Grantor Trusts
A grantor trust is a trust whose income is taxed to the person who created it rather than to the trust or its beneficiaries. For income tax purposes the trust does not exist; you and the trust are one taxpayer. That sounds like a technicality. It is the mechanism behind most of the sophisticated estate planning done today, and it is also the default status of the revocable living trust that many families already have.
The reason grantor trust status matters is that income tax and estate tax follow different rules. A trust can be a grantor trust for income tax while its assets are completely outside your taxable estate. That mismatch lets you pay the trust’s income tax, which quietly shifts more wealth to your beneficiaries without a gift, and lets you sell assets to the trust or swap assets with it without recognizing gain. It also lets you switch the status off when the tax burden becomes more than you want to carry.
Milvidskiy Law Group P.C. drafts grantor trusts for estate tax, asset protection, and Medicaid planning, and advises trustees and grantors on the income tax reporting and the decisions that turn grantor status on and off.
Key Takeaways:
- A grantor trust’s income, deductions, and gains are reported on the grantor’s personal return. The trust itself pays no income tax, and transactions between the grantor and the trust are ignored for income tax purposes.
- Grantor status is created by keeping or giving specific powers, most often a power to swap assets of equal value. Those powers are chosen so that the trust is a grantor trust for income tax without being included in the grantor’s estate.
- Paying the trust’s income tax is a tax-free gift to the beneficiaries, which is why grantor status is usually wanted. When it is not, the status can be released, and it always ends at the grantor’s death.
What Makes a Trust a Grantor Trust
Federal law treats the creator of a trust as its owner for income tax purposes when the creator, or in some cases the creator’s spouse, keeps certain interests or powers. The clearest example is the power to revoke: a revocable living trust is always a grantor trust, which is why it needs no separate tax return during your life. Other powers produce the same result without making the trust revocable and without pulling its assets into your estate:
- A power to substitute assets of equivalent value, held in a non-fiduciary capacity. This is the most common provision in estate tax trusts because it creates grantor status while leaving the trust’s assets outside the estate.
- A power to borrow from the trust without adequate security, or an actual loan outstanding at the start of the year.
- A spouse as a beneficiary. A trust from which your spouse may receive income or principal is generally a grantor trust as to you, which is why spousal lifetime access trusts are grantor trusts.
- A retained right to income or to use trust property, which is common in Medicaid asset protection trusts.
- Certain powers held by a non-adverse party to add beneficiaries or to control distributions. A related design, the beneficiary deemed owner trust, taxes the beneficiary instead.
The drafting is precise. Some retained powers cause estate inclusion as well as grantor status, and some cause neither. The goal in most modern planning is a trust that is “intentionally defective”: a grantor trust for income tax and a completed transfer for estate and gift tax.
Why You Would Want a Grantor Trust
Paying the tax is a gift that is not a gift
When you pay the income tax on a trust’s earnings, the trust grows as if it were tax-exempt, and your payment is not treated as a gift to the beneficiaries. Over many years the compounding is substantial. Suppose a trust earns $300,000 a year and you pay roughly $100,000 of tax on it personally. Each year $100,000 more stays in the trust for your children than would if the trust paid its own tax, and your taxable estate is $100,000 smaller. The figures are illustrative.
Transactions without gain
Because you and the trust are one taxpayer, you can sell an appreciated asset to the trust for a note without recognizing capital gain, which is the basis of the sale to an intentionally defective grantor trust. You can also exchange assets with the trust. Before death, swapping high-basis assets or cash into the trust in exchange for its low-basis assets brings the low-basis assets back into your estate, where they receive a step-up in basis, while the trust keeps the value.
Lower rates
Trusts that pay their own tax reach the top federal bracket at a very low level of income. For 2026 the 37% rate applies to a trust’s retained ordinary income above $16,000, according to the Internal Revenue Service’s inflation adjustment tables, a threshold an individual reaches only at a far higher income. Taxing the income to the grantor at individual rates often produces a lower overall tax even before the estate planning benefit is counted.
Simpler reporting
A grantor trust generally does not pay tax or compute its own taxable income. Depending on how it is set up, it may report through the grantor’s Social Security number or file a short informational return that passes everything to the grantor. This simplicity is one reason revocable trusts are so widely used.
Where Grantor Trusts Appear in Planning
- Revocable living trusts. Grantor trusts by definition; no separate tax identity during life.
- Medicaid asset protection trusts. Drafted as grantor trusts so that income is taxed to the grantor, the home keeps its residence exclusion, and the assets receive a step-up at death; see our Medicaid asset protection trust page.
- Spousal lifetime access trusts and dynasty trusts funded by gift, where the grantor pays the tax to accelerate growth.
- Grantor retained annuity trusts, which are grantor trusts during the term so that the annuity payments and any in-kind distributions carry no tax.
- Irrevocable life insurance trusts, often drafted as grantor trusts so that premium funding and policy exchanges are simplified.
- Sales to grantor trusts, where the disregarded status is the whole point.
Turning Grantor Status Off
The income tax burden can become larger than a grantor wants to bear, especially as a trust grows or after a liquidity event. Most well-drafted trusts allow the grantor to release the power that creates grantor status, or allow a trust protector to do so, converting the trust to a nongrantor trust that pays its own tax. The conversion has consequences: an outstanding installment note can produce gain at that moment, and the trust’s compressed brackets then apply. Some trusts include a provision allowing an independent trustee to reimburse the grantor for the tax, which must be drafted carefully so that it does not cause estate inclusion or expose the trust to the grantor’s creditors.
Grantor status also ends automatically at the grantor’s death. The trust becomes a separate taxpayer, and any planning that depended on the disregarded status, such as an outstanding note from a sale, needs to be addressed before then.
State Income Tax
New York, New Jersey, and Connecticut generally follow the federal grantor trust rules, so the trust’s income is reported on the grantor’s state return as well. When the trust becomes a nongrantor trust, each state has its own rules for whether and how it taxes the trust based on the residence of the grantor, the trustee, and the beneficiaries, and those rules can make the choice of trustee and the location of assets a tax decision. We coordinate that analysis with your CPA.
When a Grantor Trust Is Not the Right Choice
Grantor status is the wrong choice when the grantor cannot or does not want to fund the tax on the trust’s income for the long term, when the beneficiaries are in lower brackets than the grantor and the trust’s income can be distributed to them, when the trust will hold a business that must avoid disregarded status for its own reasons, or when the plan calls for the trust to be a separate taxpayer in a state with no income tax. In those cases a nongrantor trust is the deliberate choice, and our irrevocable trusts and tax planning pages describe how the two forms fit together.
What Our Grantor Trust Service Includes
- Choosing grantor or nongrantor status for each trust in your plan, with your CPA, based on the projected income, the beneficiaries’ brackets, the assets, and the estate planning goals.
- Drafting the powers that create grantor status without estate inclusion, the release mechanism, and any reimbursement provision.
- Structuring sales and swaps between you and the trust, including the documentation that supports them.
- Guidance on reporting: whether the trust uses your Social Security number or files an informational return, and how income is reported on your state returns.
- Planning the transition to nongrantor status, whether by release or at death, including outstanding notes and basis considerations.
Schedule a Consultation About Grantor Trust Planning
Whether you already have an irrevocable trust and want to understand who pays its tax, or you are considering a trust that depends on grantor status, the analysis is worth doing before the trust is signed. Our attorneys practice in New York, New Jersey, and Connecticut. Contact Milvidskiy Law Group P.C. to schedule a consultation.
This page is provided for general informational purposes only and does not constitute legal advice. Laws differ by state and change over time. Tax figures are as of the date stated and change annually. For advice about your situation, consult a qualified attorney.
Frequently Asked Questions
What is a grantor trust?
A grantor trust is a trust whose income, deductions, and gains are taxed to the person who created it rather than to the trust or its beneficiaries. For income tax purposes the trust is disregarded and the grantor and the trust are one taxpayer. The status is created by the grantor keeping certain interests or powers, such as the power to revoke or a power to swap assets.
Is my revocable living trust a grantor trust?
Yes. Because you can revoke it, a revocable living trust is a grantor trust during your lifetime. It uses your Social Security number, its income is reported on your personal return, and it files no separate tax return. At your death it becomes a separate taxpayer.
Can an irrevocable trust be a grantor trust?
Yes, and most estate tax trusts are drafted that way on purpose. Powers such as a power to substitute assets of equal value make the trust a grantor trust for income tax without causing its assets to be included in your taxable estate. Practitioners call this an intentionally defective grantor trust.
Why would I want to pay tax on income I do not receive?
Because your payment of the trust’s tax is not treated as a gift, yet it leaves the trust’s assets undiminished for your beneficiaries and reduces your own taxable estate. Over time the effect compounds significantly. Individual tax rates are also usually lower than the compressed rates a trust would pay on its own income.
What is a swap power?
It is a power, held by the grantor in a non-fiduciary capacity, to reacquire trust assets by substituting other assets of equal value. It creates grantor trust status, and it lets you exchange cash or high-basis assets for the trust’s low-basis assets before death so that the low-basis assets return to your estate and receive a step-up in basis.
Can grantor trust status be turned off?
Usually. A well-drafted trust allows the grantor or a trust protector to release the power that creates grantor status, converting the trust to a nongrantor trust that pays its own tax. The conversion can have consequences, such as gain on an outstanding installment note, so it is planned rather than done casually. Grantor status also ends automatically at the grantor’s death.
Does a grantor trust file a tax return?
It depends on how it is set up. Many grantor trusts report under the grantor’s Social Security number with no separate return. Others obtain their own taxpayer identification number and file an informational return that passes all items through to the grantor. Either way, the trust itself pays no income tax while it is a grantor trust.
Is a Medicaid asset protection trust a grantor trust?
Typically, yes. It is drafted so that the grantor is taxed on the trust’s income, which keeps the reporting simple, preserves the primary residence exclusion on a sale of the home, and supports a step-up in basis for the beneficiaries at the grantor’s death, while the assets are protected from long-term care costs after the look-back period.
How is a grantor trust taxed by New York, New Jersey, and Connecticut?
All three states generally follow the federal treatment, so the trust’s income appears on the grantor’s state return. Once a trust becomes a nongrantor trust, each state applies its own rules for taxing trust income based on the residence of the grantor, trustee, or beneficiaries, and those rules can affect the choice of trustee and where assets are held.
What is the difference between a grantor trust and a nongrantor trust?
A grantor trust’s income is taxed to its creator; a nongrantor trust is a separate taxpayer that pays tax on income it retains and passes out income it distributes to beneficiaries. Nongrantor trusts reach the top federal bracket at a very low level of retained income, above $16,000 for 2026, so the choice between the two is a real tax decision that depends on who is in the lower bracket and what the trust is meant to accomplish.
