Generation-Skipping Transfer Tax (GSTT): A Comprehensive GuideNovember 13, 2024

What is Generation-Skipping Transfer Tax (GSTT)?

The Generation-Skipping Transfer Tax (GSTT) is a federal tax imposed on transfers of wealth that skip a generation. In simpler terms, this tax applies when assets are passed down to grandchildren or individuals 37.5 years younger than the donor.

GSTT was introduced to prevent people from bypassing estate taxes by directly transferring wealth to younger generations, avoiding taxation at the parent level. This tax ensures that estates are taxed at every generational level, regardless of how the assets are distributed.

Key Features of the Generation-Skipping Transfer Tax

GSTT works alongside the estate and gift taxes but is applied in specific situations. It carries a flat rate of 40%, similar to the top federal estate tax rate. While estate taxes apply when assets pass from parents to children, GSTT kicks in when those assets skip over children to the next generation.

GSTT can apply to:

• Direct transfers to “skipped persons” (grandchildren or younger individuals).
• Distributions from trusts to skipped persons. This distinction sets it apart from the estate and gift taxes, which focus on immediate transfers.

Who Pays Generation-Skipping Transfer Tax?

GSTT is usually paid by the donor, the estate, or the trustee. In cases of direct gifts to grandchildren, the donor is responsible for the GSTT. When assets are held in trust, the trustee must ensure compliance with GSTT rules if distributions are made to skipped persons. These skipped persons typically include grandchildren, but also cover anyone more than 37.5 years younger than the donor.

The rules can be tricky, especially for large estates and trusts, where assets may be distributed over decades. Understanding who is liable and when to pay the GSTT is critical to effective estate planning.

Types of Transfers Subject to GSTT

There are three key types of transfers that trigger GSTT:

1. Direct Skips: These occur when a grandparent directly transfers assets to a grandchild, bypassing the child’s generation. For instance, if a grandparent gives a large gift directly to a grandchild, this would be a direct skip subject to GSTT.
2. Taxable Distributions: This applies when a trust distributes income or principal to a skipped person. For example, a distribution from a trust to a grandchild would trigger GSTT.
3. Taxable Terminations: This happens when all non-skip persons in a trust (such as the parent generation) die, and the trust continues to benefit skipped persons.

Exemptions and Strategies to Minimize Generation-Skipping Transfer Tax

Generation-Skipping Transfer Tax Exemption

The good news is that the GSTT includes a lifetime exemption. In 2024, the GSTT exemption is $12.92 million. This means that transfers up to this amount can be made without incurring the tax. The exemption can be used during a person’s lifetime or at death.

In addition to the lifetime exemption, annual exclusion gifts up to $17,000 per individual in 2024 can be excluded from GSTT. This allows for tax-free gifts to grandchildren each year without dipping into the lifetime exemption.

The Role of Trusts in Avoiding or Minimizing GSTT

Trusts are a powerful tool in reducing GSTT. Two common types of trusts used are:

• Dynasty Trusts: These are designed to last for multiple generations without being subject to estate or GSTT. By keeping the assets in trust for future generations, a family can preserve wealth without incurring transfer taxes at each generational level.
• Irrevocable Life Insurance Trusts (ILITs): These trusts can hold life insurance policies outside of the taxable estate, and when structured properly, they avoid GSTT entirely.

By using trusts effectively, it’s possible to pass on significant wealth without facing the heavy tax burden.

Planning Strategies for GSTT

Estate planning can offer many ways to reduce or avoid GSTT. One popular strategy is lifetime gifting, which involves using the annual exclusion gift to gradually transfer wealth to grandchildren. Another method involves Crummey trusts, which allow for tax-efficient gifts while still retaining some control over the assets.

Charitable lead trusts (CLTs) can also be used, where part of the estate is donated to charity for a set period, and the remaining assets pass to grandchildren free of GSTT.

Common Mistakes to Avoid in GSTT Planning

• Misunderstanding Generational Definitions: Many mistakenly think GSTT only applies to grandchildren, but it can apply to anyone 37.5 years younger than the donor.
• Failing to Use Exemptions: Not taking advantage of the lifetime GSTT exemption or annual exclusions can lead to unnecessary tax liabilities.

Frequently Asked Questions (FAQs) About Generation-Skipping Transfer Tax (GSTT)

What is the purpose of the Generation-Skipping Transfer Tax?

The primary goal of GSTT is to prevent wealthy individuals from avoiding estate taxes by skipping a generation. By taxing transfers to grandchildren, GSTT ensures that assets are taxed at each generational level, preserving fairness in the tax system.

How much is the GSTT exemption in 2024?

In 2024, the GSTT exemption is set at $12.92 million, allowing significant assets to be transferred without incurring GSTT.

What happens if you exceed the GSTT exemption?

If you exceed the GSTT exemption, the transfer will be taxed at a flat rate of 40%, similar to the estate tax rate.

Can Generation-Skipping Transfer Tax be avoided?

Yes, proper planning can help avoid GSTT. By using trusts, annual exclusions, and charitable giving, you can transfer wealth to future generations while minimizing tax liabilities.

What types of trusts are best for minimizing GSTT?

Dynasty trusts and irrevocable life insurance trusts are highly effective for minimizing or avoiding GSTT altogether.

Conclusion: Why Proper GSTT Planning is Critical 

GSTT can have a significant impact on multigenerational wealth transfers. Proper planning with the right strategies, including trusts and gifting techniques, can minimize this tax burden. Estate planners and tax professionals can help ensure that your family’s wealth is protected for future generations.

Please contact Lynn Conover at lconover@curchin.com with any additional questions or feedback regarding Estate Planning.