What Is a Non-Exempt Trust? Inclusion Ratio and GST Tax Rules

A non-exempt trust is a trust that has not had the grantor’s generation-skipping transfer (GST) tax exemption allocated to it, which leaves transfers from that trust to grandchildren or more remote descendants exposed to a flat 40% GST tax. In 2026, each person has a $15 million GST exemption to spread across trusts and direct gifts. When none of that exemption is applied to a particular trust—by oversight, by election, or because the trust’s value exceeds what the grantor has left—the trust is non-exempt, and the tax on later skip-generation transfers can be severe.

The Inclusion Ratio Draws the Line

Whether a trust is exempt, non-exempt, or somewhere in between comes down to one number: the inclusion ratio. It equals 1 minus the “applicable fraction,” and the applicable fraction is the GST exemption allocated to the trust divided by the value of property transferred into it.¹

Fund a trust with $5 million and allocate $5 million of exemption to it. The applicable fraction is 1, the inclusion ratio is 0, and the trust is fully exempt. No GST tax will ever apply, no matter how many generations the assets travel.

Fund the same trust and allocate nothing. The applicable fraction is 0, the inclusion ratio is 1, and the trust is fully non-exempt. Every qualifying transfer out of it is taxed at the maximum GST rate, which is currently 40%.²

Partial allocation creates the messiest outcome. Allocate $3 million of exemption to a $5 million trust and the applicable fraction is 0.60, the inclusion ratio is 0.40, and every generation-skipping transfer from the trust is taxed on 40% of its value for the rest of the trust’s life. The ratio follows the trust indefinitely, and this is where most GST planning mistakes compound.

How a Trust Ends Up Non-Exempt

The 2026 GST exemption is $15 million per person, tied directly to the federal estate tax basic exclusion amount.³ Three paths typically leave a trust non-exempt:

No exemption was ever allocated. Allocation generally happens by reporting it on a gift tax return (Form 709). Trusts created without specialized estate planning counsel often skip this step entirely and start life non-exempt.
The trust’s value exceeded the exemption available. A grantor with $15 million of remaining exemption who funds a $20 million trust can shield only the first $15 million. The excess portion carries a non-zero inclusion ratio.
The grantor opted out of automatic allocation. Sometimes this is deliberate, to reserve exemption for another trust. Sometimes it happens by checking the wrong box on Form 709.⁴

The automatic allocation rules are a safety net worth knowing about. When you make a direct gift to a grandchild or transfer property to a trust that could distribute to skip persons, the IRS presumes you want unused GST exemption applied—enough to bring the inclusion ratio to zero, if you have that much exemption left. You can override the default with a timely election on your gift tax return, but without an override, the automatic rule keeps most grantors from creating a non-exempt trust accidentally.⁴

When the GST Tax Actually Applies

A non-exempt trust does not owe GST tax simply because it exists. The tax is triggered by one of three specific events:

A direct skip: a transfer straight to a skip person, meaning someone two or more generations below the grantor, like a grandchild. Sending $1 million from a non-exempt trust to a grandchild triggers the tax immediately.
A taxable distribution: a distribution from the trust to a skip person that isn’t a direct skip or a taxable termination. If the trustee writes a check from a non-exempt trust to the grantor’s grandchild for college expenses, that qualifies. The beneficiary receiving the distribution is responsible for paying the tax.
A taxable termination: an interest in the trust ends, whether through death, a lapse of time, or the release of a power, and afterward only skip persons hold any interest. The trustee pays the tax.⁵

The effective rate is not always 40%. The GST rate equals the maximum federal estate tax rate (40%) multiplied by the trust’s inclusion ratio.² A fully non-exempt trust with an inclusion ratio of 1 pays the full 40%. A trust with an inclusion ratio of 0.40 pays 16%. A fully exempt trust pays nothing.

Splitting a Partially Exempt Trust

A trust stuck with an inclusion ratio between 0 and 1 creates ongoing headaches, because every distribution demands a fractional GST tax calculation. The tax code addresses this through a qualified severance. A partially exempt trust can be divided into two: one holding a fractional share equal to the applicable fraction, which becomes fully exempt with an inclusion ratio of 0, and another holding the remainder, which becomes fully non-exempt with an inclusion ratio of 1.¹

Once split, the trustee can direct distributions to grandchildren and later generations out of the exempt trust and reserve the non-exempt trust for distributions to the grantor’s children, who aren’t skip persons. Same pool of assets, but the GST exposure is concentrated where it does no damage.

Trusts Commonly Left Non-Exempt

Any trust can be non-exempt if GST exemption isn’t allocated, but certain structures land there more often than others.

Revocable living trusts top the list. Families usually create them to avoid probate, not for GST planning, so the exemption often goes unallocated. Because the grantor keeps full control, including the power to revoke, a revocable trust is treated as a grantor trust for income tax purposes and its assets are included in the grantor’s taxable estate.

Grantor retained annuity trusts (GRATs) are another common example. A GRAT pays the grantor a fixed annuity for a set term, and whatever remains passes to the beneficiaries. Because the value of the remainder interest is uncertain during the annuity term, allocating GST exemption at the time of the gift is inefficient. Most estate planners leave GRATs non-exempt and direct the remainder to non-skip beneficiaries instead.

Irrevocable life insurance trusts, dynasty trusts, and other long-term vehicles can also end up non-exempt if they’re funded with more than the grantor’s available exemption or if allocation is simply missed during estate administration.

Filing Obligations When the GST Tax Is Triggered

A non-exempt trust that triggers a taxable event has GST-specific filing duties on top of its regular income tax return. Trustees file Form 706-GS(T) for taxable terminations, and skip-person beneficiaries file Form 706-GS(D) for taxable distributions. Both are due on the same timeline as the trust’s income tax return, and a six-month automatic extension is available by filing Form 7004 before the original deadline. The extension covers filing, not payment: interest on unpaid GST tax accrues from the original due date.⁶

For gift and estate tax purposes generally, note that transferring assets into any trust can trigger gift tax if the transfer exceeds the annual gift tax exclusion, which is $19,000 per recipient in 2026. Gifts above that amount count against the grantor’s lifetime gift and estate tax exemption of $15 million per individual in 2026, made permanent by the One, Big, Beautiful Bill Act and adjusted annually for inflation starting in 2027.⁷ Amounts above the exemption are taxed at 40%. Whether trust assets are included in the grantor’s taxable estate depends on how much control the grantor retains, not on the trust’s GST exemption status.

1
Office of the Law Revision Counsel. 26 USC 2642 – Inclusion Ratio
2
Office of the Law Revision Counsel. 26 USC 2641 – Applicable Rate
3
Office of the Law Revision Counsel. 26 USC 2631 – GST Exemption
4
Office of the Law Revision Counsel. 26 USC 2632 – Special Rules for Allocation of GST Exemption
5
Internal Revenue Service. Instructions for Form 706-GS(T)
6
eCFR. 26 CFR 26.6081-1 – Automatic Extension of Time for Filing Generation-Skipping Transfer Tax Returns
7
Internal Revenue Service. Whats New – Estate and Gift Tax