No Generation Skipping Tax this Year

As most people know, there is no federal estate tax in the year 2010, but this tax is expected to return in 2011 with only $1.0 million exemption. In addition to the return of the federal estate tax on January 1st, there is also another tax that is taking a one year hiatus—the generation skipping tax.

The generation skipping tax was first enacted in the 1970’s, designed to prevent wealthy families from giving assets away to grandchildren, skipping the tax that might occur at the death of the children, thereby lessening the overall tax. The federal estate tax was designed to tax the estate of the owner of the property. Once the parent gives it to their child and that child dies, whatever is left in the child’s estate is again taxed. Then the child gives it to their child (a grandchild) and then there is another federal estate tax. If the parent gave the gift to the grandchild, thereby skipping the child and (in the past) the tax on the child’s estate, there would be less overall tax. As a result, Congress created the generation skipping tax, affectionately known as the GST tax.

Under the GST tax prior to 2010, donors could transfer a limited amount free of GST tax to grandchildren or nonrelatives who were at least 37-1/2 years younger. In 2009, the amount that they could transfer free of tax was $3.5 million. After 2009, such gifts became subject to a double layer of taxation. The donor would pay the GST tax and either the estate tax or gift tax on amounts above a certain level. As a result, Uncle Sam could end up with receiving more than the beneficiaries.

Even though there is no federal estate tax in 2010, there is still a gift tax in place. A donor may give up to $13,000 to each person free of gift tax, as there is a $13,000 annual exemption. There is also an additional $1.0 million lifetime gift exemption that could be used before incurring the gift tax. The maximum rate this year for the gift tax is 35%, but it is scheduled to increase to 55% in 2011.

Since there is no GST tax in 2010, many people may decide to make gifts to grandchildren in 2010, incurring a potential gift tax, but no GST tax and getting the potential appreciation out of their estate. For instance, if a parent decided to give each of 8 grandchildren an amount of $200,000 each in 2010, that would exceed the gift tax level and there would be a gift tax at 35%. If the parent made the same gift in 2011, the combined gift tax and GST tax might equate to about 90%.

Since we do not know when or if Congress will deal with changes in the estate tax law, many people are waiting until December 31, 2010 to make their gift to grandchildren.

Denice Gierach is a lawyer and owner of The Gierach Law Firm in Naperville. She is a certified public accountant and has a master’s degree in management.