Grantor Trust – The Gift That Keeps on Giving (Tax Free)

Gifts, both tax and non-tax, are great to accomplish estate planning goals. A gift to a special type of trust, called a Grantor Trust, can be one of the best types of gifts you can make.

The primary non-tax benefit of a gift is seeing the recipient use the funds for college, drive the car, or benefit from other property during your lifetime, while you are around to enjoy it.

The tax benefit is getting the assets out of your taxable estate so that they won’t be taxed at your death. The gift also gets the appreciation of those assets out of your estate. Whether this growth is dividend income or capital gains, it will be taxed to the recipient of the gift at his/her rates, which are usually lower if the gift is to a child or grandchild. Of course, the recipient must pay the income tax, but he/she at least has the principal of the gift and some of the gain, after tax, to use.

If the gift is made in trust and the funds are to be held in the trust for use in the future, the trust pays the tax, and, because of the way income tax is calculated for a trust, the trust’s income tax rates may be just as high as those of the donor. So if a gift is made in trust with the idea that the funds will grow for the future, the income tax paid by the trust will be a drag on that growth within the trust.

If you can afford it, you could agree to reimburse the recipient, an individual, or the trust for the income tax paid each year to make up for that drag, but this would be another gift. If the original gift were large enough, reimbursing the income tax each year might impact your overall estate plan and might even require you to pay gift tax.

What if you could make the original gift but NOT shift the burden of paying the income tax to the recipient? That would be the best of both worlds: you make a gift to reduce your estate, the funds grow tax free in the hands of the recipient (because you are paying the income tax) and each time you pay the income tax, it would NOT be a further gift (because legally you have the obligation to pay the tax).

Good news! You can do this by making a gift to a Grantor Trust. The IRS will ignore the trust for income tax purposes, and will tax the income and gain to you. But the gift is still made, and for estate tax purposes, the property will be out of your estate. The assets given away to the Grantor Trust will grow tax free as far as the trust is concerned, because you are paying the income tax, and you will not be treated as making further gifts, because you are obligated to pay the tax in the first place.

Even better news: each time you pay the income tax, the funds used to pay the income tax are out of your estate as well. You continue to reduce your estate without any gift or estate tax cost! A gift to a Grantor Trust is truly the gift that keeps giving every year (and gift tax free)!


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