Who Gets the Income From a Generation-Skipping Trust?

In a generation-skipping trust, income from the trust’s assets typically goes to the grantor’s children for the rest of their lives, and only after the last child’s interest ends does the income (along with principal, in most trusts) pass to the grandchildren or more distant descendants the grantor named. The trust document controls the order, and the trustee controls the timing and size of each payment. Despite the name, these trusts rarely cut the children out while they are alive.

The First Layer: The Grantor’s Children

A generation-skipping trust is an irrevocable arrangement built to move wealth to beneficiaries at least two generations below the grantor, usually grandchildren or great-grandchildren. In the most common structure, the grantor’s children are the first people to receive anything from it. They collect the income the trust produces (interest, dividends, and other earnings on the assets) for the rest of their lives.

What the children hold is called a present interest. They can take the income the trust generates, but they cannot reach the underlying principal. That boundary is the whole point of the design: the grantor provides for the children through the earnings while preserving the body of the wealth for the generations beneath them.

The Second Layer: Grandchildren and Beyond

Income shifts to the next layer of beneficiaries at a specific moment the tax code calls a taxable termination, which is the point when every non-skip person’s interest in the trust ends. In a typical family trust, that is the death of the last surviving child of the grantor.¹ After that, only skip persons remain, and the trust exists to serve them.

Federal law defines a skip person as someone assigned to a generation at least two levels below the grantor. For family, that means grandchildren, great-grandchildren, and more distant descendants.² An unrelated person can also be a skip person if born more than 37½ years after the grantor; the age gap stands in for a two-generation difference when there is no family relationship to measure against.³

Once the trust moves into this phase, the remaining beneficiaries receive income and, depending on the terms the grantor wrote, distributions of principal as well. The trust document decides which grandchildren or further descendants are entitled to what, and in what shares.

When a Grandchild Can Receive Income While a Child Is Still Alive

The two layers are not always sealed off from each other. A trustee can make a payment of income or principal to a grandchild while the grantor’s child is still alive and still receiving income. The tax code treats that payment as a taxable distribution rather than a taxable termination, because non-skip persons still hold interests in the trust.¹ Whether that is permitted at all depends on what the grantor wrote into the trust.

What the Trustee Decides

The trust document, not the beneficiary, sets the rules for how income actually comes out. Some trusts require the trustee to distribute all earned income at set intervals, such as monthly or quarterly. Those mandatory distributions give the trustee little room to adjust. Other trusts hand the trustee broad discretion to look at a beneficiary’s circumstances before deciding whether to pay anything at all, and if so, how much.

Many trusts use what is commonly called the HEMS standard, which limits the trustee’s distribution authority to a beneficiary’s health, education, maintenance, and support. Under that framework, the trustee weighs specific needs, such as a grandchild’s tuition, a child’s medical bills, or basic living costs, before releasing funds. The standard gives the trustee flexibility to respond to real needs, keeps beneficiaries from draining the trust, and keeps the trustee’s power from being treated as a general power of appointment for tax purposes.

If you are a beneficiary trying to understand what you will actually receive, the trust document is the first and most important place to look. “Income beneficiary” can mean a fixed quarterly check or it can mean a request-and-review process that depends entirely on the trustee’s judgment.

The Predeceased Parent Rule

One exception changes who counts as an income recipient and in which layer. Under the predeceased parent rule, if a child of the grantor dies before the trust is funded or before a taxable transfer occurs, that deceased child’s own children move up one generational level.⁴ Those grandchildren are then treated as if they sit in the generation immediately below the grantor, and they are no longer skip persons.

The practical effect is that those grandchildren can step into the role their parent would have held, receiving income directly without the generation-skipping transfer tax applying to what they get. The rule only reaches lineal descendants of the grantor; it does not do the same work for unrelated skip persons.⁴

What the Income Recipient Actually Keeps

Receiving income from the trust is not the same as keeping all of it. Two different taxes can reach the same dollar, and they fall on different people depending on which event triggered the payment.

Regular Income Tax

Beneficiaries who receive income from a generation-skipping trust owe federal income tax on those payments at their individual rates. The trust reports each beneficiary’s share on Schedule K-1 (Form 1041), and the beneficiary carries that income onto their personal return.⁵ Interest, dividends, capital gains, and other categories of income each flow through and keep their character on the way to the beneficiary.

Generation-Skipping Transfer Tax

On top of regular income tax, the generation-skipping transfer tax can apply at a maximum rate of 40 percent, depending on the trust’s inclusion ratio.⁶ Who writes the check depends on how the money came out:

If you are a skip person receiving a taxable distribution while non-skip persons still hold interests in the trust, you are personally responsible for the GST tax on what you received. The trust will not pay it for you unless the trust document specifically allows the trustee to do so.⁷
When a taxable termination occurs and the trust shifts fully to the skip persons, the trustee pays the GST tax out of trust assets before the beneficiaries receive what remains.⁷
On a direct skip (a transfer straight to a skip person outside the trust structure, such as a lifetime gift from a grandparent to a grandchild), the transferor pays. If a direct skip comes out of a trust, the trustee pays.⁷

If you are a grandchild and you receive a Form 706-GS(D-1) from a trustee, that is your notice that a taxable distribution was made to you and that the GST tax is yours to calculate and pay.⁸ A skip person who pays GST tax on an income distribution can deduct the portion attributable to that income on Schedule A (Form 1040) as an itemized deduction, which offsets some of the combined bite.⁵

Whether any GST tax actually applies to what you receive depends on how much of the grantor’s lifetime GST exemption was allocated to the trust when it was funded. A trust fully covered by exemption has an inclusion ratio of zero, and distributions from it carry no GST tax no matter how many generations the trust serves. A partially covered trust produces a fraction of the 40 percent rate. That allocation decision was the grantor’s to make; as an income recipient, you inherit its consequences.

1
Office of the Law Revision Counsel. 26 USC 2612 – Taxable Termination; Taxable Distribution; Direct Skip
2
Office of the Law Revision Counsel. 26 USC 2613 – Skip Person and Non-Skip Person Defined
3
Office of the Law Revision Counsel. 26 USC 2651 – Generation Assignment
4
United States Code. 26 USC 2651 – Generation Assignment
5
Internal Revenue Service. Instructions for Schedule K-1 (Form 1041) for a Beneficiary Filing Form 1040 or 1040-SR
6
Office of the Law Revision Counsel. 26 USC 2641 – Applicable Rate
7
Office of the Law Revision Counsel. 26 USC 2603 – Liability for Tax
8
Internal Revenue Service. Instructions for Form 706-GS(D)