What's a Grantor Trust?

Posted On: May 14, 2007 by Joel A. Schoenmeyer

Sometimes it seems like estate planners just invent terms and acronyms to confuse people. One of these cases involves a grantor trust, sometimes called an "intentionally defective grantor trust" or an IDGT.

So what's the deal with these things?

Basically, the term "grantor trust" relates to the taxation of a trust's income. Who pays the tax? If a trust is a grantor trust, then the grantor pays the tax (otherwise, the trust and/or its beneficiaries must have to pay the tax).

The grantor trust rules can be found here in the Internal Revenue Code (the "Code").

Estate planners use the grantor trust rules to take advantage of inconsistencies in the Code. In this case, the inconsistency is that you can set up a trust that is owned by you for income tax purposes (you pay the income tax) but not owned by you for estate tax purposes (the trust assets aren't includable in your estate).

Why would you want to do this? Because being viewed as the owner of a trust you set up means that you can pay the trust's income tax without such payments being considered an additional gift to the trust.

A revocable or living trust of which the grantor is acting as trustee will always be a grantor trust. The tax advantage discussed above is focused on irrevocable trusts (such as insurance trusts or gift trusts). Usually the goal of such trusts is to make sure that the grantor (i.e. the person who set up the trust) DOESN'T have any ownership interest in the trust. But there are certain provisions that can be included so the grantor can pay the trust's taxes. The term "intentionally defective" is misleading, since I don't think it's possible for a draftsperson to include grantor trust provisions by mistake (a more typical problem involves an inexperienced draftsperson who screws up the estate tax benefit by allowing the grantor to retain too much ownership interest in the trust).

I think the most typical provision used to make a trust a grantor trust involves giving a grantor "power to reacquire the trust corpus by substituting other property of an equivalent value" under Section 675(4)(d).

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