What Are Grantor Trust Rules?

The Internal Revenue Code (IRC) provides principles for grantor trusts, which may have tax ramifications. The grantor of a grantor trust is considered the owner of the assets and property kept inside the trust for income and estate tax purposes.

Knowing Grantor Trust Rules

These legal entities preserve the grantor’s (or originator’s) assets and income so recipients can receive them.

For instance, estate planning involves creating trusts to disburse assets to specified beneficiaries after the owner’s death. However, a grantor trust is any trust in which the grantor or owner controls income or assets.

Initially, grantor trusts provided a tax refuge for the rich. Tax rates are graded like income taxes. As trust income increased, personal income tax rates applied.

Though taxed as a personal account, the grantor received trust benefits, including money protection. Grantors might amend the trust and take money at will. The IRS created grantor trust requirements to prevent trust abuse.

The tax band for trust income rises faster than individual marginal income tax rates today. The maximum tax rate of 37% applies to trust income beyond $13,450 in 2022 or $14,450 in 2023.

Alternatively, if the trust were taxed at the individual rate, it wouldn’t be taxed at 37% until it earned $539,900 in 2022 or $578,125 in 2023. It takes less trust income to earn a higher tax rate.

Grantor trusts are no longer tax havens for affluent individuals after the IRS made adjustments. Still utilized today, grantor trusts may benefit the grantor based on their income, tax, and family status.

Grantor Trust Rules’ Benefits

Grantor trusts have various features that allow owners to use them for tax and income purposes.

Trust Income

Instead of the trust, the grantor’s income tax rate applies to trust income. Grantor trust regulations provide a tax shelter for individuals due to lower individual tax rates than trusts.

Beneficiaries

Grantors can alter trust beneficiaries, investments, and assets. They can also instruct a trustee to make changes. Trustee people or financial organizations handle assets for trust beneficiaries.

Revocable

Grantors can unilaterally revoke trusts if they are mentally competent during decision-making. This distinguishes grantor trusts from revocable living trusts. The owner, creator, or grantor can amend or cancel a revocable trust.

Changing Trust

An irrevocable trust allows the grantor to cede control, preventing amendments or cancellations without the beneficiaries’ consent. The trust will need a tax identification number (TIN) to pay taxes on its revenue.

Special Considerations

Trusts store owner assets in a distinct legal entity, among other objectives. Thus, trust owners should be aware of the possibility of its transformation into a grantor trust.

The IRS establishes exclusions to prevent grantor trust status. Suppose the trust has one beneficiary who receives the principal and income. Or if the trust has several beneficiaries who get principal and income via shareholding.

Grantor Trust Rules for Different Trusts

Grantor trust regulations specify when the IRS may regard an irrevocable trust as similar to a revocable trust in specific situations. These conditions can result in purposefully faulty grantor trusts.

In some circumstances, the grantor pays taxes on trust income, but trust assets are not included in the owner’s estate. If a grantor controls a revocable trust, they would still own trust property; therefore, such assets would apply to their estate.

An irrevocable trust transfers property from the grantor’s estate to the trust, effectively transferring ownership. People do this to leave property to relatives after death. In this situation, the property’s value may be subject to gift tax when transferred into the trust, but no estate tax is required upon the grantor’s death.

If the creator of a trust holds a reversionary interest higher than 5% of trust assets at the moment of asset transfer, the trust becomes a grantor trust.

Grantor trust agreements govern asset management and transfer after death. State law regulates the revocability and irrevocability of trusts and their repercussions.

Example Grantor Trust Rules

IRS grantor trust requirements include:

• Change or add a trust beneficiary
• Borrowing from the trust without security
• Power to pay life insurance premiums with trust income
• Ability to adjust trust composition by swapping equal-value assets

Conclusion

• The grantor of a grantor trust owns the assets and property for income and estate tax purposes.
• Grantor trust regulations govern several trusts.
• Revocable or irrevocable grantor trusts exist.
• The grantor must pay taxes on revenue from purposely flawed grantor trusts, but the assets are not theirs.