The Generation Skipping Transfer Tax
As you finish up the holidays with the family, I have a great way to get the absolute, undivided attention of your children. Mention to them that you are thinking about doing “generation skipping trusts” (GST) in your estate planning. They’ll think you’ve decided to disinherit them and leave everything to the grandchildren, confirming their suspicions that you love the grandchildren more than them!
After you observe and enjoy their reaction, calm their fears and put their false suspicions to rest. Generation skipping planning means skipping taxation, not skipping your children.
Most inheritances are promptly spent
Traditional estate planning often has a short-range view. People tend to look only at the need to transfer their estate from their own generation to the next one, typically their children. They focus on avoiding things like taxes and probate. Beyond that, they cross their fingers and hope that what they give the children will last longer than two years (the time in which the average inheritance is spent).
In that view, who can concentrate on what happens when the inherited assets pass to the next generation—at the death of your children?
Farm families may have more hope that the farm will not be “spent” by the children’s generation. If you have at least one child who is farming, and if you provide for a fair distribution to other children but keep the farm available to the one who is farming, there may be a good chance that at least the inherited farm will remain in the family to be given to another generation.
Traditional Planning: One generation
Dick and Jane create a traditional estate plan: no GST provisions. They leave their farm, worth $2,250,000, to their farming son George. They leave other assets to George’s two siblings. At the time, George had his own farm started, worth $250,000. Fast forward now, as George lives another 28 years. During that time, he teaches at least one of his own children the value of land as a stable, long-term investment, and instills in them his love of the farm life.
If the farm appreciates during George’s life at about 5% per year, when George dies his farm will be worth nearly $10,000,000. Around ninety percent of that was inherited, 10% was his own purchase. Under current tax laws (i.e., unless our current Congress passes new legislation to increase the estate tax exemption) at George’s death almost $5,000,000 will be due in estate taxes on that farm! This will create a huge problem for George to try to pass the farm, and the rest of his estate, to Dick and Jane’s grandchildren.
Bill and Mary plan to leave a similar farm to their son, Tom. Like George, Tom has a $250,000 estate of his own. Bill and Mary, however, include GST provisions in their planning.
Tom gratefully receives the $2,250,000 farm in trust. The trust protects the farm from lawsuits, divorce, and similar predators. Tom has the right to farm it and keep the income. If he needs to he can even sell land and spend the proceeds. He, like George however, keeps the farm intact for 28 years and instills the love of farming in at least one grandchild. At Tom’s death, his farm is also worth $10,000,000, and he can leave it to any of Bill and Mary’s grandchildren, under any conditions Tom chooses.
However, the $9,000,000 in property that came from Tom’s parents will incur no estate taxes. Zero. His additional $1,000,000 in land (what he purchased for $250,000) will pass free of estate tax as well.
Now, are you sitting down? The $10,000,000 that passed to grandchildren can grow for another generation, and pass to Tom’s grandchildren tax free!
This GST principle applies to all the children, not just the farmer. If you have any children you think might grow (not blow!) their inheritance, consider GST planning. Whatever you pass on, plus all growth during the life of the child, passes estate tax free to another generation.
Illinois law allows your children to apply the same principle for the next generation, and the next, and the next...forever...which is a very long time to avoid estate tax on the family farm!
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Article authored by Curt W. Ferguson and originally published in the Prairie Farmer magazine, January 2007 issue