Trusts may be considered substantially owned by
the grantor or another person. These trusts are commonly called “grantor”
trusts. A trust is considered a grantor trust due to the rules of sections
671-678 of the IRC. For example, if a trust is revocable, it is a grantor trust
pursuant to section 676. However, even an irrevocable trust may be a grantor
trust. If, for example, the income of the trust is payable to the grantor, the
grantor controls who gets benefits from the trust, or the grantor has other
administrative powers it is a grantor trust.
If the trust is a grantor trust, the income of
the trust is taxed to the grantor just as though the assets of the trust were
owned by the grantor themselves. For tax reporting purposes, a grantor trust
may use a separate Taxpayer Identification Number (TIN) (also called an
Employer Identification Number (EIN)). The grantor trust may also use the
grantor’s Social Security Number (SSN) for the trust. The exact method is set
forth in Treas. Reg. 1.671-4. Frequently, financial institutions will question
the propriety of using the grantor’s SSN, especially for an irrevocable trust.
However, if the trust is a grantor trust, the trustee may do so.
Some of the powers which trigger grantor trust
status, such as the power to revoke under section 676, also cause estate tax
inclusion. For example, the power to revoke causes estate tax inclusion under
section 2038. Other powers which trigger grantor trust status, like the power
to substitute assets under section 675, do not trigger estate tax inclusion.
Thus, it’s possible to have a trust which is a grantor trust, yet which may or
may not be included in the taxable estate. Similarly, it is possible to have a
non-grantor trust, which may or may not be in the taxable estate.
A non-grantor trust, i.e., a trust which
is not a grantor trust, has its income taxed to the trust itself. The trust
reaches the top income tax rates after very little taxable income. For example,
the top federal rate of 39.6% is reached after only $12,500 of taxable income
in 2017. By comparison, single and married joint filers would not hit that
bracket until well over $400,000 of taxable income.
Non-grantor trusts are required to file an income
tax return, Form 1041, if they have taxable income over their exemption ($100
or $300, depending on the trust). If such trusts make distributions to their
beneficiaries, those distributions generally carry out the income to the
beneficiaries and the trust gets a corresponding distribution deduction. Thus,
it is normally beneficial to have the trust distribute its income to the
beneficiaries. However, this is not always the case. If the beneficiary is in
the top income tax bracket, there may be no tax advantage to distributing the
income and there could be other advantages to retaining the assets in the
trust. Further, distributing the income to the beneficiary may cause other
consequences, like reduced financial aid or other negative results that exceed
the income tax savings. Thus, from a planning perspective, it is often best to
leave the distribution of income to the discretion of the trustee. Then the
trustee can consider all of the information which is available, including the
federal and state income tax consequences and other factors.
