Grantor Trust Rules (Internal Revenue Code Basics)


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Internal Tax Code Licensor Trust Tax Rules

When it comes to the Internal Revenue Code (IRC), one of the most complicated aspects of IRC is the tax rules applicable to grantor trusts. In general, the two main categories of trusts are grantor trusts and non-constituent trusts. The distinction between these two classes of trusts is very important for US tax purposes, as the tax consequences of these two classes of trusts differ significantly. From a basic perspective, with a grantor trust, the grantor is taxed on the income. A very simplified example would be a US person who has a US trust that holds US property that generates income. The grantor is responsible for reporting income and taxes for this rental property. Conversely, with a non-granting trust, the settlor or original settlor is not considered the owner of the trust and therefore the tax rules are different. Instead of the settlor being subject to income tax, the trust and/or beneficiaries who receive distributions are instead left to deal with tax headaches. Of course, it gets infinitely more complicated when dealing with a foreign trust, but let’s briefly review the basics of the trust.

Taxation of a grantor trust

While taxing a settlor trust is relatively simple, estate and tax planning can involve many nuances and this is something to keep in mind when evaluating a trust for tax purposes. With a grantor trust, the grantor is generally responsible for taxes. The reason for this rule is to avoid a situation where income is allocated to beneficiaries (who are usually in a lower tax bracket) who then transfer the money to the settlor – and the IRS loses taxes. This is because beneficiaries are generally taxed at a lower tax rate, and especially with the gift and estate exclusion so high, the IRS wants to make sure that no income owed to them is missed, thus contributing to the tax. difference. Therefore, the settlor’s tax rules require the settlor of the trust to be liable for tax.

Grantor Trust Rules IRC 671-679

Sections 671 through 679 of the Internal Revenue Code provide a tax roadmap for grantor trust rules. Each of these code sections refers to distinct powers and attributes of the federal tax rules relating to settlor trusts.

Settlor trust powers

In general, settlors have different powers and powers as settlor or owner of the trust. Some of the more common powers include:

  • power to withdraw income from the trust;
  • the power to substitute or exchange assets within the trust, and
  • the power to change the trustee and/or the beneficiaries of the trust.

These powers may be limited or modified depending on the specific type of grantor trust.

Participants in the grantor trust

When it comes to understanding the type of people who are part of the grantor trust, the tax authorities provide a good summary detailing the various participants.

As provided by the IRS:

Settlor is also known as trustee, settlor or founder. The settlor is the person who transfers the assets of the trust to the trustee.

The trustee is the person or entity responsible for holding and managing the assets of the trust for the benefit of the beneficiary. Trustees can be a corporate trustee or any competent person who is not a minor. The trustee holds legal title to the trust. As such, the trustee has a fiduciary duty to the beneficiaries with respect to the trust property. In the event of a breach of fiduciary duty, a fiduciary may be held personally liable. These breaches include non-payment of distributions or misappropriation. The beneficiary is the person or entity who will receive the benefits of trust ownership.

The beneficiary holds beneficial title to the trust property. The deed of trust must clearly identify the beneficiary or beneficiaries.

Foreign Trust vs Domestic Trust

Once it has been determined that a trust is a grantor trust, it is important to determine whether or not the trust would be considered a domestic trust or a foreign trust. Grantor trusts have an immediate tax implication on the income generated by the trust, so whether or not the grantor is considered a US person or a foreign person is crucial. Additionally, questions regarding whether or not the assets of the trust are based in the United States or outside of the United States and/or whether or not the beneficiaries qualify as U.S. beneficiaries may result in other tax implications. , including reporting requirements under Forms 3520 and 3520. -UN.


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