Part IV · Tax Regimes · No. 06

The generation-skipping transfer tax

A third transfer tax, parallel to the gift and estate taxes, designed to catch transfers that skip a generation and would otherwise avoid one round of the estate tax. The GST exemption and the inclusion-ratio mechanic are the operative concepts.

The rule

The generation-skipping transfer tax is imposed under chapter 13 of the Internal Revenue Code on transfers to a "skip person" — a person two or more generations below the transferor, or a trust whose beneficiaries are exclusively skip persons. The tax exists to prevent a wealthy family from cascading wealth down multiple generations through a single transfer, paying transfer tax only once.

Without GST, a grandparent could leave $50 million directly to grandchildren and pay estate tax once. The grandchildren would receive roughly $30 million after a 40% estate tax — and the children's generation, which never owned the wealth, would never be taxed on it. The GST tax adds back the missed level of transfer tax, restoring the design of a tax at each generation.

The statutory basis

• §2601 — imposition of GST tax.
• §2611 — definition of generation-skipping transfer.
• §2612 — three forms: taxable distribution, taxable termination, direct skip.
• §2613 — definition of skip person.
• §2631 — GST exemption.
• §2632 — allocation of GST exemption.
• §2641 — flat tax rate (the maximum federal estate tax rate, currently 40%).
• §2642 — inclusion ratio and applicable fraction.
• §2651 — generation assignment.
• §§2661–2664 — administrative provisions.

Scope — the three taxable events

A "generation-skipping transfer" takes one of three forms:

• Direct skip. An outright transfer (gift or bequest) to a skip person. A grandparent's gift of $1 million directly to a grandchild is a direct skip.
• Taxable distribution. A distribution from a trust to a skip person, where the trust has non-zero inclusion ratio. A trust funded by a grandparent for the benefit of children and grandchildren that distributes to a grandchild produces a taxable distribution if the trust is not fully GST-exempt.
• Taxable termination. A termination of an interest in property held in trust, with the result that no non-skip person retains an interest. When the last child beneficiary of a trust dies, leaving only grandchildren as remaining beneficiaries, the trust experiences a taxable termination.

Skip persons and generation assignment

A skip person is either (a) a natural person assigned to a generation that is two or more generations below the transferor, or (b) a trust whose interests are exclusively held by skip persons. Generation assignment follows the §2651 rules: lineal descendants are assigned by lineage; non-relatives by age difference (a person not more than 12½ years younger than the transferor is in the transferor's generation, one more than 12½ but not more than 37½ years younger is one generation below, with a new generation every 25 years thereafter); the predeceased-parent rule moves grandchildren up a generation when their parent (the transferor's child) has died.

A trust is a "non-skip person" if any non-skip person holds an "interest" in it within the meaning of §2652(c) — a present right to receive income or corpus, or status as a permissible current recipient. Future or contingent interests do not count. The precise definition matters for whether a transfer to the trust is a direct skip (taxed now) or a future taxable distribution or termination (taxed later, with allocation of exemption in the interim).

Rate and computation

The GST tax rate is the maximum estate-tax rate — currently 40%. The tax is computed on the "taxable amount" of the transfer, multiplied by the "applicable rate." The applicable rate is the maximum federal estate-tax rate (40%) multiplied by the "inclusion ratio."

The inclusion ratio is the heart of the system. It is 1 minus the "applicable fraction," which is exemption allocated divided by the value of the property transferred. A trust funded with $10 million to which $10 million of GST exemption is allocated has an inclusion ratio of zero — it is fully GST-exempt, and no GST tax is ever imposed on distributions or terminations from that trust, regardless of how the trust grows. A trust funded with $20 million to which only $10 million of exemption is allocated has an inclusion ratio of 0.5 — half of every future GST event will be taxed at 40%, producing a 20% effective rate.

The GST tax is in addition to, not in lieu of, the gift or estate tax on the same transfer. A direct skip during life is subject to both gift tax (computed on the gift) and GST tax (on the same transfer). For a lifetime direct skip the GST tax is computed on the amount the grandchild receives (tax-exclusive) and the GST tax the donor pays is itself treated as an additional gift under §2515. On an unsheltered $1 million gift to a grandchild, the GST tax is $400,000 and the gift tax is 40% of $1.4 million, or $560,000 — $960,000 of tax to deliver $1 million, about 49% of the donor's total outlay of $1.96 million.

The GST exemption

§2631 grants every transferor a GST exemption equal to the basic exclusion amount under §2010. The exemption is the same number as the unified gift-and-estate exclusion. For 2026 the GST exemption is $15,000,000 per transferor (One Big Beautiful Bill Act, Pub. L. 119-21; Rev. Proc. 2025-32), indexed for inflation from 2027 with no scheduled sunset.

The exemption is a one-time, cumulative allocation that the transferor (or executor) allocates to specific transfers or trusts. Once allocated, exemption sticks with the trust and provides a permanent shelter for that trust's transfers to skip persons. Allocation is automatic in certain default cases under §2632(b) and (c); election is available to opt out of automatic allocation.

Elections and exceptions

• Annual exclusion gifts. Gifts that qualify for the §2503(b) gift-tax annual exclusion are also exempt from GST when they are direct skips, under §2642(c) — provided the gift is to a single individual and would be a present-interest gift, and the gift to a trust meets the GST annual exclusion requirements.
• §2503(e) medical and tuition gifts. Direct payments for medical care or tuition are exempt from gift tax and from GST tax.
• Predeceased parent rule (§2651(e)). A grandchild whose parent (the transferor's child) has died is treated as the transferor's child for generation-assignment purposes — moving the grandchild up a generation and avoiding GST on transfers to that grandchild.
• Reverse QTIP election (§2652(a)(3)). Permits the predeceasing spouse to be treated as the transferor of QTIP property for GST purposes, preserving the predeceasing spouse's GST exemption.
• Late allocation. GST exemption can be allocated after the date of transfer, subject to revaluation rules. Late allocation to a trust that has appreciated since funding is generally inefficient.

Interaction with other regimes

• Gift and estate tax. GST is in addition. The cumulative effective rate on an unsheltered transfer to a skip person is materially higher than either tax alone.
• Trust law / rule against perpetuities. The economic life of a GST-exempt dynasty trust is limited by the rule against perpetuities. South Dakota, Delaware, Nevada, and others have abolished or extended the rule, making perpetual or near-perpetual dynasty trusts possible.
• State GST tax. State-level GST taxes are now rare; most were "pick-up" taxes tied to the federal credit for state death taxes, which was replaced by a deduction from 2005.
• Income tax. GST tax is not income-taxable to the recipient. Income earned by a GST-exempt trust remains subject to income tax under the normal grantor-trust or non-grantor-trust rules.

Common planning approaches

• Dynasty trust funded with full GST exemption. A trust funded with the transferor's full available GST exemption, sited in a no-perpetuities state, can grow free of estate and GST tax for generations. Dynasty trusts are the principal use of GST exemption.
• Direct skip gifts within annual exclusion. Annual exclusion gifts directly to grandchildren incur no gift tax and no GST tax.
• Crummey-trust gifts to a GST-exempt trust. Annual exclusion gifts to a trust that satisfies both §2503(b) (Crummey withdrawal rights) and §2642(c) (GST annual exclusion) can build a GST-exempt corpus over decades.
• Late allocation to underwater trust. Allocating exemption to a trust that has declined in value since funding can be a comparatively efficient use of remaining exemption.
• Sale to a GST-exempt grantor trust. Combining the dynasty trust with installment-sale leverage uses minimal exemption to control a much larger pool of appreciation.
• Avoid inadvertent partial-exemption trusts. A trust with inclusion ratio between zero and one is administratively complex and economically inefficient. Best practice is to sever trusts at funding so each is either fully exempt (inclusion ratio zero) or fully non-exempt (inclusion ratio one).

Recent developments

The feared end-2025 sunset did not occur: the One Big Beautiful Bill Act (Pub. L. 119-21, signed 4 July 2025) set the basic exclusion amount — and therefore the GST exemption — at $15,000,000 for 2026, indexed thereafter. Allocation of exemption to long-duration dynasty trusts remains the primary planning move.

Several states have continued to expand dynasty-trust capacity. The competitive dynamics among South Dakota, Delaware, Nevada, and Wyoming for trust business have produced increasingly liberal trust statutes; the GST exemption is the federal lever those statutes amplify.

Reviewed October 2026