Creating a grantor trust for clients is the cornerstone of an estate planning practice. A grantor trust is a trust over which the grantor retains either direct or indirect control to such an extent that he or she is treated as the owner of the trust for income tax purposes. Thus, it is a technique that is useful for not only sophisticated estate plans, but is often the basis for estate plans that require something more than just a sweetheart will. It may be used in everything from a medicaid trust to shelter assets, to an irrevocable life insurance trust, or as a trust in concert with other estate freezing devises. …

While a grantor trust is a trust which is treated as wholly or partially owned (depending on the circumstances) by the grantor for income tax purposes, it may also be designed so the trust is not included in the grantors estate for purposes of the estate tax.

The sections of the income tax code which are used to make a grantor trust are found in Subchapter J, in particular in I.R.C. Sections 671 through 678. Each of these sections of the Code have rules which when applied to a trust trigger specific benefits as well as detriments. In other words, there is no one right way to draft or create a grantor trust. The objective may be to use these rules to make this trust a grantor trust, but to also preclude the application of the estate and gift tax rules of Chapter 11, whereas at other times the single objective is only for income tax planning and different rules of the Code will suffice.

Some of the ways a trust may be treated as a grantor trust are as follows:…

 

Revenue Ruling 2008-22, 2008-1 C.B. 796, released on April 21, 2008, holds that the power to substitute assets of equivalent value does not cause the trust to be included in the grantors gross estate under either I.R.C. Section 2036 or I.R.C. Section 2038. The ruling provides that it is a grantor trust not included in the estate: (1) so long as the trustee has a fiduciary obligation, either via state law or the trusts terms, to ensure that the property substituted is truly of equivalent value; and (2) that the power of substitution cannot be used in a manner that favors one beneficiary of the trust over another. Equivalent value is readily understood, but the power of substitution can be shades of grey. For example, if the trust contains discretionary provisions toward multiple beneficiaries there must be an absolute duty of impartiality. In a trust without unlimited discretionary provisions the fiduciary obligation becomes irrelevant. Such trusts are best exemplified by a unitrust providing for a set percentage or a trust which is limited to a very specific standard.

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2008 brings to practitioners a safety net in designing and creating grantor trusts. Following a few simple rules the grantor acting in a nonfiduciary capacity may safely and effectively be granted the right to substitute assets of the trust with assets of equivalent value.

 

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ABOUT THE AUTHOR: Stephanie G. Rapkin is a practicing attorney in Milwaukee, Wisconsin. She was admitted to practice in 1982 and received her LL.M. in taxation in 1990. In addition to her practice, she is an adjunct professor at the University of Wisconsin-Milwaukee. Stephanie is the update author of Planning for Large Estates (LexisNexis Matthew Bender). She has also written numerous articles on estate planning and taxation for national legal publications, including Trusts & Estates, The Journal of Taxation of Investments and Taxes: The Tax Magazine. In addition to writing on these topics, she frequently lectures for continuing education programs both locally and nationally.