Understanding the Generation-Skipping Transfer Tax: A 40-Year Legal and Policy Review

What Is the Generation-Skipping Transfer (GST) Tax and Why Was It Created?

In theory, the Generation-Skipping Transfer Tax was designed to prevent ultra-wealthy families from avoiding estate and gift taxes by transferring wealth to grandchildren or even further down the family line, skipping a generation of taxation. First introduced in 1976 and revised in 1986, the GST tax was intended to:

• Protect the federal estate and gift tax base
• Ensure fairness in the tax system
• Close a major loophole exploited by high-net-worth individuals

But as with many laws, it hasn’t quite worked out as planned.

Dynasty Trusts: The Tax Loophole That Still Exists

Before 1976, U.S. tax law had no specific rules to govern generation-skipping transfers. Wealthy individuals took advantage of this by creating trusts that benefited multiple generations, bypassing estate taxes that would otherwise apply with each generational transfer.

Enter the dynasty trust—a legal structure popularized in the 1950s and ’60s that allows assets to remain in trust for many generations. Once the initial transfer is taxed, the assets inside the trust can grow and pass to future beneficiaries without further estate or gift tax. Today, these trusts are still widely used and, under current law, can operate indefinitely in some states.

Why Generation-Skipping Transfers Undermine Tax Equity

Long before the GST tax became law, policymakers knew generation-skipping transfers were a threat to the fairness of the tax system. As early as 1935, the Treasury Department flagged it as a problem. President Truman and later administrations echoed the concern that massive fortunes could escape taxation for generations, creating an elite class with unearned influence and wealth.

As one 1969 Treasury report put it: some families “pay a transfer tax at each generation,” while others are able to “avail themselves of the opportunity to skip a tax.”

How the Rule Against Perpetuities Relates to GST Trusts

Everything in estate planning goes back to common law—and that includes the infamous Rule Against Perpetuities. According to the rule, an interest in a trust must vest within 21 years after the death of a “measuring life” alive at the trust’s creation. For example, if a mother creates a trust for her living children, the trust must end 21 years after the last child’s death.

But even with this limit, modern dynasty trusts can last a very long time. A single trust created today could end up distributing assets to a transferor’s great-great-great-great-grandchild—six generations down the line. If nothing else, this shows that the rule of law, as it stands, was never built with the everyday person in mind.

Key Policy Goals of the GST Tax

When Congress enacted the GST tax in 1976 (and then revised it in 1986), the legislation aimed to fix three primary problems:

1. Base Protection

Without a GST tax, estate and gift taxes are paid only once every two or three generations. That’s a massive loss of tax revenue. The GST tax was meant to plug this hole and preserve the estate tax base.

2. Tax Fairness for the Ultra-Wealthy

The wealthiest families are the most likely to use generation-skipping strategies. The GST tax ensures these families pay their fair share, just like everyone else.

3. Neutrality in Estate Planning

Before the GST tax, tax incentives heavily favored trusts over outright gifts. The revised law was designed to remove that bias so that families wouldn’t be nudged into one strategy solely for tax avoidance reasons.

Reagan-Era Changes: Expanding the Reach of the GST Tax

In the early 1980s, the Reagan administration proposed a more comprehensive version of the GST tax. Key changes included:

• Expanding the tax to cover outright gifts to grandchildren and other skip-generation heirs
• Applying the tax to single-generation trusts where the beneficiaries are two or more generations below the donor
• Introducing a unified exemption that didn’t depend on the relationship between donor and beneficiary

These ideas were folded into the 1986 Tax Reform Act and remain the backbone of the GST tax structure today.

So… Did It Work?

That’s debatable.

Over the last four decades, high-net-worth families have continued to transfer hundreds of billions into trusts that, for all practical purposes, remain outside the reach of the estate tax system. These trusts don’t just preserve wealth—they concentrate it. They allow a small, privileged class to maintain and grow their fortunes indefinitely.

Wealth is like water. It finds its own level—and in this case, the level has been tilted in favor of those born at the top.

Final Thoughts: Revisiting the GST Tax Today

Much has changed since 1986, but the GST tax law hasn’t. Critics argue it’s time for another update. Others claim the system works just fine—if you’re rich enough to use it.

Whether you see dynasty trusts as an estate planning miracle or a tax policy failure, one thing is clear: the law still reflects the deep tensions between wealth preservation and tax equity. And as long as those tensions exist, so will the debate.