Can a generation skipping trust bypass taxes for grandchildren

Lloyd called me in a panic last week. His father had meticulously crafted a generation-skipping trust for his grandchildren decades ago, but the original codicil—the one directing exactly which assets went into the trust—was lost during a recent move. He feared that without that clear direction, the trust would be treated as a series of individual gifts to his grandkids, triggering immediate gift tax and completely defeating the purpose of the trust. He’d already received a preliminary estimate of the potential tax liability: over $250,000. That’s a heartbreaking outcome when careful planning is undone by a logistical failure.

The short answer is: potentially, yes, but it’s far more complex than many clients assume. Generation-skipping trusts (GST trusts) are powerful tools for transferring wealth to future generations, but they’re riddled with potential pitfalls. The goal, of course, is to avoid estate and gift taxes not just at your death, but also at your children’s deaths, allowing assets to pass directly to grandchildren (or later generations) without incurring an additional layer of taxation. However, simply creating a GST trust isn’t enough. The devil truly is in the details—and the ongoing administration.

Let’s start with the biggest misconception: that a GST trust automatically shields assets from all taxes. That’s simply not true. While it can bypass the estate tax at your children’s generation, it doesn’t eliminate all tax consequences. Income generated within the trust is still taxable, and distributions to beneficiaries will be subject to income tax rules. More critically, the trust must be properly structured to qualify for the generation-skipping transfer (GST) tax exemption.

Effective Jan 1, 2026, the OBBBA (One Big Beautiful Bill Act) permanently set the Federal Generation-Skipping Transfer (GST) Tax Exemption to $15 million per person; failing to allocate this exemption on Form 709 exposes the trust to a flat 40% tax on every distribution to grandchildren. Many clients, lulled into a false sense of security by the high exemption amount, neglect to make the required election, resulting in a devastating tax bill when distributions occur. I’ve seen this happen far too often.

What Happens If a GST Trust Isn’t Properly Funded?

As Lloyd’s situation illustrates, a poorly funded trust can be disastrous. If assets aren’t clearly identified as being held in the trust, they will be treated as direct gifts. This isn’t just a matter of semantics; it has significant tax implications. Without a valid codicil directing assets into the trust, those assets fall back into your taxable estate and are subject to estate tax upon your death. This defeats the entire purpose of establishing a GST trust.

For deaths on or after April 1, 2025, a home intended for the GST trust but left in the settlor’s name (valued up to $750,000) qualifies for a ‘Petition for Succession’ under AB 2016 (Probate Code § 13151). This is a critical distinction: it’s a “Petition” (Judge’s Order), NOT an “Affidavit.” This provides a streamlined process to transfer the property into the trust after death, but it requires proactive planning and adherence to the statutory requirements.

How Long Can a GST Trust Last?

Another crucial consideration is the duration of the trust. California, unlike ‘dynasty friendly’ states like South Dakota, is bound by the Uniform Statutory Rule Against Perpetuities (USRAP), which generally limits the trust’s lifespan to 90 years unless specific savings clauses are used. This means that after 90 years, the trust assets must be distributed to the beneficiaries, potentially subjecting them to estate tax. While it’s possible to draft the trust to extend beyond this period using carefully worded ‘savings clauses,’ these clauses are complex and require meticulous attention to detail.

What About Property Taxes and Grandchildren?

Beyond federal estate and gift taxes, clients often overlook the impact of California property taxes. Under Prop 19, transferring a home to grandchildren via a GST Trust almost always triggers a property tax reassessment to current market value, as the ‘grandparent-grandchild’ exclusion is severely restricted compared to the old Prop 58 rules. This can significantly erode the value of the inheritance, particularly in high-value real estate markets like Temecula. We often discuss strategies to mitigate this, such as holding the property in an irrevocable life insurance trust (ILIT) outside of the GST trust.

Protecting Digital Assets & Business Interests

In today’s world, digital assets and business interests require specific attention. Without specific RUFADAA language (Probate Code § 870) in the GST Trust, service providers can legally block your trustee from accessing crypto wallets or cloud accounts intended for future generations. Similarly, while domestic U.S. LLCs held in the trust are exempt from BOI reporting as of March 2025, trustees managing foreign-registered entities must still file updates with FinCEN within 30 days to avoid federal fines.

I’ve been practicing estate planning and as a CPA for over 35 years, and I’ve found that the most successful GST trusts are those that are proactively managed and regularly reviewed. As a CPA, I can also advise clients on the crucial issue of ‘step-up in basis.’ Properly structuring the trust allows the assets to receive a step-up in basis at each generation, minimizing capital gains taxes when those assets are eventually sold. This is a significant benefit that many estate planning attorneys without a CPA background often overlook. We carefully consider valuation issues as well, especially regarding closely held business interests.

Ultimately, a GST trust can be a powerful tool for bypassing taxes for grandchildren, but it’s not a set-it-and-forget-it solution. It requires careful planning, diligent administration, and ongoing monitoring to ensure that it achieves its intended goals.

What separates a successful California trust distribution from a costly battle over interpretation and accounting?

California trusts are designed to bypass probate and maintain privacy, yet they often fail when assets are not properly funded, trustee duties are ignored, or ambiguous terms trigger disputes. Even with a signed trust document, families can face court battles if the “operations manual” of the trust isn’t followed strictly under the Probate Code.

• Asset Protection: Explore permanent trust structures for asset shielding.
• Post-Death Creation: Understand testamentary trusts.
• Liquidity: Utilize an irrevocable life insurance trust for estate taxes.

California trust planning is most effective when the structure is matched to the specific family goal and assets are fully funded into the trust name. When administration is handled with transparency and adherence to the Probate Code, the trust can fulfill its promise of privacy and efficiency.

Verified Authority on California Generation-Skipping Trust (GST) Administration

• Federal GST Tax Exemption: IRS Estate & GST Tax Guidelines
  Reflects the inflation-adjusted exemption effective January 1, 2026, which sets the GST Tax Exemption at approximately $15 million per person. Proper allocation of this exemption is the only way to shield trust assets from the flat 40% tax on distributions to grandchildren.
• Trust Duration Limits (USRAP): California Probate Code § 21205 (90-Year Rule)
  California follows the Uniform Statutory Rule Against Perpetuities. This statute generally limits a Generation-Skipping Trust’s validity to 90 years, preventing “forever” trusts common in other jurisdictions.
• Property Tax Reassessment (Prop 19): California State Board of Equalization (Prop 19)
  Critical for GST planning. Prop 19 severely limits the “grandparent-grandchild” exclusion, meaning most real estate transfers to grandchildren will trigger a property tax increase to current market value unless the parents are deceased.
• Primary Residence Succession (AB 2016): California Probate Code § 13151 (Petition for Succession)
  If a home intended for the GST trust was accidentally left out, this statute (effective April 1, 2025) allows a “Petition for Succession” for residences valued up to $750,000, avoiding a full probate.
• Digital Legacy (RUFADAA): California Probate Code § 870 (RUFADAA)
  The authoritative statute for digital assets. Without specific RUFADAA provisions in the trust, multi-generational access to cryptocurrency and digital files can be legally denied by custodians.
• Business Compliance (FinCEN): FinCEN – Beneficial Ownership Information (BOI)
  The Corporate Transparency Act applies to most GST trusts holding LLCs. Trustees must file a Beneficial Ownership Information (BOI) report for both domestic and foreign entities. Failure to report changes within 30 days can result in federal civil penalties of $500/day.