The estate tax gets all the press, but if you are leaving property to a grandchild, there is an additional tax you should know about. The generation-skipping transfer (GST) tax is a tax on property that is passed from a grandparent to a grandchild (or great-grandchild) in a will or trust. The tax is also assessed on property passed to unrelated individuals more than 37.5 years younger. Like the estate tax, it is currently repealed, but is scheduled to return in 2011.
The GST tax was designed to close a loophole in the estate tax. Normally, grandparents would leave their estates to their children, incurring estate taxes. Then the children would pass on the estates to the grandchildren, incurring estate taxes again. Wealthy individuals realized they could leave their estates to their grandchildren directly and avoid one set of estate taxes. Congress established the GST tax to prevent this by taxing transfers to related individuals more than one generation away and to unrelated individuals more than 37.5 years younger.
A GST tax is imposed even when property is left in trust for a grandchild. For example, suppose a grandparent sets up a trust that leaves income to her children for life and then the remainder to her grandchildren. The part of the trust left to the grandchildren will be subject to a GST tax.
The GST tax has tracked the estate tax rate and exemption amounts. In 2009, the federal government exempted $3.5 million from the tax and the tax rate was 45 percent. The GST tax expired in 2010 along with the estate tax, but it is scheduled to return in 2011. Unless Congress acts in the meantime, the 2011 GST tax exemption amount will be $1 million and the tax rate will be 55 percent.