What Is the GSTT Exemption and How Does It Work?

The Generation-Skipping Transfer Tax, or GSTT, is a federal tax applied to the transfer of assets to individuals who are two or more generations younger than the person making the gift. This tax is separate from and in addition to any federal gift or estate taxes. The government provides a lifetime exemption, which allows a large amount of wealth to be passed to younger generations without triggering the GSTT, making it a useful tool in estate planning.

Core Concepts of the GSTT Exemption

The Generation-Skipping Transfer Tax exemption is a specific dollar amount that each individual can transfer to beneficiaries two or more generations below them without incurring the tax. For 2025, this exemption amount is $13.99 million per person. This figure is unified with the federal estate and gift tax exemptions and is indexed for inflation. This high exemption amount is scheduled to decrease significantly in 2026 unless Congress acts. The tax is imposed at the highest federal estate tax rate of 40%.

In addition to the lifetime exemption, there is an annual GSTT exclusion. For 2025, this allows a person to give up to $19,000 to a skip person each year without using any of the lifetime exemption. Direct payments made to an educational institution for tuition or to a medical provider for qualifying expenses on behalf of a skip person are also excluded from the GSTT. These exclusions provide additional opportunities for tax-free gifting.

The GSTT applies to transfers to a “skip person,” who is a beneficiary at least two generations younger than the transferor, such as a grandchild. The definition also includes other relatives like grandnieces or grandnephews. For non-relatives, a person is considered a skip person if they are more than 37.5 years younger than the donor.

There are three types of transfers that can trigger the GSTT. A “Direct Skip” occurs when assets are given outright to a skip person, such as a grandmother writing a check directly to her grandson. The gift is immediate and bypasses the intermediate generation.

A “Taxable Termination” is another transfer type, which involves a trust. An example is a grandparent establishing a trust that provides income to their child for life. Upon the child’s death, the remaining trust assets are distributed to the grandchildren, and the termination of the child’s interest in the trust triggers the GSTT.

A “Taxable Distribution” also involves a trust. This happens when a trust distributes to a skip person while a non-skip person, like the grantor’s child, still has an interest in the trust. If a trustee can make payments to both a child and a grandchild from the same trust, any payment to the grandchild is a taxable distribution.

Strategic Allocation of the Exemption

Allocating the GSTT exemption is fundamental to minimizing transfer taxes. Allocation is the process of assigning a portion of your lifetime exemption to a specific transfer. The value of the exemption used is based on the value of the assets at the time of the transfer, meaning if allocated to appreciating assets, all future growth can be sheltered from the tax.

The IRS has rules for both automatic and manual allocation of the exemption. The exemption is automatically allocated to any Direct Skips made during one’s lifetime to cover the transfer unless the donor elects otherwise. This default rule helps ensure that outright gifts to grandchildren do not unintentionally trigger a tax.

Donors may also manually allocate their exemption for strategic reasons by reporting the transfer and allocation on a federal gift tax return. Manual allocation provides precision, allowing a donor to direct their exemption to specific transfers, such as contributions to a long-term trust. This is useful for trusts that are not direct skips, where automatic allocation might not apply.

A donor can also elect out of the automatic allocation rules. This decision is useful in situations where a donor wants to preserve their exemption for a more significant future transfer. For example, a person might make a small gift to a trust for a grandchild but anticipate creating a much larger trust later, so they elect out to save their exemption for the larger transfer.

Reporting Transfers and Allocating Exemption on Tax Forms

The use of the GSTT exemption is documented on federal tax forms. For lifetime transfers, Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return, is the primary document. This form is used to report taxable gifts and manage the allocation of the GSTT exemption.

On Form 709, the filer must report the generation-skipping transfer and show how much of their GSTT exemption is being allocated to that gift. This creates an official record with the IRS that tracks the remaining exemption amount. The form also provides a formal mechanism for a filer to elect out of the automatic allocation rules for certain transfers.

For transfers that occur at death, the GSTT exemption is allocated on Form 706, the United States Estate (and Generation-Skipping Transfer) Tax Return. The estate’s executor is responsible for filing this return. On Form 706, the executor can allocate any of the decedent’s remaining exemption to assets passing to skip persons or to trusts established at death.

Properly completing these forms is important for an effective estate plan. Failure to correctly report transfers or allocate the exemption can lead to unintended tax consequences. The forms serve as the official communication to the IRS regarding how the exemption is being utilized.

Leveraging the Exemption with Trusts

A strategy for wealth preservation involves using the GSTT exemption with an irrevocable trust. By allocating the exemption to contributions made to a specially designed trust, it is possible to shield the trust assets from the GSTT for its entire duration. This creates what is often referred to as a “dynasty trust” or a “GST trust.”

When a donor transfers assets to a GST trust and allocates their exemption, the trust becomes “GST exempt.” This means all assets inside the trust, including any future appreciation, can be managed and distributed to multiple generations of beneficiaries without being subject to the GSTT. For example, a trust could provide for the donor’s children, then their grandchildren, and even great-grandchildren. This allows them to receive benefits while avoiding this transfer tax.

This technique offers long-term benefits for wealth preservation. A GST exempt trust can grow substantially over decades, sheltered from the tax that would otherwise be levied as assets pass from one generation to the next. It allows a family’s wealth to compound more effectively over a long period.

The creation of a GST exempt trust is a planning tool that transforms the exemption from a one-time benefit into a lasting legacy. It allows individuals to establish a protected pool of assets that can support their descendants for many years. This strategy maximizes the value of the GSTT exemption, making it a part of advanced estate planning for those looking to preserve wealth across multiple generations.