Introducing U.S. Grantor Trusts
Here's what I previously wrote about Grantor Trusts here - https://www.mooresrowland.tax/2020/04/grantor-trust.html
It is worth having a look at that link first. Now I wanted to take a deeper dive into U.S. Trusts as I see it as perhaps the most powerful of tax planning tools available to my clients. I will do so in a series of articles over this year - 2021
What is a “Grantor Trust”?
To refresh our memory, a grantor trust is a trust in which either the grantor or another person possessing sufficient specifically enumerated rights and/or interests in or over the trust is considered to be the “owner” of the trust. The retention or possession of these rights gives the person identified as the grantor dominion and control over the trust property and/or the trust income.
Once a trust is characterized as a grantor trust, the grantor when determining his or her taxable income must include all of the income,
deductions and credits available at the trust level. In addition, a person who is not a transferor of property to the trust, but who, as a beneficiary of the trust possesses certain rights, such as a power of withdrawal over the trust income or principal, may be deemed a grantor of the trust and considered to be an owner of the entire trust or a portion of the trust for income tax purposes. [IRC § 678]
What are the rights and interests retained by a grantor that require the trust to be considered a grantor trust?
- Possession of a Reversionary Interest in the Trust. A grantor is treated
as the owner of any portion of a trust in which the grantor has a reversionary interest (in either the trust principal or the trust income)
worth more than five per cent of the value of the transferred property to
the trust at the time of the trust’s inception, i.e., the date of the transfer of
property to the trust. [IRC § 673(a)] .
- Possession of a Power over the Trust to Control Beneficial Enjoyment.
The broad general rule of Code Section 674 provides that a grantor will be treated as the owner of any portion of a trust over which the grantor holds a power to dispose of the beneficial enjoyment of either the corpus
(principal) or the income of the trust, either acting alone or acting in
conjunction with any other person other than an “adverse party.” [IRC §
674(a)]. The excepted powers include the following:
- Power to apply income to support a dependent. Grantor trust status will not automatically apply where there is a power to use trust income to support a beneficiary whom the grantor is legally obligated to support, except to the extent that the income is in fact used for support.
- Power to affect the enjoyment of income. This refers to a power to affect a beneficiary’s enjoyment in a trust that is deferred for a period which, had it been a reversionary interest to the grantor, would be protected from grantor trust status, i.e. a deferral period that would result in a reversionary interest of five percent or less of the trust fund.
- Power exercisable by will. A power held by any person to control or affect beneficial enjoyment exercisable only by will does not cause a grantor to be treated as the owner of a trust.
- Power to allocate among charitable beneficiaries. The power held by any person to determine the beneficial enjoyment of trust property or trust income which is irrevocably payable for charitable purposes currently or in the future, will not cause the grantor to be treated as an owner of the trust.
- Power to distribute trust principal (corpus). The power to distribute the principal of the trust that is limited by a reasonably definite standard set forth in the trust instrument is another power that will not cause the grantor to be treated as an owner of the trust.
- Power to withhold income temporarily. The power to distribute or apply income to or for a current income beneficiary or to accumulate the income for such beneficiary does not cause the grantor to be treated as the owner of the trust so long as the accumulated income must ultimately be payable to the beneficiary from whom it was withheld or to the estate or to the appointees of such beneficiary.
- Power to withhold income during the minority or disability of a beneficiary. The power to withhold income from an income beneficiary prior to the beneficiary attaining age 21, or otherwise during the period of a beneficiary’s disability will not cause the grantor to be treated as the owner of the trust.
- Power to allocate between corpus and income. The power to allocate receipts and disbursements between trust principal and income, even if expressed in broad language, will not cause the grantor to be treated as the owner of the trust. [IRC § 674(b)(8); Reg. § 1.674(b)-1(b)(8)]
- Powers of independent trustees. Powers granted to and exercisable solely by a trustee or trustees none of whom is the grantor or the spouse of the grantor and no more than half of whom are related or subordinate parties subservient to the wishes of the grantor will not cause the grantor to be treated as the owner of the trust.
- Power to allocate income subject to a standard. Powers granted to and solely exercisable by a trustee or trustees (none of whom is the grantor or the grantor’s spouse), without the approval or consent of any other person, to distribute, apportion, or accumulate income to or for a beneficiary or beneficiaries, or within a class of beneficiaries that is limited by a reasonably definite external standard set forth in the trust instrument will not cause the grantor to be treated as the owner of the trust.
- Be wary of the power to remove a trustee. If the grantor retains a power to remove, substitute or add trustees, such a retained power may prevent the trust from qualifying for one of the above exceptions to grantor trust status, and result in the grantor being treated as the owner of the trust.
- Possession of Administrative Powers over the Trust. The grantor will be treated as the owner of any portion of a trust if the trust instrument or the operative circumstances of the trust allow the grantor, having created the trust, to exercise administrative control over the trust for the benefit of the grantor, not for the trust beneficiaries. [Reg. § 1.675-1(a)] Code Section 675 lists four categories of retained administrative powers that can cause the grantor to be treated as the owner of the trust. These include:
- Power to deal for less than adequate and full consideration. If the grantor or a non- adverse party or both, without the consent or approval of an adverse party, retains the power to purchase, exchange, or otherwise deal with or dispose of the trust income or principal, or any portion of it, for less than full and adequate consideration in money or money’s worth, the grantor will be treated as the owner of the trust. [IRC § 675(1); Reg. §1.675-1(b)(1)]
- Power to borrow without adequate interest and security.
- Actual borrowing of the trust funds.
- General powers of administration. If the grantor or a non-adverse party is permitted to exercise certain “powers of administration” in a nonfiduciary capacity (i.e., not as a trustee and without requiring the consent or approval of anyone in a fiduciary capacity), the possession of the right to exercise such powers will cause the grantor to be treated as the owner of the trust.
- Possession of the Power to Revoke the Trust. The grantor will be treated as the owner of any portion of a trust over which the grantor or a non-adverse party, or both, without the approval or consent of an adverse party, has retained the power to revoke the trust and revest title to the trust property in the grantor. voke the trust.
- Reservation of Income for the Benefit of the Grantor. The grantor will be treated as the owner of any portion of a trust the income of which, without the approval or consent of an adverse party, or in the discretion of the grantor or a non- adverse party, may be treated in one of three enumerated ways, namely:
- • Distributed to the grantor or the grantor’s spouse;
- • Held or accumulated for future distribution to the grantor or the grantor’s spouse; or
- • Applied to the premiums on policies of life insurance on the life of the grantor or the grantor’s spouse (unless such policies are irrevocably designated as payable for a charitable purpose).