¶ 4001
Overview
Scope of the chapter. A grantor trust is a trust whose income, deductions and credits are reported by the grantor, or by another person treated as the owner, because the Internal Revenue Code treats that person as owning all or part of the trust for income tax purposes. I.R.C. § 671. The rules that produce this result, in sections 671 through 679, were written to stop taxpayers from shifting income to trusts they continued to control. Modern planning uses the same rules for the opposite purpose. A settlor who makes a completed gift to an irrevocable trust, keeps the trust out of the settlor's gross estate and also keeps one carefully chosen power that makes the settlor the owner for income tax purposes can pay the trust's income tax from personal funds, sell assets to the trust without recognizing gain, and exchange assets with the trust as family circumstances and tax rules change. This chapter is concerned with the design of that arrangement: which power is chosen, who holds it and in what capacity, how the trust is funded, how the settlor's payment of tax is handled and how grantor-trust status is turned off, or turned on, when it stops serving the family.
A design choice. Grantor-trust status is an election made through drafting. No form is filed to obtain it. The instrument either confers a power that one of sections 673 through 677 treats as making the grantor the owner, or it does not. The choice has consequences for three taxes at once. For the income tax, the trust and its owner are treated as one taxpayer for most purposes. For the gift tax, the owner's payment of the trust's income tax is a payment of the owner's own liability. For the estate tax, the power that produces income tax ownership must be one that does not also bring the trust into the owner's gross estate under sections 2036, 2038 or 2042. The planner's task is to separate the income tax result from the transfer tax result, which the Code permits because the two sets of rules use different tests. The point was introduced in the discussion of retained powers in chapter 3 (see supra ¶ 350.06), and the effect of each power on advisers and protectors has been examined in chapters 8 and 12 (see supra ¶¶ 870, 1280).
Vocabulary. The Code speaks of the "owner" of a "portion" of a trust. A grantor may own all of a trust, the income portion only, the corpus portion only, or a fractional or specific portion, depending on the power that triggers ownership. Practitioners call a trust that is deliberately made a grantor trust while kept out of the grantor's estate an "intentionally defective grantor trust," or IDGT; the defect is in the income tax sense only. A trust of which a beneficiary other than the grantor is treated as owner under section 678 is called a beneficiary-owned trust. A "toggle" is a provision that allows grantor-trust status to be ended, and in some designs restored, after the trust is created. This chapter uses those terms in those senses.
Plan of the chapter. Paragraph 4010 describes the definitions in sections 671 and 672 that govern every grantor-trust question. Paragraph 4020 reviews the powers in sections 673 through 677 that make the grantor the owner, with attention to the powers used in design. Paragraph 4030 examines the power of substitution, the most common trigger, and the two revenue rulings that address its estate tax effect. Paragraph 4040 turns to section 678 and trusts owned by a beneficiary. Paragraph 4050 analyzes the sale of assets to a grantor trust for a promissory note. Paragraph 4060 addresses the grantor's payment of the trust's income tax and reimbursement clauses. Paragraph 4070 describes toggling and the consequences of a change in status during life and at death, including the Service's ruling on basis at death. Paragraph 4080 summarizes legislative proposals to change these rules and the state income tax treatment of grantor trusts. Paragraph 4090 collects the drafting choices. Foreign grantor trusts and section 679 are reserved for chapter 43 (see infra ch. 43), incomplete-gift nongrantor trusts for chapter 41 (see infra ch. 41) and spousal lifetime access trusts for chapter 42 (see infra ch. 42). The effect of a decanting on grantor-trust status is discussed in chapter 18 (see supra ¶ 1840).