What Is a Grantor Trust?

Definition and Example of a Grantor Trust

The term "grantor" describes any trust where the person who creates it is treated as the owner of its property and assets for both income and estate tax purposes. This makes them revocable living trusts. The grantor normally acts as trustee and retains control over the trust's income and assets.

• Alternate name: Revocable trust

If you want to start passing money on to your children, but you do not want them to assume the tax burden or make decisions regarding the trust, you could put the money in a grantor trust. Even though the assets will eventually go to your children, you'll still retain control over the trust as long as you have the mental capacity to do so.

How Does a Grantor Trust Work?

Grantors can amend revocable grantor trusts and make changes to them at any time as long as they remain mentally competent. They can name or change the trust's beneficiaries, manage stock options for the trust, and control trust fund investments. They can also undo or revoke this type of trust. Any income is taxed to their grantors personally because grantors personally reserve these rights.

Suppose you've set up a grantor trust, and you've funded it with interest-bearing assets. You've transferred ownership of these assets into the trust's name. They generate $10,000 in income over the course of the year. It also costs the trust $1,000 in tax-deductible costs to maintain and manage them.

This income would be reported, and the deductions would be claimed on your personal Form 1040 tax return under your own Social Security number. The trust would not be required to file its own return.

Grantor trusts automatically convert to non-grantor trusts upon the death of the grantor because the grantor is no longer alive to file a tax return. Any distributions made by the trust at that time would be taxable to the beneficiaries who receive them.

Types of Grantor Trusts

A trust doesn't absolutely have to be revocable to be a grantor trust. An irrevocable trust can be treated as a grantor trust for tax purposes when the grantor meets Internal Revenue Code requirements to become the owner of the assets. The irrevocable trust can be disregarded as a separate tax entity in this case, and the grantor will be taxed for all its income.

Irrevocable trusts are referred to as "intentionally defective grantor trusts" (IDGTs) when they treat the grantor as the owner for income tax purposes, but not for estate tax purposes.

The grantor reports trust income on their personal return in this case and pays any taxes due just as if the trust were revocable, but the trust assets aren't included in the grantor's estate for estate tax purposes when they die. This is a major advantage not shared with revocable trusts.

Grantor Trusts vs. Other Irrevocable Trusts

The grantor of an irrevocable trust that doesn't qualify to become a disregarded tax entity permanently gives up ownership and control of the assets funded into it. They no longer own the property—the trust does. Grantors of irrevocable trusts cannot act as trustees of their own trusts. They must hand over the reins of operation to someone else.

State laws and the trust's formation documents determine whether a trust is revocable or irrevocable. If the trust deed doesn't specify that the trust is irrevocable, most states will consider it revocable.