What Are the Generation-Skipping Trust Distribution Rules?

A generation-skipping trust is an irrevocable trust created to transfer wealth to beneficiaries who are at least two generations younger than the individual who establishes the trust, known as the grantor. This financial tool is often used to pass assets to grandchildren or great-grandchildren, particularly when the grantor’s own children are financially secure.

The federal government imposes a Generation-Skipping Transfer (GST) tax to regulate these transfers, preventing the avoidance of estate taxes that would typically be levied at each generational level. The rules governing distributions from these trusts define when funds can be paid out and the tax consequences that arise from these transactions.

Key Concepts and Definitions

The primary individuals are the grantor who funds the trust, the trustee who manages its assets, and the beneficiary who receives the funds. These trusts are irrevocable, meaning once established, they cannot be altered or canceled.

A core concept is the generational assignment of beneficiaries, which classifies them as either a “skip person” or a “non-skip person.” A skip person is a beneficiary two or more generations younger than the grantor, such as a grandchild. The definition also includes any individual at least 37.5 years younger than the grantor, even if not a direct descendant. A non-skip person is anyone who does not meet this definition, most commonly the grantor’s children.

To mitigate the tax burden, federal law provides a lifetime GST exemption, which allows each person to transfer a specific amount of assets into a generation-skipping trust without triggering the GST tax. In 2025, the GST exemption is $13.99 million per individual. This high exemption is temporary and is scheduled to be reduced significantly at the beginning of 2026 unless Congress intervenes.

The allocation of this exemption is tracked through the “inclusion ratio.” When a grantor allocates an exemption equal to the full value of the assets transferred into the trust, its inclusion ratio becomes zero. A trust with a zero inclusion ratio is fully exempt from the GST tax, and all future distributions are tax-free. If no exemption is allocated, the inclusion ratio is one, making the trust fully taxable, while a partial allocation results in a portion of every distribution being subject to tax.

Rules for Taxable Distributions

A taxable distribution is any payment of income or principal from the trust to a skip person. For a taxable distribution to occur, the trust must have both skip and non-skip persons as potential beneficiaries. For example, if a trust benefits both a child (a non-skip person) and a grandchild (a skip person), any distribution made to the grandchild while the child is living is a taxable distribution.

The responsibility for paying the GST tax on a taxable distribution falls on the recipient, the skip person.

The tax is calculated by multiplying the property’s value by the 40 percent federal estate tax rate. If the trust pays this tax for the beneficiary, that payment is treated as an additional taxable distribution. The trustee reports the distribution to the IRS and the beneficiary, who then uses Form 706-GS(D) to pay the tax.

Rules for Taxable Terminations

A taxable termination is another type of taxable event in a generation-skipping trust. This event occurs when a non-skip person’s interest in the trust ends, leaving only skip persons as the remaining beneficiaries. The termination can happen due to death, the passage of time as specified in the trust document, or the release of a power.

For example, a trust might direct the trustee to pay income to the grantor’s child for life, with the remaining principal distributed to the grandchildren upon the child’s death. The death of the child (the non-skip person) terminates their interest and triggers a taxable termination, as the property then passes to the grandchildren (skip persons).

In contrast to taxable distributions, the liability for paying the GST tax in a taxable termination rests with the trustee. The trustee is required to pay the tax directly from the trust’s assets before any funds are distributed to the skip person beneficiaries.

The tax is computed on the entire taxable value of the trust property involved in the termination, not just the amount distributed. This value is multiplied by the 40 percent federal estate tax rate. The trustee must file Form 706-GS(T) to report the event and remit the tax from trust funds.

Exclusions from Generation-Skipping Transfers

Certain payments made from a trust for a skip person are excluded from the definition of a generation-skipping transfer. These exclusions allow grantors to provide for the specific needs of younger beneficiaries without triggering the GST tax, even if the trust is not fully exempt.

One exclusion is for educational expenses. To qualify, the payment must be made directly from the trust to an educational institution for tuition only. Funds for books, supplies, or room and board do not qualify. If the trust distributes money to the beneficiary to pay tuition, it is considered a taxable distribution.

A similar exclusion exists for medical expenses. Payments from the trust to cover the medical care of a skip person are not considered taxable if they meet certain criteria. The payment must be made directly from the trust to the person or institution that provided the medical care, such as a doctor, hospital, or for health insurance premiums. Reimbursing a beneficiary for medical expenses they have already paid will not qualify.

Trustee Responsibilities for Distributions

The trustee of a generation-skipping trust has several responsibilities when making distributions. They must administer the trust according to the instructions in the trust instrument and fulfill their fiduciary duty. Key responsibilities include:

• Adhering to the trust’s terms for mandatory distributions or following standards for discretionary payments, such as for health, education, maintenance, and support (HEMS).
• Acting impartially when there are multiple beneficiaries, ensuring the needs of one are not favored over another without a basis in the trust’s provisions.
• Maintaining detailed and accurate records of every distribution made from the trust, including the date, amount, purpose, and recipient for tax reporting purposes.
• Communicating effectively with beneficiaries to ensure they understand the trust’s distribution policies and the potential tax implications of any payments they receive.