Grantor Trusts

Of the many common types of trusts, the grantor trust is very popular due to its simplicity.

Generally, where a living trust is irrevocable, the trust will be treated as a separate taxpayer, which adds additional complexities and costs. Such a trust will be taxed according to a special rate schedule designed for estates and trusts, which is extremely compressed--that is, it imposes high tax rates on very low levels of income. Furthermore, the trust and estate tax scheme does not allow for personal exemptions. Thus, in addition to the administrative burden, higher taxes are a very likely result.

However, language can be used in the trust to make it a "grantor trust" under the IRS definition. Here, the term "grantor" means the same thing as the term "trustor." In the grantor trust, the trust is not recognized as a separate taxpayer. Instead, the grantor, or trustor, reports the trust income on his or her personal income tax return, as if he or she owned all the trust assets personally and the trust did not exist.

This greatly simplifies the administration of the trust. At the same time, other precautions can be taken so that the trust still removes the assets from the taxable estate of the trustor. In short, the grantor trust takes advantage of exceptions to the separate income tax and estate tax rules that apply to trusts.

A popular form of grantor trust, often used for bank accounts, is called a Totten trust.

Warning Planning to eliminate federal estate taxes requires special considerations and the services of an estate planning attorney. For example, in some situations an independent trustee may be necessary, or special language must be used in the trust when the trustor is also the trustee, to prevent the trust assets from being included in the trustor's taxable estate.