C 1

1
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• GSTT in a nutshell
• The GSTT is levied, in addition to any gift or
  estate taxes that apply to the transfer
• On the value of any life insurance (and/or any
  other property)
• Transferred during lifetime or at death without
  adequate consideration
• To a transferee who is a generation that is at
  least two generations below the transferors
  generation
• Such a transferee is called a skip person
• Example transfer of an exceptionally large life
  insurance policy to a clients grandchild
• Transfer does not apply to nonskip persons
• Child
• Brother
• Sister
• Anyone in a generation higher than the
  transferors generation

2
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• GSTT in a nutshell (contd)
• GSTT is imposed as a flat tax at the highest
  federal estate tax level
• 46 in 2006
• GSTT annual exclusion
• 12,000 (in 2006) per donee annual exclusion for
  transfers to skip persons
• Double by splitting gifts with spouse
• Transfers to a trust may qualify
• All trust beneficiaries must be skip persons
• No distribution can ever be made to a nonskip
  person
• Each skip persons share is held in an account
  separate from the others

3
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• GSTT annual exclusions (contd)
• Leverage the annual exclusion
• Irrevocable life insurance trust
• Split dollar
• Survivorship life insurance
• Downsides to qualifying for the GSTT annual
  exclusion
• If the beneficiary dies before the
  client-grantor, trust includable in beneficiarys
  estate
• Crummey power techniques, such as the hanging
  power, will not qualify for the annual exclusion
• Exclusion requires dispositive rigidity (separate
  trusts required)
• Trust cannot provide financial security for
  intervening skipped generation

4
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• GSTT exemption
• 2,000,000 (in 2006) exemption per transferor
• Can allocate to transfers during lifetime or at
  death
• Can effectively double to 4,000,000 by splitting
  gifts with spouse
• Triggering the GSTT
• Direct skip
• Occurs when a transfer subject to gift or estate
  tax is made to a skip person
• For this purpose, a trust is treated as a skip
  person if all trust beneficiaries are skip
  persons
• Examples
• Client gives life insurance policy to grandchild
• Client transfers life insurance policy to ILIT
  for grandchildren and great-grandchildren
• Client dies owning life insurance and proceeds
  are paid to grandchild

5
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• Triggering the GSTT (contd)
• Taxable termination
• Occurs when there are no more nonskip persons
  ahead of the skip person
• Transfer is assumed to occur at the moment
  nothing stands between the skip person and the
  transferred cash or other asset
• Example
• Client creates a life insurance trust that
  provides Income from this trust is to be paid to
  my three children for life. At the death of the
  last survivor, principal is to be distributed to
  my six grandchildren
• When the last nonskip persons (childrens)
  interest terminates (in this example, by death),
  the property in the trust is subject to the GSTT

6
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• Triggering the GSTT (contd)
• Taxable distribution
• Occurs when either income or principal is
  distributed from a trust to a skip person
• Such distributions can occur while the nonskip
  persons are alive
• Computing the taxable amount
• Direct skip
• Amount subject to the GSTT is equal to the value
  of the transfer reduced first by the estate tax
  imposed on it
• Example
• 2,000,000 transfer, 46 estate tax bracket
• GSTT would be imposed on the 1,080,000 left
  after the federal estate tax of 920,000 was
  taken.

7
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• Computing the taxable amount (contd)
• Taxable termination
• Amount on which the tax is computed is the value
  of the property to which the termination pertains
• Example
• Client dies and 2,000,000 in policy proceeds are
  paid to a trust providing income to the clients
  son for life. Client in 46 estate tax bracket.
  1,080,000 remains after estate tax of 920,000.
• At the sons death, the remainder (assumed to
  remain constant) is to be paid to the clients
  grandson
• GSTT would be 46 of 1,080,000, or 478,400

8
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• Computing the taxable amount (contd)
• Taxable Distribution
• Amount on which the tax is computed is the value
  of the property the transferee receives.
• Example
• Client dies and 2,000,000 in policy proceeds are
  paid to a trust that can sprinkle or spray
  principal to the clients son or grandson, or
  both. Client is in the 46 estate tax bracket.
• The federal estate tax would be 920,000 (46 of
  2,000,000), leaving 1,080,000 in the trust
• Trustee immediately distributes 1,080,000 to the
  grandson
• GSTT would be 46 of 1,040,000, or 478,400

9
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• Computing the taxable amount (contd)
• Inclusion ratio
• The amount of a generation-skipping transfer that
  is subject to the GSTT is found through an
  inclusion ratio
• Example
• Value of gift 1,500,000
• Client had only 150,000 of his 2,000,000
  exemption available
• Inclusion ratio would be .900

10
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• Computing the taxable amount (contd)
• Inclusion ratio (contd)
• Leverage implications with respect to cash to
  irrevocable life insurance trusts
• Once the exemption shields a gift of life
  insurance premiums or a gift of a life insurance
  policy, the proceeds generated by those projected
  premiums or policy will not be subject to the
  GSTT when paid out
• Example
• Irrevocable life insurance trust purchases a
  20,000,000 policy on the clients life.
• Over the next 10 years, client pays 100,000 each
  year in premiums towards that policy.
• Client allocates GST exemption against each
  premium.
• None of the 20,000,000 proceeds would be subject
  to the GSST

11
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• Reverse QTIP Election
• QTIP Trust
• Obtaining a marital deduction for property that
  is not left outright to a spouse
• Client can provide income to a spouse for life,
  but at the spouses death, the client can be sure
  it will pass to the person or persons the client
  has selected
• Whatever remains in the trust at the spouses
  death must be included in the spouses estate as
  if the spouse had transferred the property
• This same fiction applies for GSTT purposes. The
  surviving spouse is treated as the transferor of
  property really transferred by the client.
• This might cause a portion or all of the clients
  GSTT exemption to be wasted

12
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• Reverse Q-tip Election (contd)
• With a reverse QTIP election, the first spouse to
  die will be treated as the transferor of reverse
  QTIP property for GSTT purposes. Therefore, that
  spouses GSTT exemption can be allocated to the
  reverse QTIP property.
• Example
• Husband dies leaving 4,000,000 of life insurance
  (the entire estate) in 2006
• Previous gifts of 500,000 made using his unified
  credit
• 1,500,000 passed into a credit equivalent bypass
  trust for his 5 children and their 5 children
• Balance of proceeds (2,500,000) was paid into a
  QTIP trust for his wife
• Executor allocates 1,500,000 of husbands GST
  exemption to CEBT and 500,000 to reverse QTIP
  trust (QTIP trust is split)
• Husband is able to use all of his 2,000,000
  exemption
• Wife can allocate her 2,000,000 exemption to
  QTIP trust
• Full 4,000,000 is exempt from GSTT
• No federal estate tax payable on husbands death

13
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• GSTT and irrevocable life insurance trusts
  (ILITs)
• Transfers to ILITs are potentially subject to
  GSTT
• Three ways to utilize the GSTT exemption with an
  ILIT
• Use it immediately
• Allocate the exemption to (a) the gift of the
  policy itself and (b) premium payments
• Wait until the client dies
• Use the exemption against the much larger
  insurance proceeds
• Wait until the client dies
• Use the GSTT exemption to shelter transfers of
  other estate assets
• It is the timely and creative use of the GSTT
  exemption coupled with life insurance that is the
  key to maximizing the exemption

14
Life Insurance and the Generation-Skipping
Transfer Tax
Appendix C Tools Techniques of Life Insurance
Planning

• GSTT and irrevocable life insurance trusts
  (ILITs) (contd)
• Costs to using the exemption to shelter premium
  payments
• The GSTT exemption is not available to avoid the
  tax on other transfers to skip persons
• The client will have to file annual tax returns
  claiming the exemption
• Opportunity cost. Exemption could be wasted if
  allocated to ILIT and ILIT later turns out to not
  be generation-skipping.