The federal transfer tax system has three parts: the estate tax, the gift tax, and the generation-skipping transfer (GST) tax. The GST tax is the least intuitive of the three, and it frequently appears on estate planning exam questions and in real-world practice when wealthy clients want to benefit grandchildren or build long-term trusts. This article explains the structure of the tax in plain terms.

Why Does the GST Tax Exist?

Without a GST tax, a wealthy person could leave property in trust for children for life and then to grandchildren. Because the children only hold an income interest, the property would not be included in their estates, and the family would skip one level of estate tax. Congress enacted the GST tax, found in Chapter 13 of the Internal Revenue Code, to impose a tax on transfers that skip a generation, effectively replacing the estate tax that would have been paid at the skipped generation.

Key Definitions

Transferor

The transferor is the person who made the transfer for estate or gift tax purposes. The GST tax is determined by reference to the transferor, not the recipient's relationship to the trustee.

Skip Person

A skip person is a natural person assigned to a generation two or more generations below the transferor, or a trust in which all interests are held by skip persons or in which no person holds an interest and distributions can only go to skip persons. Grandchildren are the typical example.

Non-Skip Person

Any person who is not a skip person, such as a child of the transferor. A trust with at least one non-skip beneficiary is generally a non-skip person for GST purposes, though later taxable events may occur.

Assigning Generations

For family members, generations are counted from the transferor, so children are one generation down, grandchildren two, and so on. For unrelated people, assignment is based on age difference: someone more than 12.5 years but not more than 37.5 years younger is one generation below, and each additional 25 years is another generation. A spouse is always treated as in the transferor's generation.

The Three Taxable Events

Direct skip: a transfer subject to estate or gift tax made directly to a skip person, such as an outright gift to a grandchild or a transfer to a trust with only skip persons as beneficiaries.
Taxable termination: the termination of an interest in property held in trust, by death, lapse of time, or release of a power, where a skip person then holds the interest. An example is the death of a child who was the income beneficiary of a trust, leaving only grandchildren as beneficiaries.
Taxable distribution: any distribution from a trust to a skip person that is not a direct skip or a taxable termination.

Rate and the Exemption

The tax is imposed at a flat rate equal to the maximum federal estate tax rate, currently 40 percent, multiplied by the inclusion ratio. Each person has a GST exemption equal to the basic exclusion amount used for the estate tax, which is indexed for inflation. For 2026 the amount is $15 million per person under current law, so a married couple can shelter $30 million. Always confirm the current amount, since it is adjusted over time and subject to legislative change.

Inclusion Ratio and Applicable Fraction

The inclusion ratio is one minus the applicable fraction. The applicable fraction is the amount of GST exemption allocated to the transfer divided by the value of the property transferred (net of taxes and charitable deductions). If enough exemption is allocated to cover the entire transfer, the applicable fraction is one, the inclusion ratio is zero, and the trust is fully "GST exempt." If no exemption is allocated, the inclusion ratio is one and every taxable event is taxed at the maximum rate. A trust with an inclusion ratio between zero and one is hybrid, which is usually undesirable and avoided through separate trusts.

Exclusions From the GST Tax

Annual exclusion gifts: transfers that qualify for the gift tax annual exclusion are generally excluded from direct skip treatment if made outright or to certain trusts, such as a Section 2642(c) trust for a single skip person who will include the property in their estate.
Tuition and medical payments: payments made directly to an educational institution or medical provider for a person's benefit are excluded under Section 2503(e), even for grandchildren.
Predeceased parent exception: if a child of the transferor has died, the grandchildren move up a generation for GST purposes, so gifts to them are not treated as skip transfers.

Allocating the Exemption

Allocation is made on a timely filed gift tax return (Form 709) or estate tax return (Form 706). Certain allocations are automatic. Direct skips receive an automatic allocation of unused exemption, and indirect skips to "GST trusts" are covered by an automatic allocation rule, although taxpayers can elect out. Because automatic rules can produce unintended results, practitioners often file a return to make a deliberate allocation or election. Taxable distributions and terminations are reported on Forms 706-GS(D) and 706-GS(T).

Planning Tools

Dynasty Trusts

A dynasty trust is designed to last for many generations, taking advantage of state laws that have abolished or extended the rule against perpetuities. When funded using GST exemption so the inclusion ratio is zero, assets can grow and be distributed for generations without further transfer tax.

Reverse QTIP Election

For a qualified terminable interest property trust that qualifies for the marital deduction, a reverse QTIP election allows the first spouse to die to be treated as the transferor for GST purposes, so the estate can use the first spouse's GST exemption even though the property is included in the surviving spouse's estate for estate tax purposes.

Separate Trusts

Splitting a trust into exempt and non-exempt shares avoids a fractional inclusion ratio and keeps administration simple.

Frequently Asked Questions

Is a gift to a grandchild always subject to the GST tax?

No. It may be sheltered by the annual exclusion, the tuition and medical exclusions, the predeceased parent exception, or an allocation of GST exemption.

Is the GST tax in addition to the estate or gift tax?

Yes. A transfer can be subject to both estate or gift tax and the GST tax.

Who pays the GST tax?

For a direct skip, the transferor pays. For a taxable termination, the trustee pays. For a taxable distribution, the recipient pays.

Review and Practice

The GST tax combines vocabulary with calculations, which makes it perfect for repetition. Test yourself with our estate planning flashcards, join for free to start practicing, and view the full question bank options on our pricing page.

Understanding the Generation-Skipping Transfer Tax: GST Basics for Estate Planning Paralegals