Accredited Wealth Management Advisor Practice Exam

How is Bill classified regarding the transfer of his estate to a trust for his heirs?

1. He will owe generation-skipping transfer tax but not gift tax.

2. He will owe generation-skipping transfer tax at the time the trust is funded as a direct skip.

3. The trust is an indirect skip with transfer tax due upon termination.

4. The trust is not subject to transfer tax because his children have an interest.

The correct answer is: The trust is an indirect skip with transfer tax due upon termination.

In this scenario, Bill's transfer of his estate to a trust for his heirs qualifies as an indirect skip under the generation-skipping transfer (GST) tax rules. An indirect skip occurs when property is transferred to a trust that benefits both the transferor's children and their descendants. In this case, because the trust may benefit Bill's grandchildren or future generations, it is classified as an indirect skip. The relevant tax implications arise when the trust ultimately terminates and the property is distributed to the grandchildren. At that point, the GST tax will be assessed because the funds are being distributed to individuals who are two or more generations below the transferor, which is essential to understanding why the classification as an indirect skip is proper. This classification is significant because it sets the timing of any potential tax liability. The transfer tax does not come into play until the trust terminates and distributions are made to the skipped generation. Such understanding allows for better estate planning, as the taxpayer can strategize to minimize tax implications beforehand. The other classifications, such as direct skips, would imply different immediate tax liabilities or conditions which do not apply in this case. Thus, recognizing the trust as an indirect skip provides clarity on when and how transfer tax becomes relevant.