Generation-skipping transfer tax: How it can affect your estate plan

Estate taxes can be hefty. One strategy to reduce estate taxes in your family over time is to “skip” a generation of heirs when passing down assets. While this strategy can be successful, it’s not necessarily tax-free.

What is the generation skipping transfer tax?

The generation-skipping transfer (GST) tax is a Federal tax imposed on assets gifted to heirs more than one generation younger than the grantor, generally grandchildren or great-grandchildren. Transfers to your own children are not considered generation-skipping. Assets transferred to a grandchild whose parent (your child) is deceased are not subject to the GST tax.

How the GST tax is assessed

The GST tax is separate from, and in addition to, the estate tax. The tax is currently calculated at a flat rate of 40% (equal to the estate and gift tax rate) on transfers above the lifetime GST tax exemption amount ($13.61 million per individual in 2024/$13.99 million in 2025). The GST exemption amount will grow each year based on inflation through 2025. The GST exemption amount is set to revert to a $7 million baseline in 2026, indexed for inflation.

The GST tax rate applies to outright transfers of property and certain other transfers of property to a trust. Generally, trust income or principal distributed to grandchildren are subject to GST.

Deciding which generation skipping transfer strategy is right for you

• Direct generation skip: You bypass your own children and give the assets qualifying for the exemption amount either directly to your grandchildren or place assets in a trust for their benefit or for the benefit of future generations.
• Generation-skipping transfers (or indirect generation skip): You place assets in a trust using your GST tax exemption. The trust pays your child income for life with the remainder passing outside of your child’s taxable estate to your grandchildren or future generations after your child is deceased.  

Who pays the generation skipping transfer tax?

The GST tax is paid by the grantor if using the direct generation skip strategy, or the beneficiary if using the generation-skipping transfer strategy. Keep in mind that the tax only applies to assets above the lifetime exemption amount ($13.61 million per individual in 2024/$13.99 per individual in 2025).

How to use a lifetime exemption from GST tax

The lifetime exemption from the GST tax offers some advantages. It may be applied to any combination of transfers during your life or made at the time of death.

Here are two potential strategies to consider when using the lifetime exemption. Discuss these strategies with your tax and legal advisors to determine which is best suited to your situation.

• During your lifetime, you make a gift of up to the current lifetime exemption amount ($13.61 million in 2024/$13.99 million in 2025) into a trust that ultimately distributes assets to your grandchildren, sheltering projected appreciation for future generations.
• At your death, you may leave up to the current exemption amount in lifetime trusts for your children. At your children’s deaths, that amount (plus any appreciation) passes to your grandchildren without incurring a GST tax or estate tax.

The federal estate, gift and GST tax exemptions are unified and indexed for inflation in future years. There is one important difference, however. With an estate tax, the unused exemption of the first spouse to die can be added to the surviving spouse’s personal exemption. The same flexibility does not apply to the GST exemption. Any of the GST exemption unused at your death is lost.

What is exempt from GST?

The GST tax does not apply to qualified nontaxable gifts. These include, but are not limited to:

• Annual exclusion gifts of up to $18,000 per recipient per year (current amount, indexed for inflation in future years).
• Payments for tuition, medical care or medical insurance made directly to a school, doctor, hospital, etc.

Gifts made for the benefit of a grandchild in these forms are generally tax-free.

Plan ahead to limit unnecessary taxes

You have the flexibility to make generation-skipping transfers during your lifetime or to plan for them to occur after your death.

During your lifetime, all applicable transfers of wealth that you make are automatically applied to your lifetime GST tax exemption, unless you elect otherwise. For transfers at death, the exemption may be allocated as you direct in your will or as your executor directs if unspecified in your will.

The rates and rules for the generation-skipping transfer tax can be complicated and subject to change. Work with your tax, legal and financial professionals to determine if and how to implement GST tax exemptions as part of your estate plan.

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