Generation-Skipping Transfer Tax in Trust Administration California

The Generation-Skipping Transfer Tax (GST tax) is one of the most complex areas of trust taxation. This 40% federal tax applies when assets transfer to grandchildren or more remote descendants, "skipping" a generation. Understanding GST tax is critical for trustees administering dynasty trusts or making distributions to skip persons.

This guide explains GST tax basics, exemptions, allocation strategies, and compliance requirements for California trustees.

What Is GST Tax?

Purpose

Congress created GST tax to prevent:

• Wealthy families from avoiding estate tax by skipping generations
• Leaving assets to grandchildren instead of children
• Creating perpetual dynasty trusts

How It Works

Tax triggers when property transfers to:

• Skip persons (people 2+ generations younger than transferor)
• Typically grandchildren, great-grandchildren
• Non-relatives 37.5+ years younger

Example without GST tax:

• Father leaves $10M to grandson (skipping son's generation)
• Estate tax paid once
• Son's generation never taxed

With GST tax:

• Estate tax: 40% on $10M transfer to grandson
• GST tax: ADDITIONAL 40% on transfer
• Combined 64% tax (40% + (60% × 40%))

GST Tax Rate

Federal rate: 40% (same as estate tax)

California: No state GST tax

Effective rate:

• 40% GST tax
• Plus estate tax if applicable
• Can exceed 60% combined

Key Definitions

Skip Person

Who qualifies:

Direct descendants:

• Grandchildren (2 generations below)
• Great-grandchildren (3+ generations below)

Non-relatives:

• Anyone 37.5+ years younger than transferor

Trusts:

• Trust where all beneficiaries are skip persons

Non-Skip Person

Who doesn't qualify:

• Children (only 1 generation below)
• Spouse
• Anyone less than 37.5 years younger (non-relatives)

Predeceased Parent Exception

Important exception: Grandchild is NOT skip person if their parent (transferor's child) is already deceased.

Example:

• Grandfather creates trust
• Son dies before grandfather
• Grandson now moves up (not skip person)
• No GST tax

Why: Grandson essentially "replaces" his deceased father.

Types of GST Events

1. Direct Skip

Definition: Outright transfer to skip person

Examples:

• Bequest to grandchild
• Gift to grandchild
• Distribution from trust to grandchild

Tax due: Immediately at transfer

Who pays: Transferor (or trust)

2. Taxable Termination

Definition: Trust interest terminates, skip persons remain

Example:

• Trust pays income to child (life)
• Then principal to grandchildren
• When child dies, taxable termination occurs
• GST tax due on assets passing to grandchildren

Tax due: At termination

Who pays: Trust

3. Taxable Distribution

Definition: Distribution from trust to skip person while non-skip person has interest

Example:

• Trust holds assets for child and grandchildren
• Trustee distributes $100,000 to grandchild
• GST tax due on distribution

Tax due: At distribution

Who pays: Usually recipient (grandchild)

GST Tax Exemption

Current Exemption (2024)

$13.61 million per person (indexed for inflation)

Married couple: $27.22 million combined

Same as estate tax exemption

How Exemption Works

Allocate exemption to transfers:

• Can apply to gifts during life
• Can apply to transfers at death
• Once allocated, permanent
• Protects transfer from GST tax

Example:

• Create $5M trust for grandchildren
• Allocate $5M GST exemption
• Trust grows to $20M
• No GST tax ever (exemption shields all growth)

This is why early allocation is powerful.

Inclusion Ratio

Formula: Inclusion Ratio = 1 - (GST Exemption Allocated / Transfer Value)

What it means:

• 0 = Fully exempt (no GST tax)
• 1 = Fully taxable (40% GST tax)
• 0.5 = Half exempt (20% GST tax)

Example 1:

• $10M transfer
• $10M exemption allocated
• Inclusion ratio = 1 - ($10M / $10M) = 0
• No GST tax

Example 2:

• $10M transfer
• $5M exemption allocated
• Inclusion ratio = 1 - ($5M / $10M) = 0.5
• GST tax = 40% × 0.5 = 20%

Dynasty Trusts

What They Are

Dynasty trust:

• Trust lasting multiple generations
• Can last 90 years in California (Rule Against Perpetuities)
• Some states allow perpetual trusts

Purpose:

• Keep wealth in family
• Provide for multiple generations
• Protect from creditors and divorce
• Minimize estate taxes

GST Tax Planning for Dynasty Trusts

Key strategy: Allocate full GST exemption at creation

Example:

• Create $13M dynasty trust
• Allocate full $13M GST exemption
• Trust grows to $50M over 50 years
• Pays grandchildren, great-grandchildren
• Zero GST tax on any distributions

Why this works:

• Exemption shields original transfer
• All growth also shielded
• No GST tax for generations

GST Tax in Trust Administration

Trustee Responsibilities

Must:

1. Determine if trust subject to GST tax
2. Track GST exemption allocation
3. Calculate inclusion ratio
4. Report GST events on Form 709
5. Pay GST tax if due
6. Maintain records

When Trusts Face GST Tax

Common scenarios:

1. Trust created without GST exemption:

• Settlor didn't allocate at creation
• Trust now faces GST tax

2. Exemption partially allocated:

• Inclusion ratio between 0 and 1
• Some distributions taxable

3. Taxable termination:

• Non-skip beneficiary dies
• Only skip persons remain

Calculating GST Tax Due

Formula: GST Tax = Transfer Amount × Inclusion Ratio × 40%

Example:

• $1M distribution to grandchild
• Inclusion ratio: 0.6
• GST tax = $1M × 0.6 × 40% = $240,000

Who Pays GST Tax

Depends on type:

GST Event	Who Pays
Direct skip	Transferor or trust
Taxable termination	Trust
Taxable distribution	Recipient (can be different)

Trust usually pays from principal.

Form 709 Filing

When Required

File Form 709 (Gift Tax Return) if:

• Direct skip occurs
• Allocating GST exemption
• Taxable distribution or termination over $18,000

Deadline: April 15 following year of transfer

Extension: Automatic 6-month extension with Form 4868

What to Report

Form 709 includes:

• Part 1: Gifts subject to gift tax
• Part 2: GST tax calculation
• Part 3: GST exemption allocation
• Schedule A: Gifts

For GST:

• Description of transfer
• Value of transfer
• GST exemption allocated
• Inclusion ratio calculation
• GST tax due

Automatic Allocation Rules

IRS automatically allocates GST exemption to:

• Direct skips
• Indirect skips to GST trusts

Unless you opt out on timely filed Form 709

Why opt out:

• Want to allocate to different transfer
• Preserve exemption
• Have better use for exemption

Strategies to Minimize GST Tax

1. Allocate Exemption Early

Benefit:

• Shields future growth
• $1M exemption today protects $10M in 30 years

Action:

• File Form 709 timely
• Allocate to trusts with highest growth potential

2. Use Annual Exclusion

$18,000 per recipient (2024)

• Can gift to grandchildren GST-free
• Doesn't use GST exemption
• Must be outright gifts (no trust)

3. Pay Education/Medical Expenses

Unlimited exclusion:

• Pay directly to institution
• No GST tax
• No gift tax
• Doesn't use exemption

Must pay directly - can't reimburse grandchild.

4. Create Multiple Trusts

Separate trusts:

• Exempt trust (full exemption allocated)
• Non-exempt trust (no exemption)

Benefit:

• Maximize use of exemption
• Flexibility in distributions

5. Leverage Dynasty Trusts

Maximum benefit:

• Allocate full exemption at creation
• Trust lasts multiple generations
• All growth protected

6. Use Spousal Access Trusts

SLAT (Spousal Lifetime Access Trust):

• Irrevocable trust for spouse
• Children/grandchildren remainder beneficiaries
• Allocate GST exemption
• Remove from estate but maintain indirect access

Common Mistakes

1. Not Allocating Exemption

Problem:

• Create trust for grandchildren
• Forget to allocate GST exemption on Form 709
• Trust faces 40% GST tax on distributions

Solution: File Form 709 timely allocating exemption.

2. Late Allocation

Problem:

• Wait years to allocate
• Trust appreciated significantly
• Exemption allocates at current (higher) value
• Wastes exemption

Solution: Allocate immediately at trust creation.

3. Partial Allocation

Problem:

• Allocate only partial exemption
• Inclusion ratio between 0 and 1
• Still face some GST tax

Solution: Allocate full exemption or split into separate trusts.

4. Missing Form 709 Deadline

Problem:

• Miss April 15 deadline
• Lose ability to allocate exemption for that year
• Or face late filing penalties

Solution: File timely or extension.

5. Ignoring Predeceased Parent Exception

Problem:

• Treat grandchild as skip person
• Pay GST tax unnecessarily
• Parent was already deceased

Solution: Check family tree for predeceased parents.

6. Not Tracking Inclusion Ratio

Problem:

• Don't know trust's inclusion ratio
• Can't calculate GST tax on distributions
• Records incomplete

Solution: Maintain clear records from trust creation.

California Trust Administration Issues

No State GST Tax

California does not impose GST tax

• Only federal GST tax applies
• Simplifies compliance

Rule Against Perpetuities

California:

• Trusts can last 90 years from creation
• Limits dynasty trust duration
• Some states allow perpetual trusts

Planning:

• Consider forming trust in no-RAP state (Delaware, South Dakota)
• California trustee/beneficiaries OK
• Governed by trust situs state law

Income Tax

GST tax separate from income tax:

• Trust still files Form 1041
• GST tax not deductible expense
• Reported separately on Form 709

When to Get Professional Help

Consult GST tax specialist if:

• Estate over $10M
• Creating dynasty trust
• Trust for grandchildren/great-grandchildren
• Complex family structure
• Previous gifts used exemption
• Trust has inclusion ratio between 0 and 1
• Facing taxable termination or distribution

Professionals needed:

• Estate planning attorney
• CPA with GST experience
• Sometimes actuary for valuation

Cost of error: Can be millions in unnecessary GST tax.

Conclusion

GST tax is complex but manageable with proper planning and exemption allocation. For high-net-worth families, strategic use of the $13.61M exemption can save millions in taxes over multiple generations.

Key takeaways:

• GST tax is 40% on transfers to grandchildren
• $13.61M exemption per person (2024)
• Allocate exemption early to shield growth
• File Form 709 to allocate exemption
• Dynasty trusts maximize multi-generational wealth
• Predeceased parent exception avoids tax
• California has no state GST tax
• Get professional help for complex situations

Proper GST planning is essential for trustees administering trusts with skip person beneficiaries.

Related Articles

Learn more about complex trust tax issues:

• Form 1041 Trust Tax Return Guide - How GST tax interacts with trust income tax returns and reporting requirements for skip person distributions.

• Trust Administration IRS Audit - IRS examination of GST exemption allocations, Form 709 filings, and common GST tax compliance issues.

• Income vs. Principal Trust Administration - How distributions to skip persons affect income and principal allocations in multi-generational trusts.

• Common Trust Administration Mistakes - Avoid costly GST exemption allocation errors and late filing penalties for Form 709.

• Trust Administration for Business Owners - GST planning for family business succession and dynasty trust structures.

Frequently Asked Questions

Does California have its own generation-skipping transfer tax?

No. California does not impose a state-level GST tax. Only the federal GST tax applies at a rate of 40%. This simplifies compliance for California trustees since you only need to track federal exemptions and file federal Form 709, without worrying about separate state reporting or taxation. However, you still must comply with all federal GST requirements including exemption allocation and proper filing deadlines.

What happens if I forget to allocate GST exemption when creating a trust?

If you fail to allocate GST exemption when creating a trust for grandchildren or more remote descendants, the trust will face a 40% GST tax on all distributions to skip persons. You can still allocate exemption later by filing Form 709, but it will be based on the trust's current value rather than the original funding amount. This wastes exemption if the trust has appreciated significantly. The IRS does have automatic allocation rules that may apply to certain transfers, but relying on these without proper planning can lead to inefficient use of your exemption.

How is GST tax different from estate tax?

Estate tax applies when assets transfer from a deceased person to anyone, while GST tax specifically targets transfers that skip a generation. The two taxes can stack on top of each other. For example, if a grandfather leaves $10 million directly to his grandson, it faces both estate tax of up to 40% and an additional GST tax of 40%, resulting in a combined effective tax rate that can exceed 60%. Both taxes share the same exemption amount of $13.61 million per person in 2024, but the exemptions must be allocated separately.

Can I avoid GST tax by making direct payments for my grandchildren's education?

Yes. When you pay tuition directly to an educational institution for your grandchildren, the payment is exempt from both gift tax and GST tax, regardless of amount. This unlimited exclusion doesn't use any of your $13.61 million GST exemption. However, the payment must go directly to the school, not to the grandchild or their parents for reimbursement. The same rule applies to medical expenses paid directly to healthcare providers. Room and board, books, and supplies don't qualify for this exclusion.

What is a dynasty trust and how does it relate to GST tax?

A dynasty trust is a long-term trust designed to benefit multiple generations of your family. In California, trusts can last up to 90 years under the Rule Against Perpetuities, while some states allow perpetual trusts. The key GST planning strategy is to allocate your full GST exemption when you create the dynasty trust. If you allocate $13 million in exemption to a dynasty trust at creation, all future growth and all distributions to grandchildren, great-grandchildren, and beyond are completely protected from GST tax. This makes dynasty trusts an extremely powerful wealth preservation tool when combined with proper GST exemption allocation.

Need Help With GST Tax Issues?

If you're dealing with GST tax in California trust administration, our attorneys work with tax specialists to minimize tax liability and ensure proper exemption allocation and compliance.

Contact us for a consultation about your GST tax matters.

This article is for informational purposes only and does not constitute legal or tax advice. GST tax rules are extremely complex and fact-specific. Consult with qualified legal and tax professionals about your specific situation.