Let's Do the Math: How Does the Generation-Skipping Transfer Tax Work?
You may have considered creating a trust to transfer wealth to your grandchildren and greatgrandchildren. But you may not have considered how the generation-skipping transfer (GST) tax
could affect this inheritance. To better explain how the tax would impact a gift in trust, we are
going to take a look at some math.
Generation-Skipping Transfer Tax Rate
The federal GST tax rate matches the highest federal estate tax rate, currently set at 40
percent.1 For high-net-worth individuals, effective GST tax planning is crucial in managing
combined estate, gift, and GST tax burdens.
Generation-Skipping Transfer Tax Exemption
You can transfer a specific value of money and property to skip persons (grandchildren, greatgrandchildren, other distant relatives, someone at least 37 ½ years younger, or a trust for a skip
person), either during your lifetime or after death, before triggering the GST tax. This exemption
equals the federal estate and gift tax exemption amount ($13.61 million in 2024). Be aware that
there is no portability for the GST tax exemption. Meaning, you will need to use it or lose it.
Exceptions to the Generation-Skipping Transfer Tax
You and your family members may have already established a trust. If so, certain irrevocable
trusts established before September 25, 1985, are grandfathered and exempt from the GST tax
provisions in Section 26.2601-1(b)(1) of the Treasury Regulations. Modifications or additions to
these trusts can jeopardize the exception. Additionally, gifts for educational or medical expenses
to skip persons, such as Health and Education Exclusion Trusts (HEET), are excluded from the
GST tax application.2
Calculating Generation-Skipping Transfer Tax
To understand how the GST tax will affect the inheritance you leave behind, you need to do
some math. The GST tax calculation relies on an inclusion ratio, indicating the extent to which a
transfer is subject to GST tax. This ratio is determined by the applicable fraction, based on the
amount of your GST tax exemption. An inclusion ratio of one means the direct skip or trust is
fully taxable. Any number between zero and one indicates the transfer is partially subject to
GST tax.3
The amount of the GST tax exemption allocated to the transfer is divided by the value of the
property involved in the transfer. The fraction is rounded to the nearest one-thousandth (.001)
and looks like this:
GST tax emption allocated
Value of property transferred
The next step is determining the inclusion ratio by subtracting the fraction from the number one.
Depending on the ratio, the trust is either fully exempt, fully taxable, or partially taxable.
Fully Exempt Trust
Let's say you create an irrevocable trust for the benefit of a grandchild and their descendants in
2024 when your entire GST tax exemption of $13,610,000 is available and you can allocate it to
the trust.
If you transfer $13,610,000 (or less) worth of accounts or property to the trust and allocate your
entire GST exemption, the inclusion ratio would be zero:
1 - (13,610,000 / 13,610,000) = 1 - 1.000 = 0
The trust would be fully exempt from GST tax.
Fully Taxable Trust
Now, let's assume that you have previously used your GST tax exemption and there was none
available to allocate to your grandchild's irrevocable trust, the inclusion ratio would be one:
1 - (0 / 13,600,000) = 1 - 0 = 1
The trust would be fully subject to GST tax.
Partially Exempt Trust
Partially exempt trusts have a portion of money or property subject to the GST tax, while
another portion may qualify for an exemption.
If you put $15,500,000 in the irrevocable trust, and your entire exemption was available, the
inclusion ratio would be:
1 - (13,610,000 / 15,500,000) = 1 - .877 = .122
The applicable fraction is .878, and the inclusion ratio is .122. The trust would be partially
subject to GST tax. When distributions are made to the grandchild, there will be a tax due. To
calculate how much will be owed, we first must know what the tax rate is at the time of the
distribution. For example, if the rate is 40 percent,
40 percent x .122 = 4.88 percent
If your grandchild receives a taxable distribution from the trust of $125,000, the GST tax would
be $6,100.
For gifts or an inheritance left directly to the skip person, the formula works similarly, the
inclusion ratio is multiplied by the GST tax in effect at the time of the transfer.
Tailoring Trusts for Success
Working closely with your other trusted advisors, we can customize your estate plan based on
your unique circumstances and goals. This also ensures compliance with federal and state tax
laws, preventing a significant combined estate, gift, and GST tax burden that could diminish
your family's wealth and legacy over time.
MEREDITH | PC
4325 Windsor Centre Trail
Suite 400
Flower Mound Texas 75028
214-513-1013
This newsletter is for informational purposes only and is not intended to be construed as written advice about a Federal tax matter. Readers should consult with their own professional Counselors to evaluate or pursue tax, accounting, financial, or legal planning strategies.
You have received this newsletter because I believe you will find its content valuable. Please feel free to Contact Me if you have any questions about this or any matters relating to estate planning.
