Generation-Skipping Trusts (GSTs)

A Generation-skipping Trust (GST) is an irrevocable trust designed to transfer wealth down multiple generations while bypassing the estate tax that would normally apply at each generational level (e.g., at the death of your children).

A transfer is subject to the Generation-Skipping Transfer Tax (GSTT) if it is made to a “skip person,” defined by IRC §2613, “Skip person and non-skip person defined” as a beneficiary at least two generations below you—a grandchild or great-grandchild—or an unrelated individual at least 37.5 years younger. IRC §2651, “Generation assignment” supplies the generation assignments themselves, including the predeceased parent rule: if your child dies before the transfer, that child’s children move up a generation and are no longer skip persons, so a bequest to orphaned grandchildren carries no GSTT.

The GSTT is a flat tax imposed at the highest federal estate tax rate (currently 40%). However, under the OBBBA, each individual is granted a permanent, inflation-indexed lifetime GST exemption of $15 million (current for 2026; $30 million combined for a married couple, each spouse allocating their own). Unlike the estate tax exemption, the GST exemption is not portable — there is no GST equivalent of the DSUE, so a spouse who dies without allocating their $15 million simply loses it. By allocating your GST exemption to transfers into a GST trust, you can establish an inclusion ratio of zero. Once a trust has an inclusion ratio of zero, the entire trust corpus—and all future appreciation—is permanently shielded from GSTT on all future distributions and terminations, no matter how large the trust grows.

The GSTT applies to three types of taxable events:

Direct Skips

An outright transfer of assets during life or at death directly to a skip person or to a trust solely for the benefit of skip persons. For lifetime direct skips, the transferor pays the GSTT on Form 709 on a tax-exclusive basis.

Taxable Distributions

A distribution of trust income or principal to a skip person. The skip person beneficiary is responsible for paying the GSTT using Form 706-GS(D) and must be provided with Form 706-GS(D-1) by the trustee.

Taxable Terminations

The termination of a non-skip person’s interest in a trust (for example, when your child dies, leaving only grandchildren as beneficiaries). The trustee pays the GSTT from the trust assets using Form 706-GS(T) on a tax-inclusive basis.

The last row hides one stacking effect: on a lifetime direct skip, the GSTT paid is itself an additional taxable gift under IRC §2515, “Treatment of generation-skipping transfer tax”, so the $800K of GSTT adds a further $\$800\text{K}\times 40\%=\$320\text{K}$ of gift tax on top of the $6.8M shown.

The GSTT Annual Exclusion Trap

Crummey withdrawal powers convert a gift into a trust from a future interest into a present one, so the contribution qualifies for the $19,000 annual gift tax exclusion; the mechanics, the notice requirements, and the 5-and-5 lapse problem are covered at section “Irrevocable Life Insurance Trusts (ILITs)”.

Here is the trap that catches multi-generational trusts. Under IRC §2642(c), a contribution that qualifies for the gift tax annual exclusion using Crummey powers does not automatically qualify for the GSTT annual exclusion. To qualify for the GSTT annual exclusion, the trust must be a vested, single-beneficiary trust where:

1.

No portion of the trust income or principal can be distributed to anyone other than that single beneficiary during their lifetime.

2.

If the beneficiary dies before the trust terminates, the trust assets must be includible in the beneficiary’s gross estate (usually achieved via a general power of appointment).

If your trust has multiple beneficiaries (e.g., a common pot trust for children and grandchildren), contributions shielded by Crummey powers for gift tax purposes will not have a zero GST inclusion ratio. You must explicitly allocate a portion of your lifetime GST exemption on Form 709 to prevent future taxable distributions or taxable terminations from triggering a 40% GSTT.

Automatic Allocation: The Election Nobody Reads

GST exemption does not sit in an account waiting to be spent. It is allocated, transfer by transfer, on a Form 709 — and Congress, having watched a generation of taxpayers forget, wrote default rules that allocate it for you. Those defaults are the single most common source of wasted GST exemption in practice, in both directions, and the only cure is to make the election deliberately every time you file.

Two statutory defaults govern allocation: under IRC §2632(b), “Special rules for allocation of GST exemption”, a direct skip — an outright gift to a grandchild, say — gets your exemption allocated automatically, whether or not you wanted it there. Under IRC §2632(c), an indirect transfer to a GST trust (a defined term with six exceptions, most of them turning on whether non-skip persons can receive substantial amounts) also gets automatic allocation. The trouble is the mismatch between the statutory definition and what you actually intend:

Exemption wasted on a trust that will never skip

Fund a trust for your children that technically meets the §2632(c) definition, and the default consumes precious exemption on a vehicle whose assets will be taxed in your children’s estates anyway. Elect out on Form 709 under IRC §2632(c)(5)—you may elect out for one transfer, for all future transfers to that trust, or both—and preserve the exemption for the dynasty trust that needs it.

Exemption missing from the trust that needed it

The reverse is worse. A trust that falls into one of the exceptions — commonly because a non-skip beneficiary such as a spouse or child may withdraw more than 25% of the corpus — receives no automatic allocation, so a family assuming the default protected them discovers an inclusion ratio of one decades later, when a taxable termination triggers 40% on the grown value. Elect in under IRC §2632(c)(5), or allocate affirmatively on the return.

The ILIT trap

An ILIT funded with annual-exclusion Crummey gifts is the classic case: the gift-tax exclusion applies, the GST exclusion of IRC §2642(c) usually does not (above), and whether §2632(c) rescues you depends on drafting nobody checked. A $40,000-a-year premium trust that will pay a $10 million death benefit to grandchildren is a $4 million mistake if the inclusion ratio is one.

Timing rules reward early action over perfection: a timely allocation on a return filed by the due date values the transferred property as of the date of the gift; a late allocation values it as of the first day of the month the allocation is made ( IRC §2642(b), “Valuation”), which on an asset that has appreciated means spending far more exemption for the same result. And where the failure was an inadvertent error, Treas. Reg. §301.9100-3 relief can sometimes rescue a missed election — expensively, through a private letter ruling, and only if you acted reasonably and in good faith. Allocate on the original return.

The practical instruction is a sentence: file a Form 709 for every transfer to every irrevocable trust, attach a statement that states explicitly whether you are allocating GST exemption or electing out, and keep a running schedule of exemption used. A $15 million allowance tracked on nobody’s spreadsheet is a $15 million allowance your executor will have to reconstruct from thirty years of returns.