With tax season in full swing and the filing deadline approaching, many wonder how trusts are taxed. That depends on the type of trust. The main difference between a grantor and non-grantor trust is how they are taxed. With a grantor trust, the grantor retains some control over the assets in the trust. A non-grantor trust is set up so that the person who established the trust has no rights, interests or powers over any of the trust assets.
With a grantor trust, the grantor typically retains certain powers such as the ability to revoke the trust, change beneficiaries, switch out the assets or distribute income. The majority of trusts created are grantor trusts because most trust creators want to retain some or all of these powers. Grantor trusts use the grantor’s social security number and income generated from the trust is reported on the grantor’s tax return.
With a non-grantor trust, the trustee is responsible for filing a trust tax return, since the trust is considered a separate legal and taxable entity. When the trust pays income to a beneficiary, the beneficiary must include that income in his or her taxable income. The grantor is personally relieved from paying taxes on this trust income.
Some situations where a non-grantor trust may be useful:
- Setting up a trust for an ex-spouse following a divorce, where the trust creator has no need to be involved once the trust is created and funded.
- Putting a sole proprietorship, partnership, LLC or similar small business into a non-grantor trust allows the business to obtain qualified business income deductions.
- Funding a non-grantor trust with high value real estate allows the trust to take state and local tax deductions.
The two main drawbacks to consider before creating a non-grantor trust are the lack of control over the assets and the costs associated with setting up and maintaining the trust. Grantors cannot serve as trustee, so a trustee must be chosen to manage the trust assets. This person or entity will be entitled to a fee which is drawn from trust assets.
Non-grantor trusts can be useful planning tools in certain situations. It is important to understand how they are treated for tax purposes as well as being comfortable with the loss of control. For more information set up a consultation with a knowledgeable estate planning attorney at Stouffer Legal in the Greater Baltimore area. You can schedule an appointment by calling us at (443) 470-3599 or emailing us at office@stoufferlegal.com.
