Generation-Skipping Transfer Tax (GST Tax)

The Generation-Skipping Transfer Tax: What It Is, How It Works, and How to Plan for It

Most families who will be affected by the generation-skipping transfer tax have never heard of it. They plan carefully for estate taxes, use trusts and exemptions, and still expose their grandchildren's inheritance to a second major federal tax that compounds the first. Understanding the GST tax is the starting point for making sure it does not quietly consume a significant portion of the wealth you are working to pass down.

The generation-skipping transfer (GST) tax is a federal tax imposed on transfers of property to beneficiaries who are two or more generations below the transferor. In practical terms, this means transfers to grandchildren, great-grandchildren, and more remote descendants, whether made directly during the transferor's lifetime, at death, or through a trust.

The tax was first enacted in 1976 and significantly revised in 1986. Its purpose is to prevent wealthy families from avoiding estate tax at each generational level by skipping over their children and transferring assets directly to grandchildren. Without the GST tax, a family could pass assets to a trust that benefited children for their lifetimes, then passed to grandchildren at the children's deaths, without triggering estate tax at the children's generational level. The GST tax closes that avenue by imposing its own separate tax on transfers that skip a generation.

The GST tax is not a substitute for estate or gift tax. It is an additional tax that applies on top of estate and gift taxes when a generation-skipping transfer occurs. A single transfer can trigger both estate or gift tax and GST tax simultaneously, compounding the overall tax burden on the transferred property.

The GST tax does not replace the estate tax. It adds to it. A generation-skipping transfer that is also subject to estate tax at the 40% federal rate and GST tax at the 40% federal rate can leave the intended beneficiary with a fraction of what was originally transferred. Planning for both taxes together is essential.

Transferor

The transferor is the person whose GST tax exemption is relevant to a particular transfer. For a direct gift or bequest, the transferor is the donor or decedent. For transfers from a trust, the transferor is the person whose GST tax exemption was or should have been allocated to the trust when it was funded. Identifying the correct transferor is essential to determining whether a transfer from a trust is subject to GST tax.

Skip Person

A skip person is a natural person who is two or more generations below the transferor, or a trust in which all current beneficial interests are held by skip persons. Grandchildren and more remote descendants are skip persons. Unrelated persons who are more than 37.5 years younger than the transferor are also treated as skip persons. A transfer to a skip person, whether outright or in trust, is a generation-skipping transfer subject to GST tax.

Non-Skip Person

A non-skip person is anyone who is not a skip person. Children are non-skip persons with respect to a parent transferor. A transfer from a trust to a non-skip person is not a generation-skipping transfer and is not subject to GST tax, although it may be subject to income tax in the hands of the recipient.

Predeceased Parent Rule

An important exception to the skip person rules applies when a child of the transferor has predeceased the transferor. In that case, the deceased child's children, who would ordinarily be skip persons as grandchildren, move up a generation and are treated as non-skip persons for GST tax purposes. This rule prevents the imposition of GST tax when wealth passes to grandchildren because their parent did not survive to inherit it.

Inclusion Ratio

The inclusion ratio is the fraction of a trust's assets that is subject to GST tax. A trust with an inclusion ratio of zero is entirely GST-exempt; no GST tax applies to any transfer from the trust, regardless of the generation of the recipient. A trust with an inclusion ratio of one is fully subject to GST tax on every generation-skipping transfer. Trusts with inclusion ratios between zero and one are partially exempt. The inclusion ratio is determined by the amount of GST tax exemption allocated to the trust relative to the value of assets transferred into it.

The GST tax applies to three distinct types of generation-skipping transfers. Understanding which type is occurring in a particular situation determines when the tax is imposed and who is responsible for paying it.

Direct Skip

A direct skip is a transfer of property directly to a skip person, either as an outright gift or bequest or as a contribution to a trust that qualifies as a skip person trust. Examples include a grandparent's direct gift of cash to a grandchild and a bequest in a will that passes directly to grandchildren. The transferor or the transferor's estate is responsible for paying the GST tax on a direct skip. Direct skips are the most straightforward type of generation-skipping transfer and are the most commonly encountered in basic estate planning situations.

Taxable Distribution

A taxable distribution occurs when a distribution is made from a trust to a skip person beneficiary and the trust is not a wholly GST-exempt trust. If a grandparent's trust makes a distribution of income or principal to a grandchild beneficiary and the trust has an inclusion ratio greater than zero, the distribution is a taxable distribution subject to GST tax. The skip person beneficiary is responsible for paying the GST tax on a taxable distribution.

Taxable Termination

A taxable termination occurs when a non-skip person's interest in a trust terminates and, after the termination, no non-skip person holds an interest in the trust and no distribution can be made from the trust to a non-skip person. A common example is when a trust provides income to children for their lifetimes and, at the last child's death, the trust assets pass to grandchildren. The termination of the children's interests is a taxable termination. The trustee is responsible for paying the GST tax on a taxable termination from trust assets.

The Tax Rate

The federal GST tax rate is a flat rate equal to the highest federal estate tax rate, currently 40%. Unlike the estate tax, which uses a graduated rate structure at lower transfer amounts before reaching 40%, the GST tax applies at 40% from the first dollar of any generation-skipping transfer that is not sheltered by the GST tax exemption. Combined with federal estate or gift tax, the effective tax rate on an unplanned generation-skipping transfer can reduce the amount reaching the grandchild to less than half of the original transfer value.

The GST Tax Exemption

Each individual has a lifetime GST tax exemption that can be used to shield transfers from GST tax. The GST tax exemption is the same amount as the federal estate and gift tax exemption, which is currently at a historically high level. Allocating the GST tax exemption to a trust or a direct gift sets the inclusion ratio of that trust or transfer to zero, permanently shielding it from GST tax.

The GST tax exemption can be allocated automatically by operation of law in some circumstances, but automatic allocation rules do not always apply and are not always optimal. Intentional allocation of the exemption on a timely filed gift tax return is the most reliable method and ensures that the exemption is applied to the right transfers in the most advantageous way.

GST Tax Exemption: Key Facts at a Glance

Amount: Equal to the federal estate and gift tax exemption (currently at a historically high level, scheduled to decrease if current law sunsets).

Per person: Each individual has their own GST tax exemption. Spouses cannot combine their exemptions for a single transfer but each can allocate their own exemption separately.

Allocation: Must be allocated on a timely filed Form 709 (gift tax return) or on the decedent's estate tax return. Automatic allocation rules apply in some circumstances but should not be relied on without professional guidance.

Portability: Unlike the estate tax exemption, the unused portion of the GST tax exemption is NOT portable between spouses. A deceased spouse's unused GST tax exemption cannot be transferred to the surviving spouse. This makes lifetime GST tax planning, and the use of each spouse's exemption during their lifetime through trusts and direct gifts, essential for married couples.

Vermont does not impose a separate state-level generation-skipping transfer tax. The GST tax is a federal tax only. However, Vermont does impose its own estate tax at a 16% flat rate on estates above $5,000,000, and Vermont's estate tax interacts with federal GST tax planning in important ways.

A Vermont family's multi-generational estate plan must address three layers of potential transfer tax: Vermont estate tax at each death, federal estate tax at each death, and federal GST tax on transfers to grandchildren and more remote descendants. A plan that addresses Vermont estate tax through Credit Shelter Trusts but does not address GST tax may still expose grandchildren's inheritance to a 40% federal tax on generation-skipping transfers.

Coordinating Vermont estate tax planning with federal GST tax planning in a single, comprehensive structure is one of the most important services we provide to Vermont families with significant assets and multi-generational wealth transfer goals.

There are several strategies available to Vermont families to reduce or eliminate GST tax exposure.

•      Fund a GST trust: Transfer assets to an irrevocable trust while allocating your GST tax exemption to the trust. The trust's inclusion ratio becomes zero, and all distributions from the trust to grandchildren and more remote descendants are free of GST tax regardless of amount or timing. Assets in the trust also compound free of estate tax at each generational level.

•      Make direct annual exclusion gifts: Annual gifts within the gift tax annual exclusion ($19,000 per recipient in 2026) to grandchildren are also automatically exempt from GST tax if they qualify as direct skips. Systematic annual gifting programs can transfer significant amounts to grandchildren over time without using any GST tax exemption.

•      Use the educational and medical exclusions: Direct payments to educational institutions for tuition and direct payments to medical providers for medical care are excluded from both gift tax and GST tax, regardless of amount. Funding a grandchild's education directly through the institution rather than through the grandchild removes these amounts from the GST tax base entirely.

•      Allocate GST tax exemption to existing trusts: If you have existing trusts that benefit grandchildren and that have not had GST tax exemption allocated to them, it may be possible to allocate exemption retroactively or to restructure the trust's funding to achieve a lower inclusion ratio. We assess existing trusts for GST exposure as part of every comprehensive estate tax planning engagement.

•      Coordinate with Vermont estate tax planning: A Credit Shelter Trust that uses the first spouse's Vermont and federal estate tax exemptions can simultaneously be structured and funded as a GST trust, allocating GST tax exemption at the first death. This dual allocation protects the same pool of assets from both estate tax at the surviving spouse's death and GST tax on subsequent generation-skipping distributions.

The federal GST tax exemption is currently at a historically high level. Under current law, this exemption is scheduled to revert to a significantly lower amount if Congress does not act to extend the current levels. Families who act before any reduction takes effect can lock in the benefit of the higher exemption permanently.

Once assets are transferred to a properly structured GST trust and the exemption is allocated, that allocation is permanent. Even if the exemption is subsequently reduced by legislation, the assets already transferred and sheltered retain their GST-exempt status. The window to fund a GST trust at the current exemption level may be limited, and families with multi-generational wealth transfer goals should evaluate their options now rather than waiting.

The current federal GST tax exemption may not be available at today's levels indefinitely. Families who fund GST trusts at current exemption levels lock in a permanent benefit that may be significantly reduced by future legislation. This is one of the most time-sensitive planning opportunities currently available.

Who has to pay the GST tax?

It depends on the type of generation-skipping transfer. For a direct skip, the transferor or the transferor's estate pays the GST tax. For a taxable distribution from a trust, the skip person recipient pays the tax. For a taxable termination, the trustee pays the tax from trust assets. In practice, GST tax planning is designed to eliminate the tax entirely through proper use of the exemption, so in a well-planned estate the question of who pays is rarely relevant.

Is the GST tax exemption portable between spouses like the estate tax exemption?

No. The GST tax exemption is not portable. A deceased spouse's unused GST tax exemption cannot be transferred to the surviving spouse. Each spouse must use their own exemption during their lifetime or at death. This non-portability makes lifetime GST tax planning particularly important for married couples; both spouses' exemptions should be used, typically through GST trusts funded during each spouse's lifetime or at the first death.

Does the predeceased parent rule help my grandchildren?

Yes, in certain circumstances. If your child predeceases you, your grandchildren, who would ordinarily be skip persons, move up a generation and are treated as non-skip persons for GST tax purposes. This means transfers to those grandchildren at your death would not be subject to GST tax. The rule applies to both outright bequests and transfers from trusts, provided the deceased child was a lineal descendant of the transferor.

Can I use annual exclusion gifts to grandchildren without triggering GST tax?

Yes. Outright gifts to grandchildren that qualify as direct skips and fall within the annual gift tax exclusion are also automatically exempt from GST tax, without using any GST tax exemption. For 2026, this means up to $19,000 per grandchild per year can be transferred free of both gift tax and GST tax. A married couple can combine exclusions and give $38,000 per grandchild per year. Over time, a systematic annual gifting program can transfer significant amounts to grandchildren entirely outside the GST tax system.

What happens if I die before allocating my GST tax exemption?

If you die without having allocated your GST tax exemption to trusts or direct skips during your lifetime, your executor can allocate your remaining exemption on your estate tax return. Automatic allocation rules may also apply to certain transfers. However, relying on post-death allocation and automatic rules is less precise and less flexible than intentional lifetime allocation. Some trusts funded during your lifetime may have received only partial exemption allocation, leaving a portion of the trust's assets subject to GST tax. We assess GST exemption allocation for every trust and every generation-skipping transfer as part of a comprehensive estate plan.

Does Vermont have its own GST tax?

No. Vermont does not impose a separate state-level generation-skipping transfer tax. The GST tax is a federal tax only. However, Vermont does impose its own estate tax at a 16% flat rate on estates above $5,000,000, and multi-generational estate planning for Vermont families must address both Vermont estate tax exposure and federal GST tax exposure in a coordinated plan.

How does a GST trust eliminate the GST tax?

A GST trust is an irrevocable trust funded with the grantor's GST tax exemption. When the exemption is properly allocated to the trust, the trust's inclusion ratio becomes zero. A trust with an inclusion ratio of zero is entirely GST-exempt; no GST tax applies to any distribution from the trust or to trust assets passing to subsequent generations, regardless of how remote those descendants are. The exemption allocation is permanent; once made, it does not expire and does not need to be renewed, even as the trust continues to benefit multiple generations.

At Will and Trust Planning, we assess every client's Vermont estate tax, federal estate tax, and federal GST tax exposure as part of a comprehensive estate planning engagement. GST tax planning does not require a separate engagement; it is integrated into the overall estate plan alongside Vermont estate tax planning, Credit Shelter Trusts, and any other irrevocable trusts the family's circumstances require.

If you have grandchildren, significant assets, or an existing estate plan that has not been reviewed for GST tax exposure, a Peace of Mind Planning Session is the right place to start. We will assess your exposure, explain the planning options available to you, and recommend a coordinated approach that addresses every layer of your transfer tax situation.

Contact Will and Trust Planning Today

For personalized advice on estate planning, including strategies to minimize or avoid probate, contact Will and Trust Planning today. Our experienced estate planning attorneys can help you understand your options, draft essential documents, and create a plan that protects your assets and achieves your goals.