A grantor trust fund is created during the lifetime of the person wanting to create the trust (the grantor). The sole purpose is to create an artificial person who would have all the requisite legal rights to hold, protect, sell, and divide the property among the grantor's legal heirs, loved ones, or beneficiaries. Such a trust can also be set up when the grantor is too busy to manage his own assets, has become ill, or too old to perform these duties alone.
What is a Grantor Trust?
A 'grantor' is the person who owns a trust fund and all the property under it. While a 'trustee' is the person who makes a contractual agreement with the grantor, agreeing to manage the grantor's property and assets during and after his lifetime. A trustee can be a corporate body as well, such as a trust company. The trustee binds himself to the contract and swears to distribute the assets among the grantor's legal heirs as per the rules and instructions mentioned in the trust agreement. Therefore, a grantor trust in simple layman's language means, the contractual agreement initiated by the grantor, between himself and the trustee for the purpose of estate planning before and after the grantor's death.
The trust can be made for the benefit of children, spouse, grandchildren, family friends, or even charity organizations, old age homes, or the church. A trust agreement is a series of instructions given by the grantor to the trustee on how the estate must be divided among the legal beneficiaries and in what ratio the trust funds have to be managed and distributed. Therefore, such a trust agreement is very similar to a 'last will and testament', barring the key fact that the grantor, can give fiduciary rights to the trustee to divide the assets in a designated manner, after death. Whereas a normal 'will', does not provide the grantor with such power. The grantor can also make changes, revoke, and terminate the entire trust while he is still alive. He also enjoys complete control over his trust property and can reap the benefits of owning it in every sense, while he is alive.
Grantor Trust Rules
At the time of setting up a trust fund, the grantor must have personal property with a reversioner interest of more than 5% of the total trust fund assets. This is mandatory because once the trust is created under the grantor's name, the taxes will be charged on the grantor's personal property and not on the trust fund. The reason for this special consideration is that the taxes levied on trusts are much higher than those levied upon normal citizens. Therefore, the grantor is exempted from high trust tax rates and asked to pay normal taxes like everyone else. In case the grantor waives or refuses his normal taxes rate and chooses to pay the trust taxes, then the trust will automatically covert itself into an irrevocable trust, whereby more taxes will be paid on any income that is taxable in the trust. The grantor will cease to hold any control over his trust and will no longer be able to receive any benefits from the trust.
Intentionally Defective Grantor Trust
ITGT or Intentionally Defective Grantor Trust are legally certified flaws that have been made a part of the grantor's trust so that income tax laws continue to treat the trust fund as a part of the grantor's personal assets and property. This is done in order to make sure that people regularly keep paying their income tax, as good citizens are expected to. The IDGT does not consider estate taxes and fortunately, the grantor is legally exempted from paying those taxes. The IDGT helps in the reduction in value of the grantor's estate to the total amount of assets transferred into the trust. Therefore, the grantor will receive promissory notes for a fixed duration of years such as up to 15 years, as on when he sells his assets to the trust. These promissory notes will pay interest to keep the trust in the market, but will take much more time to appreciate as compared to the other assets which will grow faster as they are free from the estate tax. The key beneficiaries of the IGDT are children and grandchildren who get to receive full-grown assets and even more financial gifts from the grantor without any reductions of income tax. As the income tax has already been paid by the grantor including all the estate taxes.
Grantor trust has another major advantage, which is avoiding and eliminating probate completely. This helps the trustee distribute the grantor trust among the beneficiaries without having to be delayed up to a year due to lengthy court procedures.