Talking Tax: Grantor vs Non-Grantor Trusts
March 05, 2020 | BY Leah Pancer, CPA
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:
- Power to revoke
- Power to substitute assets or borrow from trust without adequate security
- Power to distribute income from trust to Grantor or Grantor’s spouse
- 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
- 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.
- 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.
- 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
- 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
- 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.