Generation skipping tax (GST) is a federal tax aimed at preventing someone from skipping over their children in their Estate Plan. The picture is of an affluent grantor arranging to leave assets to younger generations to avoid estate tax. It is triggered if there is an inheritance left to a beneficiary who is 37 ½ or more years younger than the grantor who is leaving the assets.
The tax was implemented in the mid-1970’s and was introduced to close the loophole that once allowed inheritances to skip a generation solely for the purpose of avoiding certain taxes. GST ensures that assets placed in a trust are taxed. The beneficiary receives any amount over the tax credit. Leaving money to your children is not considered “generation skipping.” Likewise, if a child has passed away and leaves money to their child, that also does not result in “generation skipping.”
GST is different from the traditional estate tax – it’s in addition to it. GST can be a direct or an indirect skip. A direct skip is subject to gift or estate taxes. An example is a grandfather leaving property to a granddaughter. The transferor pays the taxes for this type of skip. An indirect skip has intermediate steps. In one type of indirect skip, called a taxable termination, there’s a skip person and a non-skip person. The primary beneficiary acts as the non-skip person and the skip person will receive the assets upon the death of the primary beneficiary. Taxes on an indirect skip are due when the estate passes to the skip person.
GST taxes are currently 40 percent. The GST tax exemption for individuals is $12.9 million, double for married couples, in 2023. Only the value in excess of this exemption is subject to the 40 percent tax. Most people don’t have to worry about the GST because of the high threshold that is adjusted every year for inflation. Remember, the tax only applies to inheritance in excess of the exemption.