Generation-Skipping Transfer Tax

Introduction to the Generation-Skipping Transfer Tax (GSTT)

The Generation-Skipping Transfer Tax (GSTT) is a specific federal tax designed to tax transfers of wealth that skip a generation, typically from grandparents or great-grandparents directly to grandchildren or great-grandchildren. It was enacted to close a loophole that previously allowed families to avoid paying estate taxes by bypassing the child’s generation and transferring assets directly to grandchildren.

Historical Background and Purpose

The GSTT was introduced under the Tax Reform Act of 1976, aiming to prevent “generation skipping” transactions that would circumvent estate and gift taxes. When assets skip a generation, they avoid being taxed in the intermediary generation, reducing government estate tax revenues. By adding this tax, the IRS ensures that large wealth transfers across multiple generations are effectively taxed, maintaining fairness in the estate tax system.

How the GSTT Works

GSTT applies to transfers, whether lifetime gifts or bequests at death, where the recipient is at least two generations younger than the donor. The tax generally applies in these cases:

• Direct skips: Transfers directly to a “skip person,” usually a grandchild or more remote descendant.
• Taxable terminations: When an interest in a trust terminates and the property is allocated to skip persons.
• Taxable distributions: Distributions from trusts to skip persons.

The tax is assessed at the highest federal estate tax rate currently set around 40% (subject to annual adjustment).

Exemptions and Thresholds

Each individual has a Generation-Skipping Transfer exemption amount, which often aligns with the estate and gift tax exemption. As of 2025, this exemption is $13,000,000 per individual (subject to IRS annual adjustments and inflation indexing). Transfers below this amount can avoid GSTT. This exemption can be used during life or at death, reducing the taxable GSTT base.

Example of GSTT Application

Consider a grandparent transferring $15 million directly to a grandchild. The GST exemption covers $13 million, leaving $2 million subject to GSTT. The tax on that $2 million transfer would be 40%, resulting in $800,000 owed in GSTT.

Who Is Affected?

• Grandparents or great-grandparents transferring assets to grandchildren or younger generations.
• Parents who skip transferring wealth to their children but instead pass it directly to grandchildren.
• Beneficiaries who are two or more generations below the donor.

Note that transfers to spouses or qualified charities are exempt from GSTT, as are certain transfers to trusts under specific conditions.

Strategies to Manage or Avoid GSTT

Effective estate planning can mitigate or avoid the GSTT:

• Utilize the GST exemption: Coordinate the use of lifetime gifts and estate planning to maximize exemption use.
• Establish dynasty trusts: These trusts can span many generations and are designed to minimize GST tax exposure.
• Gift splitting: Married couples can combine their exemptions and gift-splitting strategies to increase the exempted amount.
• Regular review: GSTT laws and exemptions are subject to change; regular estate planning reviews are crucial.

Related IRS Forms and Filing Requirements

Filing the appropriate IRS forms is essential when GSTT applies. Key forms include:

• Form 709: United States Gift (and Generation-Skipping Transfer) Tax Return.
• Form 706-GS(D): Generation-Skipping Transfer Tax Return for Distributions.
• Form 706-GS(T): Generation-Skipping Transfer Tax Return for Taxable Terminations.
• Form 706-NA: For nonresident aliens’ estates passing generation-skipping transfers.

Common Misunderstandings

• GSTT is not simply an extension of the estate tax but a distinct tax targeting skipped generation transfers.
• It applies only when a transfer skips the immediate next generation.
• Transfers to spouses and charities generally do not incur GSTT.

Frequently Asked Questions

Q: Is GSTT separate from estate tax?
A: Yes, GSTT is distinct but applied alongside estate and gift taxes.

Q: What is the current GST exemption amount?
A: As of 2025, it is $13 million per individual, but this changes with tax law updates.

Q: Can GSTT be avoided completely?
A: Proper planning using trusts, exemptions, and gifting strategies can reduce or eliminate GSTT liability.

Summary Table: Key Aspects of the Generation-Skipping Transfer Tax

Additional Resources

For detailed IRS guidance, visit the official IRS GSTT page.

This article is linked internally to related FinHelp topics: Form 709 – United States Gift (and Generation-Skipping Transfer) Tax Return, Form 706-GS(D), and Estate Tax Planning.