Intentionally Defective Grantor Trusts
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Learn how to effectively plan with intentionally defective grantor trusts and know the tax issues related to them.Intentionally, defective grantor trusts are a common topic of discussion among estate planners and are often promoted as an essential estate planning technique. For all their popularity, it can be difficult to understand why and how grantor trusts are created, not to mention why they are considered defective. This material will bring some clarity to the topic of grantor trusts and the reasons they form a foundation of many estate plans. Learn what triggers grantor trust status, why it might be to a client's advantage to do so, and when and how to avoid grantor trust status. This topic will also offer a brief history of grantor trusts, and an explanation of how the misnomer, defective, came to apply, along with some insight on possible changes to the rules regarding grantor trusts in the future.
AuthorsJonathan G. Blattmachr, InterActive Legal Vanessa L. Kanaga, Esq., InterActive Legal
What Is an Intentionally Defective Grantor Trust?
• Trusts Are Treated as Separate Taxpayers for Income Tax Purposes Under IRC § 641, Grantor Trusts Are an Exception to That Rule
• The Term Intentionally Defective Is a Misnomer Arising From the Historical Development of the Grantor Trust Rules
• The Effect of Grantor Trust Status Is to Treat the Grantor as the Owner of the Trust for Income Tax Purposes - What Does That Mean?
How Are Grantor Trusts Used in Estate Planning, and Why Might Someone Intentionally Create a Grantor Trust?
• Grantor Trusts Allow the Grantor to Shift More Wealth to the Trust, Gift Tax Free
• A Sale to a Grantor Trust Can Be an Effective Way to Leverage a Relatively Small Gift to Shift Income and Appreciation on an Asset to the Trust
• Other Advantages Include the Ability to Hold S Corp. Stock in the Trust, and the Ability to Reacquire Low-Basis Assets in Order to Obtain the Step-up in Basis Under IRC § 1014
How Is Grantor Trust Status Triggered?
• Grantor Trust Rules Are Found in IRC § 671-679 - Note the Spousal Attribution Rule Under IRC § 672(e)
• The Most Frequently Used Mechanisms for Intentionally Triggering Grantor Trust Status Are Found in IRC § 674 (Power to Control Beneficial Enjoyment) and § 675 (Administrative Powers)
• Other Powers That Frequently Trigger Grantor Trust Status (Intentionally or Not) Are Found in IRC § 676 (Power to Revoke) and § 677 (Income for Benefit of Grantor - or Spouse)
When Might It Be Better to Create a Non-Grantor Trust and How Do You Avoid Grantor Trust Triggers?
• In Some Cases, the Grantor Simply May Not Want to Pay the Income Tax on the Trust - Consider a Beneficiary Defective Trust Where Appropriate
• A Non-Grantor Trust Could Potentially Avoid State Income Tax or Obtain Additional State and Local Tax (SALT) Deduction for Real Property - Popular Techniques for Accomplishing This Are the Incomplete Non-Grantor or ING Trust and the SALTy SLAT
• Avoiding Grantor Trust Status Can Be Difficult Depending on the Terms of the Trust and the Identity of the Beneficiaries and Trustees; In Some Cases It May Be Necessary to Add Provisions Requiring Consent of an Adverse Party in Order to Avoid Grantor Trust Status
Is a Change in the Grantor Trust Rules on the Horizon?
• There Have Been Proposals to Include Grantor Trusts in the Grantor's Estate for Transfer Tax Purposes
• The Likelihood of Such a Change Is Unknown
• Consider Toggling and Decanting as Possible Ways to Change Grantor Trust Status in the Event the Rules Are Changed With Advance Warning