As most estate planning attorneys know, if the government is thinking of closing a loophole, it probably means it is an effective strategy. Last week, I discussed the potential closing of the so-called “backdoor Roth IRA” loophole. This week, I’ll discuss “GST” exemption and dynasty trusts in broad terms (there are many technical issues beyond the scope of this blog). For the past several years, the Obama Administration has proposed having GST exemption allocation expire after 90 years, rather than being permanent.
Congress put the estate tax in place almost a century ago and envisioned it as a tax on wealth at every generation. Savvy estate planning attorneys and their wealthy clients figured out a way to game the system: have the client leave their assets to their grandchildren rather than the children. This avoided tax at the child’s level, cutting the tax hit in half over time. The Generation-Skipping Transfer (“GST”) tax was put in place to plug this loophole (in part). However, practitioners have skillfully figured ways to expand that loophole. Rather than having the client leave the assets to the grandchild, the client leaves the money to a trust for the benefit of children, grandchildren, and more remote descendants. In this way, the assets are available for the child’s use, but will not be taxed in the child’s estate. In fact, if GST exemption is allocated at the outset, the assets are never again subject to estate and gift tax, as long as they remain in the trust. This strategy has become even more powerful as many states have repealed or modified the Rule Against Perpetuities. Now, in many states, the assets may remain in the trust forever, thus eternally avoiding transfer tax. (A trust which continues generation after generation, in perpetuity, is known as a “dynasty” trust.)
This strategy is a very powerful one to build dynastic wealth, which is why the government is looking to shrink the loophole.
Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (800) 846-1555
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