Gifts and estates
Gifts to grandchildren and the generation-skipping tax
A gift or bequest that skips a generation can be taxed twice: once by the gift or estate tax, and again by a third tax most people have never heard of. The exemption is large enough that few families pay it. The paperwork that keeps it that way is where the mistakes are.
The generation-skipping transfer tax, GST for short, is a flat 40% tax on transfers to grandchildren and other people two or more generations down, on top of the gift or estate tax on the same transfer. Everyone has a $15 million exemption from it (2026, indexed, permanent). The tax exists so that a trust paying income to a child for life and then to the grandchildren cannot pass a fortune through the child’s generation untaxed. For most of our clients the practical questions are three: does a gift to a grandchild count, does a trust for grandchildren need an election on the gift tax return, and what happens if nobody made it.
| The tax | 40% of the amount transferred to a “skip person,” in addition to gift or estate tax. Chapter 13 of the Code, §§2601–2664. |
| Skip person | A grandchild, great-grandchild or grand-niece; anyone unrelated more than 37½ years younger; or a trust whose only beneficiaries are skip persons. |
| The exemption | $15,000,000 per person for 2026, indexed, permanent — the same figure as the estate exemption, but not portable between spouses. |
| Exempt without any paperwork | Annual-exclusion gifts and tuition or medical bills paid directly, when made outright to the grandchild. |
| The trap | The same annual-exclusion gift made to a trust for several grandchildren is not automatically exempt; GST exemption has to be allocated on Form 709. |
Who is a skip person
Generations are counted from the transferor. A child is one generation down, a grandchild two; anyone two or more generations below the transferor is a skip person. Spouses and former spouses of the transferor are the transferor’s own generation; the spouse of a descendant is in that descendant’s generation; adopted and half-blood relatives count as whole-blood. For people who are not relatives the law uses age: within 12½ years of the transferor is the same generation, 12½ to 37½ years younger is one generation down, 37½ to 62½ years younger is two down, and so on in 25-year steps. A $100,000 gift from a 75-year-old to a 30-year-old friend is a generation-skipping transfer.
A trust is a skip person when every beneficiary with a present interest is a skip person — a trust for the grandchildren only. A trust that pays income to a child for life and then to the grandchildren is not a skip person today, because the child has an interest; it becomes one on the day the child dies.
The predeceased-parent rule is the exception that matters most in practice. If a grandchild’s parent (the transferor’s child) is already dead when the gift or bequest is made, the grandchild moves up into the parent’s generation and is not a skip person at all. A grandparent raising a grandchild whose parent has died can give or leave that grandchild anything with no GST consequence. The rule also covers grand-nieces and grand-nephews when the transferor has no living descendants.
The three kinds of generation-skipping transfer
| Event | What it is | Who pays | Reported on |
|---|---|---|---|
| Direct skip | An outright gift or bequest to a skip person, or to a trust that is a skip person | The donor (or the estate). The tax is figured on the amount the grandchild receives; a lifetime GST paid by the donor is itself a further gift | Form 709, Schedule A Part 2 and Schedule D; Form 706 Schedule R at death |
| Taxable termination | An interest in a trust ends (usually the child dies) and only skip persons are left | The trustee, out of the trust — so the tax comes out of what the grandchildren get | Form 706-GS(T), filed by the trustee |
| Taxable distribution | Any other distribution from a trust to a skip person — the trustee of a trust for children and grandchildren pays a grandchild’s tuition out of the trust | The grandchild who receives it; if the trust pays the tax, that is another taxable distribution | Form 706-GS(D), from the trustee’s 706-GS(D-1) |
Three examples. Income to a son for life, then to the grandchildren: nothing happens at funding, because the son has an interest; a taxable termination occurs at his death. The same trust with the remainder to the son after the spouse’s life estate is never a generation-skipping transfer, because both are one generation or less. A “spray” trust for a son and a grandson: every distribution to the grandson while the son is alive is a taxable distribution, and the son’s death is a taxable termination.
What is exempt without any paperwork
Gifts that qualify for the annual exclusion ($19,000 per grandchild per year, $38,000 from a married couple who split), and tuition or medical bills paid directly to the school or provider, are “nontaxable gifts” with a GST inclusion ratio of zero when they are made outright to the grandchild. No exemption is used, nothing is allocated, nothing goes on Schedule D. A grandparent who writes each grandchild a $19,000 check every December and pays the orthodontist directly has no GST problem and no gift tax return.
The same gift made to a trust is exempt only if the trust is for one grandchild, nothing can go to anyone else during that grandchild’s life, and the trust is included in the grandchild’s estate if the grandchild dies before it ends. A typical Crummey trust for three grandchildren qualifies for the gift-tax annual exclusion and does not qualify for this rule. Unless GST exemption is allocated to it, every dollar that later comes out to a grandchild is a taxable distribution at 40%. This is the single most common generation-skipping mistake in family trusts, and it is invisible until the first distribution.
The exemption, and how it gets allocated
Every individual has a GST exemption equal to the estate tax exemption, $15 million for 2026. A married couple has two. It is not portable: an unused GST exemption dies with the first spouse, which is one of the last remaining reasons for a bypass trust at the first death rather than leaving everything outright. When a married couple splits a gift, each spouse is the transferor of half and allocates their own exemption to their half.
Exemption can be allocated any time up to the due date of the transferor’s estate tax return, but when matters. A timely allocation on a gift tax return uses the value on the date of the gift; a late allocation uses the value on the date the allocation is filed. A trust funded with $200,000 that has grown to $600,000 costs three times as much exemption to fix late.
The law allocates exemption automatically in two situations: to every lifetime direct skip, and to every gift to a “GST trust” — roughly, a trust that could later produce a taxable termination or distribution — unless the donor elects out on a timely Form 709. The definitions are complicated enough that the automatic rule produces the wrong answer in common cases: exemption wasted on a trust for the children that will never skip, or not allocated to a trust that will. The desk rule is simple: for every gift to a trust, decide in or out and say so on Schedule D of a timely return. At death, unused exemption is allocated automatically to direct skips first and then to trusts that could skip, unless the executor directs otherwise. If a trust that should have been exempt was missed, the IRS has a simplified no-fee procedure for the annual-exclusion-trust case (Rev. Proc. 2004-46) and a ruling process for the rest.
The inclusion ratio, in one paragraph
The GST rate on a trust is 40% multiplied by its inclusion ratio, which is 1 minus the fraction of the trust’s value that was covered by exemption when it was funded. Allocate exemption equal to the full value and the ratio is zero: the trust is exempt forever, however large it grows. Allocate nothing and the ratio is one: 40% on every termination and distribution. Allocate half and the ratio is one-half, which applies to everything the trust ever distributes at whatever it is then worth — $2 million put in a trust with $500,000 of exemption allocated has a ratio of three-quarters and a 30% rate, and if the trust is worth $5 million when the child dies, the tax is $1.5 million. The planning rule that follows: never leave a trust partly exempt; fund an exempt trust and a non-exempt trust separately, or split one into two.
Behind the scenes
Every gift tax return we prepare with a trust on it gets the same question before it is filed: is this a trust that could ever pay a grandchild, and if so, is the exemption allocated or is the election out made? Schedule D is where it happens, and the automatic rule is not a substitute for answering it. We also ask, for every trust K-1 we see, whether the trust is GST-exempt — because a distribution to a grandchild from a non-exempt trust is a 40% tax the grandchild owes and usually does not know about.
The Colorado side
Colorado has no gift, estate, inheritance or generation-skipping tax. Everything on this page is federal. The only Colorado piece is the income tax on a trust’s earnings, which is on the trusts and taxes page.
What to bring your preparer
- The trust document for any trust you have funded or plan to fund for grandchildren
- Every prior Form 709 you have filed, since the GST exemption used so far is cumulative
- For a trust you are a beneficiary of: the trustee’s statement of whether the trust is GST-exempt, and any Form 706-GS(D-1) you have received
- The family tree with dates — which grandchildren have a living parent and which do not
Questions people ask
I give each grandchild $19,000 every year. Is there a generation-skipping problem?
No. An annual-exclusion gift made outright to a grandchild is fully exempt, uses no exemption, and requires no return.
I paid my granddaughter’s tuition directly to the college. Does that count?
No tax, no return, no exemption used — the same rule as for the gift tax. Pay the school, not the student.
My son died two years ago and I am leaving his share to his children. Is that a skip?
No. Under the predeceased-parent rule your grandchildren step into your son’s generation. Leave them whatever you wish; only the ordinary estate tax rules apply.
We set up a trust for the grandchildren ten years ago and nobody mentioned any of this.
Bring the trust and the gift tax returns, if any were filed. If the gifts were annual-exclusion gifts and the trust was never allocated exemption, there is a simplified IRS procedure to allocate it late; the cost is that today’s value, not the original gifts, is what the exemption has to cover.
Is the $15 million GST exemption shared between my wife and me?
You each have your own, and unlike the estate exemption it cannot be passed to the survivor. If one of you dies without using it, it is gone. That is the usual reason a will funds a bypass trust at the first death instead of leaving everything to the spouse.
Quick notes
From my course notes and the final exam — the rules in one line each, restated for 2026.
- A transfer to a child is never a generation-skipping transfer; two or more generations down is a skip, and for non-relatives the line is 37½ years younger.
- Income to a spouse for life, then to a son: no generation-skipping transfer at either death. Income to a spouse, then to a grandchild whose parent is alive: a taxable termination when the spouse dies.
- A person who holds only a future right to a trust — a remainderman — has no “interest” in it for GST purposes; a present right to income, or being a permissible current recipient, is an interest.
- A trust distribution to a grandchild while a child still has an interest is a taxable distribution; the child’s death is a taxable termination; an outright gift to a grandchild is a direct skip.
- The trustee pays the tax on a taxable termination; the grandchild pays the tax on a taxable distribution; the donor pays the tax on a direct skip, and the tax paid is itself an added gift.
- An annual-exclusion gift or a direct tuition or medical payment made outright to a grandchild has an inclusion ratio of zero; the same gift to a trust for several grandchildren does not.
- If the grandchild’s parent is already dead, the grandchild moves up a generation and there is no skip at all.
- The GST exemption equals the estate exemption — $15 million for 2026 — is cumulative over life and at death, is allocated irrevocably, and is not portable between spouses.
- Inclusion ratio = 1 minus (exemption allocated ÷ value of the property); allocate the full value and the ratio is zero forever; a partial allocation leaves a fraction that applies at whatever the trust is later worth.
- The taxable amount of a termination is the trust’s value less the expenses of the termination; the taxable amount of a distribution is what the grandchild received; exemption changes the rate, not the amount.
- The value used for the inclusion ratio is the gift-tax value for lifetime transfers and the estate-tax value for transfers at death; a late allocation uses the value on the day it is filed.
- A trust for GST purposes includes life estates, terms of years, and insurance and annuity contracts.