Generation Skipping Tax: What It Is and How It Works

Grandparents typically love showering their grandchildren with gifts. But if you’re thinking of gifting money, there are a few things you should know first.

WHAT IS THE GENERATION SKIPPING TAX?

The generation-skipping tax (also known as the generation-skipping transfer tax or GST tax) is a federal tax applied to assets gifted to heirs who are at least a generation younger – typically a gift from a grandparent to a grandchild, or any other gift or inheritance that “skips” a generation.

WHY THE GENERATION SKIPPING TAX EXISTS

This tax aims to prevent the avoidance of estate taxes through transfers that skip a generation, typically from grandparents to grandchildren, bypassing the parents. The current version of the GST tax was implemented as part of the Tax Reform Act of 1986.

HOW DOES THE GENERATION SKIPPING TAX WORK?

WHO IS SUBJECT TO GST?

There are two categories of people who inherit money (or receive it as a gift) that would cause the inheritance/gift to be subject to GST:

• Grandchildren or other relatives who are at least two generations below the settlor’s generation, often referred to as a “skip person.” This also includes spouses of people in this category.
• Unrelated individuals who are at least 37.5 years younger than the person leaving or gifting the assets.

Assigning a generation can seem straightforward, but there are special rules for:

• Spouses and ex-spouses of the giver and recipient
• Cases where the  parent is already deceased when the transfer is made to the grandchild
• A skip person who dies soon after receiving assets due to the death of the giver (depending on the timing and type of transfer)

Note that many times, people will place their assets in a trust for the benefit of a skip person. In that case, depending on the way the trust is set up, the trust may be subject to the generation-skipping tax when the assets are distributed (or when the trust is terminated) as opposed to when they are gifted. This scenario is called an indirect skip.

GENERATION SKIPPING TAX EXAMPLES

Example 1: You give $100,000 to your grandchild while you are both living. Your grandchild is a skip person.

Example 2: You establish a trust that is required to accumulate income for 10 years and then pay its income to your grandchildren and, upon their deaths, distribute the trust assets to their children. Because the trust has no current beneficiaries, and everyone to whom the trust can make future distributions is a skip person, the trust itself is a skip person.

Example 3: You give your house to your daughter and instruct that it must then be passed to your daughter’s children when she dies. This gift is considered as being made to a “trust” even though there is no explicit trust document. The right to use the house is transferred to a non-skip person (your daughter). Therefore, the trust is not a skip person and the gift is not a direct skip. The transfer is an indirect skip, however, because the trust may be subject to the GST tax when your daughter dies and the house passes to your grandchildren.

Example 4: You establish a trust that pays all of its income to your grandchildren for 10 years. At the end of 10 years, the trust’s assets are to be distributed to your children. Because everyone having a present interest in the trust is a skip person, the trust itself is a skip person, even though the trust's ultimate beneficiaries (your children) are non-skip persons. The children’s interests are considered future interests.

GST RATES AND THRESHOLDS

The current GST rate is a flat tax of 40% of the assets. Not all gifts or bequests to skip persons are subject to GST. Below, we discuss the exceptions.

GENERATION SKIPPING TAX EXEMPTIONS AND EXCLUSIONS

GST EXEMPTION AMOUNTS

There’s a certain amount that can be gifted each year without counting toward the lifetime GST exemption, called the annual exclusion. In 2025, you can gift up to $19,000 each to as many people as you want, without reporting or counting it. (Note that this only applies if the gift is of “present interest,” meaning they can use it now. You can’t use the annual exclusion on gifts that can’t be used until the future – for example, as in a trust the beneficiaries have no current access to.)

There’s also a lifetime exemption that applies to the total amount of assets passed down or gifted that would have otherwise been subject to GST. In 2025, it’s $13.99 million. Anything under that amount won’t be subject to GST.

After 2025, the limit is uncertain. Under current law, it will revert back to pre-2018 levels (and is projected to be only $7 million in 2026) as the Tax Cuts and Jobs Act expires. However, legislation may extend or increase the current limit before that happens.

But let’s say your planned generation-skipping gifts are, in fact, over the $13.99 million exemption. You can decide which gifts you want the exemption applied to. Anything else will be subject to GST.

HOW TO CALCULATE AND REPORT GENERATION SKIPPING TAX

FILING REQUIREMENTS FOR GST

Assets that are subject to GST may be received before the giver’s death (as a gift) or after (as an inheritance). The correct forms to file - and who needs to file them - depend on which scenario applies so you should consult with a tax professional to help you with this.

If you’re the owner of the assets and transferring them during your lifetime, you’ll need to file IRS Form 709 (United States Gift and Generation-Skipping Transfer Tax Return) to report the transfer, indicate whether it’s part of your lifetime exemption and calculate any tax owed.

A gift that’s subject to GST tax, given directly to a skip person, and made while the giver and recipient are living (like the scenario above) is called an inter vivos direct skip. In some limited cases, gifts to a trust that are for the benefit of a skip person can also be treated as inter vivos direct skips and will also require this form.

If you’re the executor of an estate that includes assets (inheritances) subject to GST, you’ll need to file IRS Form 706 (United States Estate and Generation-Skipping Transfer Tax Return) to calculate any tax owed.

If you’re a skip person who has received distributions from a trust that are subject to GST, you’ll need to file IRS Form 706-GS (D) to calculate the tax due.

If you’re the trustee for a trust that’s subject to GST which is being terminated, you’ll need to file IRS Form 706-GS (T) to calculate the tax due.

STEPS TO CALCULATE GST LIABILITY ON FORM 709

1. Determine whether you’re required to file.
2. Decide whether you and your spouse will elect to split any gifts, if eligible to do so. If so, typically you’ll each need to file a separate Form 709 (exceptions apply where only one spouse needs to file with the other spouse’s consent). And note that if the gifts were of jointly owned assets or property, you have to treat them as coming from each of you 50/50.
3. Fill out the information including listing the gifts in the applicable sections. Direct skips are reported in Part 2 of Schedule A. Indirect skips (and gifts that may later become subject to GST) are reported in Part 3.
4. Complete Schedule D to compute any GST due. This is where you’ll note whether you want to apply your lifetime exclusion to any of the gifts.
5. Sign and date the form.

DEADLINES AND PENALTIES

Form 709 should be filed each calendar year (for which it applies) with your income tax return, reporting gifts the previous year. The due date is the same as your tax return. For example, Form 709 reporting your 2025 gifts will be due April 15, 2026.

Form 706 is an estate tax (and GST tax) return filed after someone passes away. It must be filed within 9 months of the decedent’s death.

As with your tax return, you can be penalized by the IRS for late filing, late payment or underpayment of GST.

STRATEGIES TO AVOID OR MINIMIZE GENERATION SKIPPING TAX

TRUSTS THAT QUALIFY FOR GST EXEMPTIONS

Correctly set up, dynasty trusts can allow you to gift assets for the benefit of future generations while avoiding GST for generations. A dynasty trust is an irrevocable trust, which means you will have no control over the assets once they are placed in trust. However, you can set the rules for how the trust assets are distributed in the future.

A Crummey trust allows beneficiaries to withdraw gifts, making them eligible for the annual gift tax exclusion. Grantor Retained Annuity Trusts allow you to make gifts to beneficiaries (i.e., grandchildren) in a way that leverages the GST exemption. So, if done correctly, each of these options may enable you to avoid GST tax.

ANNUAL EXCLUSION GIFTS

If you think your estate may be subject to GST, consider reducing the size of the estate by making gifts while you’re alive. For 2025, as discussed earlier, you can give away up to $19,000 per person to as many people as you want without reporting it or owing any tax. If you’re married, your spouse can also gift $19,000 to the same people or others.

There are also other ways to give away or use your money without using any of your lifetime exclusion. For example, you can directly pay medical expenses or college tuition for someone (in any amount). These don’t count as gifts.

WORKING WITH FINANCIAL ADVISORS AND ESTATE PLANNERS

Generation skipping tax rules are complicated and there’s a lot at stake – up to 40% of the money you’ve spent your life saving or that you’ve received.

If you may be subject to these taxes (and keep in mind the potential for the limits to drop dramatically to an anticipated $7 million in 2026), it’s critical to engage an estate attorney to talk about what you can do to protect your wealth.

Or, if you’ve inherited assets that are subject to GST, you should consider speaking with a tax professional or estate attorney to make sure you’re filing the correct forms and paying what’s due to avoid penalties.

In both cases, a financial advisor can also help you understand the basics, help you connect with the right professionals and give guidance on your overall financial picture.

FINAL THOUGHTS ON MANAGING GENERATION SKIPPING TAX

Generation-skipping tax is a crucial consideration for those looking to transfer wealth across generations while minimizing estate taxes. Given the complexity of GST, the high stakes in getting it right and the sophisticated strategies typically used to help minimize it, if you suspect it may affect you, it’s strongly recommended to seek professional guidance.