Grantor Trusts

Grantor Trusts

Of the many common types of trusts, the grantor trust is very popular due to its simplicity.

Generally, where a living trust is irrevocable, the trust will be treated as a separate taxpayer, which adds additional complexities and costs. The income of such a trust will be taxed according to the rate schedule for estates and trusts, which is extremely compressed--that is, it imposes high tax rates on very low levels of income. Furthermore, the trust and estate tax scheme does not allow for personal exemptions. Thus, in addition to the administrative burden, higher taxes are a very likely result.

Tip

Beginning in 2013, a new 3.8 percent net investment income tax may be imposed on individuals whose modified adjusted gross income exceeds $250,000 for joint filers, $125,000 for married taxpayers filing separately, and $200,000 for others. Trusts and estates with income over a certain amount are also subject to the NII tax. Form 8960, Net Investment Income Tax - Individuals, Estates, and Trusts is attached to the tax return. For 2013, the IRS has provided taxpayers the ability to rely on more than one set of net investment income tax rules. The best choice varies by taxpayers and depends on the taxpayer's unique situation. Consult your advisor to determine which approach would be best for you.

However, language can be used in the trust to make it a "grantor trust" under the IRS definition. In the grantor trust, the trust is not recognized as a separate taxpayer. Instead, the grantor reports the trust income on his or her personal income tax return, as if he or she owned all the trust assets personally and the trust did not exist.

This greatly simplifies the administration of the trust. At the same time, other precautions can be taken so that the trust still removes the assets from the taxable estate of the grantor. In short, the grantor trust takes advantage of exceptions to the separate income tax and estate tax rules that apply to trusts.

A popular form of grantor trust, often used for bank accounts, is called a Totten trust.

Warning

Planning to eliminate federal estate taxes requires special considerations and the services of an estate planning attorney. For example, in some situations an independent trustee may be necessary, or special language must be used in the trust when the grantor is also the trustee, to prevent the trust assets from being included in the grantor's taxable estate.

Tax Guide

Grantor Trusts