The Generation Skipping Tax is a cleverly-devised tax to prevent the loss in tax revenue because of a loophole that existed in the law.
And it works like this: When you die, you leave your estate to your children. When they die, they leave the estate to their children, aka, your grandchildren. And the estate is taxed on both transfers.
To avoid this double-taxing, families began transferring estates directly from grandparent to grandchild.
So, in 1986, Congress established the Generation Skipping tax to plug this little loophole, and yes, it is in addition to the regular estate tax. In order to cover all bases, the GST is applicable in three scenarios:
- Skipping from Grandparent to Grandchild.
- Taxable Distribution. This is connected to the distribution of the estate from a trust.
- Taxable Termination. This is also attached to the allocation of benefits from a trust. It applies where a trust has been terminated and a grandchild benefits.
Currently, the Generation Skipping Tax is not in effect but this reprieve goes away in 2011 and the GST will return at a whopping rate of 55%.