What Is the Automatic Allocation of GST Exemption?

The federal tax system includes a levy on transfers of wealth to individuals significantly younger than the person making the gift or bequest, known as the Generation-Skipping Transfer (GST) tax. This tax applies to transfers made to “skip persons,” who are relatives two or more generations younger than the transferor, such as a grandchild, or non-relatives who are more than 37.5 years younger. The purpose of this tax is to ensure that wealth is taxed at each generational level.

To mitigate this tax, every individual has a lifetime GST exemption, an amount that can be transferred to skip persons without incurring the tax. For 2025, this exemption is $13.99 million, but it is subject to change. Under current law, the exemption amount is scheduled to be reduced significantly at the beginning of 2026, reverting to its pre-2018 level of $5 million, adjusted for inflation. To prevent taxpayers from accidentally failing to use this exemption, the Internal Revenue Service (IRS) established default rules for its application, known as automatic allocation rules.

The Concept of Automatic Allocation

The automatic allocation rules serve as a protective default mechanism within the tax code. Their purpose is to shield taxpayers from the consequences of inadvertently failing to allocate their GST exemption to transfers that could be subject to the tax. Without these rules, a person might make a gift to a grandchild and, by not filing the proper forms to assign the exemption, unknowingly create a future tax problem. The system presumes a person would want to use their available exemption to avoid a 40% tax on such transfers.

This default system operates by automatically applying a transferor’s unused GST exemption to certain types of transfers. The rules distinguish between transfers made outright to a skip person (direct skips) and those made into a trust that may benefit a skip person in the future (indirect skips). These two categories are governed by different sets of automatic allocation provisions, though the system’s application can sometimes conflict with a taxpayer’s estate planning goals.

Allocation Rules for Direct Skips

A “direct skip” is a straightforward type of generation-skipping transfer that occurs when assets are transferred directly to a skip person, such as a grandparent making an outright gift of cash to a grandchild. For any direct skip that occurs during the transferor’s lifetime, the tax code mandates the automatic allocation of the GST exemption. The system will use as much of the transferor’s available exemption as needed to make the transfer tax-free from a GST perspective.

This allocation is reported on Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return, for the year the gift was made. The allocation itself is not an elective choice for lifetime direct skips; it is a mandatory application of the rules under Internal Revenue Code section 2632. The transferor’s unused GST exemption is automatically applied to the transfer up to the fair market value of the property on the date of the gift.

Allocation Rules for Indirect Skips and GST Trusts

An “indirect skip” is a transfer made to a trust from which a generation-skipping transfer could occur in the future. An example would be a parent funding a trust that benefits their child for life, with the remaining assets passing to their grandchildren upon the child’s death. The automatic allocation rules for these transfers apply only if the recipient trust meets the specific definition of a “GST trust” under the tax code.

A trust is defined as a GST trust if there is a possibility that it will have a generation-skipping transfer in the future. More specifically, a trust qualifies as a GST trust if it is reasonably possible for a distribution to be made to a skip person. However, the code provides several exceptions. A trust is not considered a GST trust if the trust instrument provides that more than 25% of the corpus must be distributed to or may be withdrawn by one or more non-skip persons before that individual reaches 46 years of age.

Another exception prevents a trust from being classified as a GST trust if more than 25% of the corpus must be distributed to or may be withdrawn by a non-skip person who is living on the date of death of another person identified in the instrument who is more than 10 years older. Furthermore, a trust will not be a GST trust if any portion of its assets would be included in the gross estate of a non-skip person if that person were to die immediately after the transfer.

If a transfer is made to a trust that fits the definition of a GST trust, any unused GST exemption is automatically allocated to the transfer to shield it from future GST tax, effective as of the date of the transfer.

Electing Out of Automatic Allocation

While the automatic allocation rules are a safeguard, they may not align with every individual’s strategic estate planning. A person might create a trust that technically qualifies as a GST trust, but the likelihood of assets ever passing to a grandchild is remote. In such a case, automatically applying the GST exemption to that trust could be an inefficient use of a limited resource. The tax code allows taxpayers to elect out of the automatic allocation for indirect skips.

This election is made on a timely-filed Form 709 for the calendar year in which the transfer was made. To make the election, the taxpayer must attach a statement to the Form 709. This statement must clearly identify the trust and the specific transfer for which the election is being made and explicitly state the transferor is electing out of the automatic allocation.

A taxpayer can choose to elect out for a specific transfer or for all subsequent transfers to a particular trust. This provides flexibility, allowing a planner to be precise about where the exemption is used. Once made, the election prevents the default rules from applying to the specified transfers, preserving the exemption for other uses. This election must be made on a timely-filed return for the year of the initial transfer.

Making Affirmative and Late Allocations

Beyond relying on or opting out of automatic allocation, taxpayers have direct control over their GST exemption through affirmative and late allocations. An affirmative allocation is the process of assigning the exemption to a specific transfer on a timely-filed Form 709. This is done by detailing the transfer on the return and explicitly stating the amount of GST exemption being allocated to it. This method is used for transfers not subject to automatic allocation or for transfers where the taxpayer has elected out.

A “late allocation” occurs when a taxpayer allocates their GST exemption to a transfer after the due date for the gift tax return for the year of the transfer. This option provides a remedy for situations where an allocation was missed on a timely return. For a timely or automatic allocation, the exemption is applied to the value of the transferred property on the date of the gift.

In contrast, for a late allocation, the exemption is applied to the value of the property on the date the late allocation is filed with the IRS. If the assets in a trust have appreciated since the initial transfer, a much larger portion of the GST exemption will be required to shield the trust from tax. This valuation difference underscores the importance of timely allocation decisions.