The Teenaged Tax Comes of Age

1. The Teenaged Tax Comes of Age Fran M. DeMaris Executive Vice President Cannon Financial Institute, Inc.

2. Generation Skipping Transfer Tax Learning Map

3. What is GSTT? • A Transfer Tax similar to Gift and Estate tax • Applies when assets are transferred two or more generations below the transferor • Not unified with Gift and Estate Tax • Imposed at the maximum estate tax rate (45% in 2008)

4. GSTT Exemption and Rates YearExemptionGST Tax Rate 2001 $1,060,000 55% 2002 $1,100,000 50% 2003 $1,120,000 49% 2004 $1,500,000 48% 2005 $1,500,000 47% 2006 $2,000,000 46% 2007 $2,000,000 45% 2008 $2,000,000 45% 2009 $3,500,000 45% 2010 N/A (Estate & GST Tax Repealed) 2011+ $1,000,000 (plus indexing) 55%

5. Why GSTT Is Important • Not Widely, Well Understood • Millions of Millionaires • Unintentional skips • Many Existing Plans Were Created Prior To Enactment Of GSTT

6. Two Options Parent Estate/Gift $2,000,000 41-45% Estate/Gift $ 2,000,000 41-45% Child Estate/Gift $ 2,000,000 41-45% GSTT $ 2,000,000 45% Grandchild

7. Effective Dates - When Does GSTT Apply? • When a generation is “skipped” • When, in a trust or similar arrangement, interests pass down multiple generations without Estate or Gift tax vesting in each generation • When a trust has NO GPOA to a beneficiary • All transfers after 10/22/86 and lifetime transfers after 9/25/85 are subject to GSTT

8. When Does GSTT Not Apply • When trust contains a GPOA to each generation • When grandfathering rules apply: • Lifetime transfers (gifts) before 9/26/85 • Intervivos irrevocable trusts created before 9/26/85 • Testamentary irrevocable trusts before 10/22/86 • Decedents with revocable plans who have been incompetent from 10/22/86 until death

9. Generation Assignment

10. Generation Assignment Rules Family • Family members assigned by relationship • Non-family members assigned by relative age to transferor • Determines relative generation to transferor Non-Family Skip/Non-skip

11. Family Members • Family Members are assigned generations based on relationship to the transferor • Spouse is in transferor’s generation • Adopted children fall into appropriate generation • Family tree used is from transferor’s grandparents down

12. “Family Members” Grandparents Parents Uncle/Aunt Spouse Brother/Sister First Cousin Transferor Adopted Child Child Niece/Nephew Once Removed Great- Niece/Nephew Grandchild Grandchild Twice Removed Great-grandchild Great-grandchild Etc. Etc.

13. Pre-deceased Ancestor Rule • When a child predeceases the transfer, the more remote descendants all ‘step-up’ a generation • Applies to issue only, unless transferor has no issue. Then to niece/nephew, etc. Spouse Transferor Child Adopted Child Grandchild Grandchild Great-grandchild Great-grandchild

14. Pre-deceased Ancestor RuleResults of predeceased child Spouse Transferor Brother/Sister Adopted Child Niece/Nephew Grandchild Great Niece/Nephew Grandchild Great-grandchild Etc. Great-grandchild

15. Non-Family Members • Age difference determines “generation” • Each generation deemed to be 25 years • Transferor deemed to be in middle of his/her generation, thus 12½ years to end of transferor’s generation • 12½ + 25 = 37½ years • Transfer to non-family member who is 37½ years younger than transferor is a skip

16. “Skip Person” Family member two or more generations below transferor Non-family member 37½ years younger than transferor Trust with only skip person beneficiaries “Non-skip Person” Family member within two generations of transferor Non-family member with age within 37½ years of transferor Trust with any non-skip person beneficiary Generation AssignmentPutting It All Together

17. Types Of Skips

18. Direct Skip takes place when transfer becomes irrevocable GSTT due at same time Gift or Estate tax applies Direct Skip Indirect Skip might or will take place in the future Gift or Estate tax due on initial transfer GSTT due in future at occurrence of a taxable event Taxable Distribution Taxable Termination Types of Skips

19. Parent Child Direct Skip • A lifetime or testamentary transfer to a skip person in which only skip person(s) have an interest • Transferor pays the tax • Tax reporting is on Form 709 or 706 Grandchild

20. Parent Trust fbo Child Taxable Distribution • Distribution of funds to a skip person from a trust that has non-skip beneficiaries also • Recipient skip person pays the tax (may also carry out DNI) • Tax reporting on Form 706 GS(D) filed by recipient and 706 GS(D)-1 filed by trustee Distribution Grandchild

21. Parent Trust fbo Child Taxable Termination • Termination of the interest of the last non-skip person beneficiary • Trustee pays the tax • Tax reporting on Form 706 GS(T) filed by trustee Child's interest terminates Grandchild

22. Exemption & Exclusions

23. Exclusions and Exemption • Annual Exclusion • Unlimited tuition & medical expense exclusion • GSTT Exemption ($2,000,000 in 2008)

24. Annual Exclusion • Similar to Gift Tax Annual Exclusion • Applies to outright direct skips and direct skips to a special trust • Income or corpus can be distributed only to the person benefited by the gift, and • The trust must be includible in the person’s estate at death [IRC 2642 (c)] • Beware the application to Crummey trusts

25. Gift Tax Annual Exclusion (Present Interest) Outright Simple Trust Minor’s Trust Crummey Powers GSTT Annual Exclusion (Non-taxable direct skip) Outright Direct Skip Direct Skip to “Special Trust” One current beneficiary Includible in his/her estate Different Rules for Gift &GSTT

26. Exclusion for Qualified Transfers • Direct payment to the service provider of tuition and medical expenses is exempt (as for Gift Tax) • Unlimited amount • No relationship need exist • Applies to donor or distribution from a trust • §2611(b)(1) Law Degree John Q. Public

27. $$$ GSTT Exemption • $2,000,000 (Indexed starting in 1999) • Changed in 2004 to new phased in UCEEA • 2008 Exemption is $2,000,000 • Allocated by transferor or personal representative on Gift or Estate tax return • Irrevocable election • Retroactive allocation allowed for unnatural order of death • If not allocated, deemed allocation applies

28. 1986-1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 $1,000,000 $1,010,000 $1,030,000 $1,060,000 $1,100,000 $1,120,000 $1,500,000 $1,500,000 $2,000,000 $2,000,000 GSTT Exemption in Past Years

29. Allocation of the Exemption

30. Inclusion Ratio • Determines the amount (ratio) of the transfer subject to (inclusion) GSTT • Applies at time of direct skip or for the life of the arrangement for an irrevocable trust • Can be adjusted for later transfers

31. Always, Always, Always split trusts to achieve a zero inclusion ratio!!! Did I mention "always?"

32. Why Split Trusts? • To achieve zero inclusion ratio accounts • Optimizes use of the generation skipping transfer tax exemption • Fund can then be used for alternate purposes, have different distribution terms or be distributed last to non-skip persons • Can optimize tax allocation clauses • Provides specific fund to use for direct skips

33. Split Trusts, How? • Formula in document • Power to split • In document • Under state law • Qualified Severance

34. Qualified Severance • The division of a single trust and the creation of two or more trusts if: • The single trust was divided on a fractional basis, and • The terms of the new trusts, in the aggregate, provide for the same succession of interests of beneficiaries as in the original • Trustee may elect to sever a trust at any time

35. QTIP for Gift/Estate Tax Qualifies for marital deduction only if elected Treats spouse as transferor even though spouse has no GPOA Reverse QTIP for GSTT Does not affect estate tax marital deduction achieved by QTIP election Treats decedent as transferor even though assets are included in survivor’s estate Enables optimum use of GSTT exemption “Reverse QTIP” ElectionAn election to determine transferor

36. Standard GST Estate Plan Surviving Spouse may assign GSTT exemption to his/her assets and second marital trust Will or Revocable Living Trust Credit Shelter Trust Zero Inclusion Ratio Reverse QTIP Zero Inclusion Ratio Second Marital or Survivor’s Trust