxes. Instead, she insists that the wealthiest and corporations are the ones who will finally pay their fair share.