Generation skipping transfer tax (GSTT)

Generation-skipping transfer tax (GSTT) is a federal, and sometimes state-imposed tax on transfers made to any related persons two or more generations younger than the transferor, or for unrelated persons, <37.5 years younger than the transferor. Such persons are referred to as “skip persons”. The tax excludes transfers made to US citizen spouses. The tax applies to the transfer of both present and future interests and serves to to prevent wealth being sheltered from federal taxation for multiple generations.

Taxpayers each have an GSTT credit of 12,060,000 USD. This is separate from the unified credit of 12,060,000 USD. The amount of gifts/bequeathals to skip persons made in excess of the GSTT credit will be subject to generation-skipping tax, which as of now is a flat rate of 40%. Most commonly the tax is paid by the transferor, but there are situations in which the tax is paid by the recipient.

The existence of GSTT ensures that estate taxes are paid by proxy in the event of a grandparent transferring property to a grandchild (gen 3)- the tax result is the same as if the assets had first passed to the parent of the grandchild (gen 2), and then to the grandchild (gen 3) by way of an inheritance from the parent of the grandchild (gen 2).

Mrs. Client establishes a trust for the benefit of her daughter and her granddaughter. Mrs. Client has no other children. Mrs. Client’s daughter is a single mother to a 9 year old girl and Mrs. Client wishes to guarantee that her granddaughter’s share of her wealth cannot be jeopardized by any bad decisions made by her daughter, who has an unfortunate track record of mismanaging money.

Mrs. Client has made minimal gifts throughout her lifetime. She puts 10,000,000 USD into the trust. Mrs. Client’s daughter and granddaughter each have a 50% beneficiary interest in the trust. As the 10,000,000 USD falls below Mrs. Client’s remaining unified credit, and the transfer to her granddaughter (a skip person) is less than her previously untouched GSTT credit, Mrs. Client is able to establish the trust without subjecting any funds to gift, estate or generation skipping taxes.