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Key Facts
- A generation-skipping trust is a trust designed to benefit people two or more generations below the transferor, but the federal GST tax turns on statutory transfer rules rather than the trust’s label.
- Federal GST tax can arise through a direct skip, a taxable distribution, or a taxable termination.
- A “skip person” generally includes a person assigned two or more generations below the transferor and certain trusts held only for skip persons.
- Allocating GST exemption can reduce a trust’s inclusion ratio, which determines how much of a later transfer is exposed to GST tax.
- Form 709 reports certain lifetime GST transfers and exemption allocations; Forms 706-GS(D), 706-GS(D-1), and 706-GS(T) address later distributions and terminations.
- Trust validity, creditor rights, trustee duties, and perpetuities limits remain questions of the governing state’s law.
A generation-skipping trust can hold property for grandchildren or more remote descendants while providing limited rights to an intervening generation. It is an estate-planning structure, not an automatic federal tax exemption. The transfer terms, beneficiary interests, exemption allocation, and later trust events determine the federal result.
What “generation-skipping” means
Internal Revenue Code section 2613 generally treats an individual as a skip person when the person is assigned to a generation two or more levels below the transferor. A grandchild is the familiar example. The rules also assign generations to unrelated people by age and contain special rules for deceased parents and trust interests.
A trust itself can be a skip person when all interests are held by skip persons. It can also qualify when nobody holds an interest and no future distribution may be made to a non-skip person. A trust with a child’s current beneficial interest may therefore be a non-skip person even when grandchildren ultimately receive the property.
The three taxable event categories
A direct skip is a transfer subject to estate or gift tax that goes directly to a skip person. A gift to a grandchild or to a trust that is itself a skip person can fit this category. Lifetime direct skips and GST exemption allocations commonly appear on Form 709.
A taxable distribution is a distribution from a trust to a skip person that is neither a direct skip nor a taxable termination. The trustee reports the distribution to the skip-person distributee on Form 706-GS(D-1). The distributee generally computes and reports GST tax on Form 706-GS(D).
A taxable termination generally occurs when an interest in trust property ends and only skip-person interests remain, or future distributions can be made only to skip persons. Death of an intervening child beneficiary can create the classic termination. The trustee generally files Form 706-GS(T).
GST tax is separate from estate and gift tax
The GST tax supplements federal estate and gift taxes. A transfer can use gift-tax exclusion or lifetime gift-and-estate exemption and still require a separate GST analysis. The system aims to place a transfer that bypasses a generation in a tax position comparable to successive transfers through that generation.
The maximum GST rate for transfers after 2012 is 40 percent. The applicable rate is the maximum estate-tax rate multiplied by the trust’s inclusion ratio. An inclusion ratio of zero generally means the covered transfer produces no GST tax; a ratio of one means the maximum rate fully applies.
How GST exemption allocation works
Each transferor has a federal GST exemption that can be allocated to transferred property. Form 709 Schedule D records lifetime allocations and reconciles prior allocations. Allocation is technical because automatic-allocation rules, elections out, late allocations, valuations, and additions to an existing trust can change the inclusion ratio.
Exemption is not the same as a cash deduction from the trust. It is allocated to the transfer for GST purposes. Growth on property held in a trust with a zero inclusion ratio can remain protected from GST tax, while a partially exempt trust can produce a fractional taxable exposure.
Dividing exempt and nonexempt shares can simplify administration, but the governing instrument and tax rules must support the division. A trustee should preserve gift-tax returns, allocation schedules, valuation records, elections, and inclusion-ratio computations throughout the trust’s life.
Who files after a trust event
For a taxable distribution, the trustee supplies Form 706-GS(D-1) to each skip-person distributee. A distributee required to report the tax files Form 706-GS(D). The current instructions say a distributee need not file when every reported distribution has an inclusion ratio of zero.
For a taxable termination, the trustee files Form 706-GS(T), generally by April 15 of the year after the calendar year of termination. Form 7004 can provide an automatic filing extension when timely submitted, but an extension to file does not itself extend payment time.
For lifetime funding and direct skips, Form 709 can report the transfer, calculate tax, and allocate GST exemption. All gifts and GST transfers for a calendar year belong on one Form 709 for that year. The related guide to Form 709 explains the broader filing framework.
Trust drafting and tax classification are different
Federal GST rules classify transfers and people for federal tax purposes. State law determines whether the trust was validly created, what a trustee may distribute, how beneficiaries enforce duties, and how long the trust may last. The chosen situs and governing-law clause can materially affect administration.
Calling a document a “generation-skipping trust” does not establish that every beneficiary is a skip person or that every distribution is taxable. Likewise, naming a child as trustee does not by itself make the child a beneficial interest holder. The instrument and actual rights must be analyzed.
Common administration problems
Problems often begin with a missing Form 709, an unclear automatic-allocation election, inconsistent valuations, or an unrecorded addition to an old trust. A later trustee may then lack the data needed to calculate the inclusion ratio. Reconstructing the transfer history early is safer than waiting for a distribution or termination.
Another risk is treating every payment to a grandchild as GST-taxable. Tuition or medical payments made directly to a qualifying provider can fall within statutory exclusions, and distributions from a fully exempt trust may have a zero inclusion ratio. The exact payment path and trust history matter.
