April 12, 2017
Authored by: Stephanie Moll and Steve Dawson
Billionaire David Rockefeller, the grandson of John D. Rockefeller, passed away recently at the age of 101. In 2017, Forbes estimated that his fortune, investments in real estate, share of family trusts, and other holdings were worth $3.3 billion. However, because of his family history, it is quite possible that a large portion of that $3.3 billion will not be subject to the estate tax upon his death.
Historically, wealthy families such as the Rockefellers amassed fortunes generations ago and, using their tax advisors’ knowledge of the then-current tax laws, passed their wealth to lower generations in ways that reduced the ultimate amount of estate and gift tax the family would owe, often by bypassing a generation or setting up dynasty trusts that would cascade from generation to generation. For example, instead of a grandfather passing a $100 million estate to his son (who might already be wealthy), which translates to perhaps $50 million after estate tax, and then the son passing that $50 million to his own children at his death—resulting in a second imposition of estate tax at the son’s death—the grandfather might instead transfer all or a portion of his $100 million estate directly to his grandchildren. This approach would bypass the estate tax on the transfer to the son and only incur estate tax once, rather than twice, while passing the estate to the grandchildren.
In the Rockefeller family, at the death in 1937 of patriarch John D. Rockefeller (considered the wealthiest American of all time, due to his investment in Standard Oil of Ohio, which later split into other oil companies you may have heard of, such as BP, Chevron, and ExxonMobil), the majority of John’s wealth was transferred to his son, John Jr., through a trust. That trust has been further subdivided into shares for John Jr.’s descendants (including David).
In addition, prior to his father’s death, in 1934, John Jr. established trusts for each of his six children and, in 1952, he established another set of trusts for his grandchildren. According to a 1992 article in the New York Times, some of these trusts are designed to terminate at the death of the fourth generation (David’s children’s generation), so tax may be due at the deaths of David’s grandchildren, because the trust assets will be includible in their estates at their deaths.
In response to these methods of avoiding the estate tax, the generation-skipping transfer tax (“GST Tax”) was created.
The GST Tax is imposed, generally, when property is given directly to a grandchild or more remote descendant (a “skip person”) or when a trust for a child continues for the benefit of the child’s descendants at the child’s death. By imposing the GST Tax on these “skip transactions”, taxpayers are not able to avoid a level of estate or gift tax by bypassing their children and making a gift or bequest directly to a grandchild. It essentially closes a loophole in the estate tax regime. The transfer to a grandchild is not only subject to the 40% gift or estate tax, it is also subject to the GST Tax, which is also currently imposed at 40%. That makes sense because, from the government’s perspective, a death tax should be paid by each generation. So a transfer that skips a generation is charged double the tax.
Dynasty trusts (trusts that continue from generation to generation) that were irrevocable prior to the 1985 enactment of the current GST Tax are considered “grandfathered” and therefore are exempt from the GST Tax. Therefore, to the extent that any of Mr. Rockefeller’s family trusts are grandfathered, they would not be subject to estate or GST tax now, due to his death.
The GST Tax can be quite onerous. As stated above, it is currently imposed at a 40% tax rate. In addition, if the gift is also subject to the gift or estate tax, the transfer could be subject to the 40% gift or estate tax, PLUS the 40% GST Tax. Remember, the GST Tax was implemented in order to prevent a family from avoiding the 40% gift or estate tax at multiple generations. By imposing the GST Tax, the transfer is taxed twice, just as it would have been if the transfer didn’t “skip” generations, but was taxed at both the parent and the child level, before passing to the grandchild.
Each US taxpayer has an exemption from the GST Tax, which can be used during life or upon death. Currently, the exemption is $5,490,000, and is scheduled to increase for inflation in future years. That means that a taxpayer can make up to $5,490,000 in gifts to skip persons without incurring any GST Tax. In addition, if the taxpayer is making a gift to a trust that would be subject to GST Tax, she can allocate all or a portion of her GST Tax exemption to the trust, allowing the trust to pass from generation to generation without incurring GST Tax when the beneficial interest passes from one generation to the next. Although an exemption of $5,490,000 seems generous, there was previously no limit on the amount of wealth that could be placed in a dynasty trusts that would continue in trust for many generations without tax. The living relatives of David’s grandfather, John D. Rockefeller Sr., likely still benefit from such trusts created many decades ago.
Therefore, based on these laws, to the extent that any of Mr. Rockefeller’s wealth is held in trusts that were irrevocable before 1985 or in trusts to which the donor allocated her GST Tax exemption, these assets will not be counted when determining the size of Mr. Rockefeller’s estate and will not be subject to estate or GST Tax as a result of his death.