A grantor trust is a trust in which the creator of the trust (known as the grantor) retains authority over the trust, which makes the trust's income taxable to the person who set it up.
1. Certain qualities are necessary to make a trust into a grantor trust.
A grantor trust is any trust in which the grantor is considered an owner of its assets, or any portion of them. A non-grantor trust is considered a separate tax entity, and the trust itself has to pay taxes on any income it earns. A trust is considered a grantor trust if the grantor retains certain powers, such as any of the following:
If you as the grantor can do any of these things, it's a grantor trust.
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2. What is the most common purpose of a grantor trust?
The typical purpose is to transfer as many assets as possible to others to minimize the grantor's estate taxes. Transferring assets to the trust is considered complete for estate and gift tax purposes, but incomplete for income tax purposes, meaning the grantor is still responsible for paying any income tax that is incurred by those assets.
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3. This tax treatment can be beneficial for the assets in the trust.
Since the tax on the trust income is paid by the grantor, this can be considered an additional transfer of wealth to the trust that is not subject to gift tax. In other words, the appreciation in assets moves out of your estate as well. Keep in mind that since the trust is receiving the income, you as the grantor will have to be able to cover the income tax payments from other sources of income.
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