Grantor Trusts can be a source of confusion for elder law attorneys and their clients alike. That’s because they are not a typical type of trust. The biggest difference to note about a Grantor Trust is that it is about how the trust’s income is taxed rather than who receives the income or assets of the trust.
In short, a Grantor Trust is a trust in which the grantor, or the originator of the trust, retains control over the trust. Therefore, the income is included in the income of the deemed owner (usually the grantor) rather than the trust or any other person. This distinction places Grantor Trusts into the "revocable" living trust category. The goal of establishing a Grantor Trust is to tax someone other than the recipient on the income that is generated by the trust.
Because Grantor Trust status is an income tax concept (rather than a gift tax or estate tax concept), it includes both ordinary income and capital gains. Grantor Trust status could apply to one type of income but not the other — it’s not an all-or-nothing proposition. A person can also have power over a fractional share of the trust, causing grantor status only as to that share.
A grantor usually acts as trustee of his own revocable living trust, retaining control over its income and assets. The grantor can appoint and change trust beneficiaries, and determine who who receives income from the trust. As the person making all of these decisions, he or she assumes the tax liability for the trust.
Types of Grantor Trusts
Because Grantor Trust is an income tax term, it’s not a term that elder law attorneys should be using with their clients. Instead, it’s helpful to understand the types of trust that fall under the Grantor Trusts umbrella.
These include Retained Interest Trusts, such as Revocable Trusts (or Living Trust), Grantor Retained Annuity Trusts (GRAT), and Qualified Personal Residence Trusts (QPRT). Grantor Trusts can also include Intentionally Defective Grantor Trusts (IDGT). An IDGT is a completed transfer to a trust for transfer tax purposes but an incomplete, "defective" transfer for income tax purposes.
Grantor Trusts are an effective estate planning tool. Revocable trusts are the most common type of Grantor Trust and can present opportunities for savings on estate or gift taxes.
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