Grantor Trusts

Grantor Trust – What is it?
 The purpose of a Trust is to create an “Artificial Legal Person” to protect, hold, and manage your private wealth for the benefit of your heirs.

 As in any contract, someone must initiate the contract (Grantor or Trustee). So the Grantor Trust is simply someone who has initiated the Trust. Read below for what is a Non-Grantor Trust.

 The contract (trust agreement) must specify the who, what, where, when, why, and other conditions.

 Finally, the contract is for the benefit of someone or something. In other words, the beneficiaries could be the wife, children, grandchildren, church, other charitable organizations, etc.  “Grantor Trusts” are not so much a type of trust as they are an income tax classification. A trust is considered a “grantor trust” if the settlor (grantor, trustor, trust creator) has certain powers over the trust or if others have too many powers over the trust that might be exercised in favor of the settlor. All taxable income that is paid to a grantor trust will be taxed to the trust’s settlor as if the settlor owned the income-producing assets.

Revocable Trusts: Revocable trusts are always grantor trusts, but irrevocable trusts are usually designed not to be grantor trusts. The most common type of revocable trust is a Revocable Living Trust, aka Revocable Family Trust.

Irrevocable Trusts: Because an irrevocable trust is usually designed not to be a grantor trust for income tax purposes, an irrevocable trust that is a grantor trust is sometimes thought to be “defective”, and so it is sometimes called a “defective grantor trust” (“DGT”) or an “intentionally defective grantor trust” (“IDGT”). Because of the benefits discussed below, some irrevocable trusts are designed to be grantor trusts, which makes them “intentionally defective”. Such trusts are designed to be grantor trusts for income tax purposes but excluded from the grantor’s  estate for estate tax purposes.

Irrevocable Trusts – Generally: There are a number of types of irrevocable trusts that can be used to make gifts to other persons with the assets under the control and management of a trustee.

 Gifts to an irrevocable trust are sometimes motivated by a desire to minimize federal transfer taxes or to shelter assets from the claims of  future creditors and other claimants (including spouses in divorce cases and plaintiffs in civil lawsuits). Many times irrevocable trusts are used to minimize the size of the estate in order to receive additional or supplemental benefits.

 To be effective for estate-reduction purposes, the trust must be irrevocable, and the trust’s settlor should not be a beneficiary of the trust. It is also best if the settlor is not a trustee, either.

 In order to qualify for the $11,000 annual exclusion for gift-tax purposes, irrevocable trusts usually contain a provision giving the trust’s beneficiaries a temporary right to withdraw annual contributions, at least in part. This withdrawal right is often called a “Crummey power” in reference to a Ninth Circuit Federal Court case involving a family with the “Crummey” surname.

o Paying the Tax: For many irrevocable trusts, the main purpose is to make a gift of property to the trust’s beneficiaries in order to shift the income, appreciation, and value of the property away from the trust’s settlor in order to reduce the settlor’s estate tax liability at his or her death. A grantor trust requires that the grantor pay all of the trust’s tax, which is yet another way of reducing the settlor’s estate. Because the payment of the tax is required by law, it is not considered a gift. Thus, some estate planning practitioners design their trusts as grantor trusts to take advantage of this ability to give the trust’s beneficiaries yet another benefit. Most grantor trusts are designed so that the trustee’s powers and the trust’s administrative provisions that cause the trust to be a grantor trust can be cancelled.

o Transactions with a Grantor Trust: Any transaction between the grantor trust and the grantor is treated for income tax purposes as having no tax consequences. One use of that trust is for business-succession planning.

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