What is the generation-skipping tax exemption?

As you share generously with your family, your gifts could face certain tax implications. If you pass money or assets to your children and they later pass those gifts to their children, you or others may need to pay taxes on those transfers.

If you give directly to your grandchildren while your children are still alive, you may expect to avoid some of the tax burden. This is true, up to a certain high-dollar maximum. But if your giving is approaching several million dollars, you'll want to know about the generation-skipping tax.

When people "skip" over their children and give money to the next generation—e.g., their grandkids—the gift may be subject to gift taxes or estate taxes. Gift taxes apply when you give during your life, and estate taxes apply to transfers that occur after your death. Each of these can range from 18% to 40%, as determined by IRS Forms 709 and 706 respectively.

But you also may have to pay an additional tax: the generation-skipping tax. Sometimes called the generation-skipping transfer tax, the current rate is a flat 40%. That's equal to the top reach of federal gift and estate tax rates.

Enacted in 1986, the generation-skipping tax closed a loophole that previously allowed people to pass money to their children's children, with the transfer only subject to estate taxes once. Now, if you pass assets to your grandchildren, the taxation (gift/estate tax + generation-skipping tax) is essentially the same as if you passed the gift to your children and then they passed it to their children later. In other words, the gift/estate tax is applied twice—once on each transfer.

It's important to note: You can give a certain amount to qualified recipients during your lifetime before your gifts incur the generation-skipping tax.

As of 2024, that lifetime maximum is $13.61 million (up from $12.92 million in 2023) or a combined $27.22 million per married couple. Those amounts match the thresholds for a similar exemption applied to gift and estate taxes.

Gifts to grandchildren that are subject to the generation-skipping tax include:

• Cash
• Stocks and other securities
• Property
• Trust distributions

Generation-skipping taxes won't be required on any of those gifts if their combined value is less than the maximum exemption you're allowed to take (currently, $12.92 million per giver). If, over time, you pass along assets that add up to more, the amount that exceeds the exemption allowance will be subject to the 40% tax.

Gifts you give during your life and those you pass along after your death (through your will) all can count toward your generation-skipping tax exemption. So can gifts to recipients who aren't your grandchildren. Assets you pass to anyone at least 37½ years younger than you—related or not—qualify as generation-skipping gifts. That means they're subject to the generation-skipping tax—but they also count toward your lifetime exemption.

Some gifts that benefit your grandchildren are nontaxable, so they aren't subject to the generation-skipping tax at all. That means they don't count toward your exemption threshold, either. Such gifts include:

• Cash gifts up to $18,000 in 2024 (up from $17,000 in 2023)
• Tuition paid directly to a school
• Payments to a medical provider
  

How and when you give your money determines who pays the generation-skipping tax on it. Generally, if you give directly to a recipient, you pay the tax on the amount of the gift. If your gift is considered indirect—provided through an irrevocable trust, for instance— the beneficiary may be responsible for paying the tax as they receive payments.

From 2010-2017, the lifetime exemption amount (like that of the gift/estate tax exemption) rose from $5 million to $5.49 million.

In 2018, the Tax Cuts and Jobs Act (TCJA) increased that threshold dramatically, starting at $11.18 million and tying annual increases to inflation. However, the TCJA expires in 2025. If Congress takes no action to extend its terms, the maximum exemption will revert to $5 million in 2026, with increases indexed to inflation.

If building generational wealth is a goal, generation-skipping gifts may make sense as part of your overall financial plan. But it's important to consider all options and potential ramifications.

Could bypassing your children and giving to your grandchildren lead to financial challenges for some family members? Do uncertainties about the future of the generation-skipping tax exemption mean you should consider giving to your grandchildren sooner rather than later? A Thrivent financial advisor can help you address these questions and others as you thoughtfully map out the financial legacy you wish to leave behind.