Is There a Future for Grantor Trusts?

By Christopher D. Wright  |  October 17, 2021

Is There a Future for Grantor Trusts?

This is the second of a three-article series about estate and gift planning in the face of changes to
tax legislation.

Congress is negotiating legislation that would make significant changes to estate and gift tax provisions and, if enacted, would have two major impacts on estate and gift tax planning. First, it would cut in half the current estate and gift tax lifetime exemption, reducing it from $11.7 million per taxpayer to roughly $6 million. Second, the legislation would dramatically alter treatment of grantor trusts, which have long been the preferred vehicle for moving assets out of an individual’s estate.

If enacted, this legislation will make the future use of grantor trusts effectively useless. Since the legislation’s provisions would take effect as of the date of enactment, taxpayers who are considering establishing grantor trusts should act immediately, as trusts established before the effective date will continue to receive the current favorable treatment.

This legislation, which was introduced recently through the budget reconciliation process, significantly changes the landscape for estate and gift tax planning from what it was when the first in this series of articles was written. The bill is being negotiated and faces opposition from two key Democratic senators, without whose votes it cannot pass. We will keep you informed of its progress and the impact on high net worth individuals.

The legislation proposes to accelerate the 2026 reduction of the estate and gift tax lifetime exemption from the current $11.7 million to $5 million (per taxpayer) adjusted for inflation, or around $6 million. The reduction in the exemption alone is not a significant cause for concern as, absent the other changes proposed, there would still be ample planning opportunities to reduce estate taxes. The effective date for the decreased exemption is for persons dying or gifts made after 12/31/2021.

It is the changes to grantor trusts that will have the most significant impact on how we do estate planning. The changes, as discussed below, will make the future use of grantor trusts useless.

Proposed Changes to Grantor Trusts

  • The assets in the grantor trust will be included in the gross estate of the grantor at death. Under current law these assets are not included in the gross estate. If there is any good news, it does mean that the assets in the grantor trust will clearly qualify for the step-up in basis (which there has been no discussion of eliminating).

  • Distributions during the life of the grantor to any individual other than the grantor or grantor’s spouse will be treated as a gift and therefore subject to gift tax and use of the lifetime exemption on the date of distribution. Presumably, the gift would be valued at the fair market value of the asset distributed as of the date of distribution.

  • If the grantor trust becomes a non-grantor trust during the grantor’s life, the assets in the trust will be deemed a gift to the non-grantor trust.

  • The grantor and grantor trust will be treated as separate taxpayers for transactions such as sales to grantor trusts. Currently, a sale to a grantor trust has no income tax impact and does not result in capital gains as it is considered as selling the asset to yourself. Under the proposed legislation, a sale will be recognized for income tax purposes and capital gains will be recognized on the sale. The interest on any note given by the trust to the grantor will also be includible in the grantor’s income.

The effective date should these changes be passed would be the enactment date of the legislation and apply to grantor trusts created after the enactment date. The new rules would also apply to any post-enactment contributions to grantor trusts in existence prior to the enactment date. This would result in partial inclusion of the trust assets in the estate of the grantor. 

What It Means for Trust and Estate Planning

What does this mean for grantor trusts and estate planning? The short answer is that it makes them, essentially, useless. It will certainly make the use of Grantor Retained Annuity Trusts (GRATS) pointless, since the assets will be included in the gross estate and, therefore, you have accomplished nothing from an estate planning perspective. It will also make Spousal Lifetime Access Trusts (SLATS) an ineffective way to remove assets from your estate, since they are considered grantor trusts.

Perhaps the most significant impact will be on Irrevocable Life Insurance Trusts (ILITs). The vast majority of ILITs are designed to be grantor trusts. There would be little point in creating a new ILIT when the assets of the trust would end up in the grantor’s estate. Further, it will impact existing ILITs since most ILITs are designed to make use of annual exclusion gifts to fund the premium payments. Since these gifts would be post-enactment contributions to a grantor trust, a portion of the grandfathered trust would now be subject to inclusion in the grantor’s estate.

What To Do Now?

Time is of the essence if you want to make use of GRATs, SLATs or a sale to a grantor trust. All these need to be completed before the enactment date of the legislation. That could be one week from now, one month, or next year. The strategy of making large gifts now to use the current high exemption has not changed. This allows more time to plan since the exemption would not be reduced until 1/1/2022.

While the use of grantor trusts in the future may decline, non-grantor trusts remain a viable option. The following are some planning techniques:

  1. Instead of using a grantor trust to own life insurance, use a non-grantor trust. The assets would not be included in the gross estate and the trust could still be structured to make use of annual exclusion gifts to fund premium payments.

  2. Prefund existing ILITs that are grantor trusts to avoid partial inclusion in the gross estate because of post-enactment contributions to the grantor trust.

  3. Create your SLAT now before the enactment date and be careful to not make post-enactment contributions to the trust.

  4. Complete any sales to grantor trusts now, before the legislation passes.

  5. Charitable Remainder and Charitable Lead trusts may be options to provide for your descendants, reduce your estate tax bill, and fulfill a charitable goal. (This will be the topic of the last article in this series.)

The other option is to do nothing and wait to see what actually shakes out from the negotiations. While this is probably not a viable option for those taxpayers with estates well above the current exemption of $11.7 million, it may be a reasonable approach for those with estates between the reduced exemption of approximately $6 million and the current exemption amount.

While we do not know the exact timing, change is coming and now is the time to take advantage of what we know are the current estate planning options. Marks Paneth is here to help guide you through the changing tides so that you can achieve your estate planning goals.

About Christopher D. Wright

Christopher D. Wright

Christopher D. Wright, JD, CPA, Partner in the Private Client Services Group at Marks Paneth LLP, focuses on estate planning and gift, estate and trust taxation. With over 30 years of experience in accounting, tax and nonprofit organizations, Mr. Wright is adept at working with clients and their professional advisors to assist in developing estate plans that provide both estate tax savings and efficient transfer of assets to the next generation and to charitable organizations.... READ MORE +

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