Conversation about... Generation Skipping Within Estate Planning

This is part of a communication to the father of a client regarding Generation Skipping within his estate planning.

Not long ago, your lawyer gave your daughter, our client, an excerpt from your will. The provision is designed to give her a limited power to control the disposition of the “Non-Exempt Generation Skipping Portion” of the trust(s) established under your will.

As you know, the IRS becomes interested when a person leaves assets to a person that is more than one generation removed from themselves, such as a grandchild. The idea of assets escaping the estate tax for more than one generation really upsets them. More specifically, the IRS limits how much you can leave to such a person without being subject to a penalty tax, called a Generation Skipping Tax. (The tax is currently 45%.) So when you leave money to a grandchild, for example, a good estate plan splits the amount left into two pots. One pot, the “Generation Skipping TAX-EXEMPT Portion” represents the amount that can be left to a grandchild without being subject to the penalty tax. The other pot, the “Generation Skipping Tax NON-EXEMPT Portion” represents the amount that can not be left to a grandchild without being subject to the penalty tax.

A simple way to deal with the two pots is to leave the non-exempt share outright to the child/children instead of leaving it in trust for the grandchildren. The IRS is happy with this plan because they know they will be able to tax those monies in the child’s generation. The problem comes in when a parent doesn’t want to distribute the non-exempt share to the child. In this case, the non-exempt share can remain in trust for the child’s lifetime but to please the IRS there must be a provision in the terms of the trust that will cause the assets of that trust to be included in the child’s estate at his/her death. This is typically done via a General Power of Appointment (GPOA). A GPOA allows the child, by will, to appoint the assets of the trust to their estate or the creditors of their estate.

The provision in your will appears to be a Limited Power of Appointment. That is, your daughters can only appoint the assets among your issue, the spouses of your issue and some charities. While you need to consult your counsel on this, I fear that this limited power does not provide enough control to cause the assets of the Non-Exempt Trust to be included in the taxable estates of your respective daughters. If the assets are not deemed to be includable in their estates, then, the non-exempt share will be subject to the Generation Skipping Penalty Tax. The result is that distributions from this trust to your grandchild will ultimately be subject to a 45% GST penalty tax!

We believe this is an error though not being privy to the entire will we can not be sure. Also, while we have access to legal advice, we are not legally able to disseminate it. Thus, we recommend you ask your counsel, "What keeps the non-exempt GST trust from being subject to the generation skipping penalty tax?"

While we have your attention, we want you to know that we would welcome further conversations with you about your planning and investing. We have a wealth of expertise and experience at Bragg Financial, and, perhaps most important, we are truly committed to our clients and our practice. I like to say that my fellow principals and I are up against the glass ceiling. We are not going anywhere, so when we say we are going to take care of our clients, we really mean we, not the next guy that we hire when I move on to work at some new hedge fund. In fact, all four of our principals came from other financial firms so we recognize that the best folks generally leave big financial service firms to work in more intimate boutique wealth management firms where relationships are more important than this year’s goals. That may be more than you wanted to know but, having worked several years at Wachovia Wealth Management and Trust, I am keenly aware of our strengths here.