If you have started the estate planning process, you’ve surely heard of trusts. Trusts are legal instruments that can hold and manage assets on behalf of a specified beneficiary named by the original owner of the assets, the grantor. The assets held within the trust are then managed by a trustee named by the grantor.
There are two basic types of trusts that hold assets and can be used for estate planning: grantor trusts and non-grantor trusts. While very similar, there are some distinct differences in the ways that grantor trusts and non-grantor trusts are managed and taxed.
Grantor Trusts Vs. Non-Grantor Trusts
The biggest difference between grantor trusts vs. non-grantor trusts is the role of the grantor. Essentially, grantor trusts allow the grantor to retain certain powers over trust administration. While ownership of assets is technically fully transferred to the trust, the grantor typically retains full practical control as both a trustee and beneficiary of the trust. In this way, the trust becomes primarily an instrument to transfer property after the grantor dies. Until that time, the property and income of the trust remain within the control of the grantor.
A non-grantor trust, on the other hand, permanently turns all rights, titles, and interest in the assets over to the trust. With grantor trusts, the grantor has little or no control over the assets released to the trust. The grantor cannot be a trustee or a beneficiary of the income of the trust. As soon as a non-grantor trust is formed, the trustee gains ultimate control of assets within the trust.
Because of these differences in ownership, grantor trusts and non-grantor trusts are taxed differently. Grantor trusts are not considered an independent entity for taxes. Essentially, all income, deductions, and credits from the trust are reported on the grantor’s individual tax return. Non-grantor trusts, however, are separate tax entities. They therefore file their own tax returns as unique legal persons.
While both grantor trusts and non-grantor trusts are key strategies used in estate planning, they are not used for the same purposes. It’s vital for everyone to understand the distinctions between grantor and non-grantor trusts in order to make informed decisions while estate planning. If you are interested in a deeper understanding of the advantages and disadvantages of grantor trusts vs. non-grantor trusts, it can help to speak with a qualified California estate planning attorney like Michael D. Larsen.