One of the many factors to consider when setting up a trust is whether to make it a grantor trust or a non-grantor trust. While a grantor trust is more common, a non-grantor trust can be useful in certain circumstances.
A grantor trust is any trust in which the person setting up the trust (the “grantor”) retains some control over the trust. This could mean the grantor has the power to revoke the trust, change trust beneficiaries, change trust assets, or distribute income from the trust to the grantor or the grantor’s spouse, among other things. Including any provision that gives the grantor power over the trust will make a trust a grantor trust. Most trusts set up for estate planning purposes fall into this category. A non-grantor trust is any trust that is not a grantor trust, meaning the person who set up the trust has no rights, interests, or powers over trust assets.
That said, why should you care? The main difference between grantor and non-grantor trusts is how they are taxed. With a grantor trust, the grantor is responsible for paying tax on any income generated by the trust. Grantor trusts are often set up with the grantor’s Social Security number, so the income is reported directly on the grantor’s tax return. A non-grantor trust is taxed as a separate entity, so the trustee is responsible for filing a tax return for the trust. If the trust pays income to a beneficiary, the income is included in the beneficiary’s taxable earnings.
The structure of the non-grantor trust has tax benefits in some circumstances and it may be useful in the following situations:
- You do not want to be involved with the trust at all — for example, setting up a trust for an ex-spouse following a divorce.
- The beneficiaries of the trust are in a lower tax bracket than you, allowing them to pay less in income tax than the grantor would have.
- You own a small business. Putting a sole proprietorship, partnership, LLC, or similar business in a non-grantor trust could allow the business to obtain a 20 percent qualified business income deduction. The deduction is phased out for higher incomes, so separating the business into one or more non-grantor trusts may allow the business to get the deduction.
- You own expensive real estate. Putting high value real estate in a non-grantor trust could allow the trust to get a state and local tax (SALT) deduction. The SALT deduction is capped at $10,000, so if the property is included in your taxable estate, you can get only one deduction, but if it is placed in one or more non-grantor trusts, each trust will qualify for a separate deduction.
Non-grantor trusts also have their downsides. They are much more expensive to set up and maintain. In addition, the grantor loses all control of the assets in the trust. Taxes are also steeper for a non-grantor trust.
To find out if a non-grantor trust is right for you, contact your attorney.