Generation-Skipping Trust Rules: Tax, $15M Exemption, Allocation

The federal generation-skipping transfer tax is a flat 40% tax on property that moves to a grandchild, more distant descendant, or any unrelated person more than 37½ years younger than the transferor.¹² It sits on top of any gift or estate tax already owed, and Congress created it to stop wealthy families from skipping a generation of transfer tax by handing assets directly to grandchildren.³ In 2026, every individual gets a $15 million lifetime exemption that can shelter transfers from this tax, a figure the One, Big, Beautiful Bill signed on July 4, 2025 made permanent.⁴ Used correctly, that exemption can reduce the effective rate on a trust to zero. Used carelessly, you lose it.

What Transfers Trigger the Tax

Three events can set off the GST tax:⁵

A direct skip: a gift or bequest that goes straight to a skip person and is also subject to gift or estate tax. A grandparent writing a $500,000 check to a grandchild is the classic example.
A taxable termination: an interest in a trust ends and only skip persons are left holding interests. If a trust pays income to your child for life and then passes to your grandchild, your child’s death triggers it.
A taxable distribution: any distribution of income or principal from a trust to a skip person that doesn’t fit the first two categories.

Which event you’re dealing with matters because it determines who writes the check and how the tax is measured.

Who Counts as a Skip Person

For family members, generations follow the family tree. Your children are one generation below you, grandchildren are two, great-grandchildren are three. Anyone two or more generations below you is a skip person.⁶

For someone outside your family, the IRS uses age instead. A person born more than 37½ years after you counts as two generations down and qualifies as a skip person.²

A trust itself can be a skip person. If every beneficiary with a present interest is at least two generations below the transferor, the trust is a skip person before any distribution ever happens.⁶

The Predeceased Parent Exception

If your child dies before you and you then transfer assets to your grandchild, the grandchild is bumped up a generation and is no longer a skip person. The transfer isn’t a generation-skipping transfer at all.² The parent must be dead at the moment the transfer becomes subject to gift or estate tax. For transfers at the transferor’s death, anyone who dies within 90 days of the transferor is treated as having predeceased them.⁷

For recipients who are not lineal descendants of the transferor or the transferor’s spouse, the rule applies only if the transferor has no living lineal descendants at the time of the transfer.²

How the Tax Is Calculated

The rate is 40% multiplied by the trust’s or transfer’s “inclusion ratio.”¹ The inclusion ratio is one minus the “applicable fraction,” which is the amount of GST exemption you allocated to a transfer divided by the value of the property transferred (after subtracting any recovered estate taxes and charitable deductions).⁸

The math drives one goal: get the inclusion ratio to exactly zero or exactly one. Allocate $5 million of exemption to a $5 million trust and the inclusion ratio is zero. The effective GST tax rate is zero for the entire life of the trust, no matter how much it grows. Allocate nothing and the inclusion ratio is one, so every future generation-skipping event is taxed at the full 40%. A trust that lands somewhere in between is a mess to administer, because every future distribution requires splitting the calculation.

Who Actually Pays

Liability depends on the triggering event:⁹

Direct skip not from a trust: the transferor pays. A direct skip from a trust is paid by the trustee.
Taxable termination: the trustee pays from trust assets.
Taxable distribution: the recipient pays.

The transfer type also changes the tax base. Direct skips are “tax-exclusive”: the tax is calculated on what the recipient gets, not on the combined gift plus tax. A $1 million direct skip to a grandchild produces $400,000 of GST tax on a base of $1 million. Taxable distributions are “tax-inclusive,” meaning the tax base includes the tax itself, which pushes the effective burden higher. The difference is real money.

The $15 Million Lifetime Exemption

Each person gets a $15 million GST exemption in 2026, matching the federal estate tax basic exclusion.¹⁰⁴ You can split it across lifetime gifts and transfers at death any way you choose. Once allocated to a particular trust or transfer, the allocation is irrevocable. The exemption will continue to adjust for inflation in future years.

No Portability Between Spouses

Unlike the estate tax exemption, the GST exemption is not portable. A surviving spouse cannot inherit a deceased spouse’s unused GST exemption.¹¹ A married couple with $30 million of combined wealth sitting entirely in one spouse’s name risks losing half the available GST exemption at the first death. Splitting assets so each spouse can fund a generation-skipping trust with their own $15 million is standard planning for couples.

Annual Exclusion Gifts

Small direct gifts can sidestep GST tax without touching your lifetime exemption. A direct skip that qualifies as a nontaxable gift under the annual gift tax exclusion has an inclusion ratio of zero by statute.⁸ The annual exclusion for 2026 is $19,000 per recipient.⁴ A grandparent writing $19,000 checks directly to each grandchild each year uses no exemption and owes no GST tax.

Gifts to trusts don’t get the same easy treatment. A transfer to a trust gets the automatic zero inclusion ratio only if, during the beneficiary’s life, only that beneficiary can receive distributions, and if the trust still exists when the beneficiary dies, the assets are included in the beneficiary’s taxable estate.⁸ Trusts with multiple beneficiaries or that bypass the beneficiary’s estate need a formal exemption allocation instead.

Allocating the Exemption

Allocation is the act of assigning part of your $15 million to a specific transfer or trust. There are three pathways: automatic, deemed, and elective. Getting this right at the time of the transfer is far cheaper than fixing it later.

Automatic Allocation to Direct Skips

Whenever you make a direct skip, the Code automatically allocates just enough of your unused exemption to drive the inclusion ratio to zero, unless you affirmatively elect out.¹² Electing out requires a timely Form 709 for the year of the transfer. You might do it if you’d rather save the exemption for a trust with greater growth potential.

Deemed Allocation to GST Trusts

For transfers to trusts that are not direct skips, a second safety net applies. Unused exemption is automatically allocated to transfers into any “GST trust,” defined broadly as any trust that could eventually produce a taxable termination or taxable distribution.¹² You can elect out on a timely Form 709 if you’d rather preserve the exemption for other uses.

Elective Allocation and Why Timing Matters

When neither automatic rule applies, or when you’ve elected out, you allocate exemption affirmatively on Form 709 for lifetime transfers or Form 706 for transfers at death.

Timely allocation locks in the property’s value as of the date of the gift.⁸ Transfer $2 million of stock in January, allocate $2 million of exemption on a Form 709 filed by its due date (including extensions), and the trust has an inclusion ratio of zero even if the stock is worth $3 million by the time you file. A late allocation, by contrast, values the property at its fair market value on the date you file. For appreciating assets, that difference can waste millions of dollars of exemption.

The Estate Tax Inclusion Period

If you transfer property to a trust but retain an interest that would pull the property back into your estate if you died immediately, allocating exemption doesn’t take effect until that interest ends.¹³ This waiting period is the Estate Tax Inclusion Period, or ETIP. It runs until the property is no longer includable in your gross estate, or until you die or a generation-skipping transfer occurs, whichever is first.¹⁴

The catch is that the property is valued at the end of the ETIP, not the date you originally funded the trust. Fund a trust with $2 million of stock, watch it grow to $8 million before the ETIP ends, and you need $8 million of exemption to fully shelter it. ETIPs can undo the whole point of gifting appreciating assets early.

The Reverse QTIP Election

Qualified Terminable Interest Property (QTIP) trusts qualify for the marital deduction, but for GST purposes the assets are treated as if they came from the surviving spouse, not the first to die. That blocks the first spouse’s GST exemption from reaching the trust.

The reverse QTIP election, filed on the first spouse’s Form 706, treats the trust property as if the QTIP election had never been made, but only for GST purposes.¹⁵ The first spouse’s executor can then allocate the first spouse’s exemption to the trust. Because the GST exemption is not portable, this election is often the only way for a couple to fully use both $15 million allowances.

Fixing a Missed or Suboptimal Allocation

Mistakes happen, and they get more expensive as trust assets appreciate. The Code offers limited escape routes.

A late allocation can be made on any later gift tax return, but the property gets valued at its current fair market value instead of its original transfer value. For a trust that has grown, that burns through far more exemption than a timely filing would have.

There is a narrow automatic six-month extension if you missed the filing deadline.⁸ Beyond that window, as of May 2024 requests for retroactive relief on late GST allocations must go through the private letter ruling program under Section 2642(g).¹⁶ The process requires detailed affidavits from the transferor or executor and from every tax professional involved in the original transaction, carries user fees in the thousands of dollars, and has no guarantee of approval.

A separate “substantial compliance” rule can rescue a defective allocation if it clearly demonstrates intent to achieve the lowest possible inclusion ratio. The IRS may treat it as effective for the amount needed to produce that result.⁸ It’s a safety net for paperwork failures, not a substitute for filing on time.

For a trust that ends up with an inclusion ratio between zero and one, a qualified severance can split it into two trusts: one fully exempt and one fully taxable. The split must be fractional, with the new trusts preserving the same succession of beneficiary interests. The exempt trust gets a fractional share equal to the applicable fraction of the original and an inclusion ratio of zero; the other trust gets an inclusion ratio of one.⁸ Severance doesn’t create exemption or undo past mistakes. It just untangles a mixed trust into two cleaner ones.

Reporting and Penalties

The forms are where planning meets reality, and a missed form can permanently change a trust’s tax treatment.

Form 709, the United States Gift and Generation-Skipping Transfer Tax Return, reports every direct skip and every transfer to a GST trust, even when no gift tax is owed. It’s also where you make or elect out of exemption allocations. The standard deadline is April 15 of the year after the transfer, with extensions available. Filing on time is what makes an allocation “timely” and locks in the date-of-gift valuation.

Form 706, the federal estate tax return, is due nine months after the decedent’s death. It reports direct skips occurring at death, allocates the decedent’s remaining GST exemption to trusts created at death, and is the only place to make the reverse QTIP election.

Transfers involving foreign trusts add Form 3520, filed on top of any Form 709 or Form 706.¹⁷ Form 3520 penalties are severe and run separately from any GST liability.

Late filing triggers a penalty of 5% of the unpaid tax for each month the return is late, capped at 25%. Late payment adds 0.5% per month, also capped at 25%.¹⁸ On a large GST bill, those percentages translate quickly into substantial dollars. Both can be waived for reasonable cause absent willful neglect, but the IRS applies that standard skeptically when sophisticated trust transactions and professional advisors are involved.

1
Office of the Law Revision Counsel. 26 USC 2641 – Applicable Rate
2
Office of the Law Revision Counsel. 26 USC 2651 – Generation Assignment
3
Office of the Law Revision Counsel. 26 USC Ch 13 – Tax on Generation-Skipping Transfers
4
Internal Revenue Service. What’s New — Estate and Gift Tax
5
Office of the Law Revision Counsel. 26 USC 2612 – Taxable Termination; Taxable Distribution; Direct Skip
6
Office of the Law Revision Counsel. 26 USC 2613 – Skip Person and Non-Skip Person Defined
7
Federal Register. Predeceased Parent Rule
8
Office of the Law Revision Counsel. 26 USC 2642 – Inclusion Ratio
9
Office of the Law Revision Counsel. 26 USC 2603 – Liability for Tax
10
Office of the Law Revision Counsel. 26 USC 2631 – GST Exemption
11
The American College of Trust and Estate Counsel. What Is Portability for Estate and Gift Tax?
12
Office of the Law Revision Counsel. 26 USC 2632 – Special Rules for Allocation of GST Exemption
13
eCFR. 26 CFR 26.2663-2
14
Legal Information Institute (LII). 26 USC 2642(f)(3)
15
Office of the Law Revision Counsel. 26 USC 2652 – Other Definitions
16
Federal Register. Relief Provisions Respecting Timely Allocation of GST Exemption and Certain GST Elections
17
Internal Revenue Service. About Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts
18
Office of the Law Revision Counsel. 26 USC 6651 – Failure to File Tax Return or to Pay Tax