Legal Definitions - taxable distribution

A taxable distribution refers to a payment of money or property made from a trust to a beneficiary who is at least two generations younger than the person who created the trust. This type of distribution is subject to a specific federal tax called the generation-skipping transfer (GST) tax.

It specifically applies to transfers that are not considered an immediate, direct transfer of assets (known as a "direct skip") and are not the final distribution of trust assets after an intermediate beneficiary's interest has ended (known as a "taxable termination"). Essentially, it's an intermediate payment from a trust to a "skip person" (a beneficiary two or more generations younger than the grantor).

• Example 1: Grandparent's Trust for Grandchild's Education

  A grandmother establishes a trust for the benefit of her son, but also includes a provision allowing the trustee to distribute funds directly to her grandson for his college tuition and living expenses. While the son is still alive and the trust is ongoing, the trustee makes regular payments from the trust directly to the grandson's university and for his housing costs.

  How this illustrates the term: The grandson is a "skip person" because he is two generations younger than the grandmother (the grantor). The payments for his education are made directly from the trust to him. This is not the initial funding of the trust (a direct skip), nor is it the termination of the trust (which would occur later, perhaps upon the son's death). Therefore, these ongoing educational payments are considered taxable distributions.

• Example 2: Discretionary Payments to a Great-Niece

  An individual creates a trust that names their niece as the primary income beneficiary for life, with the remainder going to the niece's children (the grantor's great-nieces and great-nephews). The trust also grants the trustee discretion to distribute principal to any beneficiary for their health, education, maintenance, or support. During the niece's lifetime, one of her daughters (the grantor's great-niece) experiences a medical emergency, and the trustee distributes a significant sum from the trust directly to cover her medical bills.

  How this illustrates the term: The great-niece is a "skip person" because she is three generations younger than the original grantor. The payment for her medical emergency is made from the trust while the grantor's niece (an intermediate generation) is still alive and a beneficiary, and the trust has not yet terminated. This intermediate distribution of principal to a skip person qualifies as a taxable distribution.

• Example 3: Trust for a Grandchild's Business Venture

  A wealthy grandfather sets up a trust for his children and grandchildren. The trust terms allow the trustee to make distributions of income or principal to any beneficiary for various purposes, including starting a business. While the grandfather's children are still alive and benefiting from the trust, one of his grandchildren requests funds from the trustee to launch a new tech startup, and the trustee approves the distribution.

  How this illustrates the term: The grandchild is a "skip person" (two generations younger than the grandfather). The funds distributed from the trust to the grandchild for their business venture are made while the trust is ongoing and the grandfather's children (an intermediate generation) are still beneficiaries. This is not the initial transfer into the trust, nor is it the trust's final termination. Consequently, this payment to the grandchild is a taxable distribution.