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A grantor trust is a trust in which the creator of the trust (known as the grantor) retains authority over the trust, which makes the trust’s income taxable to the person who set it up.

The primary advantage is that it moves assets out of your client’s estate, although they are still responsible for the income tax the trust generates. It can also under certain circumstances keep an estate out of probate. 

Here are some of the key facts you should know about grantor trusts.

1. Certain qualities are necessary to make a trust into a grantor trust.

A grantor trust is any trust in which the grantor is considered an owner of its assets, or any portion of them. A non-grantor trust is considered a separate tax entity, and the trust itself has to pay taxes on any income it earns. A trust is considered a grantor trust if the grantor retains certain powers, such as any of the following:

  1. To change the trust’s beneficiary.
  2. To borrow from the trust.
  3. To change the assets in the trust by substituting assets of equal value.
  4. To pay life insurance premiums from the trust’s income.
If you as the grantor can do any of these things, it’s a grantor trust.

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2. What is the most common purpose of a grantor trust?

The typical purpose is to transfer as many assets as possible to others to minimize the grantor’s estate taxes. Transferring assets to the trust is considered complete for estate and gift tax purposes, but incomplete for income tax purposes, meaning the grantor is still responsible for paying any income tax that is incurred by those assets.

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3. This tax treatment can be beneficial for the assets in the trust.

Since the tax on the trust income is paid by the grantor, this can be considered an additional transfer of wealth to the trust that is not subject to gift tax. In other words, the appreciation in assets moves out of your estate as well. Keep in mind that since the trust is receiving the income, you as the grantor will have to be able to cover the income tax payments from other sources of income.

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4. A trust can have more than one grantor.

If several people have funded the trust, they will each be treated as grantor in proportion to the value of the cash or property that they transferred to the trust.

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5. Most grantor trusts are structured as irrevocable.

This affords the grantor the full benefits of removing assets from their estate. There is, however, a very good reason you may want to structure it as revocable.

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6. A grantor trust can help you avoid probate as long as it’s revocable.

When you put assets into a revocable trust, the revocable trust owns the property. After you die, the revocable trust still owns the property, and it gets distributed according to your instructions. Since the assets no longer belong to you, there’s no need for a court to be involved.

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7. And if it’s a revocable trust, you can make changes to a grantor trust after it’s been established and funded.

You can change the beneficiaries of the trust, terminate it, or even change it from revocable to irrevocable.

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8. If it becomes impossible for you to pay the income tax on the trust, you have options.

Most grantor trusts are structured to allow the grantor trust status to be turned off. This can relieve you of the obligation to cover the income tax payments.

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9. These trusts may be going away.

The Build Back Better Act proposed last year would have made all grantor trust assets includable in the grantor’s estate, and would have made transfers from the trust to anyone other than the grantor in their lifetime subject to gift tax. That legislation has not passed and may not pass, but if it does, all of these grantor trust provisions could be in jeopardy.

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10. But this applies only to trusts that will be created in the future, after the law is passed.

So if you’re considering a grantor trust to protect your assets from estate tax, you may want to move on it sooner rather than later.

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