Generation-Skipping Transfer Tax
What Trustees Need to Know
If your trust has grandchildren as beneficiaries, distributions to them can trigger a 40% federal tax on top of any income tax. Whether that tax applies depends on one question: is the trust GST-exempt?
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Why this tax exists
The generation-skipping transfer tax is designed to prevent families from avoiding a round of estate or gift tax by skipping a generation. If a grandparent could leave everything directly to grandchildren, the assets would pass through one fewer layer of transfer taxation. The GST tax closes that gap by imposing a flat 40% tax on transfers that skip a generation.
As trustee, you need to understand this because your discretionary distribution decisions can trigger it. A check to a child beneficiary is just an income tax event. A check to a grandchild beneficiary from a non-exempt trust is a 40% GST tax event on top of any income tax. That is a very expensive distribution to make without knowing it was coming.
The most important question: is the trust exempt?
When the trust was created, the grantor had the option to allocate their GST exemption to it. If they allocated enough exemption to cover the full value of the trust at the time of the transfer, the trust is “fully exempt” (inclusion ratio of zero). If they did not allocate any exemption, the trust is fully taxable (inclusion ratio of one). Some trusts fall in between, which is more complicated.
If the trust is fully exempt, you can distribute to anyone, children, grandchildren, great-grandchildren, without triggering GST tax. The exemption covers the trust and everything in it, including all future growth.
If the trust is not fully exempt, distributions to grandchildren or more remote descendants trigger the GST tax. Distributions to children do not.
How to find out: check the original gift tax return (Form 709) or estate tax return (Form 706) that was filed when the trust was funded. Specifically, look at Schedule D on the 709 or Schedule R on the 706. Your tax advisor can determine the trust’s inclusion ratio from these documents.
Who is a “skip person”?
A skip person is someone two or more generations below the person who created the trust. In most family trusts, that means grandchildren and great-grandchildren are skip persons. Children are not.
There is one important exception: the predeceased parent rule. If a grandchild’s parent (the grantor’s child) died before the grantor, that grandchild is moved up one generation for GST purposes. They are no longer a skip person, and distributions to them do not trigger the GST tax, even from a non-exempt trust. This rule applies only when the parent died before the transfer that created the trust.
What triggers the tax
There are two events you are most likely to encounter as trustee:
- Taxable distribution: you distribute money or property from a non-exempt trust to a grandchild or other skip person. The grandchild owes the 40% GST tax on what they receive (though the trust can pay it for them, which itself counts as another taxable distribution). You must file Form 706-GS(D) to report it
- Taxable termination: the last non-skip person’s interest in the trust ends (for example, the last child beneficiary dies), and only grandchildren remain as beneficiaries. The trust pays the GST tax from its own assets. You must file Form 706-GS(T) to report it
In either case, the tax is 40% of the transferred amount. There is no graduated rate structure.
What to do before distributing
- Determine the trust’s GST status. If you do not already know whether the trust is exempt, find out before making any distribution to a grandchild. Your tax advisor can review the original returns
- If the trust is fully exempt: distribute as the trust instrument directs. No GST concerns
- If the trust is not exempt: distributions to children are fine; distributions to grandchildren trigger the 40% tax. Consult your tax advisor before distributing to any skip person
- If the trust has a fractional inclusion ratio: this is the most complex scenario. Consider whether the trust should be severed into an exempt portion and a non-exempt portion (a “qualified severance”). Your tax advisor can walk you through this
Trust termination and GST
When a trust terminates and the remaining assets pass to grandchildren, that is a taxable termination if the trust is not exempt. This can come as a surprise: a trust that ran for decades without any GST issue suddenly owes 40% when it winds down and the remaining beneficiaries are all skip persons.
If you know the trust will eventually terminate with only grandchildren as beneficiaries, plan for this with your tax advisor. A qualified severance earlier in the trust’s life, or strategic distributions to non-skip persons, can mitigate the impact.
Frequently Asked Questions
What is the generation-skipping transfer tax?
The GST tax is a federal tax on transfers that skip a generation, like distributions from a trust to grandchildren instead of children. It is a flat 40% tax that applies on top of any regular estate or gift tax. The purpose is to prevent families from avoiding a round of transfer tax by skipping the children’s generation entirely. It applies to three types of events: direct skips (outright gifts or bequests to grandchildren), taxable distributions (trust distributions to grandchildren), and taxable terminations (when a trust’s interests shift entirely to grandchildren).
How do I know if my trust is GST-exempt?
The person who created the trust (the grantor) allocated their GST exemption to the trust, either when they funded it or on their estate tax return. If enough exemption was allocated to cover the full value of the trust, the trust has an inclusion ratio of zero and is fully exempt. Any distribution from a fully exempt trust, to anyone, is free of GST tax. If you are not sure whether the trust is exempt, check the original gift tax return (Form 709) or estate tax return (Form 706), specifically Schedule R on the 706 or Schedule D on the 709. Your tax advisor can determine the trust’s inclusion ratio from these filings.
What happens if I distribute to a grandchild from a non-exempt trust?
The distribution is a taxable distribution, subject to the GST tax at a flat 40% rate. The grandchild (the distributee) is responsible for paying the tax, though the trust can pay it on their behalf (which itself is treated as an additional taxable distribution). As trustee, you are required to file Form 706-GS(D) to report the distribution to the IRS. This is why it is critical to know the trust’s GST status before making any distribution to a grandchild or more remote descendant.
Does the predeceased parent rule affect my trust?
It can. If one of the grantor’s children (a trust beneficiary’s parent) died before the grantor, the grandchildren of that deceased child may be moved up one generation for GST purposes. That means they are no longer “skip persons,” and distributions to them would not trigger the GST tax even from a non-exempt trust. This rule applies only to lineal descendants and only when the parent died before the transfer that created the trust (or before the grantor’s death, for testamentary trusts). Check with your tax advisor to confirm whether the rule applies to your specific situation.
Related services
Trust Tax Return (1041)
The annual return for the trust, where distributions and income are reported.
Trust Termination
Winding down a trust: final return, final distributions, and potential GST consequences.
Beneficiary K-1
Each beneficiary’s share of trust income, reported alongside any GST implications.