Generation skipping transfer is an arrangement in which property is transferred to the next generation skipping a generation in the middle. In this arrangement, a beneficiary is two or more generations younger than the donor. The Generation skipping transfer was created for tax purposes. Often the skipped generation can receive income from the property while they are alive. Usually, generation skipping transfer is made by a grandparent to a grandchild, skipping the middle generation, i.e; the grandchild’s parent. A generation skipping trust is created to make a generation skipping transfer.
Generation skipping transfers made by a generation skipping trust or its equivalent may avoid estate tax and gift tax. However, large transfers of this kind are subject to a special federal generation skipping transfer tax. The generation skipping tax is a federal tax designed to ensure that family property is subject to taxation at least once each generation. The purpose is to impose a tax that is the same as if the property had been given first to the skipped generation and given subsequently to the next generation.
In a trust, the income may be distributed among a child and grandchildren in accordance with their needs. The principal of the trust will be distributed outright to the grandchildren following the child’s death. When the child dies, a generation-skipping tax will be imposed. A special rule is provided under Internal Revenue Code[i] for generation skipping transfers. When a tax is imposed on a taxable termination or a direct skip occurs as a result of the death of the transferor, a deduction can be allowed. An income tax deduction is allowed for generation skipping transfer tax imposed on a taxable termination or a direct skip occurring as a result of the death of a transferor. A deduction is given to items of gross income of a trust which weren’t properly includible in its gross income for periods before the date of that termination.
[i] 26 USCS § 691