IRREVOCABLE GRANTOR TRUST
A “grantor” trust is a trust that contains certain provisions set forth in the Internal Revenue Code,which defines these types oftrusts. With a carefully drafted irrevocable grantor trust, the incomeis imputed to you as the creator of the trust, but the trust assets are not included in your estate forestate tax purposes. In other words, as trust maker you must pay the income taxon all trustincome, but trust assets will not be subject to estate tax at your death. The effect of paying theincome tax is to further leverage the transfer to your beneficiaries at no additional gift tax cost.Grantor trusts are useful planning tools inseveral circumstances, particularly where you desire tosell appreciated assets to the trust without immediately incurring income tax. Under the InternalRevenue Code, when you sell an asset you must pay income tax on the amount above your“basis” in theproperty. In its most simplified sense, basis is the amount you paid for an assetwhen you purchased it, or if you received it by gift, it is the donor’s basis in the property
A typical sale of appreciated property causes imposition of income tax. However, a grantor trustis treated as you for income tax purposes. Since you cannot “sell” property to yourself, a sale to agrantor trust is ignored for income tax purposes. After the sale, the trust will have as its basis theamount it pays for the property.
Significantly, the sale must be for full fair market value–a sale for less than full market valuewill be treated as part sale, part gift. How does the trust obtain the ability to purchase the assets?One way to accomplish this is by you making a giftto the trust followed by the trust purchasingthe assets using an interest-bearing promissory note (with terms similar to a financing transactionwith a third-party lender), using the minimum interest rate established by the IRS. Anothermethod is for ablebeneficiaries to guarantee the payments in a commercially reasonable manner.Another instance where a grantor trust provides planning opportunities is where you own lifeinsurance in your name (or where an irrevocable trust owns life insurance in your name) and youdesire to transfer the policy to an [a new] irrevocable trust. By making the irrevocable lifeinsurance trust a grantor trust you can sell the policy for its fair market value and avoid theproblems that can occur when you transfer ownership ofan existing life insurance policy.