Grantor trust: What it is and a guide to how the rules work
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A grantor trust is a type of living trust in which the person creating the trust (the grantor) remains the owner of the assets and property in the trust for both income and estate tax purposes. A grantor trust is taxed at the grantor’s personal tax rate, which is usually lower than at trust tax rates.
Trusts can be particularly useful for individuals and families engaged in estate planning.
Here are the rest of the details on a grantor trust and how it compares to an irrevocable trust.
How does a grantor trust work?
A grantor trust is any trust that allows the grantor to retain full control over any investments or other assets held inside of the trust. Grantor trusts can be either revocable or irrevocable trusts. The grantor can make changes to the trust and the assets inside the trust as long as they are competent to do so.
The grantor is allowed to name a successor trustee(s) to take over the administration of the trust in the event they become unable to do so due to mental incapacity or other reasons. They will remain responsible for any taxes due on the trust, however.
The IRS has a set of grantor trust rules that specify how grantor trusts should operate, including how to add or change the beneficiaries, the ability of the grantor to change the composition of the trust’s assets, adding or subtract assets from the trust, who can borrow from the trust as well as other rules.
A grantor trust might be appropriate in a situation where the grantor wants to pass assets down to their children, but still wants to retain the decision making over these assets and the tax burden, during their lifetime.
If a grantor is taxed on their trust income at individual tax rates, then it’s more advantageous than being taxed at trust rates, which graduate to higher tax brackets much more quickly.
Types of grantor trusts
There are several types of grantor trusts, including:
- Revocable living trust: This is the simplest and most basic type of grantor trust. The grantor creates the trust and funds it by transferring assets into the trust. The trustee, which can be the grantor if they so desire, is responsible for managing the trust in accordance with the grantor’s wishes. As the trust is revocable, the grantor can terminate the trust or amend it at any time.
- Grantor retained annuity trust (GRAT): A GRAT is a type of irrevocable trust that allows the grantor to draw income from the trust. Assets are transferred to the trust and the grantor receives annuity payments for a set period of time. After that, any remaining assets revert to the trust beneficiaries.
- Qualified personal residence trust (QPRT): A QPRT is an estate planning vehicle that can be used to reduce taxes. With a QPRT, the grantor transfers ownership of a primary or secondary residence to the trust. This helps to avoid estate or other taxes and can be a good vehicle to transfer these assets if the grantor has a large estate.
- Intentionally defective grantor trust (IDGT): This is an irrevocable trust that treats the grantor as the owner of the assets in the trust for income tax, but not for estate tax purposes. The grantor would pay any applicable income taxes on the trust assets during their lifetime, but there would be no estate taxes due for their heirs. This type of trust can help minimize the impact of lifetime gift taxes and estate taxes for wealthier families.
Grantor trust vs. irrevocable trust
While some grantor trusts are, in fact, irrevocable trusts, the difference with a grantor trust is that it is a disregarded tax entity. This status means that any taxable income is attributable to the grantor during their lifetime, or at least until the assets in the trust revert to the beneficiaries. Here are some of the basic differences between a grantor trust and an irrevocable trust.
Grantor trust | Irrevocable trust |
---|---|
The grantor can reclaim assets from the trust. | The grantor surrenders control over the trust assets permanently. |
The grantor can serve as the trustee of the trust and manage the assets if they so desire. | A third party must act as the trustee. |
Income from the trust assets is taxed to the grantor at their personal income tax rate. | The trust files its own separate tax return and pays taxes at trust tax rates. |
In most cases, the trust’s assets are subject to estate taxes, though there are some exceptions. | The trust assets are not subject to estate taxes. |
The way in which the trust is formulated and the laws of the grantor’s state determine whether the trust is revocable or irrevocable. Even with grantor trusts, some forms are irrevocable.
Which trust should you create?
Whether a grantor trust, an irrevocable trust or some other type of trust is right for a particular situation will depend upon a number of factors, including:
- The age and situation of the grantor
- Whether or not the grantor wants to give up control during their lifetime
- The age and situation of the beneficiaries
- Taxes
When deciding what type of trust and whether or not a trust is the best way to go, it makes sense to consult with a financial advisor, a tax professional or an experienced trust attorney. In some cases, violating the rules of a trust you are trying to administer can be very costly from a tax perspective. Here’s how to select the best financial advisor for your situation.
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