A grantor trust is considered a “disregarded entity” by the IRS and comes with its own benefits, risks, and unique rules to consider.
Ready to start your estate plan?
Excellent
by Chloe Packard
Chloe is a San Diego-based writer with over a decade of writing and editing experience. She has partnered with both e...
Legally reviewed by Allison DeSantis, J.D.
Allison is the Director of Product Counsel at LegalZoom, advising and providing leadership to internal teams on the d...
Updated on: August 14, 2024 · 9 min read
A grantor trust is a type of trust in which the grantor is considered the owner of the trust assets for income and estate tax purposes, meaning that any income, deductions, or credits from the trust are reported on the grantor’s tax return.
Trusts like these are important elements of estate planning because they can help you manage your assets, facilitate transfer of wealth, and generate tax benefits. Trusts can be complicated, so let’s take a look at everything you need to know about grantor trusts, from what they are to how to implement them and what to discuss with your attorney.
A grantor trust is an estate planning tool that allows the grantor to remain in control of the trust's assets and oversee all income taxes associated with the trust.
The grantor of the trust is treated as the owner of the trust. They fund the trust with their assets, select who will receive those assets, and determine distribution instructions. It's important to note that grantor trusts are living trusts, so the grantor manages the trust over their lifetime instead of waiting until they die to distribute the trust assets.
Grantor trust rules state the grantor must report the trust's generated income, such as deductions and dividends, to the Internal Revenue Service using the grantor's own tax identification number. This is different from standard irrevocable trusts, which are treated as separate entities for tax purposes and require their own EIN. In exchange for this ability, grantors have to pay taxes on any income associated with the trust since the trust assets are considered taxable income rather than a separate tax entity.
Grantor trusts are unique in that the grantor oversees tax payments associated with the trust's income instead of passing it on to the beneficiaries, providing a tax shelter. Therefore, the trust is not subject to the gift tax, so the trust's beneficiaries can accept the trust assets without making any additional payments.
By far, the simplest type of grantor trust operates as a revocable living trust. After all, a revocable trust is a trust in which the grantor or trustee (who can be the same person) maintains control over the assets and can amend or revoke the trust at any point.
With a revocable trust, the grantor is responsible for reporting the trust income as personal income. Also, assets are considered part of the grantor's estate and subject to estate taxes after the grantor's death. Keep in mind that “revocable grantor trust” is a broad term that can describe many other, more specific types of grantor trusts.
The following three types of grantor trust in this list, however, are irrevocable—meaning that the rules and regulations by which they are governed are much stricter overall.
Also known as IDGTs, intentionally defective grantor trusts allow grantors to remove certain assets from their own estate by gifting or selling those assets to the trust itself. While this means that the grantor will need to pay personal taxes for any appreciation experienced by those assets, the structure avoids most types of estate taxes.
In many ways, intentionally defective grantor trusts walk the line between irrevocable and revocable trusts, with risks and benefits taken from each. One benefit, for example, is the “swap power,” which allows a grantor to substitute assets within the trust for other assets of equal value.
That said, this type of grantor trust is one of the more complicated estate planning tools available, so it’s important to speak with a qualified estate planning expert for help setting it up. If possible, find an attorney who has created IDGTs in the past.
Grantor retained annuity trusts, or GRATs, are a unique structure of grantor trust that establishes a regular annuity payment to be paid to the trust’s grantor across a fixed time period.
When the GRAT is created, these annuity payments are calculated using the total value of the trust’s assets and the IRS’s Section 7520 interest rate. These annuity payments can be structured to increase over the life of the trust, decrease over the life of the trust, or remain static.
Regardless of how it is structured, annuity payments are made using the assets within the trust itself, with any appreciation of those assets passing to the beneficiaries tax-free. When the GRAT ends (as determined by a timeline decided at its creation), any leftover assets not used to make annuity payments will pass to the beneficiaries.
Qualified personal residence trusts allow the grantor to transfer their primary residence into the trust while living there rent-free, a period known as the “retained interest” period. This setup allows the grantor to reduce eventual gift taxes, with the amount reduced depending on how many years they live in the residence once the trust has been established.
Additionally, a QPRT effectively removes the residence from the grantor’s estate, meaning that eventual estate taxes may be significantly reduced. This is especially useful if the residence in question is expected to appreciate throughout the lifetime of the trust, as any such growth happens without traditional estate taxation
The IRS has outlined grantor trust rules in the Internal Revenue Code (IRC). The following are a few examples of the IRC grantor trust rules outlined in Sections 671 through 678:
The trust's generated income is typically taxed at the grantor's income tax rate instead of the trust's tax rate
A grantor trust is not a separate entity, so the grantor must claim all income generated through the trust, including deductions, dividends, and credits on their personal income tax return, using their own tax identification number
A grantor can amend a revocable trust at any time. This includes changing the terms and conditions, trustees, beneficiaries, and investments
A grantor can terminate a revocable grantor trust at any time as long as they're considered mentally competent, but needs to go through standard process to terminate an irrevocable one
A grantor can borrow from the trust or even reclaim the assets
A grantor can relinquish control and make the trust irrevocable, meaning they no longer have the power to amend or revoke it
There are several advantages to setting up a grantor trust. Some grantor trust benefits include the following:
Estate planning advantages. The grantor has complete control of the assets transferred and can amend, alter, or revoke a revocable trust.
Tax advantages. The grantor can achieve more favorable income tax rates on the income generated in the trust and prevent the beneficiaries from paying any income tax on the assets. Also, if it's an irrevocable trust, the beneficiaries can bypass estate taxes when the grantor dies.
Probate process avoidance. Revocable trusts don't have to go through the probate process, which can be a costly and lengthy court procedure.
Strategic distribution of assets to beneficiaries. Because the grantor covers the income taxes and the gift tax doesn't apply, the trust assets can grow tax-free. In turn, the beneficiaries can enjoy tax-free income from the trust, essentially increasing their wealth.
Before setting up a grantor trust, it's crucial to understand everything this kind of trust involves, from tax implications to grantor responsibilities. When following the steps to setting up a grantor trust, we recommend consulting with an estate planning attorney or financial advisor and taking advantage of our trust services to ensure your grantor trust is compliant and legally sound.
The first step involves determining what assets you want to set aside for the grantor trust. These can include cash, bonds, stocks, bonds, and investments, as well as real estate, personal property, life insurance premiums, and business interests.
Next, you must decide on your trust's beneficiaries or those who will receive your assets. You can select just one beneficiary or name several, such as your spouse and children.
A trustee refers to the person who manages your grantor trust. In the case of a revocable trust, you can be the trustee, or you can appoint a trustee to oversee those responsibilities. Either way, it's important to select a successor trustee who will step in if you become incapacitated or when you die.
Now, it's time to establish the terms of your grantor trust. This involves setting certain conditions or instructions for the distribution of your assets. For example, you could determine trustee powers, like allowing them to make certain investment decisions, and declare distribution provisions, such as how and when the beneficiaries receive their assets.
Even after doing your due diligence and researching grantor trusts, you may be unsure if they’re right for you. In these cases, we suggest reaching out to a qualified attorney for estate planning advice. These experts can answer your questions, review your specific circumstances, and give you straightforward advice about the best path toward securing your legacy.
The grantor of a trust is the person who created and owns the trust. The IRS determines that the grantor retains control over the trust's income and assets and is responsible for paying the income taxes on the trust.
Yes, if the grantor trust is a revocable living trust, then the grantor has the right to amend or terminate the trust at any time.
However, if the grantor trust is an irrevocable trust in which the grantor relinquishes control over it, then the grantor cannot revoke or make changes to it. That said, there are some circumstances in which the trustee may have certain powers to revoke or modify the trust.
If it's a revocable trust, the successor trustee will take over the trust when the grantor dies. The grantor's remaining assets will become part of the grantor's taxable estate, and estate taxes will be imposed.
If it's an irrevocable trust, then the trustee would continue managing the trust. However, with this type of grantor trust, the remaining assets would remain separate from the estate and avoid estate taxes.
Estate planning is a complicated process, and you very well may decide that a grantor trust doesn’t fit your needs. In that situation, consider looking at other types of trusts or speaking with a qualified estate planning attorney to help explain your options.
You may also like
10 Questions to Ask an Attorney About Living Trusts
Find out what to ask your attorney about living trusts so you get the most out of this powerful document.
September 13, 2023 · 4min read
Living trust: Trustor vs. trustee
Are you thinking about setting up a living trust? If so, you need to understand the difference between the trustor and trustee, how the two are related, and the role of each.
February 6, 2023 · 3min read
Using an intentionally defective grantor trust to protect your assets
An intentionally defective grantor trust (IDGT) is an estate planning tool that can help preserve your assets for your beneficiaries. Get the details on how they work—and how they might save your beneficiaries from paying exorbitant estate taxes.
February 2, 2023 · 4min read