# Grantor Trust Rules: What They Are and How They Work

![Grantor Trust Rules: The tax implications for an individual who creates a grantor trust.](https://www.investopedia.com/thmb/kIJ6ZXTU7Cwv4-Qbtkxt3TFVMq4=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Grantortrustrules_final-46774a17119843e69f0deac43d00643c.png)

*— Investopedia / Michela Buttignol*

> **Definition**
>
> Income generated from trusts graduates to a higher tax bracket faster than individual marginal income tax rates.

## What Are Grantor Trust Rules?

Grantor trust rules are guidelines in the [Internal Revenue Code (IRC)](https://www.investopedia.com/terms/i/internal-revenue-code.asp) that outline certain tax implications of a grantor trust. These rules mandate the individual who creates a grantor trust as the owner of the assets and property held within the [trust](https://www.investopedia.com/terms/t/trust.asp) for income and [estate tax](https://www.investopedia.com/terms/e/estatetax.asp) purposes.

A grantor trust agreement dictates how assets are managed and transferred after the grantor's death. State laws determine if a trust is revocable or irrevocable.

### Key Takeaways

*   A grantor trust is one in which the individual who creates the trust is the owner of the assets and property for income and estate tax purposes.
*   Grantor trust rules apply to different types of trusts.
*   Grantor trusts can be either revocable or irrevocable.

## How Trusts Are Taxed

Trusts are designed as separate legal entities as part of [estate planning](https://www.investopedia.com/terms/e/estateplanning.asp) to protect the grantor's or originator's assets and the income generated from them so beneficiaries can receive them. A grantor trust allows the grantor or owner to retain the power to control or direct the income or assets within the trust.

Grantor trusts were originally used as tax shelters. Tax rates for trusts once graduated along with income tax rates. The income was taxed at the personal income tax rates. The grantor reaped the benefits, shielding money taxed as an individual account not a separate legal entity. The Internal Revenue Service (IRS) established grantor trust rules to thwart misuse.

## Benefits of Grantor Trust Rules

*   **Trust Income:** Grantor trust rules offer individuals a certain degree of tax protection because [tax rates](https://www.investopedia.com/terms/t/taxrate.asp) are generally more favorable at the individual level than for trusts.
*   **Beneficiaries:** Grantors can change the [beneficiaries of their trusts](https://www.investopedia.com/terms/b/beneficiary-of-trust.asp) and the investments and assets held within them. They can direct a trustee to make alterations. [Trustees](https://www.investopedia.com/terms/t/trustee.asp#:~:text=A%20trustee%20is%20a%20person,for%20someone%20like%20a%20minor.) are individuals or financial companies that manage assets for the trust and its beneficiaries.
*   **Revocable Trusts:** Grantors can also undo their trusts. This distinction makes a grantor trust a [revocable living trust](https://www.investopedia.com/terms/r/revocabletrust.asp) that can be changed or canceled by the owner, originator, or grantor.
*   **Changing the Trust:** The grantor can relinquish control of the trust, making it [irrevocable](https://www.investopedia.com/terms/i/irrevocabletrust.asp). This type of trust can't be amended or canceled without the permission of all beneficiaries. The trust pays taxes on the income it generates in this case and requires a [tax identification number (TIN)](https://www.investopedia.com/terms/t/tax-indentification-number-tin.asp).

> **Important**
>
> A trust may be exempt from grantor trust rules if it has a single beneficiary who is paid principal and income from the trust or has multiple beneficiaries who receive the principal and income by their shareholding in the trust.

## How Rules Apply to Different Trusts 

Grantor trust rules outline certain conditions under which an irrevocable trust can receive some of the same treatments by the IRS as a revocable trust. These situations sometimes lead to the creation of what are known as intentionally defective grantor trusts.

A grantor is responsible for paying taxes on the income the trust generates in this case but assets aren't included in the owner's estate. Assets would apply to a grantor's estate if the individual runs a revocable trust because they would effectively own property held by the trust.

The property is transferred out of the grantor's estate and into a trust with an irrevocable trust, which would then effectively own that property. Individuals often do this to ensure property is passed down to family members. A gift tax may be levied on the grantor based on the property's value when it's transferred into the trust but no estate tax would be due upon the grantor's death.

> **Warning**
>
> Grantor trust rules state that a trust becomes a grantor trust if the creator has a reversionary interest greater than 5% of trust assets when the transfer of assets to the trust is made.

## What Are Some Examples of Grantor Trust Rules?

Some grantor trust rules outlined by the IRS include the power to add beneficiaries, borrow from the trust, and use income to pay life insurance premiums.

## What Is a Tax Shelter?

A tax shelter is an arrangement that holds assets or money in such a way as to reduce or avoid taxation on their value. Some employer-sponsored retirement plans are considered to be tax shelters as are financial accounts held and maintained in other countries. Grantor trusts once served as a form of legal tax shelter.

## Can a Grantor Act As Trustee of Their Grantor Trust?

In some cases, yes. The trust must be revocable because the law allows this type of trust to be changed or undone after formation. The grantor/trustee names a successor trustee to take over at the time of their death or in the event of incapacitation that prevents them from managing the trust themselves.

## The Bottom Line

The grantor of a personal trust is typically its creator. The grantor transfers their assets, money, and property into trust ownership except in a grantor trust. The creator is still considered the owner for income and estate tax purposes and can dissolve or change the trust’s terms in the case of a revocable trust.  

> **Article Sources**
>
> 1.  Internal Revenue Service. "[Abusive Trust Tax Evasion Schemes - Questions and Answers](https://www.irs.gov/businesses/small-businesses-self-employed/abusive-trust-tax-evasion-schemes-questions-and-answers)."
>     
> 2.  Internal Revenue Service. "[5.5.7 Collection Estate and Gift Tax Accounts](https://www.irs.gov/irm/part5/irm_05-005-007)." Section 5.5.7.32(09-16-2013)
>     
> 3.  Internal Revenue Service. "[2021 Instructions for Form 1041 and Schedules A, B, G, J, and K-1](https://www.irs.gov/pub/irs-pdf/i1041.pdf)." Page 18.
>     
> 4.  Internal Revenue Service. "[LB&I International Practice Service Process Unit - Audit](https://www.irs.gov/pub/int_practice_units/FEN9432_02_07R.pdf)." Page 20.
>     
> 5.  Internal Revenue Service. "[Number 201919003](https://www.irs.gov/pub/irs-wd/201919003.pdf)." Page 2.
>     
> 6.  Tax Policy Center. "[Briefing Book/What Is a Tax Shelter?](https://www.taxpolicycenter.org/briefing-book/what-tax-shelter)"
>     
> 7.  Vail Gardner Law. "[Learn Trust Basics: Who Is the Grantor vs. Trustee?](https://vailgardnerlaw.com/estate-planning/learn-trust-basics-who-is-the-grantor-vs-trustee/)"