Maximizing Wealth Transfer with Generation Skipping Strategies

1. Finance 553 Generation Skipping Transfers

2. Generation Skipping Transfers • The Three Taxes on a Transfer • Gift Tax • If gift outside annual $14,000 exclusion • If gift outside one time exclusion • Estate Tax • Excess of estate passed to heirs above exclusions • Exclusion – Unlimited Marital Deduction • Exclusion – Charitable Deduction • Generation Skipping Transfer • Additional flat tax on asset transfer

3. Generation Skipping Transfers • Why tax transfer based on where recipient is on lineage chart or age of recipient? • Moves up the taxes on some assets that transfer at a low basis • Transfers “skipping” normal lineage against social norm • Skipped Generation • Two types of recipients – non-skip persons and skip persons • With a skip person in lineage (see Exhibit 13-2 on page 541) • With a skip person defined by age • Generation is defined as 25 years • Split for the first pass of transfers (12.5 years either way) • Next generation add 25 years • Skip is thus passing of assets to someone 37.5 years away

4. Generation Skipping Transfers • Who is in lineage, who is not? • See Exhibit 13-3 on Page 542 • Great Aunts and Uncles – outside lineage • Descendants of Great Aunts and Uncles – outside lineage • Non-lineage recipients are “skip” persons based on age difference • Other Non-Skip Persons • Trusts can be skipped or non-skipped depending on the beneficiaries of the trust – one non-skipped beneficiary makes trust non-skipped trust • Predeceased Ancestor (non-skipped person above in lineage is deceased) – Skip person moves up one generation and may become non-skipped person

5. Generation Skipping Transfers • When does transfer tax apply • Direct transfers to skipped person – direct skip • Transferee is responsible for tax (40% flat rate) • Trust making transfer, then trustee is responsible for tax • Taxable Termination • When a non-skipped person dies and the remainder goes to the skip generation from the original transferee • Trust is typically way – trust maker sets up trust to child and upon death of child, trust continues to pay or distributes assets to child’s children (grandchildren of trust maker) • Taxable Distribution • Any distribution from a trust to a skipped person not part of a taxable termination

6. Generation Skipping Transfers

7. Generation Skipping Transfers • Filing Requirements • Inter vivos gifting (while alive) – by April 15 of year following gift • Direct Skips at Death • Schedule R or R-1 of Estate Tax form 706 • Due nine months after death • Taxable Distributions • Filed by trustee • Due April 15 of year following distribution • Taxable Termination • Filed by trustee • Due April 15 of year following distribution

8. Generation Skipping Transfers • Dynasty Trusts • Trust designed to payout to future generations beyond first in line • Trust assets are not owned by any beneficiary • Therefore assets do not “transfer” via estate to each succeeding generation • No estate transfer – no estate tax • States determine when the assets must “vest” in a beneficiary for estate purposes • Either 21 Years after death of youngest beneficiary • Or 90 years maximum

9. Generation Skipping Transfers • Dynasty Trusts -- continued • Generally family trusts for direct lineage of trust maker • Typically funded with non-real estate property • Designates which “state” laws govern trust • Selects trustee (non beneficiary) – usually two independent trustees • Trustee service limited (must resign at certain age) • Trust protectors named – can remove current trustees • Trustees can terminate (if appropriate), transfer assets to new dynasty trust (if appropriate) and sell assets

10. Generation Skipping Transfers • Dynasty Trusts - continued • Assets of trust are “protected” from creditors of beneficiaries (again the trustee owns the assets not the beneficiaries) • Divorced spouse (non beneficiary) cannot claim ownership of trust assets • Distributed income from trust to beneficiaries is taxed at the beneficiaries income rates and paid by beneficiaries • Non-distributed income is taxed at the trust and paid by trustee from trust assets

11. Generation Skipping Transfers • Dynasty Trusts - continued • To manage long-term trusts with births and deaths • Sub-generational trusts are made within the larger family trust • Allows distributions to be allocated per stirpes • Funding of Trust • Typically personal property only to avoid state laws on removing real estate from commerce • Often life insurance policy used to fund trust as it “grows” tax free and tax free upon distribution

12. Generation Skipping Transfers • Dynasty Trusts - continued • Termination of a dynasty trust • Trust typically designed to terminate upon the death of the last lineal descendant • Trustee usually has power to terminate and distribute assets to beneficiaries • With no lineal descendants final beneficiary is usually a charity (family foundation for example) • In general dynasty trust is designed to pass on assets (and income from assets) to descendants free of estate, gift, and generations skipping taxes

13. Generation Skipping Transfers • What are the implications for Financial Planning? • Need to understand that some gifts can incur another level of taxation • Determined by recipients status • Is significant reduction in “estate” • Dynasty trusts are very complicated so • Drafting of trust must be done by a qualified expert • State laws can impact the rules of the trust and the assets placed in the trust • Trustees and Trust Protectors are important consideration • Questions?