Estate planning is designed, in part, to prevent future generations from paying taxes on money they inherit. An ordinary trust protects the first generation of beneficiaries (children), but does not necessarily protect the second generation (grandchildren) from tax liability. One type of trust that can help a New Jersey grantor provide for grandchildren during their lifetime is the dynasty trust.
In the past, an ordinary trust could provide for both children and grandchildren. Then, Congress passed a law instituting the generation-skipping transfer tax (GST) taxing transfers and gifts into trusts that benefit individuals that are not related to the grantor or are at least second-generation relatives such as grandchildren. Congress does allow for an exception to this tax, however.
This year, the exception is the same as the estate tax exemption. An individual can transfer or gift into trust $5.34 million, and a married couple can combine its exemption for a total of $10.68 million. A dynasty trust maximizes this exemption. So long as each generation passes on an amount equal to the maximum estate tax exemption available that year to the next generation, any gains on that exempted amount are tax-free for each successive generation.
Specific verbiage is required in order to ensure a trust stands up to scrutiny and does not violate any other federal or state laws. For instance, dynasty trusts cannot be revoked in order to keep the trust from becoming part of the grantor's estate. Limiting the control that New Jersey beneficiaries have over the trust keeps it out of the estates of each successive generation as well. Knowledge of the tax and estate planning laws can ensure that the wealth passed on by the grantor can provide for generations beyond an individual's own children while minimizing those beneficiaries' tax exposure.
Source: Forbes, Why Rich Kids Don't Pay Taxes, Brian Luster and Steven Abernathy, Feb. 26, 2014