How Does the Generation-Skipping Transfer Tax Work

What Is a generation-skipping transfer tax

Who is subject to the GST tax

The GST tax is generally applicable to recipients that are more than one generation younger than the donor, often referred to as a “skip person.” Some common examples of a “skip person” in which the GST Tax typically applies to are:

• A grandchild or great-grandchild
• A niece, nephew or other relative two generations younger
• An unrelated person who is at least 37½ years younger than the donor

If the parent of a grandchild is deceased at the time of the transfer, that grandchild effectively “moves up” a generation, and the GST tax does not apply. The GST tax has the same tax rate and exemption threshold as the estate and gift tax, but it is not portable between spouses, meaning that any unused exemption cannot be transferred to the surviving spouse.

The combined estate and gift tax exemption rate

While the GST tax can sound confusing, most individuals will never pay it due to high federal exemption limits. As of 2025, the lifetime GST tax exemption is $13.99 million per person, meaning only transfers exceeding this threshold are subject to the GST tax. The amount of the GST tax exemption also matches the federal estate tax exemption. This exemption is scheduled to increase to $15 million in 2026 under the FY2025 reconciliation bill (Public Law 119-21, also known as The One Big Beautiful Bill Act).

Married couples can generally combine their exemptions, and any unused portion of one spouse’s estate and gift tax exemption can be inherited by the surviving spouse. In addition to the lifetime exemption, individuals can make annual tax-free gifts of up to $19,000 per recipient in 2025, also indexed for inflation.

Transfers that exceed these exemption limits of $13.99 million in 2025 and $15 million in 2026 are taxed at a flat 40% rate for any amount over the limit. This lifetime exemption covers all taxable transfers you make during your life and at death. Every gift or bequest counts toward the same limit. Once you’ve used your full exemption amount, any additional transfers, whether made through gifts or an estate, are taxed at a flat 40% rate.

There’s an important distinction between bequests (transfers after death) and gifts made during life:

• Estate taxes are paid by the estate before the assets are distributed.
• Gift taxes are paid by the donor based on the value of the gift.

For example, to leave $1 million to your heirs after the exemption is fully used, your estate would need to be worth about $1.68 million before taxes. Gifting that same amount during your lifetime would require about $1.4 million to account for gift taxes, which can make lifetime gifting somewhat more efficient at that point.

However, assets that have increased in value, like investments or real estate, typically receive a “step-up in basis” when passed through an estate. That means your heirs wouldn’t owe capital gains tax on any appreciation that occurred before they inherited it. Because of this, leaving appreciated assets through your estate is often more tax-efficient, while lifetime gifts may be better suited for cash or assets that haven’t grown much in value.

How the generation-skipping tax works

The GST tax mirrors the estate and gift tax system, applying a 40% taxable rate to transfers that skip a generation if there is no exemption. It can occur through:

• Direct skips: Transfers directly to a skip person, such as a grandchild.
• Indirect skips: Transfers through trusts that include both skip and non-skip beneficiaries.
• Trust terminations: When all non-skip beneficiaries (such as a child) have died and the remaining assets pass to skip persons.

If all beneficiaries of a trust are skip persons, the trust itself may be taxed as a direct skip. When both skip and non-skip beneficiaries exist, the tax applies either to distributions made to skip persons or to the trust as a whole once the last non-skip person passes away.

Because the GST tax is in addition to estate and gift taxes, a direct skip can also face double taxation. For example:

• A $1 million bequest to a grandchild from a taxable estate could result in about $640,000 in combined taxes (40% estate tax plus 40% GST tax on the remainder).
• If that same amount were given as a gift during life, the total combined taxes would be lower (about $444,000) because the gift tax and GST tax apply to a smaller base amount.

Generation-skipping tax exemptions and planning strategies

The generous exemption amounts mean few households will ever owe GST tax. However, for high-net-worth individuals and families with significant estates, strategic planning can help preserve more wealth for future generations.

1. Use trusts strategically

Trusts, and specifically intentionally defective grantor trusts (IDGTs), allow assets to grow outside the estate while the grantor continues to pay income taxes on trust earnings. The trust can accumulate value tax-free since these payments aren’t treated as gifts.

2. Consider grantor retained annuity trusts (GRATs)

By contributing appreciating assets to a trust in exchange for an annuity equal to the present value of the contribution, donors can reduce or eliminate gift and GST tax exposure.

3. Maximize annual exclusions

Annual gifts of up to $19,000 per person (or $38,000 per couple) can be made tax-free. A married couple can collectively gift up to $76,000 to another married couple each year without using their lifetime exemption.

4. Establish family partnerships

Placing assets into a family limited partnership (FLP) allows valuation discounts for lack of control and marketability, reducing the taxable value of the estate and related GST exposure.

5. Consider reverse QTIP trusts for portability

Because GST exemptions are not portable between spouses, a reverse qualified terminable interest property (QTIP) trust can be used to ensure the deceased spouse’s GST exemption benefits future generations.

Why the GST tax matters for estate planning

While the GST tax affects only a small percentage of estates, specifically fewer than 0.1% of decedents under current exemption levels, it remains a critical consideration for high-net-worth families. Because estate, gift and generation-skipping taxes are closely connected, consulting a qualified estate planning attorney or tax advisor can help you develop a strategy that fits your long-term financial objectives.