The Internal Revenue Code is a long, complicated law with many subtitles, chapters, parts and sections. Although we are all aware of income taxes, few care that they are depicted by Subtitle A of the Code. Many are equally aware of estate taxes and gift taxes, and again few care that they are depicted by Subtitle B of the Code, Chapters 11 and 12 respectively.
Even fewer care about Subchapter J of Chapter 1 of Subtitle A of the Code, which depicts how the income of trusts is taxed. Savvy estate planning attorneys are the few individuals who study these subtitles, chapter and subchapters of the Code and use the lack of coordination between the rules for income taxes, estate taxes and gift taxes to the benefit of their clients.
The individual who establishes a trust is called the settlor or grantor. Similar to any individual, an established trust is a separate entity that must pay income taxes on its income. In 1954, Congress enacted Subpart E of Part 1 of Subchapter J of Chapter 1 of Subtitle A. This Subpart E is commonly known as the “Grantor Trust Rules.” The Grantor Trust Rules depict when the grantor of a trust rather than the trust itself will be deemed the “owner” of the trust assets and therefore responsible for paying the income taxes on the income generated by such assets. The Grantor Trust Rules were enacted to prevent abuses by taxpayers who were shifting income to taxpayers in lower income tax brackets. In years past, trust income rates were more favorable than those rates applied to individuals.
Today, tax brackets are much more favorable for individual taxpayers. The tax brackets for trusts are very compressed causing a trust to pay higher taxes at lower income amounts.
Trusts that are subject to the Grantor Trust Rules are commonly referred of as “Grantor Trusts.” Grantor Trusts can take advantage of the benefits offered by a trust and simultaneously avoid the higher income taxes imposed on non-grantor trusts.
Common types of Grantor Trusts:
A Grantor Trust should be considered for every estate plan. Please contact one of the members of our Private Client Group for more information about revocable living trusts or to discuss whether an IDGT is appropriate for you.
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