If you’re considering making asset transfers to your grandchildren or great grandchildren, be sure your estate plan addresses the federal generation-skipping transfer (GST) tax. This tax ensures that large estates can’t bypass a round of taxation that would normally apply if assets were transferred from parent to child, and then from child to grandchild.
Because of the complexity and potential tax liability, careful estate planning is essential when considering generation-skipping transfers. Trusts are often used as a strategic vehicle to allocate the GST tax exemption amount effectively and ensure that assets pass tax-efficiently to younger generations.
ABCs of the GST tax
The GST tax applies at a flat 40% rate — in addition to otherwise applicable gift and estate taxes — to transfers that skip a generation. “Skip persons” include your grandchildren, other relatives who are more than one generation below you and unrelated people who are more than 37½ years younger than you. There’s an exception, however, for a grandchild whose parent (your child) predeceases you. In that case, the grandchild moves up a generation and is no longer considered a skip person.
Even though the GST tax enjoys an annual inflation-adjusted lifetime exemption in the same amount as the lifetime gift and estate tax exemption (currently, $13.99 million), it works a bit differently. For example, while the gift and estate tax exemption automatically protects eligible transfers of wealth, the GST tax exemption must be allocated to a transfer to shelter it from tax.
3 transfer types trigger GST tax
There are three types of transfers that may trigger the GST tax:
- A direct skip — a transfer directly to a skip person that is subject to federal gift and estate tax,
- A taxable distribution — a distribution from a trust to a skip person, or
- A taxable termination — such as when you establish a trust for your children, the last child beneficiary dies and the trust assets pass to your grandchildren.
The GST tax doesn’t apply to transfers to which you allocate your GST tax exemption. In addition, the GST tax annual exclusion — which is similar to the gift tax annual exclusion — allows you to transfer up to $19,000 per year (for 2025) to any number of skip persons without triggering GST tax or using up any of your GST tax exemption.
Transfers to a trust qualify for the annual GST tax exclusion only if the trust 1) is established for a single beneficiary who’s a grandchild or other skip person, and 2) provides that no portion of its income or principal may be distributed to (or for the benefit of) anyone other than that beneficiary. Additionally, if the trust doesn’t terminate before the beneficiary dies, any remaining assets will be included in the beneficiary’s gross estate.
If you wish to make substantial gifts, either outright or in trust, to your grandchildren or other skip persons, allocate your GST tax exemption carefully. Turn to us for answers regarding the GST tax.
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