Grantor Trusts

*In this post, I discuss the grantor trust and the potential estate planning benefits it can offer. *

The grantor of a trust, also known as the settlor of the trust, is the person who establishes the trust and contributes its initial property. A grantor trust, therefore, is a trust in which the grantor retains the power to control the operation of the trust after its establishment, including the direction of the trust’s income and assets. The IRS treats the grantor of such trusts as the owner of its assets and the recipient of its income, disregarding the trust for tax purposes.

Characteristics of a Grantor Trust

Sections 671 to 679 of the Internal Revenue Code define the conditions under which the trust will be considered a grantor trust. The presence of any of the following characteristics may result in the trust’s being so recognized by the federal government:

1. The settlor maintains the power to substitute assets within the trust for assets of equivalent value.
2. The settlor has a reversionary interest in the trust property.
3. The settlor maintains the power to control who can enjoy the property.
4. The settlor has the power to deal with trust assets for less than adequate consideration.
5. The settlor has the power to revoke the trust.

The presence of all of these characteristics is not necessary. In fact, merely one characteristic may be sufficient.

Types of Grantor Trusts

Both living trusts and irrevocable living trusts can meet these requirements.

One special type—which I will discuss in more detail in a future post—is the intentionally defective irrevocable grantor trust. These trusts are irrevocable trusts that are structured in such a way that the trust property is considered to be separate from the estate of the grantor for estate tax purposes but the income is still taxed as the income of the grantor for income tax purposes. These types of trusts can serve as a valuable estate-planning tool, though they can be quite complex to set up and administer.

Understanding the different types of trusts is important as you prepare your estate plan. When dealing with large estates, determining what property is considered part of a taxable estate, what property is considered a taxable gift, and what property is distinct from its original owner is critical.

Trusts are valuable estate-planning tools, but they come in many different varieties and some can be quite complex. The assistance of competent legal counsel is therefore critical is arranging an estate plan appropriate for your individual circumstances.

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See Also:

Irrevocable Living Trusts

The Living Trust