The Tax Cuts and Jobs Act doubled the generation-skipping transfer (GST) tax exemption to $10 million beginning last year. The exemption is adjusted annually for inflation. (For 2019, the exemption amount is $11.4 million.) However, even though most families won’t be affected by the GST tax, it’s important to note that, beginning in 2026, the GST tax exemption is scheduled to return to a pre-TCJA level of $5 million.
What is the GST tax?
The GST tax is a flat, 40% tax on transfers to “skip persons,” including grandchildren, family members more than a generation below you, nonfamily members more than 37½ years younger than you, and certain trusts (if all of their beneficiaries are skip persons). If your child has predeceased his or her children on the date of the gift, however, those grandchildren are no longer considered skip persons.
GST tax applies to gifts or bequests directly to a skip person (a “direct skip”) and to certain transfers by trusts to skip persons. Gifts that fall within the annual gift tax exclusion (currently, $15,000 per recipient; $30,000 for gifts split by married couples), either outright or to qualifying “direct skip trusts,” are also shielded from GST tax.
What are potential allocation traps?
To take advantage of the GST exemption, you (or your estate’s representative) must allocate it to specific gifts and bequests (on a timely filed gift or estate tax return). Allocating the exemption wisely can provide substantial tax benefits. To avoid costly mistakes, the tax code and regulations provide for automatic allocation under certain circumstances. Your exemption is automatically allocated to direct skips as well as to contributions to “GST trusts.” These are trusts that could produce a generation-skipping transfer, subject to several exceptions.
Often, the automatic allocation rules work well, ensuring that your exemption is allocated in the most tax-advantageous manner. But in some cases, they can lead to undesirable results. Suppose you establish a trust for your children, with the remainder passing to your grandchildren. You assume the automatic allocation rules will shield the trust from GST tax. But the trust gives one of your children a general power of appointment over 50% of the trust assets, disqualifying it from GST trust status. Unless you affirmatively allocate your exemption to the trust, distributions or other transfers to your grandchildren will be subject to GST taxes.
Here’s another example: You establish a trust for your children, but there’s a remote possibility that the trust will make a generation-skipping transfer, so it’s a GST trust for automatic allocation purposes. Because the trust is unlikely to result in GST taxes, your exemption is wasted. That’s not a problem if your estate is well within the exemption amount, but what if you need to allocate your exemption elsewhere? If so, you’re better off opting out of automatic allocation and allocating your exemption to direct skips or to trusts that are more likely to trigger GST taxes.
Turn to your advisor
The rules regarding allocation of the GST tax exemption are complex, and mistakes can be costly. If you’re planning to make gifts to your grandchildren or other loved ones more than one generation below you or nonrelatives more than 37½ years younger than you, huddle with your estate planning advisor or contact us to understand the ins and outs of the GST tax.