Legal Definitions - generation-skipping tax

The generation-skipping tax (GST) is a federal tax imposed on transfers of wealth to beneficiaries who are two or more generations younger than the person making the transfer. This tax applies whether the transfer occurs during the donor's lifetime (as a gift) or at their death (as an inheritance).

Its primary purpose is to ensure that wealth transferred across multiple generations is subject to a tax similar to what would have been paid if the wealth had passed through each intervening generation. This prevents the avoidance of estate or gift taxes that would normally apply at each generational step.

Here are some examples illustrating the generation-skipping tax:

• Scenario 1: Direct Inheritance to Grandchild
  A wealthy grandmother, Eleanor, decides to leave a substantial portion of her estate directly to her granddaughter, Olivia, in her will. Eleanor's son (Olivia's father) is still alive but is not included as a beneficiary for this specific inheritance.

  How it illustrates the term: This is a "direct skip" because the wealth is transferred from Eleanor (the transferor) to Olivia (the beneficiary), who is two generations younger than Eleanor. The generation-skipping tax would apply to this transfer, assuming the amount exceeds the applicable exemption.

• Scenario 2: Trust with Subsequent Distribution to Grandchildren
  Mr. Davies establishes an irrevocable trust during his lifetime. The trust provides income to his daughter, Sarah, for her entire life. Upon Sarah's death, the remaining assets in the trust are to be distributed outright to Mr. Davies' grandchildren.

  How it illustrates the term: In this situation, the generation-skipping tax would likely apply when the trust assets are distributed to the grandchildren after Sarah's death. This is considered a "taxable termination" because the trust's interest held by Sarah (a member of the intervening generation) has ended, and the assets are now passing to beneficiaries (the grandchildren) who are two generations younger than Mr. Davies, the original transferor.

• Scenario 3: Gift to an Unrelated Younger Individual
  An elderly philanthropist, Ms. Rodriguez, makes a large financial gift to a promising young entrepreneur, Mr. Kim, who is not related to her but is 45 years younger than her.

  How it illustrates the term: Even though they are not family, the generation-skipping tax can still apply. For unrelated individuals, a beneficiary is considered two generations younger if they are more than 37.5 years younger than the transferor. Since Mr. Kim is 45 years younger than Ms. Rodriguez, this gift would be subject to the generation-skipping tax if it exceeds the exemption, as it effectively skips a generation in the eyes of the tax law.