A skip generation generally refers to a generation two or more generation below a person. For example, a generation skipping trust is a trust that one generation sets up for the ultimate benefit of beneficiaries two or more generations below them. For example, grandparents may establish trusts which may make distributions to their children, but ownership and control goes to the grandchildren, the “skip” generation.
Because people can give property directly to their grandchildren and keep the property out of their children's taxable estates, Congress enacted the generation-skipping tax on lifetime or death gifts which skip a generation. There is a $2,000,000 exemption which increases to $3,500,000 in 2009. Married couples can treat a transfer as made one-half by each spouse, which doubles the exemption. Amounts over the exemption are taxed at the maximum estate and gift tax rate. There are additional rules for getting this exemption when the gift is made to a trust. The tax is in addition to the estate tax.
The tax applies to any transfer from a "transferor" to a "skip" person. A skip person is an individual or a trust. Individuals who are two or more generations below the transferor are skip persons. This includes grandchildren and great grandchildren and also grand nieces and grand nephews. A trust is a skip person only if no non-skip person holds an interest in it and only if no non-skip person may receive a distribution from it. If a transferor's child dies before the transferor the predeceased child's descendants are moved up by one generation.