With tax season in full swing and filing deadlines approaching, people often ask how different types of trusts are taxed. he answer depends on how the trust is structured. The main difference between a grantor trust and a non-grantor trust lies in how the IRS treats their income for tax purposes.
In a grantor trust, the grantor retains specific powers or control over the trust’s assets. For example, the grantor may revoke the trust, change beneficiaries, replace assets, or direct how income is distributed. Because of this control, the IRS requires grantor trusts to use the grantor’s Social Security number, and the grantor must report all trust income on their personal tax return.
By contrast, a non-grantor trust separates the grantor entirely from the assets. Once the grantor creates and funds the trust, they give up all rights, interests, and powers over those assets. The trust becomes its own legal and taxable entity. The trustee files a separate tax return—typically using IRS Form 1041—because the IRS treats the trust as an independent taxpayer. If the trust distributes income to a beneficiary, that beneficiary must report it on their own tax return. The grantor has no tax obligation for that income.
When Is a Non-Grantor Trust Useful?
This type of trust can be valuable in specific planning scenarios, such as:
Divorce settlements: The grantor can establish a non-grantor trust to support an ex-spouse, with no further involvement required after funding the trust.
Small business ownership: Placing a sole proprietorship, partnership, or LLC into this type of trust may help the business qualify for certain deductions, including the qualified business income (QBI) deduction.
Real estate holdings: Funding a non-grantor structured trust with high-value real estate may allow the trust to take advantage of state and local tax (SALT) deductions.
Drawbacks to Consider
Before creating a non-grantor trust, consider these two potential downsides:
Loss of control: The grantor gives up all rights to manage or direct the assets within the trust.
Administrative costs: Because grantors cannot serve as trustees, they must appoint a third-party trustee, who typically charges a fee drawn from the trust’s assets.
Is a Non-Grantor Trust Right for You?
This separate taxable trust is a powerful estate planning tools, but they’re not for everyone. They offer specific tax advantages and can serve unique purposes, yet they also require a willingness to give up control.
To explore whether a non-grantor trust fits your situation, schedule a strategic meeting with the experienced estate planning attorneys at Triangle Estate Lawyers, proudly serving families across Raleigh, Cary, Clayton, Wake Forest, and surrounding areas.
