Grantor Trust: What It Is and How It Works

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What Is a Grantor Trust?

In a grantor trust, the person who creates it, known as the grantor, retains control over the investments and trust assets. Grantor trusts are subject to IRS regulations covering various aspects, including income tax liability, adding or removing beneficiaries, adjusting the asset composition, adding or removing assets, and borrowing against the trust. Individuals and families often choose these trusts to pass assets to their heirs while maintaining control over decision-making and incurring little to no estate and gift tax liability.

If you are considering setting up a trust for income tax and estate tax purposes, consider consulting our experienced and skilled DC trusts lawyer for up-to-date, local legal advice.

What Makes a Trust a Grantor Trust?

The Internal Revenue Code (IRC) lays out specific rules governing grantor trusts, defining their tax implications and operational guidelines. Under these regulations, the trust is not considered a separate tax entity.

A revocable trust is, by definition, a grantor trust. It can be modified or revoked by the grantor at any time. However, an irrevocable trust may only be considered a grantor trust if it meets the definition of grantor trusts in IRC §671 through §677.

According to the IRS grantor trust rules, if a trust’s grantor retains the following powers or privileges, it may be classified as a grantor trust for taxation purposes:

  • The power to replace the trustee

  • The power to substitute, use, or reacquire trust assets

  • The power to change, adjust, cancel, or end the trust agreement

  • The power to prevent the distribution of assets to the beneficiaries

  • The power to control and direct the trust’s income and investments

Most Common Types of Grantor Trusts

The following trust types are grantor trusts for income tax purposes:

Revocable Living Trust

A revocable trust is a type of grantor trust commonly used in estate planning. In a revocable trust, the individual creating the trust, known as the grantor, retains significant control and flexibility. They can make changes to the trust, including revoking it entirely, amending its terms, or adding or removing assets as they see fit during their lifetime.

Grantor Retained Annuity Trust (GRAT)

GRAT is an irrevocable trust used to transfer gifts to family members with minimal gift tax liability. It enables the grantor to receive annuity payments for a predetermined period. Once the period expires, the beneficiaries can receive the assets in the trust.

Qualified Personal Residence Trust (QPRT)

For those with sizable estates, a qualified personal residence trust (QPRT) exists. This is an estate planning tool that lowers taxes by transferring ownership of a primary or secondary residence to the trust.

Intentionally Defective Grantor Trust (IDGT)

IDGT is an irrevocable trust that treats the grantor as the owner of the trust’s assets for estate tax purposes and not income tax purposes. The grantor pays income taxes on trust income, but the estate incurs no estate taxes upon the grantor’s death.

Benefits of Grantor Trusts

Grantor trusts can be an addition to your estate plan. They come with a range of benefits, including:

Income Tax

Instead of being taxed to the trust itself, the income the trust generates is taxed to the grantor’s income tax rate. Individual tax rates are lower than those of trusts.

Beneficiary Flexibility

The trust’s investments and assets, as well as the trust’s beneficiaries, are all subject to change by the grantor. This provides flexibility for the grantor. A grantor can also instruct the trustee to make changes.

Changing the Trust

The grantor has the option to give up control of the trust. They can convert it into an irrevocable trust, which cannot be changed or revoked without the consent of the trust’s beneficiaries or a court order.

Irrevocable trusts will be responsible for paying taxes on the income they produce.

How Do Grantor Trusts Help With Estate Tax Planning?

The role of grantor trusts in estate tax planning depends on the type of trust you go for. However, you can expect the following estate tax benefits:

  1. Reducing Taxable Estate: Assets placed in an irrevocable grantor trust, such as a QPRT and IDGT, are typically removed from the grantor’s taxable estate. This means that when the grantor passes away, these assets are not subject to estate taxes. This can significantly reduce the overall estate tax liability.
  2. Freezing Asset Values: Some grantor trusts can “freeze” the value of assets for estate tax purposes. This can be particularly beneficial if the assets are expected to appreciate over time. By transferring them into the trust at their current value, any future appreciation occurs outside the taxable estate.
  3. Leveraging Gift Tax Exemptions: Grantors can use their gift tax exemptions to fund the trust. This allows them to transfer a substantial amount of assets into the trust without incurring gift taxes, effectively reducing the size of their taxable estate.

The benefits of grantor trusts are numerous. It is a good idea to contact your estate planning attorney in Washington, DC, to see if grantor trust planning could benefit you.

How Kevin C. Martin, Attorney at Law, PLLC, Can Help

Grantor trusts may be complicated, but the benefits they come with make them a must-have in any estate plan. If you want to transfer your assets to your loved ones with as little tax liability as possible, reach out to us at Kevin C. Martin, Attorney at Law, PLLC.

We can help you set up the right grantor trust to achieve your goals and preserve your legacy. We can also take care of your entire estate planning. Contact us today to schedule your free consultation!


Can a Grantor Be a Beneficiary of the Trust?

In some types of trusts, the grantor may also serve as the trustee, the beneficiary, or both.

What Happens to a Grantor Trust if the Grantor Passes Away?

When the grantor of a grantor trust passes away, the trust’s terms and provisions dictate what happens to its assets. The successor trustee, named in the trust agreement, takes over the management of the trust and ensures that assets are distributed to beneficiaries or heirs according to the grantor’s instructions.

If the trust is revocable, it may become irrevocable upon the grantor’s death, meaning that its terms cannot be changed.