When you transfer wealth to grandchildren, the tax code adds a layer most people have never heard of — and it can be punishing if you don’t plan for it.
The scenario. Eleanor, a widow with a $25 million estate, wanted to leave substantial wealth to her grandchildren, skipping her already-wealthy children. She simply named the grandchildren in her will. She didn’t account for the generation-skipping transfer (GST) tax, a separate 40% tax that applies on top of the estate tax to transfers that skip a generation. Without allocating her GST exemption properly, large gifts to grandchildren could be hit with both estate and GST tax — a combined rate that could exceed 60% on some transfers.
The problems.
- Transfers skipping a generation triggered GST tax in addition to estate tax.
- No proper allocation of the GST exemption.
- A potential combined effective tax rate well above 40%.
The planning solution.
The GST tax exists to stop families from avoiding a layer of estate tax by “skipping” the children’s generation and leaving wealth directly to grandchildren (or to anyone more than one generation below you, called “skip persons”). It is a flat 40% tax that applies in addition to the gift or estate tax — which is why an unplanned skip can be taxed twice.
The good news: every person has a GST exemption equal to $15 million in 2026 — a separate allowance that parallels the estate and gift exemption. The key is to affirmatively allocate that exemption to transfers that benefit skip persons, typically by reporting and allocating it on a timely gift tax return (Form 709) or estate tax return.
Rather than gifting to grandchildren outright, the powerful move is to fund a GST-exempt dynasty trust and allocate GST exemption to it so its “inclusion ratio” is zero. Done correctly, the trust’s assets — and all of their future appreciation — can pass down through grandchildren, great-grandchildren, and beyond free of additional estate and GST tax at each generation. Fund it during life with appreciating assets and you compound the benefit, because the growth occurs inside the tax-sheltered trust.
A dynasty trust also delivers non-tax benefits: assets held in trust are protected from each beneficiary’s creditors and divorcing spouses, and you can choose a favorable trust situs (a state with no state income tax on trusts and a long or unlimited perpetuities period) to maximize how long and how efficiently the trust endures.
The cautionary flip side: if you fund a generation-skipping trust but fail to allocate GST exemption, the trust is “GST non-exempt,” and distributions to skip persons later get hit with the 40% tax. Allocation is the step that turns a dynasty trust into a tax shelter — skip it and you’ve created a liability.
Key takeaways.
- Skipping a generation triggers a separate 40% GST tax on top of estate tax.
- Allocate your $15M (2026) GST exemption to a dynasty trust (inclusion ratio zero).
- Dynasty trusts also shield beneficiaries from creditors and divorce.
If you plan to benefit grandchildren or future generations, ask about a GST-exempt dynasty trust and proper exemption allocation.