Generation-Skipping Transfer Tax: What It Is and How to Plan Around It

Most business owners and affluent families are at least vaguely aware of the federal estate tax. Far fewer understand the generation-skipping transfer tax — a separate and additional tax that applies when wealth passes to grandchildren or more remote beneficiaries, either directly or through certain trusts.

What Is the GST Tax?

The generation-skipping transfer (GST) tax was enacted to prevent wealthy families from skipping a generation of transfer taxation by leaving assets directly to grandchildren rather than children. The GST tax applies at a flat rate of 40 percent — in addition to any estate or gift tax — on transfers that skip a generation.

Like the estate and gift tax, the GST tax has an exemption — currently over $13 million per person, indexed for inflation — that is also scheduled to sunset in 2026.

Direct Skips vs. Taxable Distributions vs. Taxable Terminations

The GST tax can be triggered in three ways: a direct skip (transferring assets directly to a grandchild), a taxable distribution (a trust distributing to a skip person), or a taxable termination (a trust's last non-skip beneficiary dying, leaving only skip persons as beneficiaries).

Proper GST planning requires understanding which of these events your trust is designed to avoid and allocating GST exemption to the appropriate transfers.

Dynasty Trusts and Multi-Generational Planning

For families interested in multi-generational wealth preservation, a dynasty trust — a long-term irrevocable trust designed to hold assets for multiple generations — can be an efficient vehicle. If properly funded and structured, a dynasty trust can hold assets free of estate, gift, and GST tax for the trust's entire term.

The key is allocating sufficient GST exemption to the trust at funding, so that distributions to grandchildren and later generations are not subject to the GST tax.

Reporting and Allocation

GST exemption allocation is reported on Form 709 and is critically important. Automatic allocation rules apply to some direct skips and some transfers to certain trusts, but advisors and clients who rely on automatic allocation without review often find that exemption was allocated suboptimally — or not at all.

A thoughtful review of how GST exemption has been allocated in prior years is often one of the most valuable items in an estate planning diagnostic.