The Three Tax Systems

Before you evaluate any transaction, name which of the three systems it lands in — because the same event can land in two of them at once, under different names, with different answers.

The Income Tax System

Taxes what you earn: wages, business profit, interest, dividends, realized gains. Progressive rates, a separate and lower schedule for long-term capital gain, and the whole apparatus of deductions, credits, and timing. This is the system you interact with annually and the one most of this chapter addresses. Its central lever is when and as what income is recognized.

The Estate and Gift Tax System

Taxes what you transfer, whether during life or at death, above a unified lifetime exemption — $15 million per person for 2026, permanent and indexed from 2027 — at a 40% rate on the excess. Its central lever is moving future appreciation out of your estate while it is still cheap to move.

The Generation-skipping Transfer Tax (GSTT) System (GSTT)

A second, separate 40% tax on transfers that skip a generation — to grandchildren, or to trusts for them. It exists because dynasty trusts would otherwise let a family pay estate tax once every three or four generations instead of every one. It has its own exemption, equal in amount to the estate exemption but tracked separately, and allocated on its own schedule. Failing to allocate it is one of the more expensive clerical errors available to a wealthy family.

The systems do not coordinate, and the gaps between them are where the planning lives. A transfer can be complete for gift tax and incomplete for income tax; an intentionally defective grantor trust is built precisely on that mismatch — assets sit outside your estate while the income stays taxable to you, so the tax you pay on the trust’s income is itself an additional untaxed gift to the beneficiaries. A sale to that trust is a real sale for estate purposes and a non-event for income purposes, because you cannot sell to yourself. None of that is a loophole; it is the direct consequence of three statutes that define “transfer” differently and were never reconciled.

chapter “Estate planning” handles the second and third systems in full. The rest of this chapter is the first one.