Transfer taxes: How gift, estate, and generation-skipping (GST) taxes fit together

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Playing the wealth transfer game? Uncle Sam wants in.

© Glenda Powers, devilswork.shop, Snizhana, Seventyfour, H. Ozmen/stock.adobe.com; Photo illustration Encyclopædia Britannica, Inc.

Whether we like it or not, the federal government can’t provide services without revenue—and that revenue comes from taxes. For more than a century, Americans have debated how heavily the wealthiest citizens should be taxed. Some believe higher taxes on large fortunes promote fairness, while others argue that allowing the wealthy to keep and spend more money fuels economic growth. Those competing views have shaped U.S. tax laws.

Estate, inheritance, and gift taxes have been enacted intermittently for generations in attempts to tax the most wealthy Americans. Because these taxes involve the transfer of money or property from one person to another, estate planners often group them under the umbrella term “transfer taxes.”

Congress has been taxing estates, inheritances, the creation of wills, and the transfer of property at death on and off since 1797. The modern federal estate tax dates back to the Revenue Act of 1916, which created a permanent tax on the transfer of wealth at death—a tax imposed on the estate itself rather than on the beneficiaries.

The first federal gift tax appeared in 1864, but it was repealed in 1872. Gift taxes were introduced and repealed again several times in the 1920s and 1930s. Lawmakers learned the hard way that without a gift tax, wealthy individuals could simply give away their assets tax free during their lifetime—even on their deathbeds—and avoid the estate tax entirely.

The problem was finally addressed by the Tax Reform Act (TRA) of 1976, which unified the estate and gift tax systems. Under this combined framework, large lifetime gifts are tracked and coordinated with the estate tax so that transfers made during life and at death are taxed under a single system with one lifetime exemption.

Gifts that you give to another person—cash, property, investments, and even certain insurance benefits or debt you forgive—are generally tax free as long as you stay under the annual exclusion per person ($19,000 in both 2025 and 2026).

Some transfers don’t count at all, no matter the amount:

If you give more than the annual exclusion to any one person in a year, the excess is a taxable gift and must be reported on Form 709. You don’t pay tax at that time. Instead, the running total of your taxable lifetime gifts is compared to your lifetime exemption each year. The lifetime exemption is $13,990,000 in 2025 and $15,000,000 in 2026. As long as your total taxable gifts stay under that lifetime limit, no gift tax is due. Once you go over it, gift tax applies at rates from 18% up to 40%.

You can make annual gifts to as many people as you wish, and your spouse can make gifts as well. So for example, if you and your spouse each give $19,000 to each of your three grandchildren in 2026 ($114,000 in total), those gifts are tax free and don’t affect your lifetime exemptions.

After your death, the running total of your taxable lifetime gifts is used again when your estate tax is calculated. Gifts that were excluded over the years are never added back and do not affect your estate tax.

According to the IRS, estate tax is a tax on your right to transfer property at your death. If the value of your gross estate plus your lifetime taxable gifts exceeds the filing threshold, your estate must file an estate tax return via Form 706 within nine months of the date of death. 

Your “gross estate” generally includes the fair market value of everything you owned or controlled at your death, including:

Your “taxable estate” is calculated by deducting these items from your gross estate:

Before estate tax is calculated, the IRS adds back the total of your lifetime taxable gifts made since 1977. This ensures you receive only one lifetime exemption for transfers made during life and at death combined.

Estate tax rates are progressive, with a top rate of 40% on the amount above the exemption. Any gift tax you previously paid is applied as a credit, which reduces the amount of tax you owe.

If your estate does not use all of its exemption ($13,990,000 in 2025, $15,000,000 in 2026), it may elect to pass the unused portion to your surviving spouse. Your estate must file Form 706 to make the election, even if it is not otherwise required to file. See the instructions for Form 706 for details.

Suppose Jerry gave $10,000 to each of his three children annually from 1985 to 2024. Since the annual gift tax exemption was at least $10,000 per person per year for each of those years, none of the gifts were taxable. He never had to file a gift tax form for them, and those gifts are not included in the calculation of his lifetime gift allowance, nor added to his estate upon his death.

In 2025, Jerry gave his oldest child his business, valued at $16,000,000. After subtracting the annual exclusion ($19,000 in 2025), his taxable gift was $15,981,000. Jerry filed Form 709. The lifetime exemption in 2025 was $13,990,000. So Jerry’s excess $1,991,000 (his taxable gift minus the exemption) was subject to gift tax in 2025.

When Jerry later dies, the $15,981,000 taxable gift is included in the estate tax computation as an adjusted taxable gift. Because he already paid gift tax on $1,991,000, the estate tax calculation gives him a credit for gift tax previously paid.

In addition to the estate and gift tax, the federal system includes a separate generation-skipping transfer (GST) tax that applies when wealth is transferred to someone who is more than one generation below the donor, such as a grandchild. Its purpose is to prevent families from avoiding estate tax by passing their assets directly to their grandchildren and skipping their own children. The GST has its own lifetime exemption ($13,990,000 in 2025; $15,000,000 in 2026) and uses a flat tax rate of 40%.

If your transfer of assets skips a generation, it is subject to both estate or gift tax plus GST tax, since they are two separate taxes. For example, if your $20,000,000 estate passes directly to your grandchild when you die in 2026 (and you had not already used any of your lifetime exemption, and you did not give any of your estate to your child), your estate would owe both estate tax on $5M ($20M – $15M lifetime exemption) and GST tax on $5M ($20M – $15M GST exemption). If instead you give your estate to your child (who later gives it to your grandchild), your estate would only owe tax on $5M ($20M – $15M lifetime exemption).

Over the years, estate and gift taxes have attempted to tax the most wealthy. Most people will not be affected by gift nor estate taxes, as most estates are smaller than the exemption amount. In fact, according to the IRS, less than 2% of all adult deaths result in a taxable estate tax return, and only about 1% of all federal budget receipts are made up of estate and gift taxes.

If you are wealthy enough to be subject to these taxes, understanding the way the different transfer taxes work will allow you to plan the distribution of your estate by giving it away during your lifetime or bequeathing it after your death.