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What is a Grantor Trust?

Updated: January 13, 2023

Est. Reading: 6 minutes

Grantors' trusts are governed by the IRC which outlines certain tax issues related to them. Under these laws, the person who creates a grantors' trust is recognized as the true "beneficial" holder of the assets and properties held within the trusts.

The Basics of How Grantor Trusts Work

An irrevocable grantor trust is any type of trust where the status cannot be changed for tax purposes after creation. Irrevocable grantor trusts can be created for both personal and business purposes.

If the grantor becomes mentally incapacitated, he/she may appoint one or more successors to act as trustees. However, the grantor remains liable for any tax obligations related to the trusts.

Grantors Trust Rules include rules for how grantors must operate their grantor's trust, including how they may add or change the beneficiaries of the trust, whether the grantors can change the trust’s asset mix, how the grantors can add or remove assets from the trust, and grantor trust rules.

If you want to give away some of your assets to your kids without having them pay income tax purposes on them, then a grant deed may be an option for you.

If a grantee is taxed on its trust income at an individual tax rate, then it’d be better for them to be taxed at an individual tax rate rather than a trust tax rate, which would result in lower taxes. You can always get a non-grantor trust.

Identify the Grantor

A trustee is someone who manages assets for another person.

Multiple Grantors

If there were several people who contributed funds to a trust, then each would be considered a grantee in relation to the total amount of cash or property that was contributed by each individual.

a man discussing a grantor trust with an attorney

Foreign Grantors

Under the grantee-grantors rule, if a foreign individual is treated as the owner for purposes of determining whether an interest passes from the donor to another party, and the interest passes to a U.S. citizen who makes gifts directly or indirectly to the foreign individual, then the citizen will be treated as the donor of the interest to the foreign individual.

Powers Held By a Spouse

With respect to the grantors' rights, the grantee of a trust is considered to own any power or interest held by his/her spouse. They will have control over the trust, but they are not the creator of it.

Different Types of Grantor Trusts

You should consider creating a grantee trust if you want to protect trust assets from creditors, pay taxes, or provide liquidity for beneficiaries. A grantee trust allows you to transfer property or trust assets into an irrevocable trust without having to worry about probate court proceedings.

However, a grantee trust does not allow you to avoid paying income tax on any distributions made to beneficiaries. You will have a trust deed (administrative powers/administrative control) to determine what will happen to the trust property. There are four types of trusts. These are the types of trusts:

An Irrevocable Living Trust

An irrevocable Living Will (also known as an "irrevocable" or "unconditional" Will) allows you to name yourself as the executor of your trust assets and transfer of assets. In addition, you can appoint another person to serve as the Executor of your estate if you die without having named anyone. An irrevocable Will also lets you leave money to certain people who aren't related to you. For example, you could leave money for trust distributions to your favorite charity or for your dog.

Grantor Retained Annuity Trust (GRAT)

An irrevocable grant deed (GRAT) is a type of irrevoca­ble legal instrument used to create an asset-based annuity. When creating a GRAT, you transfer assets into the GRAT and then start receiving annuities from the GRAT for a specified period of time. After the time expires, any remaining assets in your GRAT will be distributed to its beneficiaries.

Qualifying Real Estate Trust

A Qualified Personal Residence (QPR) is a type of estate plan that can help you lower your federal and state tax bill by excluding certain assets from your taxable earnings. You may use a QPR for any property that you own outright or rent out. If you're considering using a QPR, here are some things to consider. You can transfer ownership and exclude the value from taxable income. This is a good trust for estate tax purposes. The assets in a trust are included for estate tax purposes, not a trust for income tax.

Intentionally Defective Grantor Trust (IDGT)

A deliberately defective grantor-settlor irrevocable trusts (IDITs) is another type of irrevocable trust. It is similar to an irrevocable grantor-settlor testamentary trusts (IGSTs), except that IDITs treat you as the asset owner instead of the beneficiary. For example, if you own a house worth $1 million, then you would owe taxes on the full value of the home. However, if you set up an IDIT, you could transfer ownership of the property to the trustee without having to worry about paying any capital gains taxes. You also wouldn’t have to worry about paying inheritance taxes because the property would no longer belong to you. The right type of trust can help you.

Changing the Trust and Grantor Trust Rules:

A revocable trust allows the grantors to retain control of the assets within the trusts until they die. If the grantors want to give away their assets before death, they must use a revocable living trust. Revocable living trusts allow the grantors to keep control of the assets within them until they die. They may transfer these assets into another type of estate planning tool called a testamentary gift.

Pros and Cons

On the positive aspect, the main benefit of incorporating a grantor-retained annuity into your estate planning strategy is the ability to hold onto wealth while reducing your overall taxable estate. Usually, you're better off from a taxation standpoint when paying taxes on an asset at your own personal rate rather than letting the entity pay taxes. The lower you pay in taxes on the asset, the better if you're concerned with preserving as much of your wealth.

Grantor-type structures allow you to set up different kinds of asset protection strategies. For example, you can create a grantor-type structure to hold an asset for long-term purposes, such as retirement. Or, if you want to shield an asset from creditors during a legal dispute, you can establish a grantor-type entity. And, because these entities don't go through the lengthy and often costly probate process upon death, they're ideal for estate planning.

a man meeting with an attorney to discuss a grantor trust

Establishing a Grantor Retained Annuity Trust (GRATs) has one major consideration, but it doesn't assume that you have the necessary funds to pay taxes on the assets held within the GRAT. If you receive a large capital gain from the assets held within the grantor-retained annuity trusts, for example, that could cause problems at the end of your life if you don't have enough money to cover your new income taxes.

The proposed changes to the tax code regarding grantors' estates could mean that some people who create grantors' estates may want to consider transferring their assets into a revocable living irrevocable life insurance (RLII) policy instead.

However, there is an upside too. If you have a Grantor Retained Annuity (GRA), you do have the option to terminate your GRA status if necessary.

When Should You Get a Grantor Trust?

Whether it makes any difference whether you set up a grantor or revocable living trust largely comes down to your personal circumstances. If you have a lot of assets and you want them to go to your children rather than the government, then setting up a grantor or a revocable living trust may be the best option for you. However, if you don't have a lot of assets, you probably won't benefit from establishing either type of trust.

You don't need to set up a revocable living trust if you're not going to be leaving anything behind. However, you might want to consider talking to an estate planning attorney first so they can help you determine which version of a grantor living trust would work best for your situation. They can also help guide you through the decision-making process.

Contact a trust planning attorney at Monahan Law Firm PLC to go over a trust grantor and the type of living trust you can have. Call (623) 300-2727 today to book a consultation for your grantor trust agreement and the obligations on trust assets.

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Attorney Patrick Monahan

Patrick Monahan

Patrick Monahan is the managing partner of Monahan Law Firm, PLC. Patrick began his legal career practicing real estate, construction, and general business litigation.
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