You're probably aware of gift and estate taxes that the IRS assesses on the transfer of assets to beneficiaries made either during one's lifetime or at death. But you may not be familiar with an additional tax that could apply to transfers made to beneficiaries more than 1 generation below you (e.g., from a grandparent to a grandchild), known as the generation-skipping transfer tax (GSTT).
What is the generation-skipping transfer tax?
The generation-skipping transfer tax is a federal tax on transfers of assets to individuals that are considered more than one generation below the transferor, or to a trust for these individuals' benefit ("skip persons"). This would include transfers from a grandparent to a grandchild or to other individuals who are more than 37½ years younger than the transferor. This tax is equal to the highest federal gift and estate tax rate at the time of the transfer (40% in 2026) and is in addition to any other federal gift or estate tax that may be owed.
The GSTT was implemented in 1986 to prevent wealthy families from avoiding estate taxes at the death of each generation through using ongoing trusts. Prior to this tax, it was possible to pass assets to a trust for the benefit of multiple generations, thus avoiding estate taxes estate tax after the first transfer to trust as each generation passed away.
What are annual gift tax exclusions?
In general, the IRS assesses a gift or estate tax1 on transfers of assets during one's lifetime or at death to anyone other than a US citizen spouse or a qualified charity, with some exceptions, for instance:
- The IRS allows individuals to give up to $19,000 per year to an unlimited number of individuals with no federal gift or estate tax consequences. A spouse can also give the same amount, doubling the amount a couple can gift to any one recipient. For example, a husband and wife with 2 children could give away a total of $76,000 a year to their children ($38,000 to each child) without any tax repercussions. This is referred to as the annual gift tax exclusion.
- Qualified payments made directly to a qualified educational institution to pay tuition or to a medical provider for medical expenses are disregarded for gift tax purposes. There is no limit on the dollar amount of these qualified payments.
- In 2026, up to $15 million (or $30 million for a married couple) can be transferred to beneficiaries during a lifetime or at death. This is known as the federal lifetime gift and estate tax applicable exclusion. If some or all of the lifetime gift tax exclusion is used to shield gifts from taxation during one's lifetime, then that part of the exclusion won't be available to shield assets from the estate tax at death.
Unless an exception applies, and leaving aside any additional applicable deductions, any transfers during one's lifetime or at death over the federal estate and lifetime gift tax exclusion amounts will be taxed at 40%.
The exclusions for transfers to skip persons are similar. There is an annual generation‑skipping transfer (GST) exclusion. Thus, if a grandparent wanted to make an $19,000 gift directly to a grandchild (e.g., by depositing funds to a bank account in that grandchild's name), no gift tax or GSTT would be due (as long as the gift is less than the annual exclusion limit for the year in which the gift is made).2 Every US resident also has a lifetime GST exemption of $15 million (or $30 million for a married couple). In other words, a married couple could transfer a lifetime total of $30 million to a skip person without having to pay GSTT. However, it is important to understand that transfers to a skip person may be subject to both the gift and estate tax and GSTT.3
Beyond those exclusions, transfers to the skip persons will also be taxed at 40%.
Finally, keep in mind that the GSTT only applies to federal taxes; each state may have additional taxes that may affect transfers made during lifetime and at death.
What triggers the generation-skipping transfer tax?
The generation-skipping transfer tax is imposed on 3 types of taxable events:
- Direct skips: When assets are transferred from one individual to a skip person, which can be either an individual or a trust. For direct skips, the transferor (or their estate) pays the tax (or utilizes the GST exemption) at the time the transfer takes place, based on the value of the assets received by the transferee.
- Taxable distributions: An irrevocable trust has been created and a distribution of income or principal is made by the trust to a skip person (but the distribution is not defined as a direct skip or a taxable termination). For example, a trust that was set up for Sally and her children by Sally's mother makes a distribution to Sally's children during Sally's lifetime. If Sally's mother did not apply her GST exemption to the assets she transferred to the trust, this would be a taxable distribution. The GSTT is paid by the recipient when the distribution occurs.
- Taxable terminations: An interest in property held in trust terminates (e.g., due to the death of a beneficiary or the expiration of the trust term), a non-skip person doesn't have an interest immediately thereafter, distributions can still be made to skip persons, and the trust assets are not subject to estate or gift tax. The trustee is responsible for paying the GSTT when the taxable termination occurs.
Allocating the generation-skipping transfer tax exemption
In order to avoid the generation-skipping transfer tax on the initial transfer, an individual must use (allocate) some or all of their GST exemption. The GST exemption may be used for both outright transfers as well as transfers in trust. The allocation of the GST exemption is generally reported on a gift or estate tax return (IRS Form 709 or IRS Form 706).4
It is important to note that when the GST exemption is allocated to a transfer in trust, any growth on the assets to which the allocation was made is subsequently sheltered from any GSTT in the future. For example, Paul established an irrevocable trust in 2024 for the benefit of his grandchildren and future generations, funded the trust with $10 million, and allocated $10 million of his GST to this transfer. If that trust subsequently grows to $20 million, the entire trust would remain GST exempt. Thus, Paul only used $10 million of GST exemption to shelter what turned out to be $20 million of assets.
Ways to reduce the generation-skipping transfer tax
Although outright gifts may be the simplest option (e.g., a $19,000 check payable to a grandchild individually), there may be reasons to explore other methods of making gifts. For instance, grandparents may be concerned that a grandchild might not use the money wisely or grandparents may want the money to be used for a specific purpose, such as to pay for college.
Contributions to 529 plans: A common strategy is to make gifts to 529-qualified tuition programs for the benefit of grandchildren (or other skip individuals). Gifts to 529 plans are considered completed gifts, even if the transferor has the right to change the beneficiary at their discretion, and 529 plan assets must be used for qualified education expenses. A grandparent contributing to a 529 plan for a grandchild's education can accelerate up to 5 years of annual gift exclusions in 1 year (in 2026, $95,000 for an individual, or $190,000 for a married couple).
Dynasty trusts: Another dynastic wealth transfer strategy is to create an irrevocable trust that incorporates both asset protection provisions and generation-skipping transfer tax strategies. These trusts are sometimes known as "dynasty trusts" and can be designed to last indefinitely. However, note that some states limit the number of years a trust may be in existence (known as the "rule against perpetuities").
Dynasty trusts are typically designed to provide for a wholly exempt trust by the allocation of the transferor's (or grantor's) GST exemption to all transfers made to the trust. Once a dynasty trust is exempt from GSTT, distributions and terminations will not be taxable events for GSTT purposes regardless of the level of asset growth in the trust.
A dynasty trust can also be combined with other wealth transfer strategies to provide further leverage to a wealth transfer plan. Consult your tax advisor regarding what may make sense in your situation.
Final thoughts
Dealing with the GSTT can be complex and confusing. With proper planning, the GST exemption provides opportunities to reduce or potentially eliminate the transfer taxes associated with gifting or passing money to grandchildren or other skip persons, ultimately allowing more to pass to younger generations. Your Fidelity team can help you navigate this complexity, and your attorney and tax advisor can discuss how GSTT strategies may relate to your personal wealth plan.