A living trust is a type of grantor trust you create to avoid probate. Understand what a grantor is, how grantor trust rules affect taxes, and what happens to the trust after the grantor dies.
A grantor is the person who makes a living trust. They choose the property to put into the trust, name the trust beneficiaries, and decide how the trust assets will be managed. In most living trusts, the grantor is also the initial trustee, meaning they continue to control the trust property during their lifetime. This direct control is why, for tax purposes, a revocable living trust is treated as a “grantor trust.”
In practical terms, grantor trust rules mean that if you set up a revocable living trust, you’ll continue to report all income from the trust’s assets on your own tax return, just like you did before. You can also change the terms of the trust or revoke it at any time, as long as you have the mental capacity to do so. Grantor rules affect how you manage your property and how it’s taxed during your life, so let’s take a look at them here.
What Is a Grantor?
A grantor (also called settlor, trustor, or creator) is a person who establishes a trust. When establishing a living trust, the grantor defines its terms, chooses which assets to transfer to the trust, names beneficiaries, and appoints a successor trustee. The grantor must properly complete the trust and retitile property so that it is held in the trust’s name. These decisions determine the trust's structure and function, both during the grantor's lifetime and afterward.
It’s tempting to focus just on the tax rules that grantors must follow. And these are reasonable concerns. But they are only one piece of the puzzle. The full scope of the grantor's responsibilities reflects how the trust works on a daily basis and how trust property is eventually distributed.
Roles and Responsibilities of a Grantor
A grantor’s primary responsibility is to set up a living trust and define how it will work. This typically involves drafting the trust agreement, moving assets into the trust’s name, selecting beneficiaries and a successor trustee, and deciding when and how the trust’s assets will be distributed to beneficiaries.
Creating the Trust Document
A trust grantor’s most significant task is drafting the trust agreement. The grantor uses the document to specify the rules and terms of the trust, such as what the trustee can do, how and when distributions should occur, whether the trust can be changed or revoked, and which state’s laws apply. Think of the trust agreement as an operating manual. It’s up to you (the grantor and creator of the trust) to make sure that each provision is clear.
Transferring Property Into the Trust’s Name
Simply signing a trust document does not complete the process. For the trust to work, the grantor must also transfer assets (such as real estate, financial accounts, or investments) into the trust’s name so they are governed by its terms. This is called funding the trust. If a grantor fails to transfer property to the trust, those assets won’t be covered by the trust’s provisions.
Naming the Successor Trustee
A key decision for a living trust grantor is selecting both the initial and successor trustees. While the grantor usually serves as the initial trustee, a successor trustee will eventually need to take over. Choosing a reliable successor trustee is essential because this person or institution will step in to manage and distribute trust assets according to the grantor’s instructions when the grantor dies or becomes incapacitated.
Designating Beneficiaries
The grantor determines who the trust is meant to support by naming beneficiaries. Beneficiaries are the individuals or groups designated to receive distributions or other benefits from the trust, as specified in the trust agreement.
Setting Distribution Rules
Typically, the grantor decides when and how beneficiaries receive benefits from the trust. The trust might call for immediate payouts, distributions at specific milestones or ages, flexible payments at the trustee's discretion, or ongoing asset management. Clear instructions do more than just deliver stability. They also safeguard beneficiaries who may need additional protection and provide a sound plan for transferring property.
Other Common Responsibilities
In most living trusts, the grantor retains other important powers, such as the ability to modify or dissolve the trust, choose replacement trustees, or determine which state’s laws will apply.
What are Grantor Trust Rules (Tax Implications)
Grantor trust rules are a set of federal tax guidelines that determine who is responsible for reporting a trust’s income. (You can find most of these rules in Sections 671 through 677 of the Internal Revenue Code.) If you are the grantor of your living trust, these rules mean that you will be treated as the owner of some or all of the trust for income tax purposes.
Because the IRS automatically treats all revocable trusts as grantor trusts, you will be taxed on the trust’s income, deductions, and credits as if you still own the assets. Instead of the trust paying its own taxes, you simply include those items on your personal tax return. This is what people mean when they talk about the “grantor’s tax burden” with a grantor trust.
Some irrevocable trusts also qualify as grantor trusts if you keep certain powers or benefits, such as the ability to change or revoke the trust or control how trust property is used. This is where the distinction between a grantor trust and a non-grantor trust might matter for you. If your trust doesn’t meet the grantor trust rules, it becomes its own taxpayer ande IRS Form 1041 for that income.
What Happens When a Grantor Dies?
When the grantor of a living trust dies, the successor trustee steps in to manage and distribute the trust assets according to the trust's instructions. A successor trustee also typically notifies beneficiaries about the trust and then appraises trust property to make sure it can be distributed as expected.
The trust exists only long enough to distribute assets. If the trust provides for young beneficiaries, such as through a subtrust or custodianship, the successor trustee or custodian manages those assets until the beneficiary reaches the age or conditions specified in the trust.
The successor trustee might need to prepare an affidavit to establish their authority, obtain appraisals of valuable assets, and make sure property can be transferred smoothly. They also have a duty to keep beneficiaries well-informed and may need to consult professionals to fulfill their responsibilities. In most cases, the trust will not have to go through probate, and the administration process is generally simpler than settling an estate through a will.
The successor trustee is also responsible for filing necessary tax returns, including the grantor’s final personal income tax return and, if required, a federal estate tax return. In some cases, the trust itself may need to file an income tax return if it continues to hold assets and generate income after the grantor’s death.
Learn More About Making a Living Trust
Serving as a grantor of your living trust is a real responsibility. Understanding the rules a grantor must follow helps you create a trust that sidesteps probate and passes on your property as you intended.
You can find out about making WillMaker’s living trust in WillMaker’s Legal Manual.