What is a Grantor Trust?

In simple terms, a Grantor Trust is a trust in which the grantor, the creator of the trust, retains one or more powers over the trust and because of this the trust’s income is taxable to the grantor.

In some cases, a trust can be treated as a grantor trust when a third person, nonadverse to the grantor, holds an interest or control over the trust that can be attributed to the grantor (ex. the grantor’s spouse). Although a trust may be considered a grantor trust for income tax purposes, it may nonetheless be outside of the grantor’s estate for estate tax purposes (depending on the powers retained by the grantor).

Powers that Make a Trust a Grantor Trust
Most Common Types of Grantor Trusts

Powers that Make a Trust a Grantor Trust

The powers listed below are examples of powers that, if retained by the grantor, should cause a trust to be treated as a Grantor Trust for income tax purposes:

  • a reversionary interest in either the corpus or the income of the trust
  • if the beneficial enjoyment of the corpus or the income from the trust is subject to a power of disposition by the grantor without the approval or consent of any adverse party
  • certain administrative powers exercisable by the grantor for the benefit of the grantor rather than for the trust beneficiaries, or powers exercisable in a nonfiduciary capacity, including:
    • the power to deal with trust assets for less than full and adequate consideration
    • the power to borrow trust assets without adequate interest and security
    • other powers exercised in a nonfiduciary capacity by any person without the approval or consent of any person in a fiduciary capacity, including:
      • power to revoke by the grantor (or grantor's spouse)
      • power to substitute assets of equal value
      • power to add charitable beneficiaries
  • if income from the trust is used, without the consent of an adverse person, to pay the premiums on a life insurance policy on the grantor’s (or grantor’s spouse’s) life, at least to the extent of such income.

Most Common Types of Grantor Trusts

Examples of common types of Grantor Trusts include:

Retained Interest Trusts

  • Revocable Trust (also known as a Living Trust)
  • Grantor Retained Annuity Trust (GRAT)
  • Qualified Personal Residence Trust (QPRT)

Intentionally Defective Grantor Trust (IDGT)

An IDGT is a completed transfer to a trust for transfer tax purposes but an incomplete, "defective" transfer for income tax purposes

  • the trust can be outside of the grantor’s estate for estate and gift tax purposes if the grantor has not retained any powers that would cause estate tax inclusion
  • the future value of the assets transferred are removed from the grantor's gross estate on the date of the trust's funding
  • due to one of the above powers retained by the grantor, the trust is treated as a Grantor Trust for income tax purposes
  • the grantor, not a beneficiary, is taxed on all the trust's income, even though he or she is not entitled to any trust distributions

Grantor Trusts are a valuable estate planning tool, with revocable trusts being by far the most common type, and can offer significant possibilities for estate or gift tax savings. Clients should consider the importance of these trusts in their estate plans.