Irrevocable Trusts: Ideal Tools for Strategic Gift Planning
Because estate tax is levied on the estate of each decedent, one strategy taxpayers can use to avoid a level of estate tax is to place property into a trust which would benefit their children during their lifetime and then pass directly to their grandchildren, thereby avoiding the inclusion and taxation of property in the estate of their children. To neutralize the benefits of this “Generation-Skipping”strategy, Congress enacted the Generation-Skipping Transfer (“GST”) Tax, imposed on “direct skips” of property from parents to their grandchildren. When the GST tax applies, it eliminates the estate tax benefits of Generation-Skipping transfers.
IRC §2631 grants a lifetime exemption to each individual ($1,000,000 in 2011) against Generation-Skipping transfers. Using this exemption, wealth can be transferred from a taxpayer to his or her beneficiaries with no adverse GST tax consequences to the next generation and no inclusion of the property in the estate of the beneficiaries.
Securing the benefits of the GST exemption can be accomplished in several ways. One method would be to create a stand-alone irrevocable trust to be funded during the Trustor’s lifetime with gifts from the Trustor. Each transfer to this trust would use a portion of the Trustor’s GST Exemption. In addition, the Trustor could send his or her remaining unused GST Exemption upon death through a “pour-over” provision in his or her revocable trust. In this way, none of the Trustor’s GST Exemption would be wasted.
Upon death, the irrevocable trust would give maximum control to the Trustor’s children over principal and income, yet sufficiently restrict access to avoid inclusion of the trust in their respective estates. The trust corpus would subsequently pass to the Trustor’s issue (grandchildren), or to others as the Trustor’s children choose, completely free of estate tax.
Benefits of GST Trust
1. Tax-free skip. The term “generation-skipping” is a misnomer. It is not that we are skipping the children out of the benefit of an inheritance. Rather, we are skipping the IRS out of a generation’s worth of estate taxes. Upon death, the Trustor’s children have the use and enjoyment of the GST Trust for their entire lifetime. It is upon the children’s deaths that the tax-free “skip” occurs. The GST Trust passes free of any estate taxes to the grandchildren.
2. If structured properly, the assets of the GST Trust satisfy the provisions of Arizona’s “spendthrift”statute and are beyond the reach of the children’s creditors. Consequently, creditors resulting from lawsuits, divorce, or bankruptcy cannot attach the assets of the GST Trust.
If you would like more information regarding irrevocable trusts, gifting, estate and gift tax, asset protection, or any other topic discussed in this article, please contact Matt to schedule a free initial consultation.