Estate planning becomes more complex when it involves leaving assets directly to grandchildren. The Generation-Skipping Transfer Tax (GSTT) was created to ensure that taxes are paid at each generational level. This tax can significantly impact how grandparents structure their estate plans, especially if they want to preserve wealth for future generations.

What Is the GSTT?

The GSTT is a federal tax applied to transfers made to “skip persons.” A skip person is typically a grandchild or any relative who is more than 37½ years younger than the person making the transfer. The tax applies to direct gifts, trust distributions, or transfers that bypass the immediate next generation. At a flat rate of 40%, the GSTT can create a major financial burden if not planned for effectively.

Impacts of the GSTT on Estate Planning

Below are various ways GSTT affects estate planning for grandchildren.

1. Reduces the Amount Passed to Grandchildren

The GSTT reduces the value of assets reaching grandchildren if they exceed the current exemption amount. For 2025, the exemption is $13.99 million per individual. Any transfer beyond this limit is taxed at 40%, significantly lowering the inheritance for future generations.

2. Requires Careful Trust Management

Trusts are a common way to transfer wealth, but they must be managed properly to avoid unnecessary taxes. For example:

  • Inclusion Ratios: A trust’s inclusion ratio determines how much of it is subject to the GSTT. A 1.000 ratio means the entire trust is taxable, while 0.000 means it is fully exempt.
  • Trustees must ensure exemptions are applied appropriately to protect trust assets from excessive taxation.

3. Triggers Taxes at Specific Events

GSTT liability can arise from:

  • Direct Skips: Giving cash or property directly to grandchildren.
  • Taxable Distributions: When trusts make payments to grandchildren.
  • Taxable Terminations: When a trust’s non-skip beneficiaries, such as children, pass away, leaving only skip persons as beneficiaries.

Plan Wisely to Minimize Tax Impact

The GSTT adds another layer of complexity to estate planning, especially for those wishing to leave a legacy for their grandchildren. However, with proper planning, such as using trusts and allocating exemptions wisely, families can reduce its impact. If you are considering how the GSTT affects your estate plan, contact O’Brien Law Firm, LLC, today to learn how we can help you protect your family’s future.

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