A grantor trust is a revocable living trust that's a "disregarded entity" for tax purposes. It doesn't pay its own taxes or file a tax return. Instead, its income is reported and deductions are claimed on the grantor's personal tax return—the individual who created and funded the trust and who typically manages its assets.
The term "grantor" isn't a legal term. It simply indicates that the grantor and not the trust itself is responsible for paying the taxes associated with it. All grantor trusts are living trusts, but not all living trusts are grantor trusts.
What Is 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.
Grantors can name successor trustees to take over management and control of their trusts should they become incapacitated and unable to do so themselves, but the trust's income is still reported on the initial grantor's own tax return.
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.
- Alternate name: Revocable trust
How Does a Grantor Trust Work?
Let's say that 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 cost 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.
Claiming your trust's income on your personal tax return can increase your taxable income and potentially push you into a higher marginal tax bracket.
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.
IDGTs can evolve when a grantor makes an irrevocable gift to the trust or sells an asset into its ownership. That asset is no longer considered to be owned by the grantor, but by the trust, so it would not be included in the grantor's taxable estate.
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.
|Grantor Trusts||Irrevocable Trusts|
|Grantor can reclaim assets from the trust.||Grantor gives up assets for all time.|
|Grantor manages trust assets as trustee.||A third party must act as trustee.|
|Income is taxed on the grantor's personal return.||The trust files its own return and pays any associated taxes.|
|Trust's assets are subject to estate tax.||Trust assets are not subject to estate tax.|
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.
- A grantor trust is a “disregarded” tax entity that does not file a tax return or pay taxes on its own earnings.
- Taxes due from a grantor trust are passed down to the grantor or creator of the trust who must then report the income and claim deductions on their personal tax return.
- Grantor trusts are revocable trusts, but some irrevocable trusts can elect to be treated as grantor trusts for tax purposes.