What Is the Generation-Skipping Transfer Tax?

The Generation-Skipping Transfer Tax (GSTT) is a federal tax imposed on the transfer of wealth to individuals who are more than one generation below the donor, most commonly grandchildren or unrelated individuals who are at least 37.5 years younger than the person making the gift or bequest. The GSTT is designed to prevent wealthy individuals from avoiding estate and gift taxes by “skipping” over their children and transferring assets directly to grandchildren or other younger beneficiaries.

This tax functions alongside — and in addition to — the federal estate and gift taxes. Even if a transfer escapes estate or gift taxation because of exemptions, it may still be subject to GSTT unless a separate exemption applies.

Purpose and Historical Background

The GSTT was introduced in its current form as part of the Tax Reform Act of 1986. Prior to this, there were fewer restrictions on the ability to bypass a generation and pass wealth directly to descendants two or more generations below, allowing families to reduce cumulative estate taxes over time. The GSTT closed this gap by taxing transfers to “skip persons” at the highest estate tax rate in effect, regardless of the amount transferred.

The intent behind the GSTT is to preserve the integrity of the federal transfer tax system and ensure that wealth is subject to taxation as it moves between generations.

Key Components and Definitions

To understand the GSTT, it’s important to be familiar with the terminology used in its application:

• Skip Person: A person who is two or more generations below the transferor. This typically includes grandchildren, great-grandchildren, or unrelated individuals more than 37.5 years younger than the transferor.
• Non-Skip Person: Typically, the transferor’s children or others in the next generation who are not considered skip persons.
• Direct Skip: A transfer made directly from the donor or estate to a skip person. It is immediately subject to GSTT if not otherwise exempt.
• Taxable Termination: Occurs when an interest in a trust terminates, and all remaining interests pass to skip persons, such as when the child of the grantor (a non-skip person) dies and the trust remainder goes to grandchildren.
• Taxable Distribution: A distribution from a trust to a skip person that is not a direct skip or a taxable termination. The recipient — not the trust — is responsible for paying the GSTT on a taxable distribution.

GSTT Exemption and Rates

The Generation-Skipping Transfer Tax is imposed at a flat rate equal to the highest federal estate tax rate, which is currently 40%. However, each individual has a lifetime GSTT exemption that can be allocated to shield transfers from the tax. For 2025, the GSTT exemption amount is aligned with the estate and gift tax exemption, which is $13.99 million per individual (subject to annual inflation adjustments).

Married couples can effectively double this exemption by using both spouses’ limits. Transfers beyond the exemption are taxed at the GSTT rate, regardless of the size of the estate or other taxes already paid.

Allocating the GSTT exemption properly — especially when setting up irrevocable trusts such as dynasty trusts — is a key part of multigenerational estate planning. The IRS allows automatic allocation of the GSTT exemption to certain transfers, but in complex situations, manual allocation may be more effective.

Common Planning Tools and Considerations

Wealthy individuals often use irrevocable trusts, particularly dynasty trusts, to take advantage of the GSTT exemption. These trusts can hold assets for multiple generations without triggering additional estate or GST taxes as long as the exemption was properly allocated at the outset.

The annual gift tax exclusion (currently $19,000 per recipient in 2025) can also be used to make tax-free gifts to skip persons, though this does not count against the GSTT exemption unless a trust is involved or the gift is unusually large.

When a trust involves both skip and non-skip beneficiaries, determining when GSTT applies and how it should be calculated becomes more complex. Trustees and estate planners must pay close attention to the structure of the trust, the allocation of the GSTT exemption, and the timing of distributions or terminations.

Compliance and Reporting

GSTT is reported to the IRS using specific forms, most commonly Form 709 (United States Gift and Generation-Skipping Transfer Tax Return) for lifetime gifts, and Form 706 (United States Estate Tax Return) when the transfer occurs at death. For trusts, additional reporting may be required depending on how and when distributions are made.

Failure to properly report GSTT-triggering events or misallocating the exemption can lead to unintended tax liabilities. Because of the complexity involved, GSTT planning often requires collaboration between estate planning attorneys, tax professionals, and financial advisors.

The Bottom Line

The Generation-Skipping Transfer Tax is a powerful component of the federal tax system aimed at curbing multigenerational tax avoidance. Although it affects a relatively small portion of the population — primarily high-net-worth families — it plays a significant role in structuring trusts and long-term estate plans. Proper use of the GSTT exemption, along with strategic trust design, allows for efficient wealth transfer while remaining compliant with federal tax law.