One of the primary reasons to create a trust is to avoid excess taxation. Parties who place property into a trust do not have to disclose those assets for taxation or pay taxes on any income that comes from them. However, this can create problems for the beneficiaries of trusts, as they may find that taxation of the assets leaves them with a reduced inheritance when they obtain those assets.
One way to avoid this is to create an intentionally defective grantor trust. These documents allow for the trust maker to continue paying the taxes on the assets while they sit in the trust. This limits the impact of estate taxes at the federal level and in the states that still collect these payments. Reach out to an attorney to learn more about the role that intentionally defective grantor trusts can play in limiting the exposure of your estate to taxation.
Are Intentionally Defective Grantor Trusts Irrevocable?
Most trusts are irrevocable by nature. The party creating the trust relinquishes all control and responsibility for the assets. Normally, this means that the trust creator must no longer pay taxes on those items. Unfortunately, this can lead to the tax burden passing on to the trust itself or a person’s estate if the property moves upon the creator’s death.
An intentionally defective grantor trust attempts to avoid this outcome. Under these trusts, the creator continues to pay income taxes on the assets and their income while they sit in trust. By doing this, the creator is retaining a level of control over the trust in a way that resembles a revocable trust, thus reducing the tax burden on the estate. An attorney could further explain the tax benefits of intentionally defective grantor trusts.
Situations Where an Intentionally Defective Grantor Trust May be Beneficial
An intentionally defective grantor trust may be beneficial in situations where trust property is expected to have taxable income. These can include real estate, business holdings, or financial instruments. The purpose of creating the trust is to alleviate beneficiaries from needing to pay taxes when they receive the items. Additionally, this estate planning tool can allow the items to remain in trust while continuing to appreciate in value.
In most situations, the trust creator is aiming to transfer the assets to younger children or grandchildren. To accomplish this, the creator will often transfer the assets to the trust in exchange for a promissory note. This note will pay interest to the extent that is necessary to keep the trust above-market. As a result, these interest payments can help to alleviate the tax burden that will remain with the creator.
Intentionally Defective Grantor Trusts Can Help Both Creators and Beneficiaries of Trusts
An intentionally defective grantor trust is a trust that attempts to shift the burden of taxation on the trust assets. Normally, the trust itself or the beneficiaries must pay taxes on the trust’s income. However, a defective trust allows the trust maker to pay these bills for the benefit of all parties.
The trust maker can often transfer the assets to the trust in exchange for a promissory note that bears interest. In some cases, this can cover the tax obligations. At the same time, paying these bills ahead of time can lessen the chances that a state or federal government will levy an estate tax upon death.
Finally, placing assets in these trusts comes with the usual benefit of avoiding direct taxation on the assets from the perspective of the trust maker. Contact an attorney today to discover more about the benefits of intentionally defective grantor trusts.