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Klenk Law

Grantor Trusts

What is a Grantor Trust?

The person who forms a trust is called the “Grantor.” So, every trust has a Grantor. But, not every trust is a Grantor Trust.

A Grantor Trust is an Irrevocable Trust or Revocable Trust where the Grantor retains so much control that the IRS deems him responsible for the trust’s income taxes, even though the Grantor no longer owns the assets.

For example, a Revocable Living Trust is a Grantor Trust because the Grantor retains the right to revoke and take back the trust’s assets. So, the Revocable Living Trust owns the trust assets, but the Grantor reports any income created by those assets on his income tax return.

Another example is the Intentionally Defective Grantor Trust (IDGT). The IDGT is an Irrevocable Trust where, for strategic reasons, the Grantor decided to retain certain powers, so the Grantor pays the trust’s income tax.

What is an Intentionally Defective Grantor Trust?

The Grantor Trust rules were created to punish Grantors who retained to much control. The punishment is forcing the Grantor to recognize the trust’s income as his own. Sometimes, though, this is a strategic advantage. When the Grantor creates a trust and strategically and intentionally triggers the Grantor Trust Rules, the trust is called an “Intentionally Defective Grantor Trust.”

What is the Purpose of an Intentionally Defective Grantor Trust (IDGT)?

A typical IDGT plan involves a parent giving assets to an Irrevocable Trust for children. The Grantor controls the trust’s terms and retains certain powers. Congress and the IRS viewed these terms as keeping too little control to make the gift incomplete. So the trust does own the assets, but the control is so much that the IRS punishes the Grantor by having him pay the trust’s income tax. The Grantor views this not as punishment, but as a blessing. The Grantor now pays his children’s income taxes, but it is not a “gift” for GiftTax purposes. It is “punishment,” not a “gift.” This way the parent does not use his gift tax exclusion and the trust grows “tax-free” for his children.

Because the trust is designed purposefully to trigger the income tax to the Grantor, it is called an Intentionally Defective Grantor Trust.

Intentionally Defective Trust Advantages

The pros of the intentionally defective grantor trust are:

  1. Estate Freeze: the future growth within the trust is not part of the grantor’s estate.
  2. Tax-Free Growth: because the grantor pays the tax as his own, the trust grows tax-free.
  3. Asset Protection: the trust shelters assets from the grantor’s future creditors and divorce as well as the children’s creditors and divorces.
  4. Leveraging Gifts: because the income tax payment is not a gift, each payment does not reduce your gift tax exclusion.

Typical Estate Questions About Grantor Trusts:

Here are some questions clients, beneficiaries, and Trustees ask:

Can I 'Turn Off' the Grantor Trust?

Yes, your Grantor Trust Attorney can draft provisions allowing the Grantor Trust status to end.

Is a Revocable Living Trust a Grantor Trust?

Yes, a Revocable Living Trust is a typical example of a Grantor Trust. The Grantor retains so much control, the trust assets are treated as being the Grantors.

Can I be the Grantor and the Trustee?

You can be both Grantor and Trustee, but this can expose the trust to creditors and taxes.

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If you have any questions about Grantor Trusts or any other estate planning topics, please contact us to schedule a free consultation. For more than two decades Klenk Law has focused only on Estate Law. We’ve seen it all, and this experience allows us to explain complex estate law and planning techniques clearly and concisely. We make it easy for you to understand Grantor Trusts so you can make the best decisions for yourself and your family.

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