Estate Planning attorneys often have misperceptions about “grantor trusts.” Certainly, clients understand them even less.
Grantor trusts are an income tax concept, not an estate tax concept. When a trust is a grantor trust, it is income taxed to the grantor, pursuant to sections 671 to 677 of the I.R.C. (If a trust is not a grantor trust as to the original grantor of the trust, then it may be taxed to a beneficiary if they had a general power of appointment, pursuant to section 678).
All trusts that are revocable are grantor trusts. But not all grantor trusts are revocable. Many trusts which are irrevocable are also grantor trusts. An irrevocable trust may include powers which trigger grantor trust status, if desired. A common power used to trigger such status is the power to substitute assets, which causes grantor trust status, but does not cause estate tax inclusion.
An irrevocable trust may or may not be a completed gift. For example, if the grantor retains a limited power of appointment over the trust, then the gift is not complete. That is because the grantor has not given up “dominion and control” of the assets, to use the language of the regulations.
Sometimes, an attorney would want an irrevocable trust to be out of the estate for estate tax purposes. However, they may still want the trust to be a grantor trust for income tax purposes. This would allow transactions between the trust and the grantor to be unrecognized for income tax purposes, like transactions between spouses.
It’s critically important to keep these concepts clear in your mind.
- A trust may be a grantor trust and included in the taxable estate;
- A trust may be a grantor trust and excluded from the taxable estate;
- A trust may be a non-grantor trust and included in the taxable estate; or
- A trust may be a non-grantor trust and excluded from the taxable estate.
Finally, a grantor trust, even an irrevocable one, may use the grantor’s social security number as the taxpayer identification number (EIN) for the trust. This is a common area of misunderstanding for financial institutions. If they want authority, send them to Treasury Regulation 1.671-4.
Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (800) 846-1555