Examining the heightened political scrutiny of grantor trusts

ARTICLE | September 20, 2024

Authored by RSM US LLP

Executive summary

• Grantor trusts are an effective and popular wealth transfer tax tool but have been under increased scrutiny from those who perceive them as tax avoidance schemes.
• Election outcomes could end up closing the window of opportunity to utilize grantor trusts.

Examining the heightened scrutiny of grantor trusts

Irrevocable grantor trusts offer a unique combination of tax benefits that make them a valuable tool for estate planning. This is because they are treated differently for gift and estate tax purposes than they are for income tax purposes. This special treatment can result in significant tax savings. Common types of irrevocable grantor trusts include Intentionally Defective Grantor Trusts (IDGT), Spousal Lifetime Access Trusts (SLATs), Irrevocable Life Insurance Trusts (ILITs) and Grantor Retained Annuity Trusts (GRATs).

Common types of irrevocable grantor trusts include:

• Intentionally defective Grantor Trusts (IDGT)
• Spousal lifetime access trusts (SLATs)
• Irrevocable life insurance trusts (ILITs)
• Grantor retained annuity trusts (GRATs)

How do irrevocable grantor trusts generally work?

Grantor trusts are not separate entities from their deemed owner for income tax purposes. The grantor and the trust are treated as one taxpayer and the grantor is liable for the trust’s income tax. Grantor trust status can apply to the entire trust or only a portion of it, and the grantor trust status can be changed under certain circumstances.

What are some of the grantor trust tax benefits that are under scrutiny?

• Transferring assets to an irrevocable grantor trust can remove assets from the grantor’s gross estate and allow the appreciation to avoid transfer tax.
• The payment of income tax on behalf of the irrevocable grantor trust, by the grantor, is not an additional gift to the trust. This allows the trust to grow income tax free during the grantor’s life.
• Exchanges between a grantor trust and the grantor are generally not taxable transactions because the grantor is the deemed owner of the trust for income tax purposes.
• Certain grantor trust provisions allow flexibility, such as the ability to swap assets of equivalent value between the grantor and the trust without incurring income tax.
• Certain types of grantor trusts, such as a GRAT, allow individuals to transfer the appreciation on assets outside of their estate while making only a very small gift.
• Trated below, these additional legislative efforts have included:

How have lawmakers tried to limit or eliminate the benefits associated with grantor trusts?

Due to the tax advantages offered by grantor trusts, lawmakers have become increasingly concerned with their potential misuse as perceived tax avoidance tools. The repeated attempts to curtail these benefits demonstrate their persistence in addressing this issue, raising the question of whether these estate planning strategies may eventually become less effective or eliminated.

Notably, the Obama and Biden administrations have proposed eliminating these estate planning strategies.

Vice president Kamala Harris, the Democratic nominee for president, has indicated a similar intent.

Specifically, several measures proposed in Congress over the last six years have sought to limit these benefits by increasing income and/or transfer tax liabilities of high net worth individuals who utilize these techniques.

As illustrated below, these legislative efforts have included:

What does the future use of grantor trusts look like?

The future viability of grantor trusts will likely depend on the outcomes of the 2024 presidential and congressional elections. While the presidential candidates have indicated the direction in which they hope to steer these policy issues, the balance of power in Congress will go a long way toward determining whether either party can advance its agenda. However, in any scenario, the margins of majorities matter.

In the case of a Democratic sweep there is a possibility of Congress moving quickly to make changes to our tax rules. This may mean that 2024 is the last chance to institute this sort of planning; however, beating this deadline may not be a guarantee of success. The most recent proposal on the subject from Senator Warren does not protect existing planning; however, this may be an outlier as historic bills have contained such a provision.

If you are considering utilizing a grantor trust, it may make sense to be ready to act quickly. However, there is a chance that future laws could still affect your 2024 planning. Consult with your tax advisor to determine how these potential changes impact your estate plan.