Generation-Skipping Transfer Tax

Most of us are familiar with the federal income tax. If you earn a paycheck, you can’t help but notice the deductions each pay period. Perhaps less familiar are federal taxes such as the capital gains tax, estate tax, and gift tax. Even less familiar for most is the generation-skipping transfer tax.

What is the generation-skipping transfer tax?
The generation-skipping transfer (GST) tax is a federal tax on an individual’s transfer of property to a person at least two generations below the individual. Generally, GST tax applies to gifts made by an individual to grandchildren or descendants of the grandchildren. Gifts made by an individual to unrelated persons other than the individual’s spouse can also trigger GST tax. The recipients of these transfers are called “skip persons.” The GST tax is imposed on transfers both during the lifetime of the transferor grandparent or transfers through a will or trust after their death.

Congress first imposed the GST tax in the mid-1970s to prevent wealthy individuals from avoiding an estate tax on each generation by skipping a generation and transferring to grandchildren instead of to children. When transfers were made directly to grandchildren, Congress felt that they were losing the tax they would have collected if the transfer had been made from grandparent to child and then from child to grandchild. The GST tax was an attempt to collect a transfer tax at each generation.

While the GST tax follows the gift and estate tax lifetime exemption limits, the GST tax is a separate tax that applies alongside and in addition to any gift and estate taxes.

When does it apply?
The GST tax typically applies when the amount that is transferred to skip persons (related persons two or more generations removed or unrelated persons thirty-seven-and-a-half years younger than the transferor) is greater than the transferor’s lifetime GST tax exemption. Like the estate and gift tax exemption, the GST tax exemption is $12.06 million in 2022. All lifetime gifts, as well as transfers made at death by will or trust, are counted against the exemption amount. For example, if you give $100,000 to each of your five grandchildren in 2022, then $500,000 is counted against your lifetime exemption of $12.06 million. If total transfers (during life and at death) to grandchildren exceed the exemption amount, a flat 40 percent tax is assessed on the excess amount transferred.

There is an exception to the GST tax if your child predeceases you. The transfer of property to a grandchild where the grandchild’s parent has already passed away does not result in the imposition of the GST tax. Since transfers from a parent to child are not considered generation-skipping, the grandchild essentially steps into the shoes of the predeceased child (their parent).

The GST tax does not apply to tuition or medical care payments made directly to an educational or healthcare provider (a school, university, doctor, hospital, etc.). Grandparents who wish to help pay for a grandchild’s education can pay the school or college directly and no GST tax would be triggered. Likewise, if a grandparent wanted to help with the costs of medical care for a grandchild, they could pay the hospital directly and there would be no GST tax. However, if the grandparent gave money to the grandchild with the direction to pay for tuition or healthcare costs, there would be a GST tax because the payment was not made directly to the provider.

Things to Consider
While most people will not have to deal with GST tax issues at present because the value of the property transferred is not greater than $12.06 million, it is important to be somewhat familiar with the GST tax and when it applies. Under current law, the GST tax exemption amount (along with the estate and gift tax exemption amounts) is scheduled to revert to $5 million (adjusted for inflation) in 2026. Proposals to lower the exemption amount are introduced regularly. So if you are considering transferring property to grandchildren, be aware of the GST tax and be careful to know what the current exemption amounts are at the time.

Unlike the estate and gift tax exemptions, the GST tax exemption is a use it or lose it opportunity. With the estate and gift tax, if one spouse does not fully utilize their exemption with transfers made during lifetime or at death, the surviving spouse can use the unused exmeption amount of their spouse. With the GST tax, any unused exemption amount is lost at the death of the first spouse.

Let Us Help
The GST tax can be confusing and challenging. If you own assets above the exemption amount that you are considering transferring to grandchildren or other skip persons, be careful to seek out the help of qualified legal and tax counsel. Ensure that you make the most of the tax rules and related GST tax planning strategies available today. Because these rules can and do change regularly, revisit your planning with your advisors on a regular basis. We are qualified and prepared to help. Schedule an appointment with us and let us assist you with your planning.