Skip to main content
← Back to G Definitions

Generation skipping transfer tax gstt

Generation-Skipping Transfer Tax (GSTT)

The generation-skipping transfer tax (GSTT) is a federal tax levied on transfers of property to individuals who are two or more generations younger than the transferor, or to unrelated persons more than 37.5 years younger. This tax falls under the broader category of estate planning and is designed to prevent affluent individuals from circumventing estate tax and gift tax by passing assets directly to grandchildren or other remote descendants, thereby skipping an intermediate generation that would typically incur a transfer tax. The GSTT ensures that wealth transfers are subject to taxation at each generational level. The tax applies to gifts, inheritances, and transfers made through trusts.

History and Origin

Before the introduction of the generation-skipping transfer tax, wealthy individuals could legally transfer assets directly to their grandchildren or other younger beneficiaries, bypassing their children's generation and avoiding an additional layer of estate taxes. This presented a loophole in the federal transfer tax system. The first version of the GSTT was enacted as part of the Tax Reform Act of 1976. Its initial aim was to impose a tax equivalent to the estate or gift tax that was avoided by such transfers, particularly those made through multi-generational trusts.37, 38

However, the 1976 version proved administratively complex and challenging to implement. Consequently, Congress repealed it and enacted a new generation-skipping transfer tax law with the Tax Reform Act of 1986, effective October 23, 1986.36 This revised GSTT was designed to be more comprehensive, covering not only "direct skips" (outright gifts to skip persons) but also "taxable terminations" and "taxable distributions" from trusts.34, 35 The GSTT, along with the estate and gift taxes, forms a critical component of the federal transfer tax system, designed to ensure a more equitable distribution of the tax burden across generations.32, 33

Key Takeaways

  • The Generation-Skipping Transfer Tax (GSTT) is a federal tax on wealth transfers to beneficiaries who are at least two generations younger than the transferor.
  • Its primary purpose is to prevent the avoidance of estate and gift taxes that would otherwise apply at each generational level.
  • The GSTT has a specific lifetime exemption amount, which is adjusted annually for inflation.
  • Transfers exceeding this exemption are typically taxed at a flat rate, currently 40%.31
  • Effective estate planning often involves strategies to utilize the GSTT exemption to minimize tax liabilities over multiple generations.

Formula and Calculation

The generation-skipping transfer tax is generally calculated at a flat rate, which is currently 40% of the amount transferred, equivalent to the highest federal estate and gift tax rates.29, 30 This tax is applied to the value of the assets transferred that exceed the applicable GSTT exemption amount.

The formula for the GSTT is:

GSTT=(Value of Transfer to Skip PersonApplicable Exemption)×GSTT Rate\text{GSTT} = (\text{Value of Transfer to Skip Person} - \text{Applicable Exemption}) \times \text{GSTT Rate}

Where:

  • Value of Transfer to Skip Person: The fair market value of the property or assets transferred to a "skip person" (a beneficiary two or more generations younger).
  • Applicable Exemption: The portion of the transferor's lifetime GSTT exemption allocated to the transfer.
  • GSTT Rate: The flat tax rate applied to taxable generation-skipping transfers (currently 40%).

Each individual has a separate lifetime GSTT exemption. For 2025, the federal estate, gift, and generation-skipping transfer tax exemption is $13.99 million per individual.26, 27, 28 This amount is adjusted annually for inflation. Gifts qualifying for the annual exclusion generally do not trigger GSTT and do not use up the lifetime exemption.24, 25

Interpreting the GSTT

Understanding the generation-skipping transfer tax is crucial for individuals engaged in wealth transfer and legacy planning. While the tax rate is substantial, the key to interpretation lies in its application to amounts exceeding the lifetime GSTT exemption. Most individuals will never encounter this tax due to the high exemption thresholds. For example, the IRS reports that only a small percentage of decedents pay estate tax, and the GSTT applies to an even more limited number of taxpayers due to its alignment with the estate and gift tax exemptions.23

The GSTT is interpreted as a mechanism to ensure that assets passing down through generations incur a transfer tax at least once per generation. If a transfer effectively "skips" a generation that would otherwise be subject to estate or gift tax, the GSTT steps in to impose a similar levy. Proper allocation of the unified credit and the GSTT exemption is vital for maximizing tax efficiency in multi-generational transfers.

Hypothetical Example

Consider an individual, Ms. Eleanor Vance, who in 2025 wants to leave a substantial inheritance to her grandchild, David, bypassing her son, Robert. Ms. Vance's lifetime GSTT exemption for 2025 is $13.99 million. Let's assume Ms. Vance has already used $5 million of her overall lifetime exemption through prior taxable gifts to her children.

Ms. Vance decides to gift $10 million directly to David. Since David is two generations younger, this is a generation-skipping transfer.

  1. Gift Value: $10,000,000
  2. Remaining GSTT Exemption: $13,990,000 (initial) - $5,000,000 (already used for other gifts) = $8,990,000 available to allocate for GSTT purposes.
  3. Taxable Generation-Skipping Transfer: $10,000,000 (gift) - $8,990,000 (allocated exemption) = $1,010,000
  4. GSTT Calculation: $1,010,000 \times 40% = $404,000

In this scenario, Ms. Vance would owe $404,000 in generation-skipping transfer tax, in addition to any applicable gift tax on the portion of the gift exceeding her remaining gift tax exemption, if it was an inter vivos gift. This illustrates how the GSTT applies to the portion of the transfer that exceeds the available exemption, ensuring that even transfers designed to skip a generation are still subject to a form of wealth transfer taxation.

Practical Applications

The generation-skipping transfer tax plays a significant role in advanced estate planning strategies, particularly for high-net-worth individuals. One primary application involves the use of "dynasty trusts" or "generation-skipping trusts." These structures are designed to hold assets for multiple generations, potentially avoiding estate and gift taxes at each successive generational level as long as the trust is properly structured and GSTT exemption is allocated.21, 22 By funding an irrevocable trusts with assets and allocating the GSTT exemption, the grantor can shield the trust's future growth from transfer taxes for a long period.19, 20

Furthermore, the GSTT impacts reporting requirements. Transfers subject to the GSTT, even if fully covered by the exemption, typically require the filing of IRS Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return. This form is used to report taxable gifts and to allocate the generation-skipping transfer exemption.17, 18 Careful documentation and reporting are essential for ensuring compliance and effectively utilizing available exemptions.

Limitations and Criticisms

While designed to close a tax loophole, the generation-skipping transfer tax faces several criticisms, primarily regarding its complexity and its high exemption amounts. The rules governing the GSTT can be intricate, requiring sophisticated legal and financial expertise to navigate effectively.15, 16 This complexity can lead to administrative burdens and potential missteps for those unfamiliar with its nuances.13, 14

A significant criticism revolves around the substantial GSTT exemption amount. Critics argue that the high exemption, particularly following increases from the Tax Cuts and Jobs Act of 2017, effectively limits the tax's application to only the wealthiest individuals and families.12 This can be seen as undermining the tax's original intent to ensure a fair share of the tax burden on large wealth transfers. Some proposals suggest reducing the exemption to earlier levels to broaden the tax's impact.10, 11

Additionally, while dynasty trusts can be powerful for asset protection and multi-generational wealth preservation, they are also a point of contention. Some argue that these trusts, when combined with the large GSTT exemption, allow immense wealth to grow indefinitely outside the federal transfer tax base, contributing to wealth concentration.8, 9 The tax's effectiveness is often debated in the context of these long-term planning vehicles and their ability to minimize future transfer tax liabilities.

Generation-Skipping Transfer Tax (GSTT) vs. Estate Tax

The generation-skipping transfer tax (GSTT) and the estate tax are both federal transfer taxes, but they apply in different circumstances. The estate tax is levied on the value of a deceased individual's property transferred at death. It applies when assets pass directly from one generation to the next (e.g., from parent to child).

In contrast, the GSTT applies when assets are transferred to a "skip person," meaning a beneficiary who is at least two generations younger than the transferor (e.g., from grandparent to grandchild), or an unrelated person 37.5 years younger. The GSTT is an additional tax imposed in addition to any applicable estate or gift tax, specifically designed to capture the tax revenue that would have been collected if the assets had been transferred through the intermediate generation. The goal of the GSTT is to achieve a similar tax outcome as if the assets had been taxed at each generational level, preventing the "skipping" of a tax event. Both taxes share the same top statutory tax rates and operate under a unified lifetime exemption, though the GSTT exemption specifically applies to generation-skipping transfers.5, 6, 7

FAQs

Q: Who pays the generation-skipping transfer tax?
A: The person making the transfer (the "transferor" or "donor") is typically responsible for paying the generation-skipping transfer tax if it's a direct skip. For transfers through a trust, the trustee or the recipient beneficiary may be responsible, depending on the type of generation-skipping transfer.4

Q: Is the generation-skipping transfer tax always applied to gifts to grandchildren?
A: Not always. The generation-skipping transfer tax applies to transfers to grandchildren only if the total value exceeds the transferor's lifetime GSTT exemption amount. Also, if the grandchild's parent (the transferor's child) is deceased at the time of the transfer, the grandchild is "moved up" a generation and the transfer may not be subject to the GSTT.2, 3 Additionally, transfers that qualify for the annual exclusion generally do not incur GSTT.

Q: How does the generation-skipping transfer tax exemption work?
A: Each individual has a significant lifetime GSTT lifetime exemption that can be applied to generation-skipping transfers during their life or at death. This exemption amount is the total value of assets that can be transferred to skip persons without incurring the GSTT. Once this exemption is used up, subsequent generation-skipping transfers become subject to the tax. It is important to consult with a financial advisor or estate planning professional to properly allocate this exemption.

Q: Are there ways to avoid the generation-skipping transfer tax?
A: While outright avoidance of the tax on large transfers to skip persons is generally not possible beyond the exemption, strategic estate planning can minimize its impact. Utilizing the lifetime GSTT exemption, making gifts within the annual exclusion limits, and establishing properly structured generation-skipping trusts are common strategies to manage and reduce potential GSTT liability.1