Direct answer: A generation-skipping trust (GST trust) transfers wealth to grandchildren or later generations while keeping assets in trust for the intervening generation's benefit. The generation-skipping transfer (GST) tax applies at a flat 40% rate to transfers that skip a generation, but each donor has a GST exemption equal to the federal estate tax exemption ($13.61 million per individual in 2026). Families primarily use GST trusts when their estates exceed that exemption threshold. The elevated exemption is scheduled to sunset after 2025 under current law, creating time-sensitive planning considerations for families with assets in the $7 million to $13.61 million range.

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Generation-Skipping Trust Basics

Key Takeaways

What the GST Tax Is and Why It Exists

The generation-skipping transfer tax was enacted by Congress to close a perceived loophole in the estate tax system. Without a GST tax, a wealthy family could transfer assets directly to grandchildren, bypassing the middle generation and its estate tax exposure entirely. By skipping one estate tax event, a family could effectively cut its total estate tax burden in half over two generations.

The GST tax addresses this by imposing a separate flat 40% tax on transfers to skip persons: individuals who are two or more generations younger than the donor (such as grandchildren or great-grandchildren) or non-relatives who are more than 37.5 years younger than the donor. This tax applies in addition to any applicable gift or estate tax, meaning a transfer to a grandchild above the exemption could theoretically face combined tax rates approaching 70% if both taxes apply to the same dollars.

The GST exemption prevents this outcome for most transfers. Each donor has a lifetime GST exemption equal to the federal estate and gift tax applicable exclusion amount. In 2026, this is $13.61 million per individual. Transfers within the exemption face no GST tax at all. Only transfers above the exemption trigger the 40% GST rate.

How a Generation-Skipping Trust Works

A generation-skipping trust is not a single standardized trust type but a general term for any trust structured to take advantage of the GST exemption. The typical structure works as follows.

The grantor (often a grandparent) transfers assets into the trust and allocates GST exemption to cover the transfer. The trust document names the grantor's children (the skipped generation) as income beneficiaries during their lifetimes, meaning they can receive income distributions and may also receive principal distributions for health, education, maintenance, and support at the trustee's discretion. When the children die, the remaining trust assets pass to the grandchildren (the skip persons) without incurring GST tax, because the GST exemption was already allocated at the time of the original transfer.

The key mechanism is that the trust itself is not included in the children's taxable estates. Assets inside the trust grow, and the children benefit from them during their lifetimes, but those assets never legally belong to the children. When they die, the assets pass to the grandchildren outside of the estate tax system, having been shielded by the grandparent's GST exemption years or decades earlier.

This structure requires careful drafting to ensure it qualifies as a GST trust under the Internal Revenue Code and that the GST exemption is properly allocated at the time of the transfer or on a timely-filed gift tax return (Form 709).

Direct Skips, Taxable Terminations, and Taxable Distributions

The GST tax applies to three different types of events, each triggering GST tax in a different way. Understanding which type applies to a given transfer matters for knowing who pays the tax and when.

A direct skip is a transfer made directly to a skip person, either outright or into a trust from which only skip persons can benefit. An outright gift from a grandparent to a grandchild above the annual exclusion and above the GST exemption is a direct skip. The transferor (the donor) is responsible for any GST tax due, and the tax is paid at the time of the transfer.

A taxable termination occurs when a non-skip person's interest in a trust terminates and no non-skip persons remain as beneficiaries. For example, when the last child (non-skip person) who is an income beneficiary of a trust dies, and the remaining assets pass to grandchildren, a taxable termination occurs. The trustee is responsible for paying any GST tax from trust assets at that time.

A taxable distribution occurs when a trust makes a distribution of income or principal to a skip person (such as a grandchild) from a trust that is not entirely exempt from GST tax. The recipient (the grandchild) is responsible for any GST tax, though the trust may pay it on their behalf.

Properly structured GST trusts with full GST exemption allocation avoid taxable terminations and taxable distributions by making the trust itself GST-exempt from inception.

The Exemption Sunset and Planning Implications

The elevated estate, gift, and GST tax exemption ($13.61 million per individual in 2026) was set by the Tax Cuts and Jobs Act of 2017. Under current law, this elevated exemption is scheduled to sunset on December 31, 2025, after which it reverts to the pre-TCJA baseline of approximately $5 million, indexed for inflation. The inflation-adjusted figure would be approximately $7 million per individual in 2026 under current projections if Congress does not act to extend the elevated exemption.

Congress may extend the elevated exemption before the sunset date, but as of the time this content was written, no extension had been enacted. Families with estates in the range of $7 million to $13.61 million face a planning window: using the elevated exemption before it potentially reverts could lock in wealth transfer at no transfer tax cost, while waiting and having the exemption drop back could mean transfers that would have been exempt are now taxable.

The IRS has provided guidance confirming that taxpayers who use the elevated exemption during the window will not face clawback if the exemption later drops. This means gifts made now, using the elevated exemption, are locked in even if the exemption reverts. This clawback protection makes the planning window actionable rather than merely theoretical for families with assets in that range.

Families at or below the post-sunset exemption level ($7 million per individual) have less urgency from a GST planning standpoint, though they may still have reasons to consider trust structures for non-tax goals.

Dynasty Trusts

A dynasty trust is an extension of the GST trust concept designed to last for multiple generations rather than ending at the grandchildren's generation. In states with no rule against perpetuities (or an extended perpetuities period), a dynasty trust can theoretically last indefinitely, allowing assets to compound across multiple generations with a single allocation of GST exemption at inception.

The appeal is that a single exemption allocation early in time can shield compounding growth from both estate tax and GST tax across many generations. A well-funded dynasty trust can provide distributions to great-grandchildren and beyond, all from a trust structure that was established by and funded with the original grantor's GST exemption.

States that permit perpetual or near-perpetual trusts include Nevada, South Dakota, Delaware, Alaska, and several others. Each has different rules regarding trust taxation, creditor protection, and trustee requirements. Establishing a dynasty trust in a favorable state does not require the grantor to live there, but does require the trust itself to be administered under that state's law, typically by a corporate trustee with a presence in that state.

Dynasty trusts are complex instruments requiring specialized legal drafting, ongoing trustee governance, and careful beneficiary relationship management. They are not appropriate for most families and are primarily used by those with substantial multigenerational wealth transfer goals.

Frequently Asked Questions

What is the generation-skipping transfer tax?

The generation-skipping transfer (GST) tax is a federal tax on transfers of wealth to individuals who are two or more generations younger than the donor, such as grandchildren, or to non-relatives who are more than 37.5 years younger than the donor. It was designed to prevent wealthy families from avoiding estate tax by passing assets directly to grandchildren, bypassing the middle generation entirely. The GST tax rate is a flat 40%, applied in addition to any applicable gift or estate tax. However, each donor has a GST exemption equal to the estate and gift tax exemption, which was $13.61 million in 2026 for individual filers. Amounts transferred up to the exemption face no GST tax.

Do most families need a generation-skipping trust?

No. Generation-skipping trusts are primarily relevant for families whose combined estate exceeds or is approaching the federal estate tax exemption threshold ($13.61 million per individual in 2026). Families below that threshold have little to gain from a GST trust specifically, though they may benefit from other trust structures for non-tax reasons such as asset protection, spendthrift provisions, or multi-generational governance. Families with substantial wealth should also be aware that the elevated exemption is scheduled to sunset at the end of 2025 under current law, reverting to approximately $7 million (inflation-adjusted) unless Congress acts to extend it. Planning around the sunset is a time-sensitive concern for families in the $7 million to $13.61 million range.

Is this personalized financial advice?

No. This content is educational and cannot account for a reader's complete estate plan, tax situation, or goals. Work with qualified financial, tax, or legal professionals for individualized guidance.