What Is a Generation-Skipping Transfer or Trust?
A generation-skipping transfer (GST) refers to the transfer of property, either outright or in a trust, to a "skip person," who is generally a beneficiary at least two generations younger than the transferor, such as a grandchild or great-grandchild. This concept is a critical component of federal estate planning and aims to ensure that wealth does not bypass taxation at each generational level. The tax associated with such transfers is known as the Generation-Skipping Transfer Tax (GSTT), and it falls under the broader category of wealth transfer taxation. When assets are placed into a specific legal arrangement designed to facilitate such a transfer, it is known as a generation-skipping trust.
History and Origin
The federal government's engagement with transfer taxes has a long history, with various forms of death and gift taxes appearing intermittently. The modern estate tax and gift tax systems became permanent fixtures in the early 20th century. However, wealthy families historically sought ways to reduce cumulative tax burdens by transferring assets directly to grandchildren or more distant descendants, effectively "skipping" a generation's estate tax. To address this, the first version of the generation-skipping transfer tax was introduced in 1976, initially applying primarily to multigenerational trusts.27, 28
This early iteration faced administrative complexities, leading Congress to repeal it and enact a new, more streamlined GSTT law in 1986. This revised law expanded the tax to cover both outright gifts and transfers in trusts, with its effective date being October 23, 1986. The purpose of the generation-skipping transfer tax was to complement the existing transfer tax system, ensuring that substantial fortunes would contribute their share of the tax burden and preventing indefinite wealth transfer without taxation.25, 26
Key Takeaways
- The generation-skipping transfer tax (GSTT) is a federal tax on transfers to individuals who are two or more generations younger than the transferor, or to unrelated persons at least 37.5 years younger.
- The GSTT aims to prevent the avoidance of estate and gift taxes that would otherwise apply if wealth passed through each successive generation.
- The tax applies to direct skips (outright gifts), taxable distributions from trusts, and taxable terminations of trust interests.
- A substantial lifetime exemption is available for individuals, allowing for significant tax-free transfers.
- Proper estate planning strategies can help individuals maximize the use of the GSTT exemption and minimize tax liabilities.
Formula and Calculation
The Generation-Skipping Transfer Tax (GSTT) is imposed at a flat rate, which is equal to the highest federal estate and gift tax rate at the time of the transfer. This rate has been 40% since 2014.
The amount of GSTT due on a transfer depends on whether the transfer is fully or partially exempt. Each individual has a lifetime GSTT exemption. As of 2025, this exemption is set at $13.99 million per individual (or $27.98 million for a married couple).24
The taxable amount for a direct skip is the value of the property received by the skip person. For taxable distributions, the tax is based on the value of the distribution received. For taxable terminations, the tax is based on the value of the property in the trust.
The calculation of the GSTT is generally:
Taxable Amount (Value of Transfer) GSTT Rate (40%) GSTT Due
For example, if a non-exempt, taxable distribution of $1,000,000 is made to a skip person:
$1,000,000 0.40 $400,000
The GSTT is in addition to any applicable gift tax or estate tax. However, the allocation of the GSTT exemption reduces the amount subject to this tax. This allocation is generally reported on IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, or IRS Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return.22, 23
Interpreting the Generation-Skipping Transfer
Understanding the generation-skipping transfer tax is crucial for individuals with significant assets who wish to pass wealth to future generations. The GSTT applies to specific types of transfers to "skip persons," which include relatives who are more than one generation younger than the transferor (e.g., grandchildren, great-grandchildren) or unrelated individuals who are more than 37.5 years younger.20, 21
The primary goal of the GSTT is to prevent taxpayers from avoiding wealth transfer taxes across generations. If a transfer is structured to bypass an intermediate generation, thereby avoiding an estate or gift tax that would normally apply at that level, the GSTT can be triggered. Effectively, it imposes a tax as if the property had been taxed at each generation.19 Utilizing the annual gift tax exclusion and the lifetime GSTT exemption are key strategies for managing potential tax liabilities.
Hypothetical Example
Consider a wealthy individual, Sarah, who has an extensive gross estate and wants to provide for her grandchildren's education and future, potentially bypassing her children. Sarah's lifetime GSTT exemption is $13.99 million.
Sarah decides to establish an irrevocable trust for the benefit of her grandchildren. She funds the trust with $5 million in assets. To ensure these assets, and any future growth, are not subject to the generation-skipping transfer tax when distributed to her grandchildren, Sarah allocates $5 million of her lifetime GSTT exemption to this trust.
Years later, the trust assets have grown to $10 million, and the trustee begins making distributions to Sarah's grandchildren for college tuition and living expenses. Because Sarah fully allocated her GSTT exemption to the initial $5 million transfer to the trust, and this allocation covered the entire amount, any distributions from this trust to her grandchildren (who are skip persons) will be exempt from the GSTT, regardless of how much the assets grew. This strategic use of the exemption means the $10 million in distributions will not incur the 40% GSTT.
Practical Applications
The generation-skipping transfer tax primarily impacts high-net-worth individuals engaged in estate planning. It influences how they structure their wealth transfer strategies to benefit future generations while minimizing tax exposure. One common application is the creation of a dynasty trust, which is an irrevocable trust designed to last for several generations, potentially indefinitely in states that have abolished the rule against perpetuities.17, 18
By allocating the GSTT exemption to assets transferred into a dynasty trust, grantors can ensure that the trust's assets, and any appreciation, are shielded from the GSTT for the trust's duration.16 This can lead to significant tax savings over time, allowing more wealth to pass to subsequent generations. Another practical application involves making direct payments for educational or medical expenses on behalf of a skip person, as these payments can be exempt from both gift and GST taxes.15 For taxpayers, understanding how to apply their GSTT exemption is a critical component of maximizing tax efficiency.
Limitations and Criticisms
While generation-skipping trusts offer considerable benefits in asset protection and tax minimization, they also come with limitations and criticisms. The complexity and cost associated with establishing and maintaining these trusts are significant drawbacks. Setting up a GST typically requires the expertise of experienced estate planning attorneys and financial advisors, and ongoing administration can incur substantial fees for accounting, legal services, and fiduciary responsibilities.14
Furthermore, many generation-skipping trusts are irrevocable trusts, meaning the grantor relinquishes control over the assets once they are placed in the trust. The terms typically cannot be changed, nor can the assets be retrieved, which can be a limiting factor for individuals who may need future access to these funds or desire flexibility.13
Another point of criticism revolves around the effectiveness and equity of the GSTT itself. Some argue that despite its intent, the tax, particularly with its high exemption amounts and potential for certain planning strategies, has enabled the accumulation of vast wealth in "dynasty trusts" that effectively escape federal wealth transfer taxation for extended periods.12 This can lead to concerns about wealth concentration and its impact on economic and political power.11 For individuals with smaller estates, the substantial cost and complexity of a generation-skipping trust may not justify the potential tax benefits, particularly if their assets already fall below the estate tax exemption thresholds.10
Generation-Skipping Transfer or Trust vs. Dynasty Trust
While the terms "generation-skipping transfer" and "dynasty trust" are closely related in estate planning, they are not entirely interchangeable.
A generation-skipping transfer (GST) is a broad term referring to any transfer of property that "skips" a generation for tax purposes. This can be an outright gift directly to a grandchild (a direct skip) or a transfer into a trust where the primary beneficiaries are skip persons. The key element is the transfer bypassing an immediate generation for tax assessment. The Generation-Skipping Transfer Tax (GSTT) is the specific federal tax applied to such transfers when they exceed certain exemptions.
A dynasty trust, on the other hand, is a specific type of irrevocable trust structured to leverage the generation-skipping transfer tax exemption. Its primary characteristic is its intended longevity—it is designed to hold and manage assets for multiple generations, often for the longest period allowed by state law (or in perpetuity in states that have abolished the rule against perpetuities). While all assets placed into a dynasty trust typically represent a generation-skipping transfer, not all generation-skipping transfers involve a dynasty trust. An outright gift to a grandchild, for instance, is a generation-skipping transfer but does not involve a trust. Dynasty trusts are a strategic tool for managing and preserving wealth transfer across many future generations, often also providing probate avoidance benefits.
9## FAQs
What is a "skip person" in the context of a generation-skipping transfer?
A "skip person" is an individual who is at least two generations younger than the transferor (e.g., a grandchild or great-grandchild). It can also be an unrelated individual who is more than 37.5 years younger than the transferor.
7, 8### How much is the generation-skipping transfer tax exemption?
For 2025, the lifetime generation-skipping transfer tax (GSTT) exemption is $13.99 million per individual, or $27.98 million for married couples. This amount is indexed for inflation.
6### Does the generation-skipping transfer tax apply to gifts to my children?
No, the generation-skipping transfer tax generally does not apply to transfers made directly to your children, as they are considered one generation younger than you, not a "skip person." The GSTT is designed for transfers that bypass your children's generation.
5### Is the generation-skipping transfer tax in addition to other taxes?
Yes, the generation-skipping transfer tax is typically imposed in addition to any applicable federal gift tax or estate tax. It is designed to ensure that wealth is taxed at each generational level.
3, 4### Can I avoid the generation-skipping transfer tax?
With careful planning, you can significantly reduce or potentially eliminate the impact of the generation-skipping transfer tax. Strategies include fully utilizing your lifetime GSTT exemption, making annual gift tax exclusion gifts, and establishing properly structured trusts. Consulting with an estate planning professional is essential to navigate the complexities.1, 2