Before the generation-skipping transfer tax was introduced in 1976, wealthy individuals were legally able to gift money and bequeath property to their grandchildren, without paying federal estate taxes. But the new legislation effectively closed the loophole where inheritances could skip a generation to avoid double estate taxation.
What Is the GST?
A generation-skipping transfer (GST) refers to the transfer of money or property, as a gift or inheritance, to a person who is two or more generations below that of the grantor. The giving party is referred to as the "transferor" and the recipient is known as the “skip person”. While the skip person is often a grandchild, it could be any non-spousal family member, who's at least 37.5 years younger than the transferor. (To learn more, read Tax-Efficient Wealth Transfer.)
What Is the GST Tax?
The GST tax is a federal tax imposed on gifts given to skip-persons, to ensure taxes are paid at each generational level and that they are not avoided through the use of a trust. The tax is only due when a skip person receives amounts in excess of the GST estate tax credit. Fortunately, most people will never encounter the GST tax because of the high threshold. (For a complete guide, check out our Estate Planning Tutorial.)
Once a transferor exceeds the exemption, the GST tax is assessed at a flat rate. The chart below shows GST tax rates since 2001.
- Before the generation-skipping transfer tax was introduced in 1976, wealthy individuals were legally able to gift money and bequeath property to their grandchildren, without paying federal estate taxes.
- The new legislation effectively closed the loophole whereby inheritances could skip a generation, in order to avoid double estate taxation.
- A generation-skipping transfer (GST) refers to the transfer of money or property, as a gift or inheritance, to a person who is two or more generations below that of the grantor.
- While the skip person was often a grandchild, it could be any non-spousal member of the family, as they are at least 37.5 years younger than the transferor.
|Year||GST Tax Rate|
|2007 – 2009||45%|
|2013 or later||40%|
GSTs can occur before or after the death of the transferor, and the GST tax is assessed when the gift or property transfer is made. While still alive, the transferor can give the gift directly to the skip person. But upon death, the transferor's will may either stipulate that property is bequeathed to a skip person, or it may call for the establishment a trust from which distributions will be made. Form 709 is used to report both GST taxes and transfers whereby federal gift taxes are due.
Direct vs. Indirect Skips
The taxation of a GST depends on whether the transfer is a direct or an indirect skip. A direct skip is a property transfer that's subject to an estate or gift tax. An example of a direct skip would be a grandmother gifting property to a grandchild. The transferor or their estate is responsible for paying the GST tax for direct skips.
An indirect skip involves a transfer that has intermediate steps before reaching a skip person. There are two types of indirect skips: the taxable termination and the taxable distribution.
A taxable termination involves a skip person and a non-skip person. A non-skip person is the primary beneficiary who will receive property before it is transferred to the skip person. The transfer to the skip person occurs upon the death of a non-skip person -- typically the child of the transferor. As an example of a taxable termination, consider a transferor who establishes an income-producing trust for his son. Upon the son's death, the remaining property would be passed on to the transferor's grandchild, at which time those assets would be subject to the GST tax.
A taxable distribution refers to any distribution of income or property, from a trust to a skip person that is not otherwise subject to estate or gift tax. If a grandmother established a trust that made payments to her grandson, those payments would be subject to GST taxes, which the recipient is responsible for paying.
Reducing the Tax Burden for an Heir
Know your exemptions. Most beneficiaries will avoid the GST tax because their estates will be worth less than the government-provided estate tax credit. From 2006 through 2008, each taxpayer was entitled to a $2 million exemption, however the exemption has progressively increased, annually. As of 2018, the individual exemption is $11,180,000 -- more than double the previous tax year. Married couples can double these amounts to determine the exempt portion of their GST.
Create a generation-skipping transfer trust. To lower the effects of the GST tax, transferors can create a dynasty trust, which is designed to avoid or minimize estate taxes with each generational transfer. By parking assets in the trust and making specified distributions to each generation, the wealth of the trust isn’t subject to estate taxes, with the passage of each generation.
Generation-skipping transfer taxes can be complex and difficult to navigate, with strict rules and deadlines regarding lineage, the eligibility of skip persons, gift reporting and payment of taxes. An accountant or an attorney can help ensure the efficient, cost-friendly transfer from one generation to another. (Find out why you shouldn't put off putting your affairs in order; read Six Ways to Lose Your Estate.)