DEFINITION of Generation-Skipping Transfer Tax (GSTT)
Generation-skipping transfer tax is a federal tax that results when there is a transfer of property by gift or inheritance to a beneficiary who is at least 37½ years younger than the donor. Generation-skipping transfer taxes serve the purpose of ensuring that taxes are paid when assets are placed in a trust, and the beneficiary receives amounts in excess of the generation-skipping estate tax credit.
Understanding Generation-Skipping Transfer Tax (GSTT)
The generation-skipping transfer tax (GSTT) is an additional tax on a transfer of property that skips a generation. The GSTT was implemented to prevent families from avoiding the estate tax for one or more generations by making gifts or bequests directly to grandchildren or great-grandchildren. The parent's generation is skipped to avoid an inheritance being subject to estate taxes twice. The GSTT ensures that grandchildren end up with the same value of assets that they would have had if the inheritance was transferred to them directly from their parents, rather than their grandparents.
The person giving the gift is referred to as the transferor and the recipient is known as the skip person. Many people use a grandchild as a skip person, but a skip person does not have to be a family member. Any individual is eligible to receive a generation-skipping transfer as long as they are at least 37½ years younger than the transferor.
The generation-skipping transfer tax will be imposed only if the transfer avoids incurring a gift or estate tax at each generation level. To make up for the taxes that may be avoided by skipping one generation, the Internal Revenue Service (IRS) imposes a second layer of tax on gifts and bequests above the estate and lifetime gift exclusion. It means that the GSTT is only due when a beneficiary receives amounts in excess of the GST estate tax credit.
Although the GSTT commonly occurs with a transfer to grandchildren, most people will not incur this tax as the GSTT exemption is very high. Effective January 1, 2018, following the Tax Cuts and Job Acts signed by President Donald Trump, the federal estate, gift, and GSTT exemption is $11.2 million for each individual and $22.4 million for married couples. The exemption amount is to be adjusted annually for inflation beginning in 2019. The value of a person’s estate that is in excess of his or her applicable exemption will be subject to an estate tax at death at a flat rate of 40%. So, only aggregate gifts and bequests to a skip person in excess of $11.2 million would be subject to the 40% flat generation-skipping transfer tax. Additionally, transferors can create dynasty trusts which are completely released from paying the GSTT.
Some states also collect generation-skipping transfer taxes. Be sure to check with your local taxing authority to get this information.