If you are very wealthy, you might think it's clever to leave your money directly to your grandchildren, skipping your children entirely to avoid a layer of estate taxes when your children eventually die. The IRS thought of this decades ago and created the Generation-Skipping Transfer (GST) tax to stop it.
The GST Tax Penalty
The GST tax is a flat 40% tax applied to transfers made to a 'skip person' (someone two or more generations below you, like a grandchild). This tax is applied in addition to the standard 40% estate tax, meaning a direct gift to a grandchild could theoretically face an 80% combined tax rate if exemptions aren't used properly.
Important
The GST Exemption
Fortunately, every individual has a lifetime GST tax exemption (tied to the standard estate tax exemption). You can allocate this exemption to trusts to shield them from the GST tax forever.
The Dynasty Trust Solution
To maximize the GST exemption, wealthy families use Dynasty Trusts. You fund the trust with an amount up to your GST exemption limit. The trust can then benefit your children, grandchildren, and great-grandchildren for generations, growing tax-free and never being subjected to estate taxes at each generational level.