Grantor Trust Rules

The grantor trust rules are guidelines within the Internal Revenue Code, which outline certain tax implications of a grantor trust. Under these rules, the individual who creates a grantor trust is recognized as the owner of assets and property held within the trust for income and estate tax purposes.

The grantor trust rules allow grantors to control the assets and investments in a trust. The income it generates is taxed to the grantor at his or her tax rate rather than to the trust itself. In this regard, grantor trust rules offer individuals a certain degree of tax protection because tax rates are generally more favorable to individuals than they are to trusts. 

Grantors an also change the beneficiaries of a trust along with the investments and assets within it. They can direct a trustee to make alterations as well. Grantors can also undo the trust whenever they please as long as they are deemed mentally competent at the time the decision is made. This distinction makes a grantor trust a type of revocable living trust. However, the grantor is also free to relinquish control of the trust making it an irrevocable trust. In this case, the trust itself will pay taxes on the income it generates and the it would require its own tax identification number (TIN).  

Grantor trust rules also outline certain conditions when an irrevocable trust can receive some of the same treatments as a revocable trust by the Internal Revenue Service (IRS). These situations sometimes lead to the creation of what are known as intentionally defective grantor trusts. In these cases, a grantor is responsible for paying taxes on the income trusts generate, but trust assets are not counted toward the owner's estate. Such assets would apply to a grantor's estate if the individual runs a revocable trust, however, because the individual would effectively still own property held by the trust. In an irrevocable trust, property is basically transferred out of the grantor's estate and into a trust, which would effectively own that property. Individuals often do this to ensure property is passed down to family members at time of death. In this case, a gift tax may be levied on the property's value at the time it's transferred into the trust, but no estate tax is due upon the grantor's death.

Grantor trust rules also state that a trust becomes a grantor trust if the creator of the trust has a reversionary interest greater than 5% of trust assets at the time the transfer of assets to the trust is made.  

A grantor trust agreement dictates how assets are managed and/or transferred after the grantor's death. 

Ultimately, state law determines if a trust is revocable or irrevocable as well as the implications of each.