Can an Irrevocable Trust Be a Grantor Trust?

By Phil M. Fowler

An irrevocable trust can be part of a comprehensive tax reduction strategy. If the trust is not a grantor trust, the IRS treats it as a separate taxing entity from the grantor. The federal tax code is progressive, which means the more income you earn, the higher percentage of tax you pay. Putting income-producing assets into a non-grantor trust can spread income over multiple taxpaying entities, which can reduce total income tax liability. If that is your purpose in establishing an irrevocable trust, you must avoid certain circumstances that might cause it to be classified as a grantor trust.

Grantor Control

The IRS generally defines a grantor trust as any trust "over which the grantor or other owner retains the power to control or direct the trust's income or assets." The technical, statutory definition of a grantor trust under the Internal Revenue Code, as applied over time by IRS regulations and opinions, is actually much more complicated than that general definition might imply. Several different scenarios can result in the IRS treating an irrevocable trust as a grantor trust. Generally, all revocable trusts are, by definition, grantor trusts under the Internal Revenue Code. Some irrevocable trusts can also qualify as grantor trusts under the Internal Revenue Code.

Reversionary Interest

A common instance when the IRS will treat an irrevocable trust as a grantor trust is when the grantor retains a five percent or larger reversionary interest in the trust property. For instance, if a grantor puts $100,000 into an irrevocable trust, but the grantor retains the right to receive at least $5,000 of that money back at some point in the future, the trust is probably a grantor trust under Section 673 of the Internal Revenue Code.

Protect your loved ones. Start My Estate Plan

Trust Administration

The IRS also treats irrevocable trusts as grantor trusts if the grantor retains any significant level of administrative control of the trust. For instance, if the grantor is a trustee with discretionary authority to distribute trust property to himself, the irrevocable trust is, in reality, a grantor trust. Or, if the grantor has the ability to borrow money from the trust without paying market rate interest, the trust is likely a grantor trust.

Trust Income

A final sticking point for irrevocable trusts trying to avoid classification as grantor trusts is the distribution of trust income to the grantor. If the trust allows for the distribution of trust income to the grantor or the grantor's spouse, the trust may be a grantor trust. If only a portion of the trust income may be distributed to the grantor or the grantor's spouse, only a similar portion of the trust is considered a grantor trust. In other words, the IRS may consider an irrevocable trust as partially a grantor trust and partially not.

Protect your loved ones. Start My Estate Plan
Tax Treatment of Living Trust Distributions


Related articles

How to Set Up a Tax ID Number for a Trust Account

A trust is a legal arrangement that allows property to be held for the benefit of a named beneficiary. There are a variety of trusts that can fit almost any legal purpose. However, if a trust is not a grantor trust or the trust is created by two or more people, you will need to set up a tax identification number for the trust. A grantor trust is a living revocable trust in which the grantor maintains control of the trust and is the primary beneficiary. Therefore, a separate federal tax identification number is not necessary because the trust’s income is reported using the grantor’s Social Security number.

Non-Profit C4 Vs. C3

Title 26, Section 501(c) of the Internal Revenue Code recognizes several different types of nonprofit organizations. Nonprofit corporations, trusts and foundations have several advantages over for-profit organizations, including an exemption from paying federal income taxes. Two classes of 501(c) nonprofits, known as “C3” and “C4” organizations, are similar in some respects. However, they have different eligibility requirements, and the IRS places different restrictions on their activities and donations. When deciding whether to structure your nonprofit as a C3 or a C4, these distinctions should be considered.

Living Trust Guidelines

A living trust is a way of managing assets, a tool used primarily in estate planning. It offers a number of advantages over a last will and testament, including greater flexibility in the management and distribution of your assets. Living trusts are governed by state laws and these laws differ slightly from state to state.

LegalZoom. Legal help is here. Start Here. Wills. Trusts. Attorney help. Wills & Trusts

Related articles

What Are the Disadvantages of an Irrevocable Trust?

A trust is a legal device that permits a grantor to place assets under the control of a trustee, then who administers ...

Can the IRS Levy Taxes From a Revocable Trust?

Under a trust arrangement, a grantor funds the trust with assets and transfers these assets to a trustee, who holds ...

Net Operating Loss for a Sole Proprietorship

It isn’t uncommon for sole proprietors to report losses in some years, which are the result of incurring business ...

What Happens When a Beneficiary of an Irrevocable Trust Receives Money?

As the beneficiary of an irrevocable trust, you may receive periodic payments of money from the trustee. When you do, ...

Browse by category
Ready to Begin? GET STARTED