Ways to Avoid the GST Tax

In addition to the estate tax returning on January 1, the GST tax will return as well. The GST tax applies to gifts to relatives two or more generations below the donor or to nonrelatives 37 ½ years younger than the donor. After the exemption amount, gifts of this nature are subject to double taxation—the GST tax in addition to either the estate or gift tax. The government can end up pocketing more money from these gifts than the beneficiaries.

Common ways to avoid paying the GST tax are to give grandchildren no more than $13,000 per year or to pay for a grandchild’s tuition and medical bills. These payments are not subject to the GST tax if they are made directly to the school or medical care provider.

If you want to avoid the GST tax on larger sums of money, make your gifts to grandchildren before January 1. You’ll have to pay a 35% gift tax on these gifts in 2010, but if you wait until 2011, you’ll have to pay a 55% gift tax as well as the GST tax. However, there is a lot of ambiguity relating to how the IRS will deal with property put in trusts this year for GST tax purposes, so grandparents must give the assets to grandchildren outright. Another option is to put these assets into an FLP or LLC and transfer interests to grandchildren.

If you decide to make a large gift, you should wait until December 31 to do so in case Congress decides to act before then.  Waiting also avoids the risk of paying a gift tax and then dying in 2010, when the assets can be transferred free of any estate taxes.

Another option is to make a gift before January 1 to a trust for the benefit of a spouse. If the trust allows the spouse to disclaim “the gift in favor of grandchildren, the spouse would have nine months in which to wait for Congress to make a move.”

Anne Tergesen, Last Chance to Foil a Gift Tax, W.S.J., Oct. 30, 2010.

Special thanks to Jim Hillhouse (WealthCounsel) and Joel Dobris (Professor of Law, UC Davis School of Law) for bringing this to my attention.