U.S. Grantor Trusts after the Grantor dies
Thanks for reading our blog. Podcast interviews with thought leaders like Daniel, on interesting topics of interest to international entrepreneurs and expats are available on www.htj.tax which is our main website
I myself, am a Grantor in a Grantor Trust in my home state of Florida. It was created as part of my own personal estate planning. I did alot of research as part of my own estate planning and that is what I'm sharing today.
So now let's talk about death. The grantor trust status terminates with the death of the grantor. The trust instrument must be reviewed to determine what happens to the trust property after the death of the grantor.
Obviously, if the trust terminates and the property is paid outright to its individual beneficiaries, issues of ongoing trust income taxation become irrelevant. No need to read further.
In my case, the trust will continue after my death. After my death, the trust now becomes a “new” taxpayer. The trustee should obtain a new taxpayer identification number (unless there was one obtained before, which is good practice) for the trust.
Consider the issue of income tax basis for the trust assets. If the powers over the trust retained by the grantor were administrative only, although the grantor remained taxable on the trust income until death, the trust principal would not be included in the grantor’s estate. The gift to the trust would be considered complete as of the date of the transfer of the trust assets to the trust by the grantor. Accordingly, in such a situation, the grantor’s basis in the properties transferred to the trust during the grantor’s
lifetime carries over to the donees/ beneficiaries of the trust. [IRC § 1015]
Alternatively, it is possible that the grantor’s retained interest in the trust that caused the grantor trust status to be established for income tax purposes is a sufficiently broad interest (such as the power to revoke the
trust) that the retention of this interest also requires inclusion of the trust
property in the grantor’s estate for federal estate tax purposes. [IRC §§ 2036 and 2038] Where this is the case, the inclusion of the trust property
in the grantor’s estate results in an income tax basis to the grantor’s heirs
equal to the fair market value of the trust property as of the date of the
grantor’s death. [IRC § 1014]
Application of this rule could result in a basis to the heirs either stepped up or stepped down from the grantor’s original cost basis in the property.
When the grantor of a grantor trust dies, and the grantor trust status
terminates, the trust itself is often the vehicle to be used to wind up the
decedent’s affairs and distribute his or her assets to the intended heirs.
The Taxpayer Relief Act of 1997 introduced Code Section 645 which permitted an election to be made for income tax purposes to enable a
Qualified Revocable Trust to be treated and taxed as part of the decedent’s
estate, not as a separate trust.
With the substantial federal estate tax exclusion available in 2020 ($11.58 million, indexed for inflation) and the opportunity for estates of married decedents to elect portability of the exclusion, the vast majority of decedent’s estates will not be taxable and not be required to file Form 706
(except for portability purposes) so there will not be a federal estate tax
Nevertheless, the income tax benefits of the QRT election, even for two years, suggest that making the election is a worthwhile decision in the majority of cases. When a Section 645 election is made for a QRT, the trustee is not required to file Form 1041 for the short taxable year of the QRT beginning with the decedent’s date of death and ending December 31 of that year. [Reg. § 1.645-1(d)]
Form 1041 must be filed for the short taxable year of the trust beginning with the decedent’s date of death if a Section 645 election will not be made for the trust. If the Section 645 election is made, the electing trust and related estate are treated as constituting separate shares of the estate under Code Section 663(c) for purposes of computing DNI and applying the distribution provisions of Code Sections 661 and 662. If there is a distribution from the related estate to the QRT (or vice versa) the distribution reduces the distributing share’s DNI and increases the gross income of the receiving share. [Reg. § 1.645-1(e)]
Once the QRT election is made, only one Form 1041 need be filed in
the name of the estate, rather than separate returns for the trust and for the
estate. During the election period, the trust has to participate in only one
annual fiduciary income tax return filing for the combined trust and estate
under the name and identifying number of the estate. The executor of the
related estate is responsible for filing Form 1041 for the estate and for all
electing trusts. All items of income, deduction and credit for the estate and
all electing trusts are combined on the single Form 1041. One $600 annual
income tax exemption is allowed.
Perhaps the most important and desirable features of the Section 645
election are that once the election has been made, an electing trust may
utilize a number of advantages previously limited to estates. An electing
trust may select a fiscal year rather than a calendar year. The electing trust
may claim an annual exemption of $600, be possibly (depending on the
activities of the decedent) entitled to deduct up to $25,000 in real estate
passive losses, [IRC § 469(i)] and may deduct amounts paid or
permanently set aside for charity. The electing trust may hold S
Corporation stock in accordance with the broader rules allowing estates
generally, but not all trusts, to be S Corporation shareholders. [IRC §
1361(b)(1)(B) and (c)(2)] The provisions of Code Section 6654(l)(2)(A)
relating to the two-year exception to an estate’s obligation to make
estimated tax payments will apply to each electing trust for which a
Section 645 election has been made. [Reg. § 1.645-1(e)]
An electing trust will be treated as a trust and not as an estate for
purposes of the retirement plan required minimum distribution rules of
Code Section 401(a)(9). [Reg. § 1.645-1(e)] This provision assures the
trust of greater flexibility in determining the designated plan beneficiary
and greater deferral, if desired, of the payment of required minimum
distributions, and does not subject the trust to the unfavorable rules that
result when an estate is named a retirement plan beneficiary.
When the election period terminates, the combined estate and QRT terminate, and are deemed to distribute their assets to a new trust to which
Code Sections 661 and 662 apply. The deemed distribution entitles the
distributing entity to an income distribution deduction (if any income is
distributable) per Code Section 661, and the new trust must include the
income distribution in income as required by Code Section 662.
In the event a trust has been taxed for income tax purposes as a grantor
trust, but does not meet the requirements to be treated as a Qualified
Revocable Trust, the Code Section 645 election is not available. In such a
situation, the trust document must be consulted to determine whether the
trust will continue as a “standard” simple or complex trust following the
death of the grantor, or whether the trust will terminate and distributions
of the trust property will be payable to the trust beneficiaries.