Skip person

What Is a Skip Person?

A skip person is a specific designation within the context of estate planning and taxation, primarily relevant to the generation-skipping transfer tax (GSTT). Generally, a skip person is a beneficiary who is two or more generations younger than the transferor (the person making the gift or bequest). This classification helps determine when the GSTT applies to wealth transfers, preventing the avoidance of estate taxes across multiple generations. Common examples of a skip person include a grandchild or great-grandchild receiving assets from a grandparent or great-grandparent, either directly or through a trust.

History and Origin

The concept of a skip person, as it relates to the generation-skipping transfer tax, emerged from legislative efforts to curb specific estate planning strategies. Before the introduction of the GSTT, wealthy individuals could bypass intermediate generations (like their children) by making direct gifts or bequests to their grandchildren or more distant descendants. This practice effectively allowed assets to skip a generation for transfer tax purposes, avoiding an additional layer of estate tax or gift tax that would otherwise apply if the assets passed through each generation.¹²

To address this perceived loophole, Congress first enacted a generation-skipping transfer tax as part of the Tax Reform Act of 1976.¹¹ However, that initial version proved to be administratively complex.¹⁰ The current framework of the GSTT, including the precise definition of a skip person, was significantly revised and expanded with the Tax Reform Act of 1986.⁹ This legislation aimed to ensure that wealth passing directly to a skip person would be subject to tax at each generational level, thus maintaining the integrity of the federal transfer tax system.⁸ The history of federal transfer taxes, including the estate, gift, and generation-skipping taxes, showcases a continuous evolution influenced by revenue needs and efforts to ensure equitable taxation across generations.⁷

Key Takeaways

A skip person is a recipient of wealth who is two or more generations younger than the transferor.
This designation is crucial for determining the applicability of the Generation-Skipping Transfer Tax (GSTT).
The GSTT aims to prevent the avoidance of multiple layers of transfer taxes by bypassing intermediate generations.
A trust can also be classified as a skip person under specific conditions.
Transfers to a skip person can include direct gifts or distributions from a trust, which may be categorized as a direct skip, taxable termination, or taxable distribution.

Interpreting the Skip Person

Understanding who qualifies as a skip person is fundamental for estate planning, especially when substantial wealth is involved. The Internal Revenue Code (IRC) Section 2613 provides the legal definition. A natural person is considered a skip person if they are assigned to a generation that is two or more generations below that of the transferor. For unrelated individuals, a person is generally a skip person if they are more than 37½ years younger than the transferor.
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A trust can also be classified as a skip person. This occurs if all interests in the trust are held by skip persons, or if no person holds an interest in the trust and, at no time after the transfer, may a distribution be made from the trust to a non-skip person. The determination of generational assignment is critical, and there are specific rules, such as the "predeceased parent rule," which can alter a person's generational assignment if their direct lineal ancestor (who was a lineal descendant of the transferor) is deceased at the time of the transfer.
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Hypothetical Example

Consider Jane, a grandparent, who wishes to transfer $500,000 to her grandchild, Alex, who is 30 years old. Jane’s child (Alex’s parent) is still living. In this scenario, Alex is a skip person because he is two generations younger than Jane.

If Jane makes this transfer directly to Alex, it would be considered a direct skip for GSTT purposes. The value of the gift would be subject to both the gift tax and potentially the generation-skipping transfer tax, depending on Jane's available exemption amount.

Now, imagine Jane sets up a trust for the benefit of Alex and her other grandchildren. If the trust dictates that only the grandchildren can receive distributions, then the trust itself could be classified as a skip person. Any distributions from this trust to Alex would not be further generation-skipping transfers because the trust itself is already treated as a skip person.

Practical Applications

The concept of a skip person has direct and significant implications in wealth transfer strategies and tax compliance:

Estate Planning for High-Net-Worth Individuals: Understanding the definition of a skip person is essential for individuals with large estates seeking to transfer wealth across multiple generations efficiently. Strategies often involve the strategic use of the GSTT exemption.
Trust Design and Administration: When creating multi-generational trusts, such as a dynasty trust, identifying potential skip persons among beneficiaries is paramount. The structure of the trust, and whether it qualifies as a skip person itself, dictates how and when the GSTT might apply to distributions or terminations. Trustees, acting as fiduciarys, must accurately identify skip persons to fulfill their tax obligations.
Tax Compliance and Reporting: Any transfer that involves a skip person must be carefully reported to the IRS. For example, direct skips generally require the transferor (or their estate) to pay the GSTT, while for taxable terminations or taxable distributions from a trust, the trustee or the beneficiary may be responsible. The ²IRS provides guidance and forms, such as Form 709 (Gift and Generation-Skipping Transfer Tax Return), for reporting these transfers.
Legal and Financial Advisory: Estate planning attorneys and financial advisors routinely use the skip person definition to advise clients on minimizing potential GSTT liabilities and structuring their legacies in accordance with their wishes and current tax laws. This often involves intricate calculations and a deep understanding of tax code provisions.

Limitations and Criticisms

While designed to address tax avoidance, the generation-skipping transfer tax and the definition of a skip person have faced scrutiny and criticism:

Complexity: The rules surrounding the GSTT, including the precise determination of a skip person and the various types of generation-skipping transfers (direct skips, taxable terminations, and taxable distributions), are often cited as highly complex. This complexity can make compliance challenging for individuals and even some professionals, potentially leading to errors or overlooked tax implications.
High Exemption Amounts: Critics argue that the perpetually high exemption amount for the GSTT (which typically aligns with the federal estate tax exemption) effectively limits the tax's impact to only the wealthiest individuals and families. This undermines the original intent of broader wealth transfer taxation.
¹Perpetuities and Dynasty Trusts: The existence of the GSTT, coupled with the repeal of the Rule Against Perpetuities in some states, has facilitated the creation of very long-term or "dynasty" trusts. These trusts can hold assets for many generations, potentially escaping federal wealth transfer taxation indefinitely if structured correctly and sufficient GSTT exemption is allocated. Some legal scholars argue this feature allows ultra-wealthy families to shield significant assets from future transfer taxes, exacerbating wealth inequality.
Unintended Consequences: Despite its intent, the GSTT can sometimes lead to unintended outcomes or harsh penalties if not properly managed. For instance, a failure to properly allocate the GSTT exemption could result in unexpected tax liabilities later.

Skip Person vs. Non-Skip Person

The distinction between a skip person and a non-skip person is fundamental to the application of the generation-skipping transfer tax (GSTT). A skip person is, as defined by tax law, a person who is two or more generations younger than the transferor, or a trust where all interests are held by such individuals. This includes common relationships like a grandchild or great-grandchild receiving a gift from a grandparent.

Conversely, a non-skip person is any individual or entity that does not meet the definition of a skip person. This typically includes the transferor's spouse, their children (unless the deceased parent rule applies), or any individual who is less than 37½ years younger than the transferor if not a lineal descendant. Transfers made directly to a non-skip person are generally subject to regular estate tax or gift tax, but not the additional layer of GSTT. Confusion often arises because the "generation" is defined by specific tax rules, which may not always align with colloquial family relationships, particularly when unrelated individuals or complex trust structures are involved.

FAQs

What is the primary purpose of defining a skip person?

The primary purpose of defining a skip person is to identify transfers of wealth that are subject to the generation-skipping transfer tax (GSTT). This tax prevents individuals from avoiding multiple layers of federal estate and gift taxes by directly transferring assets to beneficiaries who are two or more generations younger.

Can a trust be considered a skip person?

Yes, a trust can be considered a skip person under specific tax rules. This occurs if all interests in the trust are held by individuals who are themselves skip persons, or if no one holds an interest in the trust and no distributions can ever be made to a non-skip person.

What is the "deceased parent rule" and how does it affect the skip person definition?

The deceased parent rule is an exception that can change a person's generational assignment for GSTT purposes. If a lineal descendant of the transferor (e.g., a child of the transferor) dies before the transfer occurs, their children (the transferor's grandchildren) are "moved up" a generation and are no longer considered skip persons relative to that specific transfer. This means the GSTT would not apply to that particular transfer, though other transfer taxes like the estate tax might.

Does the generation-skipping transfer tax apply to all gifts to grandchildren?

Not necessarily. While grandchildren are typically considered skip persons, the generation-skipping transfer tax only applies to transfers that exceed the annually adjusted exemption amount. Additionally, certain transfers, such as direct payments for educational or medical expenses made directly to the institution or provider, are exempt from both gift and GST taxes.