How to Avoid the Generation-Skipping Tax

The Generation-Skipping Transfer (GST) tax is a federal transfer tax. It ensures that wealth passed down through multiple generations, bypassing the immediately succeeding generation, is subject to taxation at each generational level. This tax prevents individuals from avoiding estate tax at each generational step. This article explores the fundamentals of the GST tax and outlines methods to manage or avoid its application.

Understanding Taxable Generation-Skipping Transfers

A generation-skipping transfer (GST) occurs when wealth is transferred to a “skip person.” A skip person is an individual two or more generations younger than the transferor, such as a grandchild or great-grandchild. A trust can also be considered a skip person if all its beneficiaries are skip persons. Conversely, a “non-skip person” is an individual who is not a skip person, for example, the transferor’s child.

The Internal Revenue Code identifies three primary types of generation-skipping transfers:
A “direct skip” involves a transfer subject to gift or estate tax made directly to a skip person. For instance, a gift from a grandparent directly to a grandchild is a direct skip.
A “taxable termination” occurs when an interest in property held in trust ends, and after this termination, only skip persons have an interest in the property. This typically happens when the interest of a non-skip person, such as a child, in a trust terminates, and the trust property then passes to the grantor’s grandchildren.
A “taxable distribution” is any distribution from a trust to a skip person that is not a direct skip or a taxable termination. For example, if a trust makes an income distribution to a grandchild while a child is still a beneficiary, this is a taxable distribution.

The GST tax is imposed in addition to any applicable estate or gift tax. The GST tax rate is a flat 40% of the taxable amount, equivalent to the top federal estate and gift tax rate.

Transfers Not Subject to Generation-Skipping Tax

Certain transfers are excluded or exempt from the GST tax.
Annual Gift Tax Exclusion: Gifts qualifying for the annual gift tax exclusion under Internal Revenue Code Section 2503(b) are generally exempt. For 2025, individuals can gift up to $19,000 per recipient annually without incurring gift tax. These gifts are also exempt from GST tax, provided they are outright gifts or transfers to certain trusts that meet specific requirements, such as Crummey trusts.
Direct Payments for Medical or Tuition Expenses: Payments made directly to an educational institution for tuition or to a medical provider for medical care, as outlined in Internal Revenue Code Section 2503(e), are not considered taxable gifts. These payments are also exempt from GST tax. This exclusion is unlimited, but the payment must go directly to the institution or provider, not to the individual.
Transfers to Non-Skip Persons: Transfers made to individuals who are non-skip persons are not subject to GST tax. For example, a transfer directly to a child does not trigger the GST tax. Transfers to a trust where non-skip persons are current beneficiaries also avoid GST tax unless a taxable termination or taxable distribution occurs involving a skip person.
Qualified Disclaimer: If a beneficiary who is a skip person makes a qualified disclaimer of an inheritance, and as a result, the property passes to a non-skip person, the GST tax on that transfer can be avoided. This redirects the property to an individual in the immediately succeeding generation.

Leveraging the Generation-Skipping Tax Exemption

Each individual possesses a lifetime generation-skipping transfer (GST) exemption amount, which is indexed for inflation. For 2025, this amount is $13.99 million per individual. This exemption can be applied to transfers made during life or at death to skip persons, or to trusts established for their benefit.

The primary purpose of this exemption is to reduce the “inclusion ratio” of a transfer or trust to zero, effectively making it exempt from GST tax. The inclusion ratio determines the portion of a trust or transfer that remains subject to the GST tax after applying the exemption. A zero inclusion ratio means no part of the trust or transfer will be subject to GST tax, regardless of future appreciation or distributions.

If a transferor allocates their full GST exemption to a trust, the inclusion ratio becomes zero. This effectively “leverages” the exemption, particularly when allocated to assets expected to appreciate significantly over time. Placing appreciating assets into an irrevocable trust and allocating GST exemption means all future growth within that trust, and all distributions from it to skip persons, will be free from GST tax.

The GST exemption is often allocated to specific types of trusts designed for multi-generational wealth preservation. These trusts, sometimes referred to as “Dynasty Trusts” or “GST Exempt Trusts,” are structured to hold assets for multiple generations, allowing wealth to grow free of further transfer taxes once the exemption is applied.

Strategies for Applying the Generation-Skipping Tax Exemption

The generation-skipping transfer (GST) exemption requires formal allocation by the transferor or their executor. This intentional act ensures the exemption is utilized effectively for wealth transfer planning.

Automatic allocation rules apply in certain situations, such as direct skips, or to certain indirect skips to “GST trusts” unless an affirmative election is made to opt out. However, relying solely on automatic allocation might not always align with a transferor’s planning objectives, particularly with complex trust structures.

For transfers made during a transferor’s lifetime, a timely allocation of the GST exemption is made on IRS Form 709 for the calendar year in which the transfer occurred. A timely allocation values the property at its fair market value on the date of the transfer, which is advantageous for appreciating assets. This locks in the value for exemption purposes, allowing future appreciation to escape GST tax.

If an allocation is not made on a timely filed Form 709, a late allocation can still be made. A late allocation values the property at its fair market value on the date the late allocation is made, which could be less favorable if the property has appreciated. For transfers occurring at death, the executor allocates the decedent’s unused GST exemption on IRS Form 706, effective as of the date of death.

Transferors also have elections available, such as electing out of automatic allocation for certain transfers or electing to treat a trust as a “GST trust” to trigger automatic allocation. These elections, made on Form 709 or Form 706, provide flexibility in managing the application of the GST exemption.

Trust Structures for Generation-Skipping Planning

Specific trust structures are frequently employed in conjunction with the GST exemption to achieve long-term wealth transfer objectives.
Dynasty Trust (GST Exempt Trust): This irrevocable trust is designed to hold assets for multiple generations, potentially in perpetuity depending on state laws. Once the GST exemption has been allocated to transfers into this trust, the assets and all their future appreciation can pass through generations free of further estate, gift, or GST taxes.
Crummey Trusts: These trusts, commonly used for annual exclusion gifts, can also be structured to facilitate GST planning. While gifts to Crummey trusts typically qualify for the annual gift tax exclusion, they generally do not automatically qualify for the GST annual exclusion unless specific requirements are met. However, if the inclusion ratio of the Crummey trust is zero due to an allocation of GST exemption, or if the trust is designed as a GST trust, distributions to skip persons can be exempt from GST tax.
Qualified Terminable Interest Property (QTIP) Trusts with Reverse QTIP Election: For married couples, QTIP trusts offer a specific strategy involving a “reverse QTIP election.” A QTIP trust allows a spouse to provide for their surviving spouse while controlling the ultimate disposition of the trust assets. A reverse QTIP election allows the first spouse to die to be treated as the transferor of the QTIP property for GST tax purposes, even though it will be included in the surviving spouse’s estate. This enables the first spouse to allocate their GST exemption to the QTIP trust, ensuring that the property passing to skip persons upon the surviving spouse’s death is exempt from GST tax.
Irrevocable Life Insurance Trusts (ILITs): An ILIT is designed to own life insurance policies, keeping the death benefit proceeds out of the grantor’s taxable estate. By allocating GST exemption to the premiums paid into the ILIT, or directly to the trust, the life insurance proceeds, when distributed to skip persons, can also be free from GST tax. This strategy leverages the tax-free nature of life insurance proceeds and the GST exemption to transfer significant wealth across generations.