Most people are familiar with federal income tax because they see it deducted from each paycheck. Other federal taxes, including capital gains tax, estate tax, gift tax, and the generation-skipping transfer tax, may be less familiar.
The generation-skipping transfer tax, commonly called the GST tax, is particularly complicated. It can apply when someone transfers substantial property to grandchildren, later generations, or certain unrelated individuals.
Most families will not owe this tax because of the federal GST exemption. However, families making large gifts or creating trusts for multiple generations need to understand how it works.
What Is the Generation-Skipping Transfer Tax?
The generation-skipping transfer tax is a federal tax that may apply when property passes to a person who is two or more generations below the person making the transfer.
A common example is a grandparent transferring money or property directly to a grandchild.
The GST tax can apply to transfers:
- Made as gifts during a person’s lifetime
- Made through a will after death
- Made through a trust
- Distributed from certain multigenerational trusts
- Created when an interest in a trust ends
The tax is separate from the federal gift and estate taxes. In some circumstances, GST tax may apply in addition to gift or estate tax.
Why Does the GST Tax Exist?
Congress created the GST tax to prevent wealthy families from avoiding estate tax at one or more generations.
Without the GST tax, a person could leave property directly to grandchildren instead of children. The property would then avoid being included in the children’s estates before passing to the grandchildren.
For example, assume a grandparent leaves substantial property to a child. When the child later dies, the remaining property may be subject to estate tax as part of the child’s estate.
If the grandparent transfers the property directly to a grandchild, that intermediate transfer is skipped. The GST tax is intended to address this skipped level of taxation.
Who Is Considered a Skip Person?
A recipient who is two or more generations below the person making the transfer is generally called a “skip person.”
Skip persons commonly include:
- Grandchildren
- Great-grandchildren
- More remote descendants
- Certain trusts created for those descendants
An unrelated individual may also be assigned to a generation based on age. In general, an unrelated person who is more than 37½ years younger than the transferor may be treated as being at least two generations below the transferor.
The IRS provides more detailed definitions of skip persons and generation assignments.
Can a Trust Be a Skip Person?
A trust may be treated as a skip person if all interests in the trust are held by skip persons.
A trust can also qualify if no person currently holds an interest and the trust can never make a distribution to someone who is not a skip person.
Trust classification can be complicated. The treatment depends on the beneficiaries, distribution provisions, and interests created by the trust agreement.
What Types of Transfers Can Trigger GST Tax?
The GST tax generally applies through three categories of transfers:
- Direct skips
- Taxable distributions
- Taxable terminations
Each category has its own rules and reporting requirements.
Direct Skips
A direct skip is a transfer directly to a skip person that is also subject to federal gift or estate tax rules.
A grandparent’s outright gift to a grandchild is a common example. A direct transfer to a qualifying trust for grandchildren may also be a direct skip.
Taxable Distributions
A taxable distribution may occur when a trust distributes money or property to a skip person.
For example, a trust might allow distributions to the transferor’s child and grandchild. A distribution to the grandchild could be a taxable distribution, depending on how GST exemption was allocated to the trust.
The trustee may have reporting responsibilities, and the recipient may be responsible for calculating or paying the tax.
Taxable Terminations
A taxable termination can occur when the interests of all nonskip beneficiaries end and only skip persons retain interests in the trust.
For example, a trust may provide income to the transferor’s child for life, with the remaining property passing to the grandchildren after the child dies. The child’s death could produce a taxable termination.
When Does the GST Tax Apply?
The tax may apply when the value of transfers to skip persons exceeds the transferor’s available GST exemption or when a transfer is made from a trust that is not fully exempt from GST tax.
Every individual has a lifetime GST exemption that may be allocated to generation-skipping transfers or to property placed in a trust.
For 2026, the federal GST exemption is $15 million per individual. The amount is scheduled to be adjusted for inflation beginning in 2027.
Because Congress can change tax laws, families should verify the exemption in effect when planning or making a transfer. The IRS maintains updated information through its GST tax forms and instructions.
What Is the GST Tax Rate?
The GST tax rate is tied to the highest federal estate-tax rate.
For transfers occurring after 2012, the maximum GST tax rate is 40 percent. The actual calculation can depend on the taxable amount and the trust’s inclusion ratio.
The IRS instructions for Form 706-GS(T) provide the applicable maximum tax rates and explain how an inclusion ratio is used.
An Example of the GST Exemption
Assume a grandparent gives $100,000 to each of five grandchildren.
The grandparent has made $500,000 in transfers to skip persons. Depending on the circumstances, the annual gift-tax exclusion and the grandparent’s GST exemption may apply.
Transfers covered by properly allocated GST exemption may avoid GST tax. However, the filing and allocation rules are important.
A family should not assume that a transfer is automatically exempt merely because the donor has unused exemption. A federal gift-tax return may be needed to report the gift and allocate GST exemption.
The IRS uses Form 709, United States Gift and Generation-Skipping Transfer Tax Return, to report certain lifetime gifts and GST transfers.
What Happens If a Child Dies Before the Grandparent?
A special rule may apply if the generation between the transferor and recipient has already died.
For example, suppose a grandparent’s child dies before the grandparent makes a gift to that child’s children. Under the predeceased-parent rule, those grandchildren may move up one generation for GST tax purposes.
As a result, the transfer may not be treated as generation-skipping.
The rule is technical and depends on the family relationship, timing, and other circumstances. It should be reviewed with a qualified tax professional before relying on it.
Are Tuition and Medical Payments Subject to GST Tax?
Certain direct payments for tuition or medical care are excluded from federal gift-tax treatment and generally do not use the donor’s lifetime gift or GST exemption.
To qualify, the payment must be made directly to the educational or medical provider.
Direct Tuition Payments
A grandparent may pay a grandchild’s qualifying tuition directly to a school without the payment being treated as a taxable gift.
The exclusion generally applies only to tuition. It does not automatically cover:
- Books
- Supplies
- Housing
- Meal plans
- Transportation
- Other living expenses
If the grandparent gives the money to the grandchild or parent instead of paying the school directly, the exclusion may not apply.
Direct Medical Payments
A grandparent may also pay qualifying medical expenses directly to a healthcare provider.
Payments may include certain medical care or insurance expenses, but the funds must be paid directly to the provider or insurer to qualify for the exclusion.
The IRS confirms in its GST tax instructions that qualifying direct payments for medical and educational expenses may be excluded from GST treatment.
Does the Annual Gift-Tax Exclusion Apply?
The annual gift-tax exclusion can apply to certain outright gifts to grandchildren or other skip persons.
However, the gift-tax annual exclusion and GST exemption are separate concepts. A transfer that qualifies for the annual gift-tax exclusion does not always receive the same treatment for GST purposes, particularly when the gift is made through a trust.
The type of gift, withdrawal rights, trust provisions, and identity of the beneficiaries can all affect the result.
Large gifts and gifts to trusts should be reviewed before the transfer is completed.
Why Allocation of the GST Exemption Matters
A person may allocate GST exemption to a direct transfer or to property placed in a trust.
Proper allocation can protect both the original property and its future appreciation from GST tax. An incorrect, late, or missed allocation can produce unexpected tax consequences years later.
Some transfers receive an automatic allocation under federal law. In other situations, the donor or the donor’s executor must make an affirmative allocation on Form 709 or Form 706.
Once made, an allocation is generally irrevocable.
Trusts Can Be Partially Exempt
If the available GST exemption does not cover the entire value transferred to a trust, the trust may be only partially exempt.
The IRS uses an “inclusion ratio” to determine what portion of a future distribution or termination is subject to GST tax.
For this reason, trustees and beneficiaries should retain records showing:
- The value of property transferred to the trust
- The GST exemption allocated
- Copies of gift and estate tax returns
- The trust’s inclusion ratio
- Later additions to the trust
Missing records can make it difficult to determine the tax treatment years or decades later.
Married Couples Cannot Rely on GST Portability
Married couples may effectively have two individual GST exemptions, but each spouse’s exemption must be planned and allocated separately.
The GST exemption is not portable between spouses.
With the federal estate-tax exemption, a surviving spouse may be able to use a deceased spouse’s unused exemption if the appropriate portability election is made. That rule does not apply to the GST exemption.
If the first spouse dies without using or properly allocating the available GST exemption, that exemption is generally lost.
Why the GST Tax Still Matters With a High Exemption
Most people will not currently make generation-skipping transfers large enough to exhaust the federal exemption.
However, the tax can still matter when:
- A family has substantial or rapidly appreciating property
- A business may increase significantly in value
- A trust is intended to last for several generations
- Large gifts are being made to grandchildren
- Life insurance proceeds will be held in a multigenerational trust
- Existing trusts have unclear GST allocations
- A married couple wants to use both spouses’ exemptions
Tax laws and exemption amounts can change. A plan that works under current law may need to be revised later.
The value of the property can also grow substantially after it is transferred. Allocating exemption while an asset has a lower value may provide benefits that are not available after it appreciates.
Review Multigenerational Plans Regularly
The generation-skipping transfer tax is one of the more complicated parts of federal estate and gift-tax law.
Few families need to pay the tax, but mistakes involving GST exemption can be costly and may not become apparent for many years.
If you are transferring substantial property to grandchildren or creating a trust for multiple generations, work with legal and tax professionals who understand:
- Gift and estate-tax reporting
- GST exemption allocation
- Trust inclusion ratios
- Direct skips
- Taxable distributions
- Taxable terminations
- Spousal planning
- Recordkeeping requirements
Because the rules and exemption amounts can change, multigenerational estate plans should be reviewed regularly.
We Can Help With Multigenerational Estate Planning
McDonald Law Firm can help families create and review estate plans involving children, grandchildren, trusts, and other multigenerational planning concerns.
Attorney André O. McDonald assists clients in Howard County, Montgomery County, and the District of Columbia with estate planning, special needs planning, Medicaid planning, and related matters.
For tax-specific advice, we may also recommend coordinating with a qualified tax professional.
To schedule a consultation, call:
- Howard County: 443-741-1088
- Montgomery County: 301-941-7809
- District of Columbia: 202-640-2133
DISCLAIMER: THE INFORMATION POSTED ON THIS BLOG IS INTENDED FOR EDUCATIONAL PURPOSES ONLY AND IS NOT INTENDED TO CONVEY LEGAL, INSURANCE, OR TAX ADVICE.
