A Look at the Generation-Skipping Transfer Tax

Before the generation-skipping transfer tax was introduced in 1976, wealthy individuals could legally 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.

Key Takeaways

  • Before 1976 when the GST tax was set into law, wealthy individuals could legally gift money and bequeath property to their heirs without paying federal estate taxes. 
  • The new legislation closed the loophole whereby inheritances could skip a generation.
  • A generation-skipping transfer (GST) is the transfer of assets to a person who is two or more generations below that of the grantor.
  • The skip person could be any non-spousal member of the family, at least 37.5 years younger than the transferor.
  • The GST tax was put into place to ensure taxes were paid on gifts in excess of the GST estate tax credit.

What Is the Generation-Skipping Transfer?

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.

What Is the Generation-Skipping Transfer 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 a trust. The tax is only due when a skip person receives amounts over the GST estate tax credit. Fortunately, most people will never encounter the GST tax because of the high threshold.

Once a transferor exceeds the exemption, the GST tax is assessed at a flat rate.

GSTs can occur before or after the transferor's death, 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 of 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: taxable termination and taxable distribution.

Once a transferor exceeds the exemption amount, the tax is assessed at a flat rate rather than as a percentage.

Taxable Termination

A taxable termination involves a skip person and a non-skip person. A non-skip person is a 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 transferor's child. 

As an example of a taxable termination, consider a transferor who establishes an income-producing trust for their 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.

Taxable Distribution

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.

The chart below shows GST tax exemptions since 2010:

Year GST Exemption
2010 $5,000,000
2011 $5,000,000
2012 $5,120,000
2013 $5,250,000
2014 $5,340,000
2015 $5,430,000
2016 $5,450,000
2017 $5,490,000
2018 $11,180,000
2019 $11,400,000
2020 $11,580,000
2021 $11,700,000
2022 $12,060,000
Federal GST Tax Exemption Amount

Reducing the Tax Burden for an Heir

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.

In 2021, the individual exemption is $11,700,000 and in 2022 the amount goes up to $12,060,000. 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.

The Bottom Line

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.

Article Sources

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  1. Internal Revenue Service. “The Estate Tax: Ninety Years and Counting,” Page 123. Accessed Jan. 6, 2022.

  2. Internal Revenue Service. “Instructions for Form 706-GS(T).” Accessed Jan. 6, 2022.

  3. Cornell Law School, Legal Information Institute. "26 CFR § 26.2612-1 - Definitions." Accessed Jan. 6, 2022.

  4. Cornell Law School, Legal Information Institute. “26 U.S. Code § 2632. Special Rules for Allocation of GST Exemption.” Accessed Jan. 6, 2022.

  5. Cornell Law School. “26 U.S. Code § 2612. Taxable Termination; Taxable Distribution; Direct Skip.” Accessed Jan. 6, 2022.

  6. Internal Revenue Service. "Estate Tax." Accessed Jan. 6, 2022.

  7. Internal Revenue Service. "Instructions for Form 706-GS(T) (Rev. November 2021)," Page 6. Accessed Jan. 6, 2022.