The generation-skipping transfer (GST) tax goes hand-in-hand with gift and inheritance taxes. It's aimed at gifts made to a younger generation or transfers into a trust for their benefit.
The tax applies to recipients who are more than 37.5 years younger than the donor unless the recipient is related. In the case of relatives, it applies if a generation exists between the donor and the recipient, such as between a grandparent and a grandchild.
Congress enacted this tax in 1976 in an effort to prevent wealthier taxpayers from dodging an estate tax by giving their assets away to future generations during their lifetimes.
How the Exemption Works
The Internal Revenue Code (IRC) allows a GST tax exemption just as it does with gift and estate taxes. All of these taxes share the same exemption: $11.7 million for the 2021 tax year and $12 million beginning in 2022.
Only the portion of gifts and transfers that exceed the amount of the federal exemption is taxable. You—or your estate—would be taxed on $20,000 if the total value of your estate, gifts, and transfers amounted to $11.72 million at the time of your death. But this assumes that you did not pay the GST and gift taxes on lifetime transfers at the time you made them. You have that option if you want to preserve the exemption for your estate.
The chart below shows the estate tax rate from 2000 to 2022.
Each time you dip into the exemption amount to avoid taxation during your lifetime, it subtracts from the total exemption, leaving less to protect your estate at the time of your death.
The amount of the exemption has been adjusted annually for inflation since 2012, and that's expected to continue. But this might not prevent the exemption from being slashed to roughly half what it is now in 2025 or sooner. The GST tax rate has remained at 40% since 2013.
The chart below shows the growth of the lifetime gift tax exemption from 2000 to 2022.
The Tax Cuts and Jobs Act
When the Tax Cuts and Jobs Act (TCJA) went into effect in January 2018, it effectively doubled the amount of the estate/gift/GST exemption. The exemption increased from to $10 million before accounting for inflation adjustments. That $10 million figure worked out to $11.18 million with an inflation adjustment.
But the TCJA "sunsets" or expires at the end of 2025—it's not a permanent law. The exemption amount will drop back to $5 million, plus an inflation adjustment on Jan. 1, 2025, unless Congress acts to renew the TCJA or even just that one provision of the tax law.
The Annual Exclusion
Not every dime you transfer during your lifetime will be taxed, because the IRC also affords taxpayers an annual exclusion from taxation. That exclusion is set at $15,000 per person per year as of 2021. If you should give your grandchild $20,000, only $5,000 of it would subtract from your lifetime exemption, or you could pay the GST tax on it in the year of the transfer.
You could also give your grandchild $10,000 on December 31 and $10,000 on Jan. 1, because those dates occur in different years. Both gifts would fall below the $15,000 annual exclusion.
The History of the GST Tax Rate
The exemption for federal generation-skipping transfer taxes has steadily increased over the years. The chart below shows the changes from 2000 through 2021.
Tax years 2010 through 2012 were based on the Tax Relief, Unemployment Insurance Reauthorization and Job Creation act signed into law by President Barack Obama on Dec. 17, 2010. "TRA 2010" or the "2010 Act," as it came to be called, was only intended to cover a two-year period. It would expire on Dec. 31, 2012.
Under TRA 2010, the federal GST tax exemption and rate would default to the numbers that were in effect in 2001 and 2002 on Jan. 1, 2013. Then-President Obama signed the American Taxpayer Relief Act—"ATRA" for short—into law on Jan. 2, 2013.
ATRA permanently extended the laws governing estate taxes, gift taxes, and generation-skipping transfer taxes that had been put in place under TRA 2010, with one significant exception: The top estate tax, gift tax, and GST tax rate under TRA 2010 was 35%, but ATRA increased it to 40%.
TRA 2010 also unified the estate tax, the gift tax, and the generation-skipping transfer tax exemptions, and it indexed these exemptions for inflation beginning in 2012, so the amount of the exemption increases annually.
|Historical and Future Generation-Skipping Transfer Tax Exemptions and Rates|
|Year||GST Exemption||GST Tax Rate|
A Special Provision in 2010
TRA 2010 made a special provision for the generation-skipping transfer tax for the 2010 tax year. Although the tax wasn't abolished, and the exemption amount increased to $5 million that year from $3.5 million in 2009, the tax rate was temporarily set to zero. But TRA 2010 was signed into law on Dec. 17, so that loophole actually only gave donors a couple of short weeks to take advantage of tax-free giving if they hadn't already done so in 2010.
Internal Revenue Service. "Instructions for Form 709," Page 9.
Internal Revenue Service. "What's New in Estate and Gift Tax."
Internal Revenue Service. "Form 706," Page 25.