Generation-Skipping Trust Rules: Exemption, Allocation, Reporting

The federal generation-skipping transfer tax is a flat 40% levy on assets that move to a grandchild, later descendant, or other person at least two generations below you, and it sits on top of any gift or estate tax already owed. Every individual gets a $15 million lifetime exemption from this tax in 2026 under the One, Big, Beautiful Bill signed into law on July 4, 2025.¹² The tax exists to stop wealthy families from skipping a generation of transfer tax by handing assets straight to grandchildren, and Chapter 13 of the Internal Revenue Code houses the rules.³ Whether the tax actually hits a transfer depends almost entirely on how the exemption is allocated, and those allocation choices are largely irreversible once made.

What Triggers the Tax

The tax applies whenever property moves to a “skip person.” For relatives, generations follow the family tree: children are one generation below you, grandchildren two, great-grandchildren three.⁴ For non-relatives, the IRS uses age: a person born more than 37½ years after you is treated as two or more generations below.⁵

A trust itself can be a skip person if every beneficiary with an interest is at least two generations below you.⁴ So a trust funded exclusively for grandchildren is a skip person on day one, even before any money leaves the trust.

Three events trigger the tax:⁶

A direct skip is a transfer straight to a skip person that is also subject to gift or estate tax. A grandparent writing a $500,000 check to a grandchild is a direct skip.
A taxable termination happens when an interest in a trust ends and only skip persons hold interests afterward. Classic case: a trust pays income to your child for life, remainder to your grandchild, and your child dies.
A taxable distribution is any distribution of income or principal from a trust to a skip person that isn’t already a direct skip or a termination. A $10,000 income distribution to a great-grandchild qualifies.

The category matters because it determines who pays and how the tax base is measured.

The Predeceased Parent Exception

If your child dies before you and you then transfer assets to your grandchild, the grandchild moves up a generation for tax purposes and the transfer is no longer a generation-skipping transfer at all.⁵ The parent must be dead when the transfer becomes subject to gift or estate tax. For transfers at death, anyone who dies within 90 days of the transferor is treated as having predeceased.⁷

The rule applies automatically once the conditions are met. There is a limit for recipients outside the transferor’s direct line of descent: for non-lineal descendants, the rule only helps if the transferor has no living lineal descendants at the time of the transfer.⁵

How the Tax Is Calculated

The tax rate equals the highest marginal federal estate tax rate, which is 40% in 2026, multiplied by the transfer’s “inclusion ratio.”²⁸ The inclusion ratio is where the exemption does its work. A trust fully covered by allocated exemption has an inclusion ratio of zero, so the effective GST rate is 0%. A trust with no exemption allocated has an inclusion ratio of one, and every skip event pays the full 40%.

Applicable Fraction and Inclusion Ratio

The inclusion ratio equals one minus the “applicable fraction.” The applicable fraction is the amount of GST exemption you allocate divided by the value of the property transferred, after subtracting estate taxes recovered from the trust and any charitable deductions.⁹

Allocate $5 million of exemption to a $5 million trust and the applicable fraction is 1, the inclusion ratio is 0, and the trust is permanently exempt. Allocate nothing and the trust carries an inclusion ratio of one forever. A trust with an inclusion ratio between zero and one is a “mixed” trust, and it is the outcome practitioners work hardest to avoid, because every future event has to be split into exempt and taxable slices for decades.

Who Pays

Liability for the tax depends on which event triggered it:¹⁰

Direct skip not from a trust: the transferor pays. A direct skip from a trust is paid by the trustee.
Taxable termination: the trustee pays out of trust assets.
Taxable distribution: the recipient pays.

The category also shifts the effective cost. Direct skips are “tax-exclusive”: the tax is calculated on what the recipient receives, so a $1 million gift to a grandchild produces $400,000 of tax on the $1 million base. Taxable distributions are “tax-inclusive,” meaning the tax base includes the tax itself, which pushes the effective burden higher.

The $15 Million Exemption

The GST exemption for 2026 is $15 million per person, matching the federal estate tax basic exclusion.¹¹¹ The One, Big, Beautiful Bill made the higher amount permanent and it continues to adjust for inflation. You can spread your $15 million across any mix of lifetime gifts and transfers at death, but once you allocate exemption to a particular trust or transfer, that allocation is irrevocable.

The Exemption Is Not Portable Between Spouses

Unlike the federal estate tax exclusion, the GST exemption cannot be transferred from a deceased spouse to a surviving spouse.¹² Each spouse must use their own $15 million during life or at death, or lose it. A couple with $30 million titled in one spouse’s name risks forfeiting half their available exemption. Splitting assets between spouses so each can fund a generation-skipping trust with their own exemption is a standard response.

Annual Exclusion Gifts

Some gifts avoid the tax without touching the lifetime exemption. A direct skip that qualifies as a nontaxable gift under the annual gift tax exclusion gets an inclusion ratio of zero by statute.⁹ The 2026 annual exclusion is $19,000 per recipient.¹ A grandparent writing $19,000 checks directly to each grandchild each year owes no GST tax and burns no exemption.

Gifts to trusts are trickier. A transfer to a trust only earns the automatic zero inclusion ratio if two conditions hold: during the beneficiary’s life, only that one beneficiary can receive distributions, and if the trust still exists when the beneficiary dies, its assets must be included in the beneficiary’s taxable estate.⁹ Multi-beneficiary trusts and trusts designed to bypass a beneficiary’s estate won’t qualify and need a formal allocation.

Allocating the Exemption

Allocation is the act of assigning part of your $15 million to a specific transfer or trust so the inclusion ratio comes out where you want it. The Code offers three routes: automatic allocation for direct skips, deemed allocation for transfers to certain trusts, and elective allocation on a return. Timing controls valuation, and valuation controls how much exemption a transfer consumes.

Automatic Allocation for Direct Skips

When you make a direct skip, the Code automatically allocates enough of your unused exemption to bring the inclusion ratio to zero unless you affirmatively elect out.¹³ Electing out requires a timely Form 709 for the year of the transfer. You might elect out to save your exemption for a trust with more growth potential, since each dollar of exemption shelters more future appreciation there.

Deemed Allocation for GST Trusts

For transfers to trusts that are not direct skips, a second safety net kicks in. Unused exemption is automatically allocated to transfers into any “GST trust,” broadly meaning a trust that could eventually produce a taxable termination or taxable distribution.¹³ You can elect out on a timely Form 709 if you want to save the exemption for something else.

Elective Allocation and Why Timing Matters

When neither the automatic nor deemed rules apply, or when you’ve opted out, you allocate affirmatively on Form 709 for lifetime transfers or Form 706 for transfers at death. Timing has real financial teeth.

A timely allocation, made on a return filed by its due date including extensions, values the property as of the date of the gift.⁹ Transfer $2 million to a trust in January and the property is worth $2 million for allocation purposes, even if it has grown to $3 million by the filing date. A late allocation values the property at fair market value on the date the late election is filed. For rapidly appreciating assets, the gap between timely and late can waste millions in exemption.

The Estate Tax Inclusion Period

If you transfer property to a trust but keep an interest that would pull the property back into your estate if you died immediately, your GST exemption allocation doesn’t take effect until that interest ends. This waiting period is the Estate Tax Inclusion Period, or ETIP.¹⁴ The ETIP runs until the property is no longer includable in your gross estate, or until you die or a generation-skipping transfer occurs.¹⁵

Property is valued at the end of the ETIP, not at the original transfer date. Fund a trust with $2 million of stock that grows to $8 million by the time the ETIP ends and you need $8 million of exemption to fully cover it. The ETIP can wreck the strategy of gifting appreciating assets early, so structures triggering it need to be designed with that in mind.

The Reverse QTIP Election

A Qualified Terminable Interest Property (QTIP) trust qualifies for the marital deduction, but for GST purposes the property is normally treated as coming from the surviving spouse, not the first spouse to die. That means the first spouse’s GST exemption cannot reach the QTIP assets.

The reverse QTIP election fixes this. Filed on the first spouse’s Form 706, it treats the trust property as if the QTIP election had never been made, but only for GST tax purposes.¹⁶ The executor can then allocate the first spouse’s exemption to the QTIP trust and drive its inclusion ratio to zero. Because the GST exemption is not portable, this election is often the only path to using both spouses’ exemptions in full.

Fixing a Missed or Bad Allocation

Allocation mistakes are common and get more expensive as the trust assets grow. The Code provides limited paths back, and none are painless.

Late Allocations and Relief

A late allocation can be made on any later gift tax return, but the property is valued at its current fair market value rather than its original transfer value. On a trust that has appreciated significantly, that eats far more exemption than a timely allocation would have.

An automatic six-month extension is available if you missed the filing deadline.⁹ Beyond that window, as of May 2024 requests for retroactive relief on late GST allocations must go through the private letter ruling program under Section 2642(g), replacing the older Section 9100 process. The PLR process requires detailed affidavits from the transferor or executor and from every advisor involved, and the IRS weighs all circumstances including intent shown in the trust instrument.¹⁷ User fees run into thousands of dollars and relief is not guaranteed.

A separate substantial compliance provision allows the IRS to treat a technically defective allocation as effective for the amount needed to reach the lowest possible inclusion ratio, if the intent is clear.⁹ It rescues good-faith paperwork failures, not missed deadlines.

Qualified Severance

When a trust ends up with an inclusion ratio between zero and one, a qualified severance can split it into two trusts: one fully exempt, one fully taxable. The split has to be fractional, and the new trusts must preserve the same succession of beneficiary interests as the original. The exempt trust takes a share equal to the applicable fraction and comes out with an inclusion ratio of zero; the other trust has an inclusion ratio of one.⁹ Severance doesn’t create new exemption. It just untangles a mixed trust so the exempt half can grow and distribute cleanly.

Reporting and Compliance

Form 709 for Lifetime Transfers

Form 709, the United States Gift and Generation-Skipping Transfer Tax Return, reports lifetime transfers and records GST elections. Every direct skip and every transfer to a GST trust goes on this form, even when no gift tax is due. Form 709 is also where you make or opt out of exemption allocations. It’s due April 15 of the year following the transfer, with extensions available. Filing on time is what makes an allocation “timely” and locks in the lower date-of-gift valuation.

Form 706 for Transfers at Death

Transfers at death and any remaining exemption allocation are reported on Form 706, the federal estate tax return, due nine months after death. Form 706 handles direct skips at death, allocates the decedent’s unused exemption to trusts under the will or revocable trust, and is the only place to make the reverse QTIP election.

Foreign Trusts

Generation-skipping transfers involving foreign trusts add another layer. U.S. persons who engage in transactions with foreign trusts or hold interests in them must file Form 3520 on top of any required Form 709 or 706.¹⁸ Form 3520 penalties are severe and separate from any GST liability.

Penalties

Filing late triggers a penalty of 5% of unpaid tax per month, capped at 25%. Failing to pay adds 0.5% per month, also capped at 25%.¹⁹ Both can be waived for reasonable cause without willful neglect, but the IRS applies that standard skeptically when professional advisors handled the transaction.

1
Internal Revenue Service. What’s New — Estate and Gift Tax
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Office of the Law Revision Counsel. 26 USC 2641 – Applicable Rate
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Office of the Law Revision Counsel. 26 USC Ch 13 – Tax on Generation-Skipping Transfers
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Office of the Law Revision Counsel. 26 USC 2613 – Skip Person and Non-Skip Person Defined
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Office of the Law Revision Counsel. 26 USC 2651 – Generation Assignment
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Office of the Law Revision Counsel. 26 USC 2612 – Taxable Termination; Taxable Distribution; Direct Skip
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Federal Register. Predeceased Parent Rule
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Office of the Law Revision Counsel. 26 USC 2001 – Imposition and Rate of Tax
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Office of the Law Revision Counsel. 26 USC 2642 – Inclusion Ratio
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Office of the Law Revision Counsel. 26 USC 2603 – Liability for Tax
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Office of the Law Revision Counsel. 26 USC 2631 – GST Exemption
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The American College of Trust and Estate Counsel. What Is Portability for Estate and Gift Tax?
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Office of the Law Revision Counsel. 26 USC 2632 – Special Rules for Allocation of GST Exemption
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eCFR. 26 CFR 26.2663-2
15
Legal Information Institute (LII). 26 USC 2642(f)(3) – Estate Tax Inclusion Period
16
Office of the Law Revision Counsel. 26 USC 2652 – Other Definitions
17
Federal Register. Relief Provisions Respecting Timely Allocation of GST Exemption and Certain GST Elections
18
Internal Revenue Service. About Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts
19
Office of the Law Revision Counsel. 26 USC 6651 – Failure to File Tax Return or to Pay Tax