The U.S. tax law contains something called the generation-skipping transfer tax (GST). The GST is intended to prevent the transfer of wealth from one generation to a person of two or more generations below the giver without paying federal estate or gift tax. The GST applies when transfers of property by gift or at death by a person to a person that skips a generation such as to a grandchild or great-grandchild and the value of the property transferred exceeds the estate/lifetime exclusion amount.
In the pre-GST days (before 1976), people could create a trust that provided that assets transferred to their children and their descendants and held in trust would benefit each generation as long as the child or descendant were alive (the trust equivalent of creating a life estate) and on the death of a child or descendant, the assets would continue to be held in trust for the next generation. Because all the beneficiaries only had an interest in the assets while they were alive and did not have a general power of appointment to designate who would inherit their beneficial interest in the trust on their deaths, the value of assets transferred in trust was never subject to federal estate tax. The GST was enacted into law for the purpose of closing this huge estate and gift tax loophole.
GST is a complex area, not for the faint of heart. For people who want to learn more about the GST, I recommend an article called “The Generation-Skipping Transfer Tax – A Quick Guide” by attorney Mark E. Powell. It’s written for lawyers and accountants, but it is also a good summary of the GST for lay people.