Last year, the Tax Cuts and Jobs Act (TCJA) was signed into law and began to affect more than just individual income taxes. This is new law brought major changes to estate planning and in turn bolstered dynasty trusts and their potential value.
Changes to Exemptions
When you take a closer look at the TCJA, it’s essential to understand that it does not repeal the estate tax—which lawmakers previously discussed before its passage. This particular tax was kept in the law once finalized. When it comes to the estates of dying individuals, and gifts that are being made or planned to be made, after December 31, 2017, and before January 1, 2026, the generation-skipping transfer tax exemption and the gift and estate tax exemption amounts have been increased to reflect inflation. These rates have been adjusted $10 million, or $20 million for married couples ($11.18 million and $22.36 million, respectively, for 2018).
If no further congressional action occurs, these exemptions will revert to their inflation-adjusted 2017 levels beginning January 1, 2026. All three taxes will remain at their marginal tax rate of 40%.
How to Avoid Generation-Skipping Transfer Taxes
Now, it’s time to discuss dynasty trusts and their potential value. These arrangements are irreversible and allow for pretty considerable amounts of wealth to grow without the interference of federal estate, gift, and generation-skipping transfer (GST) taxes. The law of the state in which a dynasty trust is established determines its specific longevity. Several states have laws that allow trusts to remain in existence for hundreds of years or even without an end date.
The GST tax encompasses an additional 40% tax on transfers that skip a generation—grandchildren or other family members, potentially consuming substantial amounts of wealth. The GST tax exemption mirrors the gift and estate tax exemption, $11.18 million for 2018. In order for a transfer to a “skip” person to be completely free of any tax, both the gift or estate tax exemption and the GST exemption must be applied.
Post-TCJA reveals the power of the dynasty trust by showcasing its ability to transfer a sum of $11.18 million to a properly structured dynasty trust. This ability to transfer a sum also operates under the assumption that you have not yet taken advantage of your gift and estate tax exemption or your GST tax exemption. Since the transaction is within your unused exemption amount, no gift tax will be applied. The funds, plus any future appreciation, will also be withdrawn from your taxable estate.
What is most important to understand is that you can ensure any future distributions or other trust asset transfers to your grandchildren or subsequent generations will avoid gift, estate, and GST taxes simply by allocating your GST tax exemption to your trust contributions. Even if the exemption is lowered in the future or the value of the assets increases well beyond the exemption amount, this will still remain true.
Think Outside of the Box When Considering a Dynasty Trust
Even without the potential tax implications, a dynasty trust has several valid nontax reasons that exhibit the benefit of setting one up. First off, with this kind of trust, you are able to designate the specific beneficiaries of your trust assets, even if they span over multiple generations. Traditionally, the setup provides for assets to follow down the line of descendants—children, grandchildren, or great-grandchildren. You can also impose certain restrictions on the assets within the trust, such as limiting a beneficiary access to funds until he or she becomes a certain age or earns a college degree.
Second, assets placed in a properly structured trust are protected from the reach of a beneficiary’s creditors, including divorce claims, traffic accidents, or a failed business.
CRI Has Your Best Interests in Mind
As any process like this is, setting up a dynasty trust with neither be quick nor simple. The process includes choosing the proper structure, allocating assets (real estate, business interests, life insurance policies, and securities), and naming the right trustee. Alongside your attorney, your CRI tax advisor is here to not only help you determine whether a dynasty trust is right for you but also help you maximize the tax benefits.