Business & Tax Planning Ideas for Our Clients and Friends
A grantor trust is generally used when planning a persons will
and distribution of an estate. A grantor trust is a specific type of trust that allows the
person who creates the trust (grantor) to control the assets in the trust and recognize
income generated by the trust. (This type of trust is also referred to as a revocable,
living, or inter vivos trust.) To understand the advantages of a grantor trust, you must
first understand how it is created and how it differs from other trusts.
Creating a grantor trust
A grantor trust is so called because it is created during the
grantors lifetime. It is a revocable trust, which means that the trust can be
terminated or changed during the grantors lifetime, as long as he or she is mentally
capable. When the grantor dies, the trust becomes irrevocable and the trust is then
administered according to the instructions in the trust documents.
Naming a trustee
The trust documents designate who is a trustee. The grantor may serve
as the trustee, or if the grantor does not have the time or experience to manage a trust,
he or she may name an experienced person as trustee or co-trustee. A trustee must manage
assets, carry out the objectives of the trust as set out in the trust documents, and take
care of all reporting requirements and paperwork.
Trust documents determine who has control and ownership of the trust
and who manages and disposes of the trust assets. The trust documents should also contain
contingency plans in case of death or incapacity of the grantor. In such cases, the trust
should designate who is to act on the grantors behalf (the successor trustee). The
trust documents should also direct the successor trustee on how to manage and distribute
the assets. Naming a successor trustee is extremely important, as it allows the assets of
the trust to be immediately accessed. If no successor trustee is named, the family of the
grantor must apply to a court to be named as a conservator the grantors assets.
During this court process, the family would have no access to the assets. If any assets
are short-term or require immediate or continuous attention, such as stocks or options,
lack of the access could hinder the sale or purchase of the assets and affect their value.
Advantages of a grantor trust
Assets held in a grantor trust are not subject to the probate process
because at the death of the grantor, the trust is considered a separate legal entity.
Probate is a process supervised by a probate court. The process validates the will and the
appointment of an executor of the will, oversees the administration of the estate, and can
take two years or more to complete. Because the trust is not probated, the beneficiaries
of the trust have immediate access to the trust assets, and therefore the distribution of
the assets is generally quicker.
In addition, for a less complicated estate, the administrative costs
of administering the trust assets will be less than the costs of administering assets
subject to probate, since a grantor trust usually will not be required to file an annual
accounting of assets with the probate court.
Income, gift and estate taxes
If the grantor of the trust is also a trustee, a separate income tax
return may not be needed for the trust. If a grantor makes gifts from the trust during his
or her lifetime, generally the gifts are considered as being made by the grantor and may
be subject to the gift tax. After the grantors death, any property in a grantor
trust is included in the grantors estate and subject to the estate tax.
Note: Due to the Taxpayer Relief Act of 1997, if the grantor dies
after August 5, 1997, a grantor trust can be combined with the decedents estate for
federal tax purposes. This means that only one tax return would need to be filed, and the
trust could take advantage of tax benefits-such as passive losses-from the combined tax
Factors to consider
When considering a grantor trust, you should also consider other
factors, such as state laws and the type of asset(s) you want to transfer to the trust.
For example, if you are considering transferring real estate, the transfer to a trust
legally changes the title of ownership to the trust. When doing so, you must take into
account whether there is a mortgage on the property. If so, check with the bank or
institution that holds the mortgage to see if the title can be transferred without
affecting the mortgage; the loan could become payable in full upon transfer.
If the real estate is owned in another state, a grantor trust could
help reduce probate costs in the other state. Many times if the owner of property is
domiciled in another state, the property may be subject to probate and transfer taxes in
those states. However, the trust laws of the state should be carefully reviewed as each
state has its own trust requirements. For example, some states require that the trustee be
a resident of the state.
If you would like further information on grantor trusts, please
contact our office.
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In 1994, a taxpayer purchased an annuity contract for $195,643 from
insurance company A. Payments under the contract would begin February 4, 2029. Later that
year, the taxpayer asked company A to withdraw $119,000 from the annuity contract and to
issue a check in favor of, and to directly transfer the funds to, insurance company B. The
funds were to be used to purchase a new annuity contract from company B. Company A
complied with the taxpayers request, and retained $10,000 from the $119,000 as a
"surrender charge". Upon receipt of the check from company A for $109,000,
company B opened an annuity contract for the taxpayer with a principal amount invested of
$109,000. The terms and provisions of the Company B annuity were substantially similar to
those of the company A annuity. The taxpayers application to company B expressly
requested that the transfer of funds and purchase of another annuity were to be treated as
Section 1035 exchange. The IRS claimed it was not a Section 1035 exchange because the
entire company A annuity was not replaced by the company B annuity. The taxpayer argued
that it was a nontaxable exchange because: 1) company A did not distribute any of the
funds to her personally, but to company B instead, and (2) she gave up a portion of her
company A annuity solely in exchange for the company B annuity.
The Tax Court found that the direct transfer of a
portion of the funds invested in the company A annuity contract into the company B annuity
contract qualifies as a nontaxable exchange under Section 1035. The court found that
neither Section 1035 nor the regulations require the exchange of an entire annuity
contract for nonrecognition treatment. The legislative history of the section states that
it was enacted to provide nonrecognition treatment for taxpayers "who merely
exchanged one (annuity contract)
for another better suited to their needs and who
have not actually realized gain". The court concluded that because 1) the taxpayer
was in essentially the same position after the exchange as she was before, 2) the funds
were still in annuity contracts, and 3) the taxpayer had not received use or benefit from
the funds, the transaction qualifies as a nontaxable exchange.
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Still wondering whether you should listen to all the dire warnings
about Y2K or just bury your head in the sand? Chances are, Y2K will affect you and your
family in some manner, so it is best to take some precautions. Here are some steps to
By mid-December withdraw enough cash to cover your expenses for about a month. This
way you will have money to buy necessities in case your credit and ATM cards dont
work. If you or a family member receives Social Security or pension checks, make sure
enough cash is on hand in case these checks are delayed.
Avoid flying during the first few days after the New Year. Airlines and the Federal
Aviation Administration depend on high-tech equipment that is particularly vulnerable to
Y2K errors. If you must travel, take cash and travelers checks. Dont rely on
credit cards and cash advances, particularly if you are traveling to a foreign country.
Other countries are less prepared than the United States for Y2K. Find out about travel
insurance that offers reimbursement, if trips are canceled. Be sure the insurance does not
exempt Y2K computer problems.
Try not to schedule elective surgery for early in 2000. Critical hospital equipment
is dependent on computer chips that may not be functioning properly.
Make sure important bills such as insurance policies, property tax bills, water
bills, etc. have been paid and that payment records are well documented. After the New
Year, examine all bills carefully before paying to make sure that there are no errors in
If you trade stocks over the Internet, have a backup system and/or printout of your
transactions and holdings in case you cannot access the information via the Internet.
Dont panic, but make sure you have necessary items such as candles, batteries
for radios and flashlights, bottled water and non-perishable food. Make sure you car has a
full tank of gas.
Fill all prescriptions before 2000, and make sure you have a 60-day supply of needed
prescription medication of hand by December 1. American drug manufacturers depend on
foreign suppliers for many ingredients, and Y2K may be a bigger problem outside the United
Know the local phone numbers for the police, fire, and ambulance services in your
town, since 911 may not work.
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