South Carolina Trust
and Estate Law Blog

Attorneys can be a strange lot.  They make up terms that nobody understands seemingly for no reason.  One such term is the intentionally defective grantor trust.  What is a grantor trust? Why would it ever be defective? And why would this be done intentionally?  Good questions all.

First, what is a grantor?  Well, a grantor is the person that sets up the trust and transfers his/her assets to it.

Second, what is a grantor trust? A grantor trust is a trust that is deemed to be owned by the grantor. This is important because it is the owner who is responsible for paying and filing the income taxes.  When the trust is a grantor trust, then it is the grantor that owns the income from the trust, and gets the benefit of the deductible expenses of the trust.  This allows the trust income tax brackets to be avoided in favor of the more favorable individual income tax brackets.  A grantor trust does not have to apply for a new taxpayer identification number because the grantor’s social security number is used.

How do you know whather a trust is a grantor trust? You determine this by reference to the trust instrument itself. What does the trust say? What powers does it grant? How is it structured? When you know this, you then take a look at the Internal Revenue Code, Sections 672 through 678. These sections are commonly known as the Grantor Trust rules.  As an example, a trust that is revocable by the Grantor is a grantor trust, and we know this by reference to IRC Section 676.  A trust that allows the Grantor to amend it to add beneficiaries (other than after adopted or born children) is a grantor trust and we know this by reference to IRC Section 674.  There are many other powers that can be granted in the trust to cause the trust to be a grantor trust.

Now that we know what a grantor trust is, why would we ever set up an intentionally defective grantor trust? An intentionally defective grantor trust is a trust that intentionally contains a provision that causes the trust to be a grantor trust.  This is done in the situation where it is desirable to structure a trust in a way that allows the trust assets to not be includible in the grantor’s estate, but still taxable for income tax purposes to the grantor.

The Irrevocable Life Insurance Trust (ILIT) is an example of (Click here for more…)

There were no real Congressional debates in September on extending the Bush Tax Cuts, or what to do about the repeal and pending reinstatement of the estate and generation skipping transfer taxes.  Congressional members have left D.C. until after the midterm elections in November.  Democrats did not want to suffer a defeat on their proposals prior to the midterms, and the Republicans wanted to keep the issue alive as a talking point in the run up to Election Day. Unsurprisingly, playing politics has won out to responsibility in our tax laws.  Can this be one of the reasons it seems a majority of the American people is fed up with politics as usual?

One way or the other, we will soon have certainty on the future of the estate and generation skipping taxes.  Stay tuned……