Grantor Trust Rules Definition
There are certain guidelines in the Internal Revenue Code that define some tax implications of a grantor trust. These guidelines are called the “Grantor Trust Rules”. Based on these rules, an individual is held accountable for income for estate tax purposes if he/she is the creator of the grantor trust. This individual is also identified as the owner of the assets and the property held by the trust.
A Little more on What are Grantor Trust Rules
As per the rules, the assets and the investments within a trust are controlled by the grantor. For any income that is generated, tax is calculated based on the tax rate for the individual who is the beneficiary rather than the trust itself. This is favorable to the individual, as it offers tax protection to a certain level. Tax rates for individuals are more sympathetic as compared to the trusts.
Many trusts are revocable. Grantors of a revocable trust can modify the beneficiaries of a trust or they can assign a trustee to make any changes. This includes the change in investments and assets. As long as the grantor is mentally competent while making the decision, they can undo a trust. This is the identifying feature which makes it a type of revocable living trust.
The trust is considered an irrevocable trust if the grantor fully relinquishes the control of the trust. If this happens, then the trust pays taxes on any generated income. A tax identification number (TIN) will also be needed in such a case.
How Grantor Trust Rules Apply to Different Trusts
According to the grantor trust rules, under some conditions, an irrevocable trust can be treated by the IRS (Internal Revenue Service) in the same way as the revocable trust. This can result in the generation of a defective grantor trust.
When this happens, the grantor pays taxes on the income generated by the trust but the assets that are included in the trust are not included in the owner’s estate. These assets apply to the grantor’s estate for purposes of the estate tax. In this way, the individual will essentially own the property held by the trust. This is true for revocable trusts.
In an irrevocable trust, the property gets transferred to the trust from the owner’s estate. The trust then owns the property. This is carried out by individuals to make sure that upon death, the property is passed down to a family member. A gift tax on the property value is implemented in such cases. Upon the death of the grantor, no estate tax is due.
As per the grantor trust rules, when the assets are transferred to the trust, if the trust creator has a reversionary interest of more than 5% of the trust asset, then the trust becomes a grantor trust.
The asset management and/or transfer after the grantor’s death are defined by the grantor trust agreement.
Lastly, whether a trust is revocable or irrevocable, it is determined by the state laws. The implications of both are also defined by state law.
References for Grantor Trust
Academic Research on Grantor Trust
- · Reforming the Grantor Trust Rules, Soled, J. A. (2000). Notre Dame L. Rev., 76, 375. The grantor trust rules are basically same as the ones the Clifford Trust Regulations constituted, published 50 years ago. The IRC (Internal Revenue Code) ignores the separate identity of the trust while applying the grantor trust rules. The grantor owns the association of items e.g. income, tax credits and deductions. Thus, he cannot deflect the income away from himself to the trust, beneficiary or any other, whose income tax is applied at a less marginal rate. It is to protect the progressive rate arrangement of income tax.
- · The Grantor Trust Rules Should Be Repealed, Ascher, M. L. (2010). Iowa L. Rev., 96, 885. The GT (Granted Tax) Rules were crucial because they denied the separate status of the taxpayers and made the income taxable to the grantor directly, thus, limiting the benefits of income tax for the taxpayers, they could gain from creating particular living trusts. Then in 1986, Congress made the tax brackets more compact in section 1(e), applying a flat tax. The marginal rate was highest on essentially the whole income of the trust. Now, a settlor cannot derive any considerable income tax benefits from applying the tax on trust income at its own rates. Because the settlor, as well as the beneficiaries, do not have to go in an overtax bracket as compared to the trust. So, the grantor trust rules (GTR) are now obsolete. The taxpayers and the advisors, both, laugh at these so-called “Intentionally Defective Grantor Trusts”. They were complex and not more than a part of the gaming system. They had to be cancelled officially.
- · Foreign Investors: Using a US Grantor Trust, Masek, M. A. (1989). This paper shows, to get a US business or real estate, a “wealthy” foreign investor uses a grantor trust. With the foreign corporation, he can protect his US earnings by availing the “taxfree” interest applied to himself. The policy should make the foreign investors able to avoid the 30% withholding tax, which is levied on such interest. On the untimely death of the foreign investor, it should reduce the US estate tax.
- · Mineral Royalty Trust Transactions: The Use of the Grantor Trust to Avoid Corporate Income Tax, Gelinas, A. J. (1981). Tax. Tax L. Rev., 37, 225. This paper states how to use the Grantor Trust in order to stay clear from the Corporate Income Tax.
- · Income tax effects of termination of grantor trust status by reason of the grantor’s death, Blattmachr, J. G., Gans, M. M., & Jacobson, H. H. (2002). Journal of Taxation, 97(3), 149-149. This study addresses the status of grantor trust in case of death of the grantor and its effects on income tax thereupon.
- · The Accidentally Perfect Non-grantor Trust, Steiner, B. D., & Kapian, W. (2005). TRUSTS AND ESTATES-ATLANTA-, 144(9), 28. This research highlights the facts related to high income-tax on a taxpayer and he is going to gain larger investment benefits.
- · Taxpayers Get a Sigh of Relief: Congress Corrects Mistaken Interpretation of the Grantor Trust Rules by the IRS in the Taxpayer Relief Act of 1997, Denham, M. (1998). Tex. Tech L. Rev., 29, 181. This paper elaborates the Grantor Trust Rules as corrected by the Congress in Taxpayer Relief Act, 1997.
- · Assets of foreign grantor trust not includible in grantor’s US gross estate., Zink, W. J., & Ochsenschlager, T. P. (1994). Tax Adviser, 25(2), 84-85. This article contains information regarding the assets owned by the foreign grantor trust, which are not included in the grantor’s gross estate of the US.
- · When Is a Grantor Trust Not a Grantor Trust, Frost, S. G. (2000). J. Passthrough Entities, 3, 11. The study shows the conditions when the grantor trust is not regarded as a grantor trust.
- · Sale of limited partnership interest to an irrevocable grantor trust, Reardon, D. C. (2002). Journal of Financial Service Professionals, 56(5), 27. The paper reviews the IGT ( Irrevocable Grantor Trust) sale and the payment of interest.
- · The Private Annuity Sale to a Grantor Trust, Miller, S., & Schrader, D. S. (2004). J. Retirement Plan., 7, 19. This study explains the sale of business interests to the Grantor Trust, means the Private Annuity Sale.
- · Basis Step up for Grantor Trust Assets Not Included in Grantor’s Taxable Estate, Richman, L. I. (2013). J. Passthrough Entities, 16, 13. Estate planners identify transactions taxable between the grantors and the trusts. These entities cannot participate in any transaction for income tax. While the trust grantor is living, the basis of trustee and grantor is alike.