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Not all wills and trusts are alike. Buried in the back of many wills and trusts is a paragraph or two which seeks to deal with the possible imposition of generation skipping transfer tax (GST tax) if a child of the settlor of the trust dies prematurely leaving young children to inherit his or her share of the trust. The GST tax has been in effect in this current form since 1986 and currently imposes a tax of 45% on transfers of wealth where the settlor on death or during his or her life skip a generation and give wealth to grandchildren. For example, a trust which provides benefits to a child of the settlor with eventual distribution to the issue of the child
where the child dies is a typical GST transfer. A second (and more common) pattern is a gift in trust to a child with outright distribution of the trust when the child attains age 40. If the child dies before age 40 and his or her share of the trust passes to grandchildren of the settlor, that share of the trust estate may be subject to the 45% GST tax on the childs death. While the law provides an exemption from GST tax of the first two million dollars in trust assets, assets in excess of two million dollars passing to the grandchildren can be subject to the 45% GST tax.
There are ways to avoid the GST tax through careful design of the will or trust. If the document includes a provision which gives the child a general power of appointment on death, then no GST tax will be imposed and instead the assets will be subject to estate tax in the childs*estate. If the deceased child has significant unused estate tax exemption, then the assets can pass free of estate and free of GST tax to the grandchildren. For example, if there were a $1,000,000 trust which is not GST tax exempt, the result of such a general power of appointment provision could save $450,000 in death taxes. There are two problems. First, if you grant the child a general power of appointment, he or she might, in fact, exercise the power to redirect the assets in a way the settlor might not want. For example, the child might appoint the
trust to his or her current spouse, friends or organizations of any type. Rutter Hobbs & Davidoff developed drafting solutions to this problem so that the child will be deemed to have a general power of appointment so as to eliminate GST tax but cannot unwisely exercise the power of appointment in favor of persons or organizations outside of the family. Second, many estate planning documents provide the trustee with the right to grant a general power of appointment to a child if it appears that such a power of appointment will save estate tax. Death, however, is often unexpected, particularly with younger persons, and the trustee may not have time or willingness to grant the child a power of appointment prior to the death of the child. At Rutter Hobbs & Davidoff, we have developed a formula provision which automatically grants a power of appointment to the child to the extent such power of appointment will actually save GST tax.
If you have questions about your estate planning, contact the attorneys at Rutter Hobbs & Davidoff. Not all estate planning attorneys are alike.
Terence Nunan is certified by the State Bar of California in probate, estate planning and trust law. Terry offers practical solutions to the challenges and risks of preserving family wealth. His advice ranges from simple to complex matters, including estate planning, estate and trust administration and post-mortem tax planning. He helps clients create living trusts, irrevocable life insurance trusts, family limited partnerships and defective grantor and reverse defective trusts. Terence can be reached at (310) 286-1700 or tnunan@rutterhobbs.com.