Legal Definitions - generation-skipping trust

A generation-skipping trust is a type of legal arrangement designed to transfer assets to beneficiaries who are two or more generations younger than the person creating the trust, such as grandchildren or great-grandchildren, while bypassing the generation in between (e.g., the children).

Historically, these trusts were primarily used to avoid certain estate and gift taxes that would normally apply if the assets were transferred directly to the intermediate generation first. However, the enactment of the Generation-Skipping Transfer Tax (GSTT) significantly reduced the tax advantages of these trusts. As a result, such transfers are now subject to a specific tax designed to capture the previously avoided taxes, largely eliminating the original tax benefits these trusts offered.

• Example 1: The Grandparent's Legacy

  Mrs. Eleanor Vance, an affluent grandmother, wanted to ensure her considerable wealth would directly benefit her grandchildren, Liam and Olivia, rather than first passing through her son, Robert. She established a generation-skipping trust, naming Liam and Olivia as the primary beneficiaries. Her intention was to transfer assets directly to them, thereby historically avoiding a layer of estate taxes that would have been incurred if the assets had first gone to Robert and then from Robert to his children. This illustrates the "skipping" of Robert's generation in the direct line of inheritance for tax purposes.

• Example 2: The Family Business Succession

  Mr. David Chen, the founder of a successful manufacturing company, had two children who were not interested in taking over the business. However, his granddaughter, Maya, showed great promise and a keen interest in entrepreneurship. To ensure the long-term continuity of his company within the family, Mr. Chen considered setting up a generation-skipping trust to transfer ownership of the business directly to Maya upon his passing. This arrangement would bypass his children's generation, aiming to historically minimize the total transfer taxes that might have applied if the business first went to his children and then later to Maya.

• Example 3: The Impact of the GSTT

  In the late 1980s, Mr. Arthur Jenkins had established a generation-skipping trust for his great-niece, Sarah, intending to transfer a substantial sum to her directly, bypassing his niece. While Mr. Jenkins's trust was set up with the historical goal of avoiding estate taxes on the intermediate generation, the subsequent enactment of the Generation-Skipping Transfer Tax (GSTT) meant that the transfer to Sarah would now be subject to this specific tax. This example highlights how the GSTT changed the landscape, making such "skipped" transfers taxable, thus largely eliminating the original tax advantage these trusts offered.