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The Practical Planner
Dynasty Trusts & the GST Exemption: Protecting Wealth Across Generations
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- [00:00]
Ann
Foreign.
- [00:11]
Thomas Coleman
Welcome back, everyone, to another episode of the Practical Planner podcast. I'm your host, Thomas Coleman, here with me, Dave and Ann. And today we're going to be talking about Dynasty Trust and the GST exemption. And basically we're going to hand it all off to Ann, and she's going to just rattle things off for 30 straight minutes, and we're all just going to clap as she dives into all of the fun stuff that relates to these two topics.
- [00:34]
Dave
You make me sound like such a nerd, but I truly do love GST taxes. I was like, we have to put this some something about gst.
- [00:43]
Thomas Coleman
Very open floor. Let us know what does that even mean? Because I think most advisors should know what this is, but it is something that you have to move up the wealth space for it to actually become impactful in planning.
- [00:57]
Dave
Yeah. So the GST tax, which stands for generation skipping transfer tax, is actually the third type of transfer tax, the one that, like very few people ever talk about, other than the estate tax at the federal level and the gift tax at the federal level. And, you know, we can get into state taxes, but it's just, you know, for purposes of this episode, let's just leave that aside for now. But the idea of the generation skipping transfer tax is kind of in the name, is that. Imagine like the Rockefellers of old, right? They started getting really cute about certain transfers because they were thinking, okay, let's say I have a million dollars that I want to transfer and I could transfer a million dollars straight to my child so that when they die, they transfer, let's say, the million plus the growth to their grandkids to. To my grandchild. And at every step, when there's a death, there's going to be a 40% tax, right? And so grandfather decides to get cute about it and is like, well, my child is independently wealthy already. Like, I've already done plenty of transfer to my kid, so let me just skip one of those deaths and transfer the million dollars straight to my grandchild. And especially if it's in a trust, right? That's how you can get away with doing things like that. And so that skips a generation and that skips an estate tax. And so the GST tax is basically there to mimic as though you had imposed some sort of an estate tax by making sure that any distribution to what's called a skip person. So this is somebody who's in the generation more remote than just your children, is going to have to pay a tax on that distribution that they get from you. And the definition of the skip person is pretty much what I said. It's any descendant of yours who's in a generation that's lower than just your kids or a person who's apparently younger than you by 37 and a half years. That's just like what how they define this. And so the idea is, let's say you're very wealthy and you give a Van Gogh painting or something straight to your grandchild, because that's the grandchild who loved that painting when it was hanging in your house. That distribution is subject to that GST tax upon your death. And the child is responsible. Sorry, the grandchild is responsible for picking up the tax bill on the painting. The value of the painting. GST is also interesting because there is an exemption amount that comes with it and a tax rate. Right. And it tracks the estate tax. So that's where it like gets a little confusing because the exemption amount is exactly the same for GST purposes as your state exemption amount. So currently 13.99 million. But importantly, it's tracked as a completely separate bucket from the estate tax. So in estate tax world, you're kind of used to this idea of like the estate tax is 13.99 million. So if somebody dies, they can only pass, you know, 13.99 million or below completely tax free. But the GST tax actually works the same way. It's just that you can pull from it in different ways because your gift only the gifts to skip people to those grandkids start counting and how that plays out. And I'm going to take a pause here, but how that plays out is that, let's say, for example, you did cut a check for $200,000 to your child. You just pulled from or reduced your estate and gift tax exemption by $200,000. But you never touched the GST tax exemption that stayed at 13.99 million. So one of your pools of exemption just got reduced by 200k down to now 13.79. But your GST tax exemption stayed exactly the same. So you can start because of gifting throughout life, you can start actually having the two buckets be different numbers for the same exact person. Pause here.
- [05:28]
Thomas Coleman
For the same exact person who's the gifter?
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Dave
Yes.
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Thomas Coleman
Okay. Okay, that makes sense. So this is actually interesting. I know some about this. I wouldn't say I'm the expert on this. So when you use that age difference, what if your kids are past that age difference?
- [05:44]
Dave
So it's an either or kind of situation. So, you know, descendants are tracked In a very different way. And then the 37 and a half years is more like, you know, I don't know, like housekeepers. There are some beneficiaries, nieces and nephews kind of situation where the 30 and 7 and a half plays in Davis.
- [06:04]
Ann
Yeah, no, that like, you know, Your kid was 40, like Al Pacino just had. Had a child. Like, it's if, if he gives to his child, it's not going to be generation skipping.
- [06:14]
Thomas Coleman
Okay.
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Ann
Tax concerns, because his child.
- [06:16]
Thomas Coleman
Okay, that makes sense. I was like, I know people have kids a little later now, so I don't know if that changes it in any way. Okay, question.
- [06:24]
Dave
Yeah. And then that tax is also at 40%. So that's why it gets so confusing with GST, because it wants, it looks like it mimics a little bit the estate tax, but it is actually just a different tax regime and it only applies to certain types of gifts and distributions to these types of, like skip people. That's only one that's technically like, you.
- [06:44]
Thomas Coleman
Know, let's say you're 80 years old. You, you technically have 13.99. Twice as long as you have grandkids or nieces and nephews and people to be. To use that too.
- [06:54]
Dave
Yes, potentially.
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Ann
Well, yes, but remember that when you're gifting to a, like if it's a direct gift to a grandchild, you're using both at once.
- [07:03]
Dave
Yes.
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Thomas Coleman
Oh, okay.
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Ann
You know, like if you give $5 million directly to a grandchild, you're using your estate tax and your generation skipping tax exemption at the same time with that one gift.
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Dave
So in my example, I'm gifting to the child. So I only implicate the estate tax exemption. Because GST is for skip people and a child is not a skip person. The reverse is not necessarily true. Which is if you give to a grandchild, you only implicate the gst. That's not how it works. You implicate both.
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Thomas Coleman
Okay, so how do you max leverage this in practice?
- [07:39]
Dave
So in practice, right, you. There are a couple of ways in which GST starts playing and it really is a technique for really high net worth people, like ultra high net worth people. Because you're thinking that the money could last not just your child's generation, but with appreciation, et cetera, and investments, your money could potentially last another generation and reach your grandchildren. And so this is where we pull in the dynasty trust. Okay? So every single person has this 13.99 million of GST tax. And so if you want to create some sort of structure like The Rockefellers had where a pool of asset will never get taxed again by the US Government upon people's deaths, then what you want to do is form a trust to hold those assets so that the trust kind of like, you know, is the owner. And as that pool of assets keeps growing, it may potentially never get subject to the GST tax again because you have assigned to that trust your entire GST exemption of 13.99 million to shield those assets. What ends up happening with these trusts is that you can have trusts that have kind of some assets are GST exempt, but some are not. Right? Let's say you have a 15 million dollar trust because that happened to be how much you wanted to transfer into it. And you only can assign that 13.99 million. That leaves a million and ten thousand dollars that's not GST exempt. So the IRS figures that when distributions come out to your kids, your grandkids, whatever, that they can actually get a portion of that distribution still taxed. There's like a fraction problem here, a percentage problem. Some of it is GST exempt, some is not. And what ends up happening is, is that that beneficiary is going to always have to basically pay the GST tax anytime they get a distribution, which is really not great planning, right? Like you don't want that beneficiary to have to file income tax returns and have to declare that a portion and that trust portion changes. That portion is still GST subject to GST tax. So what ends up happening in the space is that you end up having to what's called sever trusts. You literally cut them at the point in time where like the GST is exempt versus non exempt. You split off the trust so that for those beneficiaries, you only give them non exempt gifts so that they do not have to pay tax on any portion of their distributions. So a ton of planning is done around the GST tax for the people who have dynasty trusts.
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Thomas Coleman
Okay, I think I'm tracking with you pretty well here. I can't guarantee it though.
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Ann
I think, you know, I think the point is, is that like a good, like a good planner, like no one's going to end up paying GST tax or they shouldn't, right? Probably. And Ann, you can probably correct me on this, but probably, no matter your level of wealth, if you planned right, there should never be a GST tax issue in any way, shape or form.
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Dave
Yes, and here's what I would say too, which is you don't need to worry very much as a Financial advisor about the GST tax, but for making sure that you have your clients that have that kind of net worth have a really solid form in their hands to do their estate planning. Because a really solid form will have baked into its boilerplate certain rules about the GST tax, such as, yes, you can sever a trust like a very big trust into its exempt and non exempt portions. You can do certain other kinds of planning because to Dave's point, you should never have to pay the GST tax. And so you can have benefits. Beneficiaries themselves use their own exemption for GST purposes and assign it to the trust. But that needs to be done in the document itself creating the trust. And so this is the GST tax at the end of the day is about the power of your documents to allow you to do planning in 30 years when it becomes relevant.
- [12:15]
Ann
And I also think the inverse is true because we get this with the gift tax a lot. But it also comes up with a generation skipping taxes. People who in no way shape or form are ever going to have to worry about this type of thing. Hearing about a tax, if you gift to grandchildren, hearing about generation skipping tax and thinking I can't give to my grandchildren because of it. The rules are so complex, but it really is tied more to the ultra high net worth. It doesn't mean you shouldn't worry about it. You should talk to your advisor about it, you should plan for it. But it is something that advisors should be aware of when to worry about it and when. You know, when you can be a little bit more relaxed. If someone, you know wants to give $10,000 to their grandchild for whatever, whatever the reason is, you're probably going to be okay.
- [13:12]
Dave
Yeah. And the other point that I'll make here is if you have a client who is ultra high net worth for whom GST tax may become applicable, just be very mindful, you know, hearkening back to another episode of ours when they do just gifting like they feel flush and they want to help their kids or whatever, that when they're cutting those big checks that you've had a conversation about that to them. Because this is the type of family where actually having a trust make a distribution instead of having the client directly cutting the big check might actually be the smarter planning because for them they need to also think about their GST tax exemption. And if all of a sudden, you know, in my previous example, you're cutting a big check to a child, then they're not utilizing their GST exemption, but now Their estate tax exemption has started going down. And so there's a mismatch between the two. And for a family where any exemption dollar is really important to try to pay less taxes, all of a sudden you're creating that mismatch and then somebody, probably an attorney is going to get paid a lot of money to try to recover or find a way to get that GST exemption to still be used. And so that's where all of a sudden you get into all these slightly more complex transfer strategies. Whereas if initially that gift had been done in a way that takes into account the GST tax, it could have been done in a much more efficient way.
- [14:47]
Ann
And I think, you know, the, the other thing is too, you know, and I was mentioning like some people don't have to worry about it because they're not ultra high net worth. We also don't know where the law is going. Right. So why use exemption? You know, because I think, you know, there's two angles to this. It's like, well, I don't have a $13.99 million estate, so what do I care if I give $500,000 to my grandchild and use up a little bit of it? You don't know where your net worth is going. You don't know where the law is going. We don't know where any of this is going. So why use up exemption if you don't have to, if there are good planning tools to avoid it?
- [15:26]
Thomas Coleman
Yeah, that makes sense. What about. So on the dynasty trust side of things, where do typically, where do people typically set up these dynasty trusts? Because I know you typically go pretty state specific, right. On one laws and rules and safety there, but two, on length of the trust, right?
- [15:43]
Dave
Yep, absolutely. So GST is a federal tax regime, Right. So now we're getting into the state issues for why a dynasty trust should be cited or you know, like lives in or resides in a specific state. There are a couple of things that people look for and that makes certain states better than others. Number one is the length of that that trust could potentially last. So you are always looking for a state that has moved away from what's called the common law rule against perpetuities. Common law rule against perpetuities is this like very old like English idea that if especially you have land and land is at a premium.
- [16:24]
Ann
Right.
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Dave
England is smaller then land. You know, you don't want to tie it up in these like old trusts forever and nobody can do anything about them and there are no beneficiaries left and like, you know, like you basically have tied up something like a really valuable asset like land inside of a dead trust. And so the rule is basically at the time that, that in that land got tied up, you start a counter, a clock ticking. And there needs to be a person alive today. And after that person has passed away plus 21 years now that land needs to magically come out. So you're basically like looking at a baby, right? Somebody with a very long lifespan potentially. So like let's say these days, 80 years plus 21, that's about 100 years. So if you are in a state that has one of these, like common law rule against perpetuities, you can tie up things in a trust for about 100 years. 100 years is what, like three generations? Three human generations. And for a dynasty trust. Yeah. These days, you know, these days people are like, I want more than that. Right. I'm going to have descendants forever that don't want to pay taxes on anything. And so you look for a state like Florida, Texas, Alaska, you know, there are certain state states that have moved away from the common law rule against perpetuities and allow for things like 360 years, 400 years, you know, trust to last like a really, really long time. And so that's the number one thing that you're looking for is a state with a long rule against perpetuities. The second is state income taxes. Right. So trusts are still subject to income tax. They earn money inside the trust. And this is where you want your trust, if it can, to not pay the state income tax, even though they have to still pay federal. Right. And so those are again states like Alaska, Florida, Texas, Nevada. And then lastly, you're looking for very strong asset protection laws. So this is where a beneficiary is a bad actor or has gotten divorced or whatever. You know, they have a somebody coming after their money. And the question becomes, because this person is a beneficiary of this big trust in Nevada, can the creditor also fulfill their judgment or their money? You know, ask request from the trust and not just what the beneficiary owns in their own name. And so you want state laws that really protect the sanctity of that trust and say that's a separate entity from the beneficiary. Don't come here looking for, you know, money to fulfill that judgment.
- [19:08]
Thomas Coleman
Okay, makes sense to me. Anything we haven't talked about for this topic on dynasty trust or the GST exemption?
- [19:19]
Dave
Nope. I think that, you know, part of the reason why I wanted to talk about this is because it's become kind of in the news a little bit that we have dynasty trusts or that this is a thing that people do. You have, like the Murdoch family, for example, that just in October or November of last year went through a pretty public fight over a trust in Nevada. Theirs was actually not a dynasty trust, but it just kind of brings up this idea of, like, keeping wealth within, you know, generations and generations tied up as the family, like, bank, if that makes.
- [19:53]
Ann
Yeah. And, you know, the other thing I sometimes think about is that clients think about planning to save on estate taxes for themselves. Let's even say for state purposes, like I'm here in Massachusetts, a $2 million estate. If you have a couple that's worth less than $4 million, they can basically avoid estate taxes in Massachusetts by using a credit shelter trust. They leave all that money, let's say they have one child. They leave all that money to one child outright. Now that child is going to inherit it. They're going to have an estate tax issue because everything is coming into their estate. Now. They have to figure out how to do estate tax planning. If they had taken these steps to do something like a dynasty trust, where it avoids their estate, they can avoid that child lumping assets on top of their estate and them having an estate tax issue. And obviously this works for federal as well. But, you know, it's an interesting concept to think, you know, you don't always just think about planning for your own estate. Think about what if I lump all this on top of my child's estate, are they going to have an estate tax issue or would I rather preserve it for future generations while they still can have the benefit of it? Which is, I think, the important thing. Yeah.
- [21:11]
Dave
And I think the big planning point here today that I would make to piggyback off of what Dave has said is it's really important for you to understand if your clients are coming into an inheritance and how much that might be.
- [21:23]
Thomas Coleman
Good point, good point. Okay, cool. Well, very interesting topic. I learned, actually a lot today. There's. I feel pretty well versed in a lot of the estate planning topics, but honestly, I love getting to host this and getting to learn from both of you. So thanks for diving into this. I know you. You hinted a lot at. This is like, this is just something to be aware of. This isn't necessarily the advisor's role, but sometimes it is ours to just nudge them to the right estate planning attorney to make sure documents are right for parents, et cetera. So this was an awesome one. And, like, every episode. Everybody, please rate and subscribe. This is a podcast that we work hard on, that we put a lot of time into, but we also love doing. So please rate and subscribe and we'll see you back here in a couple weeks. I know we have a. A few really awesome guests that we have coming up for you that I know you guys are going to like. So until next time.