The Ming Dynasty ruled China for 276 years. The dynastys demise in 1644 was due, in part, to the depletion of the imperial treasury.
If the dynastys rulers had access to todays financial planning strategies for preserving wealth, there is no telling how many generations of this powerful family could have occupied the throne of the Middle Kingdom.
Like the Ming Dynasty, wealthy American families encounter wealth transfer problems of their own. Currently, there are two roadblocks to passing a familys treasure ad infinitum to subsequent generations: (1) state anti-perpetuity laws, and (2) the generation-skipping tax. Most states have anti-perpetuity rules that only permit a trust to remain in existence for 21 years plus nine months beyond the lifetime of those trust beneficiaries who were alive when the trust was created. These are called “RAP” states since they have rules against perpetuity.
Be aware, however, that currently there are approximately 19 non-RAP states. These are states that allow a trustee to continue to manage trust assets ad infinitum, generation after generation. The assets in the trust need never vest in the trust beneficiaries. Lets call them the “perpetuity states.”
A taxpayer, regardless of where domiciled, can create a trust in any “perpetuity” state and transfer and/or re-title his or her property to an irrevocable trust in that state. The only requirement is that the independent trustee of that irrevocable trust be a resident of, or do business in, that perpetuity state.
Creating a perpetual trust, however, is only one part of the multi-generational wealth continuation solution. Perpetuity by itself does not address or solve the problem of the generation-skipping tax (GST) that may be incurred whenever property is transferred to someone more than one generation removed or to someone 37 or more years younger than the donor. That GST can be a devastating tax.
First, the 2003 GST is a flat tax of 49% that is paid in addition to the standard gift tax that may be due when property is transferred without adequate consideration. Second, the GST paid by the donor may itself be considered another gift made by the donor that is also subject to taxation up to the top 49% marginal bracket rate.
Just as the Ming Dynasty needed a shield to preclude the dissipation of its wealth, so do todays estate owners. The current uncertain tax environment only increases and intensifies the need for a pre-emptive tax planning strategy. That effective strategy or shield is the Generation Skipping Perpetuity Trust (GSPT), created in one of the available perpetuity states to build a permanent protective shield around a taxpayers assets to avoid excessive depletion of estate assets.
The Economic Growth & Tax Reform Reconciliation Act (EGTRRA) of 2001 enhanced the value of GSPT planning by indexing the generation-skipping tax exemption to the very same scheduled increases of the IRC Section 2505 estate exemption equivalent. That means the $1.12 million GST exemption in 2003 will increase to $1.5 million in 2004, $2 million in 2006 and $3.5 million in 2009. The exemption amounts can even be doubled with a split gift. A split gift occurs when a taxpayers spouse elects to also allocate his or her GST exemption to a spouses gift.
EGTRRA also allowed for automatic allocations of the GST exemption to all generation-skipping transfers whether those transfers are direct gifts to a grandchild or indirect gifts to a trust for a grandchild. Still, it is recommended that a timely gift tax return (Form 709) with a notice of GST allocation always be filed with each and every gift to the GSPT trust to avoid any future conflict.
Lets examine how the GSPT strategy works. Business owner Tom Barry can leverage his lifetime GST exemption into a $50 million legacy GSPT that effectively can avoid potential estate, gift and generation-skipping taxes in a most cost- and tax-effective way for all future generations.
Step 1: Tom lives in Connecticut but decides to establish his multimillion-dollar GSPT in a perpetuity state like South Dakota with a resident institutional trustee. South Dakota is one of the most favorable perpetuity states because any income generated by the trust there is not subject to state income taxation.