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March 05, 2020 — BY Leah Pancer, CPA

Talking Tax: Grantor vs Non-Grantor Trusts

Talking Tax: Going Deeper Into Section 962
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Grantor and non-grantor trusts are taxed differently.

Non-grantor trusts are treated as separate entities (like a C-Corporation). But grantors of grantor trusts maintain significant rights to the trust’s assets and income. Because of that, they’re treated as if they are direct owners of the trust assets (like a sole proprietorship).

A grantor trust is any trust in which the grantor is treated as owner of any portion of the trust. This is determined by a list of powers. Some of the most common powers are:

  1. Power to revoke
  2. Power to substitute assets or borrow from trust without adequate security
  3. Power to distribute income from trust to Grantor or Grantor’s spouse
  4. Power to add beneficiaries

There are many other powers that can cause a trust to be a grantor trust; a grantor only needs one of these powers for the trust to be a grantor trust.

How Grantor Trust income is taxed

When Trust has only 1 Grantor: 3 options

  1. The payer issues a 1099 (or K-1) to the trust with the trust TIN. The trust files form 1041 with no income reported. The trust issues a grantor letter to the grantor reporting all the income the trust earned. The grantor reports this income on his 1040

Example: Reuven transferred $10M to The Reuven Family Trust; TIN 45-6789100; a Grantor Trust. The funds are invested in a Charles Schwab Brokerage account. The account is held in the name and TIN of the Trust. At year end, a 1099B  is issued in the name and TIN of the trust. The trust files a 1041. No income is reported on the 1041 and a statement is attached stating that the income is taxable to the Grantor. A Grantor letter specifying the income earned by the trust is filed with the 1041 and issued to the  a Grantor. The Grantor uses this to report the income on his 1040.

  1. The payer issues a 1099 (or K-1) to the trust but uses the Grantors SSN. The income is reported directly on the grantors 1040 and no 1041 is filed.

Example: Reuven transferred $10M to The Reuven Family Trust; TIN 45-6789100; a Grantor Trust. The funds are invested in a Charles Schwab Brokerage account. The account is held in the name of the trust but with the SSN of the grantor Reuven.. At year end, a 1099B is issued to The Reuven Family Trust with Reuven’s SSN. Reuven uses this 1099B to report the income on his 1040.

  1. Payer issues 1099(or K-1) to the trust using the trust TIN. The trust issues a 1099  to the grantor. The Grantor reports this income on his 1040. No 1041 Filed. (not typically done)

Example: Reuven transferred $10M to The Reuven Family Trust; TIN 45-6789100; a Grantor Trust. The funds are invested in a Charles Schwab Brokerage account. The account is held in the name and TIN of the Trust. At year end, a 1099B is issued in the name and TIN of the trust. The trust then issues a 1099 to Reuven specifying all the income earned by the trust to Reuven. The trust does not file a 1041. Reuven uses the 1099 he received from the trust to report the income on his 1040.

When Trust has more than 1 Grantor: 2 Options

  1. The payer issues a 1099 (or K-1) to the trust with the trust TIN. The trust files form 1041 with no income reported. The trust issues a grantor letter to the grantor reporting all the income the trust earned. The grantor reports this income on his 1040
  2. Payer issues 1099(or K-1) to the trust using the trust TIN. The trust issues a 1099  to the grantor. The Grantor reports this income on his 1040. No 1041 Filed. (not usually done)

 

A non-grantor trust is any trust that is not a grantor trust.

How Non-Grantor trust income is taxed

  • As a separate tax entity, a non-grantor trust is required to have its own TIN and must file a 1041 and issue K-1s to the Beneficiaries
  • There are 2 basic types of non-grantor trusts. Complex and simple trusts.
  • Non-grantor trusts must pay taxes on income received, which is typically at much higher rates than for individuals.
  • Distributions to beneficiaries are deducted from the taxable income of the trust and  K-1s are issued to the beneficiaries for the amount of the distribution. The beneficiaries report this income on their 1040.
  • The major difference between a complex trust and a simple trust is that a simple trust must distribute all its income to the Beneficiaries while a complex trust does not need to. So a simple trust would have no taxable income, pays no taxes, issues K-1s to the beneficiaries and the Beneficiaries report all the trust income on their 1040. A complex trust pays taxes on the portion of income it did not distribute and issues K-1s to its beneficiaries for the distributions.

Example: Reuven transferred $10M to The Reuven Family Trust; TIN 45-6789100; a Non-Grantor Complex Trust. The funds are invested in a Charles Schwab Brokerage account. The account is held in the name and TIN of the Trust. The trust distributed $100,000 to Levi ( a beneficiary) in the current tax year. At year end, a 1099B  is issued in the name and TIN of the trust. The trust files a 1041. Income and deductions are reported  and taxed on the return. The trust deducts $100,000 from its taxable income for the distribution to Levi. A K-1 is issued to Levi with $100,000 of taxable income. Levi uses this to report the income on his 1040.