Generation-skipping transfers

A separate transfer tax applies to gifts and bequests that skip a generation. It is not widely understood and it can be triggered without anyone intending it.

What it addresses

The estate tax is designed to apply once per generation.

Leaving assets directly to grandchildren, rather than to children who would later pass them on, avoids one round of estate tax.

The generation-skipping transfer tax exists to prevent that, by imposing a separate tax on transfers to skip persons.

It applies in addition to any estate or gift tax, at a flat rate equal to the highest estate tax rate — which makes it severe where it applies.

Who is a skip person

Generally a person two or more generations below the transferor.

Grandchildren and more remote descendants. Unrelated individuals more than a defined number of years younger.

An important exception: where the intervening generation has died, a grandchild generally moves up a generation and is no longer treated as a skip person.

Trusts can also be skip persons, depending on who their beneficiaries are.

The exemption

Each person has a generation-skipping transfer exemption, which has generally matched the estate tax exemption amount.

Transfers within the exemption are not subject to the tax.

Which means the great majority of families never encounter it, because their total transfers fall well within the exemption.

The exemption must be allocated to transfers, and allocation rules are technical. Automatic allocation applies in some circumstances and not others, and getting it wrong can leave a trust partially exposed.

The critical difference from estate tax

Portability does not apply to the generation-skipping exemption.

A surviving spouse cannot use a deceased spouse's unused amount.

Which means a couple relying on portability for estate tax purposes may waste the first spouse's generation-skipping exemption entirely.

Preserving it requires affirmative planning — generally through a trust structure at the first death — and it is one of the stronger arguments for not relying on portability alone in larger estates.

The three types of transfer

The tax applies to transfers falling into defined categories.

Direct skips, where a transfer is made directly to a skip person.

Taxable terminations, where an interest in a trust held by a non-skip person ends, leaving only skip persons as beneficiaries.

Taxable distributions, where a trust makes a distribution to a skip person.

The last two mean that a trust can generate the tax years or decades after it was created, which is why trusts intended to benefit multiple generations require exemption to be allocated properly at the outset.

The exclusions

The annual gift tax exclusion generally applies to direct skips as well, so ordinary annual gifts to grandchildren are not affected.

Direct payments of tuition and medical expenses are excluded entirely, as with gift tax.

Which means grandparents making the common gifts — annual amounts, paying school fees directly — are generally well within safe territory.

Dynasty trusts

Where the exemption is used deliberately.

A trust funded with the exemption amount, structured to last for as long as state law permits, can benefit multiple generations without further transfer tax at each generational level.

Several states have abolished or extended the rule against perpetuities specifically to permit very long-lasting trusts, which is why these are frequently established in particular jurisdictions.

The trade-offs are real: permanence, loss of flexibility, administration cost across generations, and the loss of basis adjustment at each generation.

They suit families with substantial wealth and a genuine multi-generational intention, and are inappropriate for most.

The practical advice

For most families, this tax is not a concern and the annual exclusions cover ordinary generosity to grandchildren.

For families with estates approaching the exemption, or with trusts benefiting grandchildren, the allocation of the exemption is technical and worth professional attention.

Where a plan involves any trust with multiple generations of beneficiaries, confirming that the exemption has been properly allocated is a specific item worth raising at the next review.

General information only, not legal or tax advice. These rules are technical and exemption amounts change — consult a qualified estate attorney.