What is the generation skipping transfer tax, and when does it apply?

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What Is the Generation Skipping Transfer Tax?

The generation-skipping transfer tax is a separate federal transfer tax imposed on certain transfers to persons two or more generations below the transferor, such as grandchildren, or to certain trusts for their benefit. Section 2601 imposes tax on every generation-skipping transfer, and section 2611 defines those transfers as direct skips, taxable distributions, and taxable terminations. It can apply to lifetime gifts and transfers at death, in addition to any gift or estate tax otherwise due. In practical estate tax planning, the tax is designed to prevent transfer tax avoidance through multigenerational transfers that bypass the children’s generation.

Who Is Considered a Skip Person Under the GST Rules?

A skip person generally is someone assigned to a generation that is two or more generations below the transferor, which commonly includes a grandchild. A trust can also be treated as a skip person if all interests in the trust are held by skip persons, or if no person holds an interest and no future distribution can be made to a non-skip person. In non-family situations, generation assignment can also apply by age-based rules, but the cited authorities here specifically confirm the family example of grandchildren and the trust rule. Whether a transfer is a GST event is determined by reference to the most recent transfer subject to estate or gift tax.

What Triggers the GST Tax and What Does Not?

The three triggering events are:

1. Direct skip – A gift or bequest subject to estate or gift tax that is made directly to a skip person. Example: A grandparent makes a taxable gift outright to a grandchild.
2. Taxable distribution – A distribution from a trust to a skip person that is not already treated as a direct skip or taxable termination. Example: A trust makes a payment to a grandchild.
3. Taxable termination – The end of a trust interest after which only skip persons remain as beneficiaries. Example: A trust provides income to a child for life, with the remaining trust interests passing only to the child’s children (the grantor’s grandchildren). When the child dies, ending the child’s interest, only skip persons remain as beneficiaries, resulting in a taxable termination.

How Does the GST Exemption Work and How Is It Allocated?

How It Works

• Lifetime Shield: Every individual receives a lifetime exemption amount. In 2026, up to $15 million (or $30 million for a married couple) can be transferred to beneficiaries during a lifetime or at death.
• Tax Avoidance: Transfers under this limit bypass the GST tax entirely.

How It Is Allocated

• Automatic Allocation: IRS automatically applies the exemption to direct skips and certain indirect transfers to trusts.
• Manual Election: Donors can opt out of automatic rules or manually allocate exemption via IRS Form 709 to maximize tax efficiency.

How Do Dynasty Trusts Use the GST Exemption to Preserve Wealth Across Generations?

A properly structured generation skipping trust can hold assets for multiple generations while avoiding repeated transfer taxation if GST tax exemption is properly allocated when the trust is funded. A dynasty trust funded with GST-exempt property generally has a zero inclusion ratio, allowing future appreciation and certain distributions to remain outside the GST tax system. When funding these trusts with interests in closely held businesses or other assets, valuation factors such as discounts for lack of control (DLOC) and discounts for lack of marketability (DLOM) may affect the taxable value of the transfer

Conclusion

The GST regime applies only when a transfer falls within one of the three statutory categories and involves a skip person or certain skip-person trusts. Correct exemption allocation is critical because once a trust is funded without sufficient exemption, later taxable distributions or terminations can produce long-term GST exposure.

How BT Can Help

For more than four decades, Bennett Thrasher has provided businesses and individuals with strategic business guidance and solutions through professional tax, audit, advisory, and business process outsourcing services. Contact Jonathan Swartz, partner in Bennett Thrasher’s Trusts & Estates Planning, or call us at 770.396.2200.

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