How One Little-Known Loophole Fuels Toxic Dynastic Wealth

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Reflecting Roosevelt’s concerns, the estate tax, as originally enacted, would subject extraordinary wealth to tax each time it passed from one generation to the next.

But wealthy families discovered they could circumvent the estate tax by placing their wealth in trust. The estate tax is a tax on the act of transmitting wealth. When the beneficiary of a trust dies, however, there typically is no transmission of wealth. The rights of the beneficiary to receive trust distributions simply expire. The creator of the trust might pay gift or estate tax upon the initial transfer of wealth into the trust, but never again while the wealth remained there, no matter how much it accumulated.

If reports on the growth of the Mars family fortune over the past 25 years are accurate, they show what happens when dynastic wealth placed in trust accumulates without a once per generation payment of estate tax: exactly what Roosevelt feared. According to Forbes’ reporting, upon the passing of Forrest Mars, Sr. in 1999 and Forrest Mars, Jr. in 2016, the Mars family wealth was not reduced by an estate tax bill. Today, the family controls wealth totaling over $90 billion.

Combatting Undue Wealth Accumulation: The Generation-Skipping Tax

Can something be done to combat this accumulation? Yes. In 1976, Congress enacted the generation-skipping tax, or GST, on the multi-generational passage of wealth to prevent circumvention of the taxes on estates and gifts.

Although there were delays, the 1986 Tax Act amended and implemented the GST. The GST was intended to roughly equalize the tax treatment of the passage of wealth from a person to a grandchild or more remote descendant with the tax treatment of the passage of wealth one generation at a time – i.e., parent to child, followed by child to grandchild, followed by grandchild to great-grandchild, and so on.

The GST works by imposing an additional layer of tax on wealth transfers that skip a generation, for example, from grandparent to grandchild. In the case of a trust providing for multiple generations of an ultra-rich person’s descendants, the additional layer of tax would occur as each generation of descendants passed on and the next generation became the primary beneficiaries of the trust, or upon any distribution to a more remote descendant of the trust creator than the beneficiaries then nearest in generation to the trust creator.

Unmet Goals: GST Design Defects

Due to flaws in the design of the GST, however, the goal of once-per-generation taxation remains unrealized.

There are three major flaws in the GST, all involving the exemption that each person is allowed from GST taxation. The first is that the GST exemption, at $11.7 million per person, is too large. If an ultra-rich grandparent applies her GST exemption to an $11.7 million gift to her young, also ultra-rich grandchild who won’t need to touch the wealth, the gift easily could grow to $500 million during the grandchild’s lifetime.

The second and even more problematic flaw in the GST exemption is that it can be applied to a trust that will last for multiple generations. This trust, known as a “dynasty trust,” is a trust designed to exist for multiple generations of a person’s descendants. The laws of some states allow dynasty trusts to last in perpetuity.

When the GST exemption is used in tandem with other tax avoidance vehicles, the amount wealthy Americans are able to lodge in dynasty trusts is far greater than the current $11.7 million statutory exemption. Massive fortunes, sometimes exceeding one billion dollars, can be placed in dynasty trusts that will remain exempt from wealth transfer taxation for centuries. Consider the accumulation of wealth if, instead of starting out with $11.7 million, a dynasty trust started with $11 billion. Or if the accumulation continued not for the lifetime of a grandchild, but for several centuries.

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