Mind the GST Trap: Why Annual Exclusion Gifts to Trusts Aren’t Always Tax-Free

Legal Alert

September 2, 2025

One of the simplest and most effective strategies for shifting wealth to the next generation is the use of the annual gift tax exclusion, which allows transfers to children and grandchildren without triggering federal gift tax. In 2025, individuals may give up to $19,000 per recipient (or $38,000 for a married couple electing gift-splitting) free of gift tax.

However, gifts to trusts—especially those designed for long-term wealth preservation—require extra planning, particularly around the generation-skipping transfer (GST) tax.

To qualify for the annual gift tax exclusion, a gift must be a present interest. Gifts to trusts are usually considered future interests unless the trust includes withdrawal rights (often called Crummey powers) giving beneficiaries a limited time to withdraw contributions. These powers make the gift a present interest for gift tax purposes.

The GST tax has its own rules, and not all gifts that qualify for the gift tax annual exclusion also qualify for the GST annual exclusion. For a trust gift to qualify for the GST annual exclusion, the trust must be structured as follows:

The trust must be for the benefit of a skip person (i.e., a gift to a grandchild), and such person must be the sole beneficiary during his or her lifetime; and
The trust assets must be includible in the beneficiary’s estate for estate tax purposes.

Many multi-beneficiary Crummey trusts meet the gift tax exclusion but fail the GST test—meaning gifts to those trusts may require use of your lifetime GST exemption to keep the trust GST tax exempt, even when no gift tax applies. Life insurance trusts (ILITs) are the most common example of trusts that fail the GST exclusion test. While contributions to an ILIT qualify for the gift tax annual exclusion, ILITs usually have multiple beneficiaries, requiring an allocation of GST exemption to safeguard the contributions and avoid GST tax.

If your focus is on immediate, flexible giving, a Crummey-style trust may work best. If your priority is long-term, multi-generational wealth transfer without GST tax, a GST annual exclusion trust might be the better fit—though it comes with tighter rules and only one current beneficiary. Some families blend both strategies, using Crummey trusts for flexibility while selectively funding GST-exempt trusts for future generations.

* As a reminder, you can make unlimited transfers for qualified education or medical expenses without incurring gift tax, so long as the payments are made directly to the school or medical provider.

The right approach depends on your goals, family structure, and the nature of the assets. If you’re considering how best to structure your annual exclusion gifts—or refine your current plan—our team can help design a strategy that balances flexibility, tax efficiency, and your legacy objectives.