A client from Manhattan came to my office with a simple goal. He had built a successful business over 40 years and wanted to give a significant portion of it directly to his grandchildren, who were just starting their own careers. His son, the middle generation, was already financially secure and supported the idea. “I want them to have it now,” he said, “not after it’s been taxed twice.”
He was right to be concerned. His plan brought a very specific federal tax into play—the Generation-Skipping Transfer (GST) Tax. This is not a state tax or a sales tax. It is a federal tax designed to prevent wealthy families from avoiding an entire generation of estate taxes by “skipping” their children and leaving assets directly to grandchildren or younger beneficiaries.
The GST tax is a flat 40% on transfers that exceed a lifetime exemption. The question I hear most often is not about the rate, but the timing: when, exactly, is this tax paid?
What Triggers the GST Tax?
The GST tax applies to transfers made to a “skip person.” A skip person is typically a grandchild or a more distant descendant. It can also be an unrelated individual who is at least 37.5 years younger than the donor. The type of transfer dictates who pays the tax and when.
We see three main types of generation-skipping transfers:
- Direct Skips: This is the most straightforward scenario, like my client’s. It is an outright gift during the donor’s lifetime or a bequest at death made directly to a skip person. Writing a check for $1 million to your grandson is a direct skip.
- Taxable Distributions: This occurs when a distribution of income or principal is made from a trust to a skip person. If a trustee makes a payment from a trust directly to a grandchild, that is a taxable distribution.
- Taxable Terminations: This happens when a non-skip person’s interest in a trust ends, causing the assets to pass to a skip person. If your child, the trust beneficiary, passes away, their interest terminates. The assets now held for your grandchildren trigger a taxable termination.
Each event has its own rules for reporting and payment.
Timing the Payment: Lifetime Gifts vs. Trust Distributions
When the GST tax is due depends on the nature of the transfer. Responsibility for payment also shifts depending on the circumstances.
For Direct Skips
When a donor makes a direct skip during their lifetime—a gift of stock or real estate to a grandchild—the GST tax is due at the same time as the federal gift tax. The donor files IRS Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return, by April 15 of the year following the gift. The donor pays the tax on a lifetime direct skip, based on the value of the gift.
If the direct skip occurs at death through a will or revocable trust, the estate pays the GST tax. The executor files IRS Form 706, the United States Estate (and Generation-Skipping Transfer) Tax Return, typically within nine months of the date of death. The estate pays the tax from its assets before distribution.
For Trusts: Distributions and Terminations
The timing for trusts is more complex. In New York, trusts are governed by our Estates, Powers and Trusts Law (EPTL) Article 7. A trustee has a fiduciary duty to manage administration and tax reporting properly.
In a taxable distribution, when the trustee distributes funds to a grandchild, the responsibility for payment shifts. The recipient—the grandchild—is liable for the GST tax. They must file Form 706-GS(D) and pay the tax by April 15 of the year after receiving the distribution.
For a taxable termination, when the interest of the non-skip beneficiary ends, the burden shifts back to the trust. The trustee files Form 706-GS(T) and pays the tax from the trust’s assets. The due date is generally tied to the trust’s tax year.
The Critical Role of the GST Exemption
The GST tax does not apply to every transfer. Each individual has a lifetime GST exemption, unified with the federal estate and gift tax exemption. For 2024, that amount is $13.61 million per person. This exemption is the most powerful tool we have for planning.
The exemption is not automatic. A donor or their executor must affirmatively allocate the exemption to transfers on their gift or estate tax returns. A prudent plan involves deliberately allocating this exemption to specific gifts or to contributions made to a long-term, multi-generational trust—often called a dynasty trust.
Allocating the exemption to a trust when it is funded shelters all future growth and appreciation inside that trust from the GST tax. This allows assets to pass from generation to generation without being diminished by this 40% tax at each step. It is the cornerstone of intentional, long-term legacy stewardship.
Understanding when the GST tax is paid is more than an accounting exercise. It is a crucial part of designing a generational wealth plan that functions as intended. The timing and liability rules determine how much is left for your heirs and who is responsible for the tax bill—you, your estate, your trust, or your grandchildren.
If your estate plan involves significant transfers to grandchildren or future generations, the first step is to confirm how—or if—your GST exemption has been allocated. I invite you to schedule a review of your existing wills and trusts with our firm, where we can analyze your documents for potential GST tax exposure and ensure your legacy is structured for the generations to come.
