The Generation-Skipping Transfer Tax (GSTT) is imposed by the Internal Revenue Code (sections 2601 to 2664) at the Federal level as an estate tax anti-avoidance measure when there is a transfer of property by gift or inheritance to a beneficiary other than a US citizen spouse (the “skip person”) who is at least 37½ years younger than the transferor, and the transferred amount exceeds the estate tax exclusion threshold. GSTT is imposed at a flat rate of 40%.
The GSTT applies to transfers by “US persons” for US transfer tax purposes (being US citizens and US domiciliaries) and non-US persons who hold certain US situs property (such as real estate located in the US or stock in a US corporation).
GSTT can apply in a number of scenarios:
Example 1 – Direct Skip: Miriam transfers cash and assets valued at of $13.5 million to a U.S. irrevocable trust established for the benefit of her grandchildren, Bob and Mary (“skip persons”). Miriam must report this transfer and pay tax on $1.92 million (being the amount in excess of the lifetime GSTT exclusion of $11.58 million in 2020), at the rate of 40%.
Example 2 – Indirect Skip (taxable termination): Miriam transfers the cash and other assets referred to in Example 1, to a U.S. irrevocable trust established for the benefit of her son, John (“non-skip person”), during his lifetime. The terms of the trust agreement state that the property to pass to John’s children, Bob and Mary (“skip persons”) upon John’s death. The assets transferred to Bob and Mary on John’s death would be subject to GSTT at that time.
Example 3 – Indirect Skip (taxable distribution):
Miriam transfers the cash and other assets referred to in Example 1, to a U.S. irrevocable trust established for the benefit of her grandchildren, Bob and Mary (“skip persons”). If no estate or gift taxes applied for the transfer from Miriam to the trust, then the distributions from the trust to Bob and Mary would be subject to GSTT, and payable by Bob and Mary.
GSTT is not imposed where an irrevocable “dynasty trust” is established:
Example 4 – Dynasty trust:
Miriam transfers $11 million in cash and other assets to a U.S. irrevocable “dynasty trust”, and appoints “USA Bank” as the independent trustee to control the trust. The trust agreement specifies Miriam’s children John and Jenny as the immediate beneficiaries of the trust. Following the death of the survivor of John and Jenny, each of their children is to become an eligible beneficiary of the trust. The initial trust fund ($11 million) and any accretion to it, would be excluded from the value of Miriam’s taxable estate. The trust fund is also afforded asset protection from third party claims as the beneficiaries do not control the trust.
Our whitepaper International Estate Planning for U.S.-Australia cross-border clients provides an in-depth analysis of international estate planning issues.
For more information, please contact:
Head, US-Australia Tax Desk