Grantor Trusts

Individuals look at tax planning as one of the way to manage their wealth and estate planning. One of the most common options is the grantor trust. It is important to understand how grantor trusts work if you want to minimize taxes, protect assets and create stability. A grantor trust is an irrevocable trust where the creator (grantor) retains certain control or benefits from the trust. By adopting this structure, the classes of control and responsibility of the grantor are made flexible enabling management of assets that benefits the grantor and/or beneficiaries. Grantor trusts are frequently employed for tax planning, as well as asset and estate protection. In this article, we will take a look at how grantor trusts work, their advantages and things to think about when setting one up. A Grantor Trust is What? A grantor trust is one where the “grantor” has some powers like the right to revoke the trust. These powers might pertain to beneficiary changes, revocation of the trust, or dictating how the trust’s income is distributed. As a result of this control, the grantor will be treated as the owner of the trust’s assets for tax purposes, even though they are in the trust’s name. Grantor Trusts Types Revocable Grantor Trusts – A revocable trust, being the name implies that the grantor can make changes in the trust anytime during his lifetime.  The grantor may also change the beneficiaries or terms of the trust. People use such estates to avoid probate proceedings or the undergoing of probate. For an irrevocable grantor trust, the grantor cannot modify or revoke the trust without the consent of the beneficiaries. Regardless, the grantor has certain powers concerning the trust like controlling the income distribution of the trust. Grantor trusts are highly beneficial Tax Benefits: The income of the trust is charged to the grantor and may result in lower tax rates in some cases. Asset Protection: The assets rightfully belong to the trust, but since the grantor retains significant control, they are protected from certain creditors. Estate planning with a grantor trust allows the grantor to determine how and when their death is to be distributed and helps avoid probate on their death. What Do Grantor Trusts Do to Assist with Tax Planning? Typically used for tax planning purposes, grantor trusts are popular because the income is taxable to the grantor. This allows flexibility in management of tax payments especially in cases of wealthy individuals. Tax Effect A grantor trust means that the grantor will pay tax on any income earned by the trust’s assets. It can be beneficial in certain situations where the grantor trust is in a lower tax bracket than the trust would be as a separate entity. The grantor may apply any deductions available to them to offset income earned by the trust. For example, when a trust is set up and the grantor gets the income from the trust, they can report this on their tax return.  The grantor can utilize personal deductions, exemptions, and credits to minimize the grantor’s taxable income. Gift Tax Issues A transfer to a grantor trust may incur gift taxes if the asset transferred is valued. However, the grantor is still in control of the trust and may revoke the trust which means this transfer will not be a completed gift. As a result, the grantor’s annual gift tax exemption and the unified credit against estate and gift taxes can be utilized. Also, the grantor can avoid estate tax liability by gifting assets to the trust during their life. The grantor continues to be liable for the income taxes; however, the property in the trust is not included for estate tax purposes in the grantor’s estate. This provides the potential for reduction of estate tax liability based on death. Examining Grantor Trusts and Alternative Types of Trusts Grantor trusts are not the only trust in the estate planning toolbox. Knowing the differences between grantor trusts and other kinds of trusts can help you make an informed decision. Trust Type Control Retained by Grantor Tax Implications Flexibility Grantor Trust High (Grantor retains significant control) Income is taxed to the grantor Flexible, can be modified or revoked (in revocable trusts) Irrevocable Trust None (Grantor loses control) Trust is a separate taxable entity Limited, cannot be modified or revoked without beneficiary approval Living Trust Moderate (Depending on structure) Taxable to the grantor or the trust Flexible, can be revoked or amended by the grantor Testamentary Trust None (Created upon death) Taxed to beneficiaries after the grantor’s death Not flexible, terms established in the will Comparison of Trust Types Based on Control, Tax Implications and Flexibility If you want maximum control, grantor trusts are the best option as they give the grantor the highest level of control and flexibility over the trust assets and in making changes to the trust as needed. Irrevocable trusts do not provide control and flexibility to the client; however, they provide maximum benefit regarding taxes as they take the trust’s assets out of the grantor’s taxable estate, thereby serving as a tax planning tool for legacies. Living Trusts are like a Grantor trusts in that they provide control and flexibility during the grantor’s lifetime. In other words, living trusts are set up to help avoid probate, but not so much to save taxes. Creating a Grantor Trust: Easy to Follow Steps Creating a grantor trust needs planning and expertise in law. When establishing a grantor trust, here are practical steps to follow. The first step in setting up a grantor trust is consulting an estate planning attorney. An attorney specializing in trust law can help you estimate this trust. They can assist you in identifying which kind of trust is best for you. Choose the Trust Type: Decide whether you would set up a revocable or irrevocable grantor trust. How you like to give up control will depend on your financial goals. The trustee who will manage the assets in the trust should be chosen