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Debate: Should Congress Tighten Tax Rules on Grantor Trusts?

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The $2.1 trillion tax plan approved by the House Ways and Means Committee in mid-September contains significant estate planning changes that would affect grantor trust rules.

A grantor trust is one where the trust creator (the grantor) and the trust are treated as one for income tax purposes. Many trust structures fall into this broad category of trusts, which are typically used to transfer wealth during life to avoid estate taxes.

The proposal provides that assets transferred into a grantor trust created after the date of the act would be included in the grantor’s estate for estate tax purposes. If the grantor ceases to be the owner of the trust during life, the trust assets would be treated as though they were transferred by gift from the grantor for gift tax purposes (distributions would also be treated as gifts for federal gift tax purposes).

We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions about the proposed changes to the grantor trust rules.

Below is a summary of the debate that ensued between the two professors.

Their Votes:

Bloink

Byrnes

Their Reasons:

Bloink: Grantor trust structures are one of the most common planning tools that the most wealthy Americans use to avoid paying their fair share of federal income taxes. They’re able to get away with it because they have assets that far exceed what they’ll actually need for living expenses — a luxury that the average American doesn’t have. 

We need a system where these trust assets are taxed at some point. Treating grantor trust assets as though they were owned by the grantor for estate tax purposes and gift tax purposes makes absolute sense. After all, those assets are already treated as owned by the grantor for income tax purposes in many cases. 

Byrnes: If enacted, this proposal wouldn’t function the way that Democrats think it would. This is the type of proposal that would merely create an incentive for wealthy Americans to develop or use alternative strategies to remove assets from their estate. This proposal would affect grantor retained annuity trusts (GRATs), installment sale arrangements and many other valuable planning techniques that we currently understand — meaning that new techniques will simply be developed to take their place. 

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Bloink: In reality, grantors often retain true control over their trust assets even if they’re transferred to these trusts because of the ways that the trust can be structured and, of course, the identity of the beneficiaries. The average American doesn’t have the luxury of creating an inheritance for heirs while they’re still alive. After all, they need their funds to live — and those funds are taxed accordingly. These grantor trusts are yet another way the wealthy can avoid taxes. 

Byrnes: It’s important to note that this proposal wouldn’t even apply to current grantor trusts, meaning that we would have a two-track regime where the treatment of the same trust would differ depending upon the date of creation. All existing grantor trusts would be grandfathered in, regardless of whether they were created to minimize tax liability. In other words, this proposal would merely create more complications that our tax system simply doesn’t need. 

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Bloink: Wealthy Americans have access to a seemingly endless array of trust structures from which to choose. That’s what complicates the system. Eliminating the tax benefits of those various trust structures would go a long way toward simplifying our tax system.

Byrnes: We’re talking about trusts where the grantor relinquishes control of the assets, at least for a period of time, which is why transfer to the trust can have the effect of removing those assets from the estate. Whether or not that’s how the system truly functions — for legal purposes, this is exactly how it functions, so it’s not fair to then tax that individual on the value of assets they no longer possess. 

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