Your Guide to Understanding the Generation-Skipping Transfer Tax
Generation-Skipping Transfer Tax 101
Many people are familiar with the existence and some aspects of estate and gift taxes. If you are part of an ultra-high-net-worth family, it is important to also understand the generationskipping transfer (GST) tax and how it may affect your particular situation. During the planning process, it is vital to consider unique family dynamics, financial goals, and values when deciding the best tax strategies to distribute your generational wealth.
What Is the Generation-Skipping Transfer Tax?
The government collects federal estate taxes to generate revenue when wealth is passed down to subsequent generations. When people die, they usually leave their money first to their spouses, then to their children, then to their grandchildren, and then to more distant relatives. At each passing of generational wealth, the government collects an estate tax.
Wealthy families found a way to avoid estate tax by skipping a generation and transferring wealth directly to grandchildren and great-grandchildren, allowing them to pass down more wealth to future generations. Estate taxes were avoided when the skipped generation (in our example, the children) died because the children never owned the money or property.
The government responded with legislation in 19761 and again in 19862, attempting to eliminate the transfer tax advantage of skipping a generation by imposing a GST tax when a skip occurs. This ensured that large estates still paid estate tax at each generation. The GST tax rate is currently 40 percent (the same as the highest federal estate and gift tax rate) so the tax burden on high-net-worth individuals can be substantial. Luckily, there is a GST exemption amount of $13.61 million for individuals in 2024 (the same lifetime exemption as the federal estate and gift tax exemption) that can be used when someone wants to make gifts or leave an inheritance that would otherwise be subject to the GST tax.3 If you have a significant estate, your family may need to use their GST tax exemption in addition to the estate and gift tax exemptions.
Who Are the Parties Involved in a Generation-Skipping Wealth Transfer?
There are typically three parties involved in a generation-skipping wealth transfer:
● The transferor: the person making the wealth transfer to an individual or a trust
● The skip person: the person receiving the money or property, who must be two or more generations removed from the individual making the transfer or is at least 37 ½ years younger than the transferor; a skip person may also be a trust in some instances
● The non-skip person or skipped person: the generation between the individual transferring wealth and the one receiving it4
Why Should You Be Mindful of This Tax?
If you have a substantial estate and are considering making sizable gifts or bequests to skip persons, you need to work with experienced professionals to ensure that the right strategy is used to maximize your gift and minimize the tax consequences.
The earlier you can get started, the better your results will be. It will take time and collaboration with trusted advisors to ensure the best possible outcome. After your estate plan is created, you will need regular reviews for updates due to changing circumstances.
Professionals to Align Legal and Tax Planning Strategies
You and your loved ones will need comprehensive advice when creating your estate plan to ensure that legal, financial, and tax implications are all considered in your estate planning strategy. We welcome the opportunity to collaborate with your existing advisors. When strategizing the best outcome for you, your loved ones, and your hard-earned money, it takes expertise from multiple areas to create the best plan possible.
Let’s Do the Math: How Does the Generation-Skipping Transfer Tax Work?
You may have considered creating a trust to transfer wealth to your grandchildren and greatgrandchildren. But you may not have considered how the generation-skipping transfer (GST) tax could affect this inheritance. To better explain how the tax would impact a gift in trust, we are going to take a look at some math.
Generation-Skipping Transfer Tax Rate
The federal GST tax rate matches the highest federal estate tax rate, currently set at 40 percent.5 For high-net-worth individuals, effective GST tax planning is crucial in managing combined estate, gift, and GST tax burdens.
Generation-Skipping Transfer Tax Exemption
You can transfer a specific value of money and property to skip persons (grandchildren, greatgrandchildren, other distant relatives, someone at least 37 ½ years younger, or a trust for a skip person), either during your lifetime or after death, before triggering the GST tax. This exemption equals the federal estate and gift tax exemption amount ($13.61 million in 2024). Be aware that there is no portability for the GST tax exemption. Meaning, you will need to use it or lose it.
Exceptions to the Generation-Skipping Transfer Tax
You and your family members may have already established a trust. If so, certain irrevocable trusts established before September 25, 1985, are grandfathered and exempt from the GST tax provisions in Section 26.2601-1(b)(1) of the Treasury Regulations. Modifications or additions to these trusts can jeopardize the exception. Additionally, gifts for educational or medical expenses to skip persons, such as Health and Education Exclusion Trusts (HEET), are excluded from the GST tax application.6
Calculating Generation-Skipping Transfer Tax
To understand how the GST tax will affect the inheritance you leave behind, you need to do some math. The GST tax calculation relies on an inclusion ratio, indicating the extent to which a transfer is subject to GST tax. This ratio is determined by the applicable fraction, based on the amount of your GST tax exemption. An inclusion ratio of one means the direct skip or trust is fully taxable. Any number between zero and one indicates the transfer is partially subject to GST tax.7
The amount of the GST tax exemption allocated to the transfer is divided by the value of the property involved in the transfer. The fraction is rounded to the nearest one-thousandth (.001) and looks like this:
GST tax exemption allocated
Value of property transferred
The next step is determining the inclusion ratio by subtracting the fraction from the number one. Depending on the ratio, the trust is either fully exempt, fully taxable, or partially taxable.
Fully Exempt Trust
Let’s say you create an irrevocable trust for the benefit of a grandchild and their descendants in 2024 when your entire GST tax exemption of $13,610,000 is available and you can allocate it to the trust.
If you transfer $13,610,000 (or less) worth of accounts or property to the trust and allocate your entire GST exemption, the inclusion ratio would be zero:
1 – (13,610,000 / 13,610,000) = 1 – 1.000 = 0
The trust would be fully exempt from GST tax.
Fully Taxable Trust
Now, let’s assume that you have previously used your GST tax exemption and there was none available to allocate to your grandchild’s irrevocable trust, the inclusion ratio would be one:
1 – (0 / 13,600,000) = 1 – 0 = 1
The trust would be fully subject to GST tax.
Partially Exempt Trust
Partially exempt trusts have a portion of money or property subject to the GST tax, while another portion may qualify for an exemption. If you put $15,500,000 in the irrevocable trust, and your entire exemption was available, the inclusion ratio would be:
1 – (13,610,000 / 15,500,000) = 1 – .877 = .122
The applicable fraction is .878, and the inclusion ratio is .122. The trust would be partially subject to GST tax. When distributions are made to the grandchild, there will be a tax due. To calculate how much will be owed, we first must know what the tax rate is at the time of the distribution. For example, if the rate is 40 percent,
40 percent x .122 = 4.88 percent
If your grandchild receives a taxable distribution from the trust of $125,000, the GST tax would be $6,100.
For gifts or an inheritance left directly to the skip person, the formula works similarly, the inclusion ratio is multiplied by the GST tax in effect at the time of the transfer.
Tailoring Trusts for Success
Working closely with your other trusted advisors, we can customize your estate plan based on your unique circumstances and goals. This also ensures compliance with federal and state tax laws, preventing a significant combined estate, gift, and GST tax burden that could diminish your family’s wealth and legacy over time.
What You Need to Know about the Generation-Skipping Transfer Tax Returns
If you have significant wealth, things like estate, gift, and generation-skipping transfer (GST) taxes need to be discussed. If you want to make a gift or leave a large inheritance to a grandchild (while your child is still alive) a more in-depth conversation surrounding the GST tax, the impact it can have on the inheritance you leave behind, and the additional steps that may occur during the administration process after your death, will be warranted. Several different returns involve the GST tax. The appropriate form that needs to be filed with the Internal Revenue Service (IRS) will depend on the situation.
What Is Form 709?
This form would be used when a client decides to make a gift to a skip person during their lifetime. Form 7098 is used to report transfers that are subject to federal gift and certain GST taxes. This also includes the allocation of lifetime GST exemption to property transferred during the transferor’s lifetime. The IRS has provided instructions for the transferor to complete the form.9
What Is Form 706-GS(D-1)?
Form 706-GS(D-1)10 is used for trustees of a trust to report distributions from a trust to a beneficiary that are subject to the GST tax. For additional assistance, the IRS has published instructions for completing the form.11
What Is Form 706-GS(D)?
Form 706-GS(D)12 is used for skipped persons to report tax due on distributions made from a trust to them, that is subject to the GST tax. Like the other forms from the IRS, some instructions walk through the completion of the form.13
What Is Form 706-GS(T)?
Form 706-GS(T)14 helps your trustee and any other entities or responsible parties to calculate GST taxes and report what is due from certain distributions and terminations subject to the generation-skipping tax. It includes instructions15 for tax computation and separate sections for required information for the transferor (you) and the trust.
You and your advisors can work together to develop a detailed list of documents and information required to determine the value of the money and property transferred to your trust or given outright as a gift or part of an inheritance.
Understanding the complex calculations when applying the GST tax, exemption amount, and any exceptions is critical. This is where professional tax advice is essential. They can calculate the amount of the GST tax exemption allocated to wealth transfers by dividing the value of the property involved in the transfer.16 The fraction is rounded to the nearest one-thousandth (.001) and looks like this:
GST tax exemption allocated
Value of property transferred
The next step is determining the inclusion ratio by subtracting the fraction from the number one. Depending on the ratio, the trust is either fully exempt, fully taxable, or partially taxable.17
Completing the Form
To fill out the applicable forms, you need to gather a significant amount of information. Here is a
list of information that may be needed:
● The legal name of the trust and its federal tax identification number
● Name and Social Security Number (SSN) or Employer Identification Number (EIN) of the individual making the GST
● A list of all beneficiaries, including their names and relationships to the transferor
● The generation of each beneficiary in relation to the transferor (skip person or non-skip person)
● Name and address of the trustee(s) responsible for managing the trust
● A detailed list of all assets held within the trust, including values at the time of the GST
● Appraisals of assets to determine their fair market values
● Information about any other gifts or transfers made by the transferor during their lifetime that could be subject to the GST tax
● Indication of how the transferor’s GST tax exemption will be allocated among the trusts
● Allocations to skip persons, including any direct skips, indirect skips, or taxable terminations
● Details about the transferor or any beneficiary who is deceased
● Copies of the trust agreement and any amendments
● Any legal documents relevant to the GST
● Specific dates of GSTs
Filing Deadlines
Generally, these forms must be filed by April 15 of the year following the calendar year when distribution or termination occurred. Be organized and prepared throughout the year to provide accurate information. Maintaining clear records will streamline the process of completing the filing on time.
Sailing Through Tax Season
Working with your trusted advisors ensures accuracy and compliance with the GST tax rules. When we work together, we can provide you and your loved ones with the best possible service and help you protect the legacy you are leaving behind.
1 Troy Segal, What is the Generation-Skipping Transfer Tax (GSTT) and Who Pays?, Investopedia (Feb. 7, 2023), https://www.investopedia.com/terms/g/generation-skipping-transfer-tax.asp.
2 Legal Info. Inst., 26 C.F.R. § 26.2601-1 Effective Dates, Cornell L. Sch., https://www.law.cornell.edu/cfr/text/26/26.2601-1 (last visited Feb. 14, 2024).
3 Derek Silva, What is a Generation-Skipping Trust? Policygenius (Jan. 2, 2024), https://www.policygenius.com/trusts/what-is-a-generation-skipping-trust/.
4 Troy Segal, What is the Generation-Skipping Transfer Tax (GSTT) and Who Pays?, Investopedia (Feb. 7, 2023), https://www.investopedia.com/terms/g/generation-skipping-transfer-tax.asp.
5 Derek Silva, What is a Generation-Skipping Trust? Policygenius (Jan. 2, 2024), https://www.policygenius.com/trusts/what-is-a-generation-skipping-trust/.
6 Legal Info. Inst., 26 CFR § 26.2601-1 Effective Dates, Cornell L. Sch., https://www.law.cornell.edu/cfr/text/26/26.2601-1 (last visited Feb. 14, 2024).
7 Id.
8 IRS Form 709, IRS.gov, https://www.irs.gov/pub/irs-pdf/f709.pdf (last visited Feb. 27, 2024).
9 IRS Instructions for Form 709, IRS.gov, https://www.irs.gov/pub/irs-pdf/i709.pdf (last visited Feb. 27, 2024).
10 IRS Form 706 GS(D-1), IRS.gov, https://www.irs.gov/pub/irs-pdf/f706gsd1.pdf (last visited Feb. 27, 2024).
11 IRS Instructions for Form 706 GS(D-1), IRS.gov, https://www.irs.gov/pub/irs-pdf/i706gsd1.pdf (last visited Feb. 27, 2024).
12 IRS Form 706 GS(D), IRS.gov, https://www.irs.gov/pub/irs-pdf/f706gsd.pdf (last visited Feb. 27, 2024).
13 IRS Instructions for Form 706 GS(D), IRS.gov, https://www.irs.gov/pub/irs-pdf/i706gsd.pdf (last visited Feb. 27, 2024).
14 IRS Form 706 GS(T), IRS.gov, https://www.irs.gov/pub/irs-pdf/f706gst.pdf (last visited Feb. 14, 2024).
15 IRS Instructions for Form 706 GS(T), IRS.gov, https://www.irs.gov/pub/irs-pdf/i706gst.pdf (last visited Feb. 14, 2024).
16 Legal Info. Inst., 26 CFR § 26.2654-1 – Certain Trusts Treated as Separate Trusts, Cornell L. Sch., https://www.law.cornell.edu/cfr/text/26/26.2654-1 (last visited Feb. 14, 2024).
17 Legal Info. Inst., 26 CFR § 26.2642-6 – Qualified Severance, Cornell L. Sch., https://www.law.cornell.edu/cfr/text/26/26.2642-6 (last visited Feb. 14, 2024).