Estate Tax: Once Bad, Twice Unacceptable

June 10, 2011

When people debate the fairness of the estate tax the primary argument against it is the fact that it is in and of itself an instance of double taxation. You pay income and payroll taxes, and then you have the remainder which may be as little as 70% of what you actually earned.   With this remainder you go forth, and as you do you must pay sales tax, property tax, capital gains tax, and any number of additional taxes. Then when you pass away your estate is taxed yet again, and at an exorbitant rate exceeding one third of the taxable portion.
The above is a pretty convincing argument, isn't it? But it really doesn't stop there. Let's say you leave a bequest to your children that is subject to the estate tax. They are successful in their own right and never touch that money. When they pass away and leave it to your grandchildren the taxable portion is once again going to be shaved down by the death levy, and in fact this can go on and on into future generations until nothing is left but the exempt amount.
This can be avoided, at least in part, through the creation of a generation-skipping trust. With these vehicles you name your children and grandchildren as the beneficiaries.  They can receive cash distributions, live in property that has been placed into the trust rent-free, and even direct trust administration in large part through a special power of appointment.  Plus, since these assets are not owned by the beneficiaries they are protected from the beneficiaries' potential future divorces and creditors (e.g., lawsuits).  Perhaps the greatest benefit, upon the death of your children, and even your grandchildren in states like Nevada, because the assets are owned by the trust and not the beneficiary, they are not once again subject to estate taxes.
The children and grandchildren can receive liberal benefits from the trust, but the assets can be passed down to future generations estate tax free.   The generation-skipping transfer tax is applicable, but there is a $5 million exclusion so many people will limit their contribution into the trust to this amount.

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