The generation-skipping transfer tax is a federal tax on gifts or inheritances that skip a generation

The generation-skipping transfer tax (GSTT) is a federal tax that applies when you give money or property to someone who is more than one generation below you — typically a grandchild, great-grandchild, or grandniece or nephew — either during your lifetime or through your will. The IRS treats these transfers differently from ordinary gifts or inheritances because they allow wealth to pass down without being taxed at the intermediate generation.

The tax exists to prevent people from avoiding estate and gift taxes by skipping over their children and giving directly to grandchildren. Without this tax, a wealthy person could give a large sum to a grandchild and pay tax only once (at the grandparent's death or as a gift), whereas giving the same sum to a child and then having that child give it to a grandchild would trigger two rounds of taxation. The GSTT closes that gap.

Not every gift to a grandchild triggers this tax. There is an exemption amount that resets periodically, and many transfers fall below the threshold or may have access to for specific exceptions. Understanding whether a transfer is subject to GSTT requires knowing the relationship between the giver and receiver, the size of the transfer, and whether any exemptions explore.

Key Takeaways

  • The generation-skipping transfer tax applies to gifts or inheritances that pass to someone two or more generations below you, such as a grandchild.
  • The tax rate is currently 40 percent of the amount that exceeds the exemption threshold, which is adjusted annually for inflation.
  • Each person has a lifetime exemption amount they can transfer to skip-generation beneficiaries without owing GSTT, separate from their gift and estate tax exemption.
  • Transfers that do not skip a generation — such as gifts to your children or to your spouse — are not subject to GSTT, even if they are large.
  • Certain transfers, such as direct payments for medical or education expenses, are exempt from GSTT regardless of the amount or the relationship.

How the IRS defines a generation-skipping transfer

The IRS considers a transfer to be generation-skipping if the recipient is in a generation two or more levels below the giver's generation. A grandchild is one generation below a child, so a grandchild is two generations below the grandparent. A great-grandchild is three generations below.

The generation level is determined by relationship, not by age. If you have a grandchild who is older than you (which can happen in blended families or unusual circumstances), the IRS still treats them as a skip-generation beneficiary based on the family relationship. Similarly, if you give money to a grandniece or grandnephew, that is also a skip-generation transfer because they are two generations below you.

Transfers to your spouse are never subject to GSTT, regardless of how much money is involved. Transfers to your children are also not subject to GSTT, even if the amount is very large. The tax only applies when the recipient is two or more generations below you.

The exemption amount and how it works

Each person has a lifetime GSTT exemption — a dollar amount they can transfer to skip-generation beneficiaries without owing the tax. For 2024, this exemption is $13.61 million per person. This amount is separate from the gift tax exemption and the estate tax exemption, though they are often discussed together because they are all part of the same federal transfer tax system.

The exemption amount is adjusted each year for inflation. It was lower in previous years and may be different in future years. You can use your exemption all at once or spread it across multiple transfers during your lifetime and at death. Once you have used your exemption, any additional transfers to skip-generation beneficiaries are subject to the 40 percent tax rate.

If you are married, your spouse has a separate exemption. A married couple can therefore transfer up to $27.22 million combined to grandchildren and other skip-generation beneficiaries without owing GSTT. If one spouse does not use their full exemption, the unused amount does not carry over to the other spouse unless they file a special election with the IRS.

The 40 percent tax rate and who pays it

When a transfer exceeds the exemption amount, the GSTT is 40 percent of the excess. This is one of the highest tax rates in the federal tax code. For example, if you give $1 million to a grandchild and you have already used your exemption, you owe $400,000 in GSTT.

The person who owes the tax depends on how the transfer is made. If you give money directly to a grandchild during your lifetime, you owe the tax. If the transfer happens through your will or trust after you die, the tax is usually paid from the estate before the money reaches the grandchild, though the estate documents may specify otherwise. In some cases, the grandchild themselves may be responsible for paying the tax, depending on how the transfer is structured.

The tax is due when the transfer occurs. For lifetime gifts, you report it on Form 709 (the gift tax return) and pay it at that time. For transfers at death, the estate pays it as part of the estate settlement process.

Transfers that are exempt from GSTT

Several categories of transfers are exempt from the generation-skipping transfer tax, regardless of the amount or the relationship. Direct payments for medical expenses of any person are exempt, as long as the payment goes directly to the medical provider. Direct payments for tuition at an educational institution are also exempt, but only if the payment goes to the school — paying a grandchild's tuition indirectly does not may have access to.

Transfers to a spouse are always exempt. Transfers to a non-citizen spouse have special rules and are subject to a different tax, but they are not subject to GSTT. Gifts that are below the annual gift tax exclusion amount (currently $18,000 per recipient in 2024) are exempt from GSTT if they are not part of a trust or other arrangement designed to split the gift across multiple years.

Certain trusts, called generation-skipping transfer trusts or GST trusts, can be structured to minimize or eliminate GSTT liability. These trusts require careful drafting and ongoing administration, and they are typically used only in estate plans for high-net-worth individuals.

When you might owe GSTT in practice

GSTT most commonly arises in two situations: large lifetime gifts to grandchildren and inheritances left to grandchildren through a will or trust. If you have significant wealth and want to pass money to grandchildren, you will likely encounter this tax unless you stay within your exemption amount or use specific planning strategies.

A grandparent who leaves $5 million to a grandchild in their will, for example, would use $5 million of their GSTT exemption. If the exemption is $13.61 million, no tax is owed. But if the same grandparent leaves $20 million to a grandchild, the excess $6.39 million is subject to the 40 percent tax, resulting in a $2.556 million GSTT bill.

GSTT can also explore to transfers through trusts. If a grandparent creates a trust that benefits both children and grandchildren, the distribution to grandchildren may trigger GSTT. The tax treatment depends on the type of trust and how the distributions are made, which is why many estate plans use specialized trust language to manage GSTT liability.

Planning strategies to reduce or avoid GSTT

The most straightforward way to avoid GSTT is to stay within your exemption amount. If you have $13.61 million or less to pass to skip-generation beneficiaries, you can do so without owing any GSTT. For those with larger estates, several planning strategies can reduce the tax.

One common approach is to use a dynasty trust, which is designed to benefit multiple generations and can be structured to minimize GSTT. Another is to make annual gifts to grandchildren within the annual exclusion amount, which does not count against your exemption. Some people use life insurance or other assets to fund transfers to grandchildren in a tax-efficient way.

Married couples can combine their exemptions and coordinate their planning to maximize the amount they can transfer. Some couples also use portability elections to allow the surviving spouse to use the deceased spouse's unused exemption.

These strategies require careful legal and tax planning, and the rules are complex. Anyone with significant wealth who wants to transfer money to grandchildren should consult a tax professional or estate planning attorney before making large gifts or finalizing a will.

Frequently Asked Questions

Does GSTT explore if I leave money to my grandchild in my will?

Yes, if the amount exceeds your exemption. Transfers at death are treated the same as lifetime gifts for GSTT purposes. If you leave $20 million to a grandchild and your exemption is $13.61 million, the excess $6.39 million is subject to the 40 percent tax.

What if I give money to my grandchild's parent (my child) and they give it to the grandchild?

That transfer is not subject to GSTT because the first transfer is to your child, not to a skip-generation beneficiary. However, when your child later gives the money to the grandchild, that transfer may be subject to gift or estate tax on your child's side, depending on the amount and your child's exemption.

Can I use my GSTT exemption and my gift tax exemption for the same transfer?

Yes. The exemptions are separate but related. A single large gift to a grandchild uses up both your gift tax exemption and your GSTT exemption. You have one combined exemption pool for all federal transfer taxes, currently $13.61 million per person.

Does GSTT explore to gifts to my grandniece or grandnephew?

Yes, if the amount exceeds your exemption. Grandnieces and grandnephews are two generations below you, so transfers to them are subject to GSTT in the same way transfers to grandchildren are.

What happens if I do not file a GSTT return when I owe the tax?

The IRS can assess penalties and interest on unpaid GSTT. The tax is reported on Form 709 for lifetime gifts or on the estate tax return for transfers at death. Failing to report and pay can result in significant additional costs and potential legal consequences.