Fidelity discloses wealth move that triggers hidden IRS tax
Most Americans have never heard of the generation-skipping transfer tax, yet it can erase nearly two-thirds of an intergenerational wealth transfer.
The Internal Revenue Service imposes a flat 40% generation-skipping transfer tax on top of the regular gift and estate tax when assets pass directly to grandchildren or further down the line.
Combined with the standard estate tax, the effective federal rate on a grandchild’s inheritance can exceed 60%, turning a $1 million bequest into roughly $360,000, according to Congress.gov.
The trap is procedural: families with estates below the $15 million-per-person exemption can trigger the tax by mishandling required IRS filings. The exemption system can have significant tax implications, even for estates that fall short of eight figures.
A June analysis from Fidelity Investments breaks down the generation-skipping transfer tax and reveals why the paperwork itself creates the biggest exposure for families.
The firm’s report outlines which transfers activate the tax, what dollar thresholds apply in 2026, and how families can protect their exemption through precise documentation.
How the generation-skipping transfer tax adds a second 40% rate
Congress created this tax in 1976 after wealthy families used multigenerational trusts to pass assets across generations without paying estate tax at each generational step.
The generation-skipping transfer tax applies whenever assets move to a “skip person,” which Fidelity defines as someone more than one generation below the transferor.
That category covers grandchildren, great-grandchildren, and any unrelated person who is more than 37.5 years younger than the individual making the gift or bequest.
The IRS taxes these transfers at 40% and collects the levy on top of any regular estate or gift tax already owed. A $1 million bequest to a grandchild from a taxable estate could produce about $640,000 in combined taxes when both levies apply, Congress.gov stated.
What the $15 million exemption covers for grandparent transfers in 2026
The federal lifetime generation-skipping transfer tax exemption stands at $15 million per person under the One Big Beautiful Bill Act.
President Donald Trump signed the law on July 4, 2025, permanently setting the exemption at this level, with annual inflation adjustments beginning in 2027.
Married couples can combine their exemptions for a total of $30 million in transfers to grandchildren or other skip individuals without triggering the tax.
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Beyond the lifetime exemption, the IRS allows individuals to give up to $19,000 per year to unlimited recipients without triggering the gift tax.
A married couple can double that annual exclusion to $38,000 per recipient, meaning two grandparents could gift $76,000 to two grandchildren each year tax-free.
One critical distinction separates this exemption from regular estate planning: the generation-skipping transfer tax exemption is not portable between spouses, Associated Bank noted.
If one spouse dies without using their $15 million generation-skipping exemption, the surviving spouse cannot inherit that unused portion for generation-skipping transfer tax purposes.
Late Form 709 filings cost families their generation-skipping tax exemption
Families must actively allocate their generation-skipping transfer tax exemption to specific transfers by filing IRS Form 709, the federal gift tax return.
When an exemption is allocated to a trust on time, all future growth on those assets remains sheltered from the generation-skipping transfer tax, the Fidelity report noted.
The firm offered an example: a $10 million trust with full exemption allocation that later grows to $20 million remains entirely exempt from the tax.
That growth shelter is one of the most powerful features of timely allocation, but it vanishes when families miss the filing deadline or skip allocation.
Andrew M. Nerney, an attorney in the Private Clients Group at Cummings & Lockwood LLC, wrote in a Trusts & Estates Magazine article, titled “Gift Split Gaffe,” that many older Americans making gifts may not fully understand the tax rules that apply to them.
Does every octogenarian, for example, keep track of his available generation-skipping transfer tax exemption when he makes gifts to skip persons?
Late allocations lock in fair market value at the filing date rather than the original transfer date, which can waste the exemption on appreciated assets.
Seeking IRS relief for a missed allocation requires a private letter ruling under § 2642(g), which can be prohibitively expensive once IRS user fees and professional costs are combined, according to Revenue Procedure 2026-1.
How 529 plans and direct tuition payments reduce generation-skipping tax exposure
The Fidelity report highlights two approaches that allow grandparents to move wealth to younger generations entirely outside the reach of the generation-skipping transfer tax.
Contributions to 529 education savings plans count as completed gifts for tax purposes, even when the contributor retains the right to change beneficiaries.
Grandparents can front-load five years of annual exclusions into a single 529 contribution, up to $95,000 individually or $190,000 per couple, the firm noted.
The IRS treats that contribution as spread across five tax years, so it avoids triggering gift tax or consuming any lifetime exemption allocation.
Tuition paid directly to a qualified school and medical bills paid directly to a provider also escape both gift tax and generation-skipping tax entirely.
These qualified payments carry no dollar limit and rank among the most efficient vehicles for transferring wealth across generations without using an exemption, the firm confirmed.
Fidelity’s analysis identifies timely filing of Form 709 and allocation of exemptions to every relevant trust transfer as among the most consequential steps for families making generation-skipping gifts.
Related: IRS rules hide a brutal HSA tax trap for heirs
