Taxes are a fact of life, but some tax schemes are better known than others. For example, everyone who earns a paycheck knows about the federal income tax deductions from their pay each pay period. Lesser known taxes include capital gains, gift, and generation-skipping transfer taxes.
The generation-skipping transfer tax (GST) is a federal tax levied when the property is transferred by gift or inheritance to a person at least two generations (at least 37 ½ years younger) removed from the individual. The most common example is when grandparents gift money and bequeath property to their grandchildren or descendants of their grandchildren.
Congress first introduced the GST tax in the mid-1970s to close a loophole that allowed wealthy individuals to legally gift money and property to their grandchildren without paying estate taxes. By skipping the grandchildren’s parents, they could avoid estate taxes at the first generation.
The GST tax follows the gift and estate lifetime exemption limits. However, it is a separate tax that applies alongside and in addition to any gift or estate taxes.
When does the GST tax apply?
The person giving the gift is referred to as the transferor, and the person receiving the gift is the skip person. In many cases, the skip person is a grandchild. Gifts made by an individual to an unrelated person other than an individual’s spouse can also trigger the GST tax. The GST generally applies when the gift amount transferred to the skip person is greater than the transferor’s lifetime GST tax exemption, which is $12.06 million in 2022. All lifetime gifts and transfers made at death by will or trust are counted against the exemption amount.
If a grandparent gifts each of five grandchildren $100,000 in 2022, then $500,000 is counted against their $12.06 million lifetime exemption. If total transfers during life and death exceed the exemption amount, a flat 40% tax is levied.
Exemptions to the GST tax:
- Transfer of property to a grandchild when the grandchild’s parent has already passed away (there is no skip if the grandchild’s parent has died, so the grandchild steps into the shoes of their predeceased parent)
- Tuition or medical care payments made directly to an institution (payments directly to a college to pay tuition would not trigger a GST tax)
GST tax points to consider
Most people will not be affected by the GST tax because the cumulative value of the gift or property will be less than the $12.06 million cap. However, the GST tax exemption will revert to $5 million (adjusted for inflation) in 2026. This tax is also frequently revisited, so changes may occur before 2026.
Unlike the estate tax, the GST tax is lost upon the death of a spouse. Married couples essentially have double the GST tax, but their remaining exemption amount does not pass to the other partner when a partner passes.
Estate planning and GST taxes can become very complicated. If you are concerned that you may trigger the GST tax and incur a penalty, consult with an experienced attorney to learn more about your gifting options. Doing so will ensure that you maximize your GST tax exemption. In addition, GST tax rules change regularly. Your estate attorney can provide you with the latest updates.