A Guide to Understanding Tax on Generation-Skipping Transfers

March 6, 2023Filed Under: Estate Planning, Taxes

In the US, generation-skipping transfer (GST) is the US government’s tax on transfers of property that skip a generation. Its primary design is to prevent wealthier individuals from avoiding estate and gift taxes by transferring large amounts of assets to their grandchildren, bypassing their children. The GST tax applies on top of all other applicable estate or gift tax, and its calculation is a percentage of the transfer’s value. The tax ensures that transferred wealth has tax consequences from generation to generation.

Benefits

Even though GST can have tax consequences, there are still several benefits when implementing a generation-skipping transfer:

Estate Tax Savings – This type of transfer may allow a person to reduce or eliminate the estate tax liability.
Asset Protection – The transferor may be able to protect those assets from creditors or other potential claims.
Wealth Continuation – Skipping a generation may ensure that the property remains in the family for multiple generations.
Property Control – When transferring property to a trust, the transferor may retain some control over the property, even after the transfer.

It’s important to understand that the specific benefits of implementing a GST tax plan will depend on the individual’s specific circumstances. Consult an estate planning attorney to determine the best plan for generational wealth transfer.

What is a “Skip Person”

Skipping the immediate child’s generation and naming grandchildren as beneficiaries allows inheritable assets to skip one generation of the estate tax. The person in the generation being bypassed is the “skip person.” In 1986, the IRS Internal Revenue Code (IRC) began applying a flat tax on generation-skipping transfers. A grandfather clause permits older irrevocable trusts from being affected by the GST tax.

The GST can also apply to direct transfers to these beneficiaries and any gifts made to them through a trust. Therefore, under certain circumstances, some trusts can also be a “skip person.” There are exceptions for those descendants who are grandchildren of parents who have predeceased them. In this instance, the children effectively “move up,” taking their parents’ place, so the GST tax no longer applies to them as the gift doesn’t skip a generation.

It’s important to note that the IRC provides GST tax exclusions, as it does with gift taxes. In 2023, the GST lifetime exemption excludes the first $12.92 million, whereas the gift tax exclusion annually allows $17,000 tax-free per person. Married couples may double the amount because the tax-free status applies to each person gifting.

How does the IRS Assess the tax, and who pays the GST?

GST calculations are currently a flat rate of 40% which is equal to the estate and gift tax rate on transfers above the lifetime GST tax exemption amount. According to the IRS, the 2023 federal estate, gift, and GST basic exclusion amounts are $12,920,000 per person. This lifetime GST tax exemption amount will grow annually through 2025 based on inflation rates. Without Congressional action, the exemption amount in 2026 will revert to a $5,000,000 baseline, indexed for inflation.

Some states collect generation-skipping transfer taxes. Typically this occurs in states that already impose estate taxes. These states may continue mimicking federal GST regulations and revert to a $5 million baseline in 2026, although some states may act independently.

If the assets and money are in a direct GST, the trust grantor, who opens and funds the trust, will set up provisions to pay the tax. If assets are in an indirect GST, the skip beneficiary (usually a grandchild) is responsible for paying the tax; however, they may pay out of inheritance proceeds.

Using a Lifetime Exemption from GST

The lifetime exemption offers some advantages as it can apply to any combination of transfers during your life or those made at the time of death. Two potential strategies might be:

During your lifetime, you can gift up to $12.92 million into a trust that eventually distributes assets to your grandchildren. This strategy will shelter projected appreciation for future generations.
At your death, your testamentary trust may leave up to $12.92 million in lifetime trusts for your children. Upon their death, the trust’s $12.92 million (plus appreciation) passes to your grandchildren without incurring a GST or estate tax.

Although you don’t need much money to implement a GST tax plan, most people will never encounter the GST because of the high dollar threshold.

Why an Estate Planning Attorney is Recommended

While you aren’t legally required to hire a lawyer to handle your GST tax situation, you should consult with one. GST tax can be complex, and there are many rules and regulations. An estate planning attorney understands the tax implications of your planned transfers and ensures that your estate plan’s structure will comprehensively minimize your tax liability. Additionally, an estate planning lawyer can navigate any legal issues that arise and provide valuable advice on the best course of responsive action. Hiring an estate planning attorney to assist with the GST tax process is a sound strategy if you have a significant estate and are considering transferring assets to future generations.

We hope you found this article helpful. If you’d like to discuss your particular situation, please don’t hesitate to reach out. Please contact our Cincinnati office by calling us at 513-771-2444 and schedule a consultation. We look forward to the opportunity to work with you.

GETTING MARRIED? YOU MAY WANT TO CONSIDER A PRENUP!

July 26, 2020Filed Under: Asset Protection, Dissolution, Divorce, Property Division

By Chris Diedling

If you are engaged and planning a wedding, this is supposed to be one of the happiest times in your life. You are soon to be married to the love of your life and your “happily ever after” is all that matters, right? The last thing you want to think about is what happens if you and your future spouse get divorced. However, as much as a marriage is the ultimate, intimate bond between two people who love each other, marriage is also a formal, civil contract between you, your partner, and the State. This civil contract comes with certain rights and legal obligations concerning assets, debts, and finances.

To put it simply, you are signing up for a lot more than “happily ever after” Marriage is a legal commitment involving sharing of property, debt, and the duty of support. The decision to enter into a prenuptial agreement is one that ought to be discussed by every soon-to-be-married couple. This discussion is a crucial planning tool for couples to get on the same page before any issues arise. Rapper Kayne West perhaps said it best about prenups, “It’s something that you need to have because when she leaves your a**, she’s gonna leave with half”

WHAT IS A PRENUP?
A prenuptial agreement, also known as a premarital agreement, antenuptial agreement, or colloquially referred to as a “prenup,” is a written contract entered into by a couple prior to a marriage. This contract establishes the property and financial rights of each spouse in the event of a divorce or separation. A prenuptial agreement determines at least three important questions to be answered in a future marriage termination: 1) How your assets & debts will be divided; 2) How your assets & debts will be categorized; 3) Whether either party will be paying support to the other.

WHY WOULD I NEED A PRENUP?
You may be reading this article with skepticism and have thoughts such as, “if my future spouse and I really love each other, we wouldn’t need a prenup” or that “prenups are only for couples who can’t fully trust each other.” This is a perfunctory and naïve way of thinking. It is so easy to be blinded by love and the idea of “happily ever after” to the point where you never stop to consider the reality of marriage.
Some other common misconceptions and falsehoods about prenups include: “prenups are only for wealthy people,” “I have zero assets going into the marriage, I don’t need a prenup” “a prenup automatically means no future spousal support or alimony,” “prenups show a lack of commitment or faith in the marriage.”

All of these notions are completely false. Many of these myths have caused reasonable, intelligent people to entirely dismiss the whole idea of a prenup when planning their wedding. Some have been lucky enough to never know the consequences of not having one; others wish they would have had a prenup.

I am not trying to rain on your joyous wedding parade in the least. By all means, there is absolutely nothing wrong with being ecstatic about your upcoming marriage! Love and happiness are both real and attainable and you should be thrilled on reaching that point with your soul mate! But, it is equally important to acknowledge reality and plan responsibly for the future. After all, responsible adults commonly plan for life events, both positive and negative, as everyday occurrences. We utilize insurance policies to plan for disasters such as floods, fires, and car accidents, etc. We use estate plans to distribute assets to our beneficiaries after we’re gone. We set up trusts and college funds for our children. We invest and save for the future. Why should a prenuptial agreement be any different? Forget the minimal, temporary discomfort in approaching the subject with your partner. The reality is, at least 50% of marriages end in divorce and that statistic could be increasing according to recent studies.

Wouldn’t you want to be prepared for any event that has at least a 50% chance of occurring?
A prenuptial agreement is not planning for a likely marital failure. Rather, it is a vital tool for couples who genuinely trust each other enough to reach a comfortable agreement on the terms of a separation in the event the marriage does fail. Instead of looking at a prenup as a lack of trust or commitment in a marriage, look at it as an indicator of common sense!
A top-notch family law attorney once told me, “never marry someone you couldn’t stand to get divorced from.” Valuable advice indeed. If you are able to discuss the issues covered by a prenuptial agreement with your future spouse, you are planning for success. After discussing these issues, you and your partner will have a better understanding of each other’s expectations and a lot of future conflict can be avoided.

WHAT DOES A PRENUP DO FOR YOU?
A prenup will serve as a roadmap for an amicable resolution in the context of separation and through all of strife that comes with it. A prenup can save a lot of time, expense, and emotional hardship should a divorce ever occur.
Identify and allocate separate and marital property/debt: The prenup can identify each spouse’s separate property and/or debt and how these assets/liabilities shall be treated if a divorce should occur. You can also decide how marital property will be divided rather than leaving it up to the court to decide through divorce proceedings.
Spousal support considerations: The prenup can be used to guarantee either spouse a minimum amount of spousal support in the event of divorce. A couple can agree on no spousal support, a fixed or sliding amount, payments for a finite period of time or until a triggering event (such as remarriage) occurs. Keep in mind that all prenuptial agreements are subject to a court’s review and if your agreement isn’t fair, the court could invalidate the provision.
Allow children from a prior marriage to inherit separate property: The prenup can ensure that children from a prior marriage inherit their share of your estate when you die. Without a prenup, the surviving spouse may have the right to claim a large portion of the deceased spouse’s property, leaving little to nothing for the children of the prior marriage.

WHAT DOES A WELL-DRAFTED PRENUP NEED?
The most essential factor for a successful and legally valid prenup is full and complete disclosure of each spouse’s assets and debts going into the marriage. Full disclosure ensures that the prenup process is both fair and equitable in the eyes of the court.
Additionally, every valid prenup must be in writing and voluntarily signed by the parties. The prenup must be fair and reasonable and both parties must understand and clearly indicate such understanding of the agreement. Both parties must have had adequate opportunity to consult with legal consul. It is highly recommended that both parties to a prenup obtain legal representation. You will want to contact and attorney to ensure your prenup is prepared and executed in compliance with the law.

HOW CAN I GET A PRENUP?

If you would like to contact Chris to discuss a prenuptial agreement, please call 513-771-2444 to schedule a free 30-minute consultation!

Who Gets to Claim the Children on their Taxes during a Divorce/Dissolution?

April 24, 2013Filed Under: Dissolution, Divorce, Property Division, Taxes

Who Gets to Claim the Children on their Taxes during a Divorce/Dissolution?

This is a common problem among my clients, so I thought it would be appropriate to give a general overview on here.

Taxes can be very complicated. It is hard enough to sort out when a child is a child on line X, but not line Y, and when a qualifying dependent qualifies for the purposes of C, but not D. But who actually gets to claim the children in the first place? Like so many other legal questions, the answer is “It depends, and what it probably depends on is the judge.”

In many if not most cases, ex-spouses simply agree on who gets to claim the children. Parents who retain joint legal custody, especially in situations with 50/50 parenting time arrangements, frequently decide to split each year. This can be done by each taking half (in the case of four children, each spouse claims two), or, more commonly, the parents go year by year (Dad claims the children in year 1, Mom in year 2, etc.). The latter is generally more preferable not only because of the legal absurdity of chopping a child in two in the case of an odd number of children, which you cannot do on Ohio or Federal tax returns, but claiming multiple children frequently qualifies parents for a more favorable tax bracket, such as head of household, or qualifies them for additional exemptions or credits, like the Earned Income Tax Credit (EIC), resulting in a net gain for both parents over two years.

The question gets more difficult when the soon to be ex-spouses do not agree. Even in the most amicable dissolutions, I like to inform my client how a judge would likely rule should an agreement not be made, if only for them to better understand what is fair, or more accurately put, what the Ohio legislature and courts believe is fair.

The Ohio Legislature has given the courts a large amount of deference when it comes to divorce/dissolution agreements. However, in regards to claiming dependents, the code uses the word “shall,” a word fairly obscure in Ohio domestic relations statutes (as opposed to “may”). The codes uses “shall” to dictate that when the parties of a divorce or dissolution agree who ought to claim the children as dependents, as in the court “shall designate that parent as the parent who may claim the children.” [See Ohio Revised Code 3119.82] In cases where the parties do not agree, courts may exercise their discretion in determining who may claim the exemptions.

When an Ohio court rules that the residential custodial parent (in the case that there is only one residential and custodial parent) may claim their children for tax purposes, that is likely the end of the business. No additional analysis by the court is mandated by law, and should the ruling be appealed, the appellate court will review the decision on an abuse of discretion standard (really high standard). The court may however award the exemption to a non-residential and non-custodial parent when it rules to do so would be in the child(ren)’s best interest. Factors the courts are to use in determining what is in child(ren)’s best interest include net tax savings between the parents, the relative financial circumstances and needs of the parents/children, the amount of time the children spend with each parent, the eligibility of either or both parents for the EIC, and any other relevant factor. While statute mandates these factors be considered, how to weigh them lies in the discretion of the trial court.

That is domestic relations tax law in a nutshell. Like any other legal determination, the wisest thing to do is retain an appropriately knowledgeable attorney that knows how local judges weigh and are likely rule on each issue. Additionally, it is important to understand that complicated tax issues must be handled by a tax attorney along with your domestic relations attorney. I just hope this article clarified a few common questions my clients frequently have.

Embarrassing Information: What to Tell Your Attorney

March 29, 2013Filed Under: Dissolution, Divorce, Misc Advice, Property Division

Embarrassing Information: What to Tell Your Attorney

Everything. Excuse me. What I actually meant was ABSOLUTELY EVERYTHING. This is one of the biggest mistakes people make when they are going through a legal matter. They think “this is irrelevant” or that “if it is important, they will ask.” Also, the devil’s in the details. Leaving out details, misleading your attorney, or worse, lying to your attorney will do nothing but hurt you down the road.

Domestic Relations law is frequently seen as a messy business. Unfortunately, many parties in these cases (and sometimes even their lawyers) prove that representation true. It can be messy because we are not in the business of drafting patents or protecting corporations, but rather mending and moving lives and families. Keeping secrets from your attorney does not make the process less messy, it just makes you vulnerable. Even if no one in the world knows something except for you, if it could conceivably hurt you, undermine you, or make you look bad, your attorney needs to know it. We are duty bound to keep your secrets except in extraordinary circumstances (like if you were going to hurt someone or were about to defraud the court). Your attorney is on your side. Better put, our side is your side, so be as candid as you can.

Big Things to Tell Your Attorney

1. Assets

Make an inventory of all assets you and your spouse hold together and separately. Note when they were acquired and under what circumstances (purchase, inheritance, lease, etc.) and the date of acquisition. You absolutely must disclose all of your assets and liabilities to your spouse when you are going through a divorce or dissolution. You will eventually testify under oath to the court that you made a full disclosure of these things.

2. Prior Legal Proceedings, Civil and Criminal

If you have been involved in any other legal proceeding, civil or criminal, your attorney really needs to know. Tell when it happened, what happened, and what the outcome of the proceeding was (settlement, damages, convictions, acquittals, etc.). Give the case number if you have it so we can look it up, and if it happened as a juvenile, look up the case as best you can. Your attorney may need your help to get access.

3. Violence, Threats of Violence, or Harassment by You or your Spouse

Interpret this broadly. Hardly any domestic relations matter occurs without at least some form of “violent” or intense contact. This includes shouting matches or particularly heated arguments. It probably means nothing, but we need to know. If you or your spouse has ever hurt one another, even accidentally, tell us. If you have ever threatened or been threatened with violence, even if no one in the world, if there, would have interpreted it as an actual threat (i.e. “to the Moon, Alice!”), tell us. We want you to be ready for anything. Lastly, outline all the contact you have had with your spouse since you began to consider divorce. Cooler heads prevail in domestic relations, but any ugly contact from you or your spouse needs to be known by your attorney.

In conclusion, tell us everything. We are your advocate, and while I can only speak for myself, your attorney will not judge you. Your attorney only wants the most accurate picture possible so they can get you through this in the best position possible.