Generation-Skipping Transfer Trust

Generation-Skipping Transfer Trust: Passing Wealth to Your Grandchildren and Beyond Without Double Taxation

Every time significant wealth passes from one generation to the next, estate tax takes a bite. Without planning, a family's wealth can be substantially reduced at each generational transfer. A Generation-Skipping Transfer Trust is designed to break that cycle, allowing assets to benefit your grandchildren, great-grandchildren, and beyond while being subject to transfer tax only once rather than at every generation.

The generation-skipping transfer (GST) tax is a federal tax imposed on transfers of wealth to beneficiaries who are two or more generations below the transferor, typically grandchildren, great-grandchildren, and more remote descendants. It was enacted to prevent wealthy families from avoiding estate tax at each generational level by transferring assets directly to grandchildren and bypassing the children's generation entirely.

Without the GST tax, a family could transfer assets to a trust for the benefit of grandchildren, children would use the trust income without owning the assets, and estate tax would never apply at the children's generation because the assets would be held in trust rather than passing through the children's estates. The GST tax closes that perceived gap by imposing a separate tax, in addition to gift or estate tax, on transfers that skip a generation.

The GST tax rate is equal to the highest federal estate tax rate, currently 40%. Critically, it applies in addition to any applicable gift or estate tax on the same transfer. Without proper planning, a generation-skipping transfer could be subject to both estate tax at one rate and GST tax at another, dramatically compressing the amount that ultimately reaches grandchildren and more remote beneficiaries.

Without GST planning, a transfer of $10,000,000 to a grandchild could be subject to both estate tax and GST tax. With a properly funded GST trust, that same $10,000,000 can be transferred to a multi-generational trust that benefits grandchildren, great-grandchildren, and beyond, subject to transfer tax only once and sheltered from GST tax for the trust's entire existence.

A GST trust, also called a Generation-Skipping Transfer trust or dynasty trust, is an irrevocable trust specifically designed and funded to hold assets for multiple generations of beneficiaries while being exempt from GST tax. It accomplishes this by using the grantor's federal GST tax exemption, which shields a defined amount of assets from GST tax when the trust is funded. Assets transferred to the trust within the exemption amount are permanently sheltered from GST tax for the trust's entire existence, no matter how many generations benefit from them.

The federal GST tax exemption is the same amount as the federal estate and gift tax exemption. Once the exemption is allocated to a GST trust at funding, the sheltered assets can pass from generation to generation within the trust without triggering GST tax. If the trust is also structured to keep assets outside each generation's taxable estate, those assets can be transferred across multiple generations subject to transfer tax only at the initial funding, not again at each generational level.

A GST trust is typically structured as a long-term or dynasty trust, intended to last for multiple generations. Vermont's rules governing the maximum duration of such trusts should be confirmed with an experienced estate planning attorney to ensure the trust is structured to achieve its multi-generational goals within the applicable legal framework.

Funding the Trust and Allocating the GST Exemption

The grantor transfers assets to the GST trust and allocates their federal GST tax exemption to the trust. This exemption allocation is the critical step that shields the trust from GST tax going forward. The allocation must be properly made on a timely filed gift tax return. Automatic allocation rules may apply in some circumstances, but it is essential to confirm that the exemption has been properly allocated to ensure the trust's GST-exempt status.

Once the exemption is allocated, the trust's inclusion ratio, the fraction of the trust subject to GST tax, is set to zero, meaning no GST tax applies to distributions from the trust or to the trust's assets passing to subsequent generations.

Beneficiaries Across Multiple Generations

The GST trust names beneficiaries spanning multiple generations: children, grandchildren, great-grandchildren, and potentially more remote descendants. During any generation's beneficiaries' lifetimes, they receive income and distributions from the trust according to the trust's terms, typically using a health, education, maintenance, and support standard or a broader discretionary distribution standard. Because the trust holds the assets rather than the individual beneficiaries owning them outright, the assets are not included in each generation's taxable estate.

This is the GST trust's most powerful feature. Assets held in the trust benefit each successive generation but are not taxed in each generation's estate at death, because the beneficiaries never own the assets outright. The transfer tax is paid only once, at the initial funding.

Assets Are Protected From Estate Tax at Each Generation

When a child beneficiary dies, the assets in the GST trust are not included in that child's estate because the child never owned them. The trust continues for the next generation. The same is true at the grandchild's death and at every subsequent generation. As long as the assets remain in the trust, they are sheltered from estate tax at each generational level. Over multiple generations, this estate-tax-at-every-level avoidance compounds into a dramatic preservation of family wealth.

Distribution Provisions and Trustee Oversight

The grantor specifies the standards and criteria governing distributions to beneficiaries at each generational level. Common provisions include distributions for health, education, maintenance, and support; discretionary distributions based on the trustee's judgment; and provisions that protect trust assets from the beneficiaries' creditors, divorcing spouses, and poor financial decisions. A spendthrift clause is standard. A trust protector may be named to modify administrative terms, replace trustees, and respond to changes in tax law or family circumstances across the decades or generations the trust is expected to last.

The federal GST tax exemption is the same as the federal estate and gift tax exemption. Each individual has one combined exemption for estate, gift, and generation-skipping transfers. Allocating exemption to a GST trust uses a portion of this unified exemption, which also reduces the amount available for other gifts and bequests.

The federal exemption is currently at a historically high level and is scheduled to be reduced significantly in future years if current law changes as anticipated. Families who fund GST trusts at today's higher exemption levels lock in the benefit of that exemption permanently. Even if the exemption is subsequently reduced, assets already transferred to a GST trust and sheltered by the allocated exemption retain their GST-exempt status.

The window to fund a GST trust at current exemption levels may be limited. Families who act now can lock in a permanent transfer tax benefit that may not be available at the same scale in future years. This is one of the most time-sensitive planning opportunities currently available for families with significant assets.

Many families have trusts in place that benefit children and grandchildren without being specifically structured and funded as GST trusts. The distinction matters significantly.

•      A standard family trust without GST exemption allocation: Assets in a trust that has not been funded with the GST tax exemption will be subject to GST tax when distributions are made to grandchildren or more remote descendants, or when the trust terminates and assets pass to those beneficiaries. The trust does not avoid the GST tax; it simply defers it.

•      A GST-exempt trust: A trust funded with the GST tax exemption and structured to maintain its GST-exempt status can hold assets for multiple generations, making distributions to grandchildren and more remote descendants, without ever triggering GST tax. The assets are subject to transfer tax only at the initial funding.

•      Coordination with estate tax planning: A well-designed estate plan often combines a Credit Shelter Trust to use both spouses' Vermont exemptions with a GST trust structure that also allocates the GST tax exemption. This dual structure can shelter assets from both estate tax at each generational level and from GST tax on generation-skipping distributions and terminations.

A GST trust is most appropriate for the following circumstances.

•      You have a large enough estate that assets are likely to pass to grandchildren and more remote descendants, either directly or through a multi-generational trust.

•      You want to transfer significant wealth to multiple generations while being subject to federal transfer tax only once rather than at each generational level.

•      You want to lock in the benefit of the current federal GST tax exemption before it is reduced by future legislation.

•      You have existing trusts that benefit grandchildren and want to ensure they are properly structured and funded to maintain GST-exempt status.

•      You want to protect transferred assets from the beneficiaries' creditors, divorcing spouses, and their own financial decisions across multiple generations.

•      You are implementing a broader estate tax plan that includes a Credit Shelter Trust, a SLAT, or other irrevocable trusts and want to coordinate GST exemption allocation across all of those instruments.

What is the generation-skipping transfer tax rate?

The federal GST tax rate is equal to the highest federal estate tax rate, currently 40%. The GST tax applies in addition to any applicable gift or estate tax on the same transfer. This means a generation-skipping transfer that is also subject to estate tax could face a combined transfer tax rate that dramatically compresses the amount reaching the intended beneficiary. A properly funded GST trust eliminates GST tax on transfers from the trust by setting the trust's inclusion ratio to zero through proper allocation of the GST tax exemption.

What is an inclusion ratio and why does it matter?

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 distributions from the trust or to trust assets passing to subsequent generations. A trust with an inclusion ratio of one is fully subject to GST tax on every generation-skipping transfer. Achieving and maintaining an inclusion ratio of zero requires proper allocation of the GST tax exemption at the time the trust is funded, typically on a timely filed gift tax return.

Who is a “skip person” for GST tax purposes?

A skip person is a beneficiary who is two or more generations below the transferor, or a trust in which all interests are held by skip persons. For an individual transferor, grandchildren and more remote descendants are skip persons. A child who has predeceased the transferor may also cause grandchildren to move up a generation and be treated as non-skip persons under a predeceased parent rule. The classification of beneficiaries as skip or non-skip persons determines whether the GST tax applies to a particular transfer.

Does Vermont impose a separate 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, and the interaction between Vermont estate tax planning and federal GST tax planning requires coordination. A GST trust that is also structured as a Credit Shelter Trust can address both Vermont estate tax exposure and federal GST tax exposure in the same instrument.

How long can a GST trust last in Vermont?

Vermont's rules governing the maximum duration of trusts, including the rule against perpetuities, affect how long a GST trust can remain in existence. Vermont has modified the traditional rule against perpetuities in ways that permit trusts to last for extended periods under certain conditions. The specific rules that apply to a multi-generational GST trust in Vermont should be confirmed as part of the drafting process. We structure every GST trust to achieve its generational goals within Vermont's applicable legal framework.

Can I add GST planning to my existing estate plan?

Yes. If you have existing trusts or are planning new trusts, we can assess whether GST tax exemption has been or should be allocated to those trusts. For new trusts, we structure and fund them with careful attention to GST exemption allocation. For existing trusts that were not funded with GST exemption, we assess whether retroactive allocation is available or whether a new GST trust should be established alongside the existing plan. Many families discover that their existing plans did not address GST tax exposure and benefit significantly from adding a GST component.

What is the relationship between a GST trust and a Credit Shelter Trust?

A Credit Shelter Trust uses the first spouse's Vermont or federal estate tax exemption to shelter assets from estate tax at the surviving spouse's death. A GST trust uses the grantor's federal GST tax exemption to shelter assets from generation-skipping transfer tax on distributions to grandchildren and more remote beneficiaries. Many estate plans structure a Credit Shelter Trust to also be a GST trust by allocating both the estate tax exemption and the GST tax exemption at the first death. This dual allocation shelters the same pool of assets from both estate tax at each generational level and from GST tax on generation-skipping transfers.

A Generation-Skipping Transfer Trust requires careful planning to ensure that the GST tax exemption is properly allocated, the trust's inclusion ratio is set to zero, and the trust is structured to maintain its GST-exempt status across multiple generations. It must also be integrated with the grantor's broader estate plan, including Vermont estate tax planning, Credit Shelter Trust provisions, and any other irrevocable trusts already in place or being considered.

At Will and Trust Planning, we assess the full scope of your Vermont and federal estate tax and GST tax exposure as part of every comprehensive estate tax planning engagement. We explain the interaction between Vermont estate tax, federal estate tax, and the federal GST tax in plain language and build a plan that addresses all three in a coordinated and legally sound structure.

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.