Can an Irrevocable Trust Be a Grantor Trust?

By Larissa Bodniowycz, J.D.

Can an Irrevocable Trust Be a Grantor Trust?

By Larissa Bodniowycz, J.D.

In most cases, an irrevocable trust is not considered a grantor trust. Generally, a grantor of an irrevocable trust gives up control over trust assets and no longer owns these assets. Instead, the trust owns the assets. However, there are some exceptions to this general rule.

Man with arms folded holding glasses sitting at a able looking at an open laptop

Grantor Trust

A grantor is someone who creates a trust as a way to hold his assets and later distribute those assets to his or her beneficiaries. A “grantor trust" is a tax term.

According to the Internal Revenue Service (IRS), a grantor trust is any trust where the grantor retains the power to control trust income or assets. The person who created a grantor trust is the owner of trust assets for tax purposes and taxed directly on trust income.

Irrevocable Trust

An irrevocable trust is a trust that is locked in and cannot be revoked or changed by the grantor. An irrevocable trust can only be modified with permission of the trust's beneficiaries.

In contrast, a revocable trust is a trust that the grantor may revoke or amend. All revocable trusts are grantor trusts for IRS purposes because with a revocable trust the grantor has the power to amend the trust and therefore has the power to control or direct trust income and assets.

When an Irrevocable Trust Can be a Grantor Trust

An irrevocable trust can become a grantor trust if the trust meets certain IRS requirements. If any of these requirements are met, the trust will no longer be considered a separate tax entity and the grantor is taxed on trust income.

1. The Grantor Maintains a Reversionary Interest

An irrevocable trust may become a grantor trust under Internal Revenue Code (IRC) Section 673(a) if the grantor holds a “reversionary interest" in a trust that is greater than 5 percent of trust principal or income. A reversionary interest is the right of a grantor to later get back some of the trust assets.

Example. A grantor establishes an irrevocable trust and deposits $50,000 into that trust, but under the trust terms, reserves the right to later recover $2,500 or more of that money. The grantor has a reversionary interest because they are reserving a future interest to recover money from the trust. In this situation, the irrevocable trust may be considered a grantor trust.

2. The Grantor Has the Power to Control Beneficial Enjoyment

An irrevocable trust may become a grantor trust under IRC Section 674 if the grantor can control the “beneficial enjoyment" of trust income or assets. In other words, the grantor cannot hold the power to allocate trust income to beneficiaries or add more beneficiaries after the irrevocable trust has already been created.

3. The Grantor Maintains Administrative Control

An irrevocable trust may also become a grantor trust under IRC Section 675 if the grantor maintains administrative control over the trust that he can exercise for his own benefit. For example, the trust cannot allow the grantor the power to take out a loan from trust money without paying adequate interest rates. The trust may also be considered a grantor trust if the grantor has previously borrowed from the trust and has not timely repaid the loan plus interest.

4. The Grantor Maintains Revocation Powers

The trust will become a grantor trust under IRC Section 676 if it allows the grantor to revoke any part of the trust and then take back or reclaim the trust's assets.

5. The Trust Distributes Income to the Grantor

Typically, trusts distribute income to trust beneficiaries. If the trust instead distributes trust income to the grantor, the trust may become a grantor trust under IRC Section 677(a). Trust income cannot be paid out to the grantor, accumulated for future distribution to the grantor, or be used to pay for insurance policies on the grantor's life.

Powers Held by the Grantor's Spouse

A grantor's spouse is deemed to have the same powers and beneficial interests as the grantor under IRC Section 672(e). This means that a grantor cannot evade IRS rules regarding what constitutes a grantor trust by granting any of the above-prohibited powers or interests in a trust to his or her spouse.

Details are important when preparing trusts of any type. An online legal service provider can prepare a living trust on your behalf so you can have peace of mind that the document is properly prepared.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.