# What Is the Generation-Skipping Transfer Tax (GSTT) and Who Pays?

![Generation-Skipping Transfer Tax (GSTT): A federal tax that applies when gifting assets to someone two or more generations younger.](https://www.investopedia.com/thmb/D-qkw8jE3rSVWjKgQmJe-VUt30U=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Generation-skipping-transfer-tax_final-47daf218bcda41f6b521edf325a701a8.png)

*— Investopedia / Michela Buttignol*

## What Is the Generation-Skipping Transfer Tax (GSTT)?

The generation-skipping transfer tax is a federal tax on a gift or [inheritance](https://www.investopedia.com/terms/i/inheritance.asp) that prevents the donor from avoiding estate taxes by skipping children in favor of grandchildren. With the generation-skipping transfer tax, grandchildren receive the same amount as if the inheritance were coming from their parents.

Before the generation-skipping transfer tax was introduced in 1976, wealthy individuals were legally able to gift money and bequeath property to their grandchildren, without paying federal [estate taxes](https://www.investopedia.com/terms/e/estatetax.asp) the way they would if the bequest had been made to their children. The legislation effectively closed the loophole where inheritances could skip a generation to avoid double estate taxation.

### Key Takeaways

*   The generation-skipping transfer tax (GSTT) is a federal tax that results when there is a transfer of property by gift or inheritance to a beneficiary (other than a spouse) who is at least 37½ years younger than the donor.
*   The GSTT effectively closed the loophole that allowed wealthy individuals to legally gift money and bequeath property to their grandchildren without paying federal estate taxes. 
*   The GSTT tax rate is a flat 40%.
*   Most people will never encounter the GSTT because of the high threshold.

## Understanding the Generation-Skipping Transfer Tax (GSTT)

The generation-skipping transfer tax (GSTT) is an additional tax on a transfer of property that skips a generation, known as a generation-skipping transfer (GST) for short. The GSTT was implemented to prevent families from avoiding the estate tax for one or more generations by making [gifts](https://www.investopedia.com/terms/g/gift.asp) or bequests directly to grandchildren or great-grandchildren.

The parent's generation is skipped to avoid an inheritance being subject to estate taxes twice. The GSTT ensures that grandchildren end up with the same value of assets that they would have had if the inheritance was transferred to them directly from their parents, rather than their grandparents.

The person giving the gift is referred to as the [transferor](https://www.investopedia.com/terms/t/transferor.asp) and the recipient is known as the skip person. Many people use a grandchild as a skip person, but a skip person does not have to be a family member. Any individual is eligible to receive a generation-skipping transfer as long as they are at least 37½ years younger than the transferor.

The generation-skipping transfer tax is imposed only if the transfer avoids incurring a gift or estate tax at each generation level. To make up for the taxes that may be avoided by skipping one generation, the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp) imposes a second layer of tax on gifts and bequests above the estate and lifetime gift exclusion. It means that the GSTT is only due when a beneficiary receives amounts in excess of the GST estate tax credit.

## Direct vs. Indirect Skips With the GSTT

The taxation of a GST depends on whether the transfer is a direct or an indirect skip. A direct skip is a property transfer that's subject to an estate or gift tax. An example of a direct skip would be a grandmother gifting property to a grandchild. The transferor or their estate is responsible for paying the GST tax for direct skips.

An indirect skip involves a transfer that has intermediate steps before reaching a skip person. There are two types of indirect skips: the taxable termination and the taxable distribution.

A taxable termination involves a skip person and a non-skip person. A non-skip person is the primary [beneficiary](https://www.investopedia.com/terms/b/beneficiary.asp) who will receive property before it is transferred to the skip person. The transfer to the skip person occurs upon the death of a non-skip person—typically the child of the transferor.

As an example of a taxable termination, consider a transferor who establishes an income-producing trust for his son. Upon the son's death, the remaining property would be passed on to the transferor's grandchild, at which time those assets would be subject to the GST tax.

A taxable distribution refers to any distribution of income or property, from a [trust](https://www.investopedia.com/terms/t/trust.asp) to a skip person that is _not_ otherwise subject to estate or gift tax. If a grandmother established a trust that made payments to her grandson, those payments would be subject to GST taxes, which the recipient is responsible for paying.

## How Much Is the Generation-Skipping Transfer Tax?

In the past, the GSTT has been hefty, ranging from 35% to 77%. The current rate, which has been in effect since 2014, is 40%; however, the Tax Cuts and Jobs Act, which passed in 2017, dramatically decreased the number of estates that might be affected by it by raising the exemption level.

The federal estate, gift, and GSTT exemption sets how much an individual can transfer during their life or at death without being subject to federal transfer taxes. The exemption increased significantly when the Tax Cuts and Jobs Act (TCJA) was passed and is adjusted annually for inflation. Married couples can generally combine their exemptions, which doubles how much they can exempt.

> **Important**
>
> Some states also collect generation-skipping transfer taxes, generally the ones that impose their own estate taxes.

Only the value of an estate or lifetime gifts that exceeds the federal exemption amount is subject to estate or GSTT taxes. Aggregate transfers to skip persons, such as grandchildren, above the exemption are taxed at a flat 40% rate.

The GSTT is assessed when the gift or property transfer is made; GSTs can occur before or after the death of the transferor. While still alive, the transferor can give the gift directly to the skip person; depending on the size of the gift, federal gift taxes may be due. Upon death, the transferor's will may either stipulate that property is bequeathed to a skip person, or it may call for the establishment of a trust from which distributions will be made. [Form 709](https://www.investopedia.com/form-709-united-states-gift-and-generation-skipping-transfer-tax-return-5114636) is used to report both GST taxes and transfers that are subject to federal [gift taxes](https://www.investopedia.com/terms/g/gifttax.asp).

## Tax Strategies

Most beneficiaries will avoid the generation-skipping transfer tax because the estates they inherit will be worth less than the government-provided estate tax credit. The GSTT exemption is very high, as noted above.

However, in cases where the tax could apply, transferors can create [dynasty trusts](https://www.investopedia.com/terms/d/dynasty-trust.asp), which are designed to avoid or minimize estate taxes with each generational transfer. By parking assets in the trust and making specified distributions to each generation, the corpus of the trust isn’t subject to estate taxes with the transfer.

## What Triggers the Generation-Skipping Transfer Tax?

The generation-skipping transfer tax is triggered when a person gifts another person an asset but skips a generation in doing so. For example, a person could stipulate in their will that their home and other assets will go to their grandchild, skipping their child (the grandchild's parent).

## Who Pays the Generation-Skipping Transfer Tax?

The generation-skipping transfer tax is paid by either the grantor or the skipped beneficiary depending on how the bequest is structured. The grantor pays the direct generation-skipping tax, while an indirect generation-skipping tax is paid by the skipped beneficiary. The former is the most common scenario.

## How Much Can a Parent Gift a Child Tax-Free?

Parents are allowed to give their children gifts each year up to a certain limit without triggering a gift tax or using up their lifetime exemption. This exclusion is adjusted annually for inflation and applies per donor and per recipient. This means that two parents can combine their gifts to increase the amount they transfer tax-free to a child, the child's spouse, or another recipient.

## The Bottom Line

The generation-skipping transfer tax (GSTT) is a federal tax on property transfered to beneficiary (other than a spouse) who is 37½ years or more younger than the person making the gift or bequest. This tax was designed to close a loophole that allowed the wealthy to avoid estate taxes by making bequests to grandchildren, rather than children.

The GSTT is a flate-rate tax of 40%, but most estates will never be subject to it. Estates must be larger than the federal estate tax exemption, which was raised by the Tax Cuts and Jobs Act in 2017 and subsequently adjusted for inflation.

> **Article Sources**
>
> 1.  Internal Revenue Service. "[The Estate Tax: Ninety Years and Counting](https://www.irs.gov/pub/irs-soi/ninetyestate.pdf)," Pages 121-123.
>     
> 2.  Internal Revenue Service. "[Instructions for Form 706-GS(T): Generation-Skipping Transfer Tax Return for Terminations](https://www.irs.gov/pub/irs-pdf/i706gst.pdf)," Page 7.
>     
> 3.  Internal Revenue Service. "[Instructions for Form 706-GS(T): Generation-Skipping Transfer Tax Return for Terminations](https://www.irs.gov/pub/irs-pdf/i706gst.pdf)," Pages 1-2.
>     
> 4.  Internal Revenue Service. "[Instructions for Form 706-GS(T): Generation-Skipping Transfer Tax Return for Terminations](https://www.irs.gov/pub/irs-pdf/i706gst.pdf)," Page 6.
>     
> 5.  Internal Revenue Service. "[Instructions for Form 706](https://www.irs.gov/pub/irs-pdf/i706.pdf)," Page 46.
>     
> 6.  Internal Revenue Service. "[Instructions for Form 706-GS(T): Generation-Skipping Transfer Tax Return for Terminations](https://www.irs.gov/pub/irs-pdf/i706gst.pdf)," Pages 1-3.
>     
> 7.  Internal Revenue Service. "[Instructions for Form 706-GS(D)](https://www.irs.gov/pub/irs-pdf/i706gsd.pdf)," Page 1.
>     
> 8.  Internal Revenue Service. "[The Estate Tax: Ninety Years and Counting](https://www.irs.gov/pub/irs-soi/ninetyestate.pdf)," Pages 122-124.
>     
> 9.  Internal Revenue Service. "[Estate Tax](https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax)."
>     
> 10.  Internal Revenue Service. "[Instructions for Form 709: United States Gift (and Generation-Skipping Transfer) Tax Return](https://www.irs.gov/pub/irs-pdf/i709.pdf)," Pages 1, 8.