What Is a Grantor Trust?

Living Trust Documents
••• DNY59 / Getty Images

Is a living trust a grantor trust? All grantor trusts are living trusts, but not all living trusts are grantor trusts. Confused yet? It might help to understand that the term "grantor trust" isn't actually a legal term at all, but rather a tax term.

Tax Implications of a Grantor Trust 

According to the Internal Revenue Code, the term "grantor" describes any trust where the person who creates the trust is treated as the owner of its property and assets for both income and estate tax purposes. In the words of the IRS, a grantor trust is one "over which the grantor ... retains the power to control or direct the trust's income or assets."

This distinction places grantor trusts into the category of "revocable" living trusts. Trustmakers, also called grantors, can undo this type of trust. They can amend them and make changes to them at any time as long as they remain mentally competent. 

The Role of the Grantor 

A grantor typically acts as trustee of his own revocable living trust, retaining the power to control its income and assets. A grantor can name or change the trust's beneficiaries, and he can decide who receives trust income. He/she can manage stock options for the trust and control trust fund investments. Because the grantor personally reserves all these rights, any income the trust generates is taxed to him/her personally. 

Revocable Living Trusts vs. Irrevocable Living Trusts 

Although all revocable living trusts are considered grantor trusts during the lifetime of the grantor, most "irrevocable trusts" are not grantor trusts. In most cases, the grantor of an irrevocable trust does not report the trust's income on his own tax return because he has irrevocably given up ownership and control of the assets he placed into the trust. He no longer owns them -- the trust does.

But as with all things taxes, some exceptions exist. An irrevocable trust can be treated as a grantor trust for tax purposes when the grantor meets the Internal Revenue Code requirements to become the owner of the assets. In this case, the irrevocable trust may be disregarded as a separate tax entity and the grantor will be taxed for all its income.

Intentionally Defective Grantor Trusts

These irrevocable trusts are called "intentionally defective grantor trusts" because they're drafted to treat the grantor as the owner for income tax purposes but not for estate tax purposes. The grantor reports trust income on his personal return and pays any taxes due, but the trust assets are not included in the grantor's estate when he/she dies for estate tax purposes -- a major advantage not shared with revocable trusts. When the grantor acts as trustee of a revocable trust and essentially retains an extension of ownership over the assets placed into it, those assets still contribute to his/her taxable estate.  

State law and the trust instrument, also known as the trust deed, determine whether a trust is revocable or irrevocable. If the trust deed does not specify that the trust is irrevocable, most states will consider it revocable.

NOTE: State and local laws change frequently, and this information may not reflect the most recent changes. Please consult with an accountant or an attorney for up-to-date tax or legal advice. The information contained in this article is not tax or legal advice, and it is not a substitute for tax or legal advice.