What is the Generation Skipping Tax (GST) in Estate Planning

Estate planning is all about securing your legacy, ensuring that your wealth is passed down to future generations as smoothly and tax-efficiently as possible. One of the key factors that can affect how much of your estate your beneficiaries receive is the Generation Skipping Tax (GST). This federal tax plays a significant role in estate planning, especially when it comes to transferring assets to grandchildren or younger beneficiaries. Let’s explore what the generation skipping tax is, why it exists, and how you can plan to minimize its impact.

Understanding the Generation Skipping Tax

The generation skipping tax is a tax levied by the federal government on the transfer of assets to individuals who are at least two generations younger than the person making the gift or bequest.
In most cases, this means that if you pass your wealth directly to your grandchildren, skipping over your children, the IRS will apply the GST. The goal of this tax is to prevent wealthy families from avoiding estate taxes by passing assets directly to younger generations and bypassing one layer of taxation.

For example, if a grandparent leaves a large inheritance directly to their grandchildren, this transfer would usually trigger the GST. However, if the estate is passed down to the children first and then to the grandchildren, the transfer may not be subject to the GST, though estate taxes may still apply.

How the Generation Skipping Tax Works

The generation skipping tax is applied to both gifts made during the donor’s lifetime and inheritances transferred upon death. When someone makes a gift or bequest that “skips” a generation, the transfer is subject to both estate or gift taxes and the GST, making it a significant tax burden on those transfers. The tax is currently calculated at a flat rate of 40% (equal to the estate and gift tax rate) on transfers above the lifetime GST tax exemption amount, which is $13.61 million per individual in 2024.
This means any assets that exceed this exemption threshold will be subject to the GST.

For example, if a grandparent gives their grandchildren $20 million, the first $13.61 million is exempt from the GST, but the remaining $6.39 million would be taxed at a rate of 40%, resulting in a tax liability of over $2.5 million. This significant tax obligation makes it crucial for individuals to plan carefully when considering multi-generational wealth transfers.

Why the Generation Skipping Tax Exists

The generation skipping tax was created to close a loophole in estate tax laws that allowed families to pass their wealth to grandchildren or younger generations, avoiding estate taxes for one generation. Normally, wealth would be taxed each time it is passed from one generation to the next, such as from parents to children. By skipping the children’s generation and transferring assets directly to grandchildren, some wealthy families were able to avoid estate taxes entirely.

To prevent this, the federal government introduced the GST to ensure that wealth is taxed when it skips generations. The goal of the tax is to create a level playing field and prevent the ultra-wealthy from bypassing estate taxes and creating an unfair advantage over others who transfer their wealth more traditionally.

Generation Skipping Tax Exemption

Fortunately, there is a generation skipping tax exemption that allows a certain amount of wealth to be transferred to younger beneficiaries without triggering the tax. As of 2024, each individual can transfer up to $13.61 million to grandchildren or other beneficiaries who are two or more generations younger without incurring the GST. This exemption amount is adjusted annually for inflation, so it may continue to increase over time.

If you and your spouse are planning to make transfers to your grandchildren, you can each use your GST exemption, effectively allowing a combined exemption of $27.22 million. This means you can transfer significant wealth to younger generations without worrying about the tax, as long as the total amount remains under the exemption threshold.

However, once the value of the assets transferred exceeds the generation skipping tax exemption, the excess is subject to the GST at the flat 40% rate. This is why it’s important to work with an experienced estate planning attorney to carefully structure your gifts and bequests to minimize tax exposure.

How to Minimize the Generation Skipping Tax

Though the generation skipping tax can be costly, there are strategies you can use to reduce or even eliminate its impact. One of the most effective ways to avoid the GST is to take full advantage of the GST exemption by structuring your gifts and estate plan to maximize the amount you can transfer tax-free. Here are some common strategies that individuals use in estate planning:

Lifetime Gifting

You can make lifetime gifts to your grandchildren or other younger beneficiaries, spreading the gifts out over several years to stay within the generation skipping tax exemption limits. By making smaller, annual gifts, you can transfer significant amounts of wealth over time without triggering the GST.

Generation Skipping Trusts

A generation skipping trust is an estate planning tool that allows you to transfer assets to a trust for the benefit of multiple generations. By placing your assets in a trust, you can transfer wealth to your grandchildren or other younger beneficiaries without having to worry about multiple layers of taxation. The trust assets can grow over time, benefiting future generations while minimizing tax exposure.

Annual Exclusion Gifts

Under current IRS rules, you can give up to $17,000 per year (as of 2024) to as many people as you like without triggering the gift tax or GST. These smaller gifts can add up over time, allowing you to transfer wealth gradually and avoid the tax.

When Does the Generation Skipping Tax Apply?

The generation skipping tax only applies when wealth skips over a generation and exceeds the GST exemption. For example, if you leave assets directly to your grandchildren, bypassing your children, this would likely trigger the tax. However, if you transfer assets to your children first and they later pass the wealth down to their children, the GST would not apply.

It’s also important to note that the GST can apply to beneficiaries who are not your biological descendants. For example, if you leave assets to a close family friend or someone significantly younger than you, the IRS may consider them a “skip person” for tax purposes, and the generation skipping tax could be imposed on that transfer.

Why Estate Planning is Essential for Avoiding the Generation Skipping Tax

Avoiding or minimizing the generation skipping tax requires careful estate planning. With the help of an experienced estate planning attorney, you can develop strategies that allow you to transfer wealth to younger generations while minimizing the tax burden. This might include setting up trusts, making lifetime gifts, or using other planning tools that take full advantage of the GST exemption.

By planning ahead, you can ensure that your wealth is passed down to your grandchildren or other younger beneficiaries with as little tax impact as possible. Proper estate planning allows you to preserve your financial legacy and ensure that it’s distributed according to your wishes, without being diminished by unnecessary taxes.

Contact Gudorf Law Group for Help with Your Estate Planning Needs

Navigating the complexities of the generation skipping tax and other estate planning issues can be challenging, but you don’t have to do it alone. The experienced attorneys at Gudorf Law Group can help you understand how the GST might affect your estate and work with you to develop a customized plan that minimizes tax liability and ensures your wealth is passed down to future generations.
Contact Gudorf Law Group today for a free consultation and let us help you protect your family’s financial future.