Did you know that as much as 79.7% of a transfer you make to your grandchild can end up going to the government? Transfers that skip a generation are subject not only to a gift or estate tax, but also to a generation-skipping transfer (GST) tax. While gift and estate taxes are based on a sliding scale at rates currently ranging from 37% to 55%, the GST tax is assessed at the highest currently applicable estate and gift tax rate -- 55%. As a result, planning to reduce or minimize the GST tax is critical. Here are five ways you can avoid the GST tax.

1.       Use Your GST Tax Exemption

The simplest way to reduce your GST tax burden is to use your GST tax exemption. Each person is allowed to make a total of $1 million of transfers to “skip persons” – persons who are more than one generation below you, such as grandchildren, great-grandchildren, grandnieces, grandnephews and unrelated people more than 37 years younger than you – without incurring the GST tax. Through smart allocation of your GST tax exemption, such as applying it to leveraged gifts like property that you expect to appreciate greatly or life insurance premiums, you can significantly increase its effectiveness. The GST tax exemption can be allocated either to outright gifts or to gifts made in trust.

2.       Make Annual Exclusion Gifts

If you wish to give your grandchildren more than $1 million, you can make outright annual exclusion gifts of $10,000 ($20,000 if you and your spouse split gifts) to each of them. The gifts will not only qualify for the annual exclusion from gift tax, but also for annual exclusion from GST tax. This can be beneficial if you want to save your GST exemption or have already used it.

3.       Make Gifts To Crummey Trusts

If your grandchildren are young or not financially responsible, you may prefer to make gifts to a trust, such as a Crummey trust. For gifts to the trust to qualify for the annual gift tax exclusion, the trust agreement must give the beneficiaries the right to withdraw all or a proportionate share of any gifts you make to the trust each year, and the trustee must notify all beneficiaries of the amount of these gifts and the amount that the beneficiaries may withdraw. For the gifts to also qualify for the annual GST tax exclusion, the trust must have only one beneficiary and must be taxed in his or her estate upon the beneficiary’s death.

4.       Make Gifts To 2503(c) Minor’s Trusts

If your grandchildren are minors and you don’t mind if they have complete access to trust assets when they reach age 21, you can avoid the administrative burdens of a Crummey trust by making gifts to a 2503(c) minor’s trust. These gifts will qualify for the annual exclusion for gift tax and GST tax purposes if the trust agreement:

• Allows trust income and principal to be distributed for the child’s benefit before he or she reaches age 21,
• Allows the child to withdraw the entire trust corpus when he or she reaches age 21, and
• Requires that, if the child dies before age 21, the trust corpus pass to the child’s estate or to the person the child has appointed.

5.       Make Gifts From A Grandfathered Trust

Irrevocable trusts created before Sept. 25, 1985, are grandfathered from GST tax. Thus, if you created such a trust and have kept it grandfathered (by not adding new assets to
 the trust), distributions made from the trust to your grandchildren will not incur the GST tax. Distributions also can be made through the exercise of granted powers of appointment in favor of beneficiaries who otherwise would be considered skip persons.

Stretch Your GST Tax Exemption

Gifts made directly to grandchildren or other skip persons not only benefit them today, but avoid double exposure to transfer tax -- once when you pass the property to your child and again when your child passes the property to your grandchild. The methods described above allow you to stretch your GST tax exemption for additional tax savings.

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