Here’s a way to cut your GST tax exposure through direct gifts. You and your spouse could each give up to $15,000 annually to each of your three grandchildren. This could be via outright gifts or gifts to Crummey trusts set up for each grandchild. Each grandchild must be the sole beneficiary of his or her Crummey trust. Under this arrangement, each grandchild can be given up to $30,000 each year without any GST tax or gift tax and without using up any of your or your spouse’s $11.4 million GST tax exemption or any of your or your spouse’s $11.4 million unified federal gift and estate tax exemption. That way, both you and your spouse can preserve your exemptions to shelter future gifts and bequests you intend to make under the terms of your wills.
You can also avoid both GST tax and gift tax issues when you make direct gifts to cover a grandchild’s tuition (not room and board or books) or medical expenses. These are a great wealth-transfer tools, because there is no limit on the amount you can give. For example, say you decide to pay your granddaughter’s $56,000 tuition to attend Duke University. As long as you make the payment directly to the school, no GST or gift taxes are due. And, if you wish, you can still make annual $15,000 tax-free gifts to your grandchild (or up to $30,000 annually if you and your spouse make joints gifts) to cover other expenses such as room and board, emergency pizza runs, other incidentals, transportation, and so forth.
Indirect gifts are trickier
A whole book could be written about how the GST tax can unexpectedly come into play when you make indirect gifts or bequests to trusts. But you probably wouldn’t want to read it. So here’s the gist.
By indirect gift or bequest, I mean when you give or leave money to a trust with your grandchildren named as contingent beneficiaries. Or when your grandchildren are primary beneficiaries of a trust, along with one or more other persons from an older generation. When money or assets come out of one of these multiple-beneficiary trusts to a grandchild, watch out! The GST tax will generally be due, unless you or your estate’s executor has affirmatively allocated (used up) some or all of your $11.4 million GST tax exemption to cover the initial gift.
For gifts, you make an affirmative exemption allocation on Form 709 (the federal gift tax return) filed for the year you make the gift. To make the GST-tax-saving allocation, you must file Form 709 even if you don’t actually owe any GST or gift taxes for that year. For bequests, your executor can make the allocation as part of handling the estate tax return.
Let me give you a very simple example of how an indirect gift can cause big-time GST tax problems down the road.
Say you give $10 million worth of stock in 2019 to a trust set up for your adult daughter. She is to receive all the trust income for her life. Whatever’s left in the trust after she dies goes to her two children (your grandchildren). So far, so good. There’s no gift tax, because your gift is under your $11.4 million federal gift tax exemption. And there’s no current GST tax, because your grandkids are only contingent beneficiaries (they get nothing until your daughter passes away). So when you set up the trust, you fail to allocate any of your GST tax exemption to the gift because you don’t see any problems. Wrong! Years later when your daughter dies, the stock is worth $30 million. So the trust is liquidated, and your two grandchildren receive $15 million each. Unfortunately, they will have to pay a GST tax bill amounting to several million dollars. Why? Because they are each treated as receiving a $15 million gift from you under the GST tax rules. Had you simply allocated $10 million of your GST tax exemption back when you funded the trust in 2019, there would be zero GST tax due when your grandchildren get their millions.
Bottom line
As you can see, the GST tax is a nasty trap for generous well-off but unwary individuals. And this area of the tax law is very unfavorable turf for do-it-yourselfers. I recommend consulting with a competent — make that very competent — tax adviser anytime you are thinking about doing anything that could conceivably benefit your grandchildren or great-grandchildren. You’ll spend some money on professional fees. Consider it a wise investment.
This story was updated on Feb. 15, 2019.
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