There is a federal estate tax and a federal gift tax. The purpose of the gift tax is to prevent reduction in federal estate taxes through gifts. The purpose of the estate tax is to tax estates estates over a certain size. In 2012, only estates over $5.12M are taxed. In 2013 that sum is reduce to $1M. The generation-skipping transfer tax is imposed to prevent reduction in federal estate tax liability because the transfer has "skipped a generation" and has been made to grandchildren, as opposed to a child. It is imposed when a transfer by gift or trust avoids incurring a gift or estate tax any particular generation level.
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Mr. Daymude gave a good explanation. To add to it ... the generation skipping transfer tax applies if more than a certain amount is given to anyone other than your spouse and children or to unrelated people who are more than 37-1/2 years younger than you (so if you're 60 and you give assets to someone who is age 22-1/2 or younger, it would be a generation-skipping gift). Until Dec. 31st, you won't run into the generation-skipping tax until you give away more than $5.12MM dollars. Unless Congress fixes the law beginning 1/1/2013, you could run into this problem if you give away over $1MM.
The tax is a flat 55% on all gifts that are considered "generation-skipping transfers". That tax is in addition to - not instead of - the "regular" estate tax. So if you had a $6MM estate and gave it all to a "skip person" this year, you'd pay the regular 35% estate tax on $6MM - 5.12MM and you'd pay an ADDITIONAL 55% Generation-Skipping Tax. If you wait until next year and the exemption goes down to $1MM, you'd pay up to 55% regular "sliding-scale" estate tax on $6MM - $1MM (the exemption decreases next year and the maximum tax rate increases) PLUS the 55% GST Tax.
This is an area that has a number of very technical requirements and there are several exceptions to the rule (for example, if the donor is making the gift to his grandchild because his child - the grandchild's parent - is deceased, the grandchild is not considered a "skip person"). If you have questions, you need to consult a competent estate planning lawyer for assistance.
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Both attorneys offer tremendous answers. The point here is that this is a SECOND estate tax that can result if too much is given to grandchildren. However, if it is less than $5,120,000 this year then there is no problem. Therefore, in the right situation setting up a GST trust would be ideal in 2012. Get with an estate planning attorney immediately.
Hope this helps.
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