A grantor trust is one of the more powerful wealth-transfer tools available to New York families. It combines flexibility, asset protection and a distinctive tax result: the person who creates the trust keeps paying the income tax, while the assets themselves can sit outside that person’s taxable estate. This page explains how that works, which trusts fall into the category, and the New York rules that shape the planning.
What Is a Grantor Trust?
A grantor trust is a trust in which the person who creates it, the grantor, retains certain powers or interests that cause the trust’s income to be taxed to the grantor personally rather than to the trust. Under the Internal Revenue Code this treatment is triggered when the grantor keeps specific rights, such as the power to substitute trust assets, the power to borrow without adequate security, or certain administrative powers over trust property.
Although the grantor pays income tax on the trust’s earnings, the assets in the trust can be removed from the grantor’s taxable estate for federal estate tax purposes if the trust is structured as an irrevocable grantor trust. Income taxed to the grantor, assets outside the estate: that combination is what creates the planning opportunity.
Benefits of Grantor Trusts Under New York Law
The first benefit is estate tax reduction. New York imposes its own estate tax with a steep cliff that can dramatically increase the tax on an estate that exceeds the state exemption, and a properly structured grantor trust moves appreciating assets out of the taxable estate. The second is tax-free growth for the beneficiaries: because the grantor pays the income tax on the trust’s earnings, the trust assets compound undiminished by tax, which amounts to an additional tax-free gift to the beneficiaries every year.
Trust assets are also generally shielded from the beneficiaries’ creditors, divorcing spouses and lawsuits. The grantor can keep the power to swap assets of equivalent value, which allows for basis planning and continued investment management. And when combined with generation-skipping transfer tax planning, a grantor trust can benefit children, grandchildren and later generations.
Common Types of Grantor Trusts
New York’s tax environment and each family’s circumstances determine which structure fits. These are the grantor trusts we draft and administer most often.
| Trust | What it does |
|---|---|
| Intentionally defective grantor trust (IDGT) | “Defective” only for income tax purposes and fully effective for estate tax planning. The grantor pays the income tax so trust assets grow undepleted. Often used in an installment sale, where the grantor sells appreciating assets to the trust for a promissory note, freezing the value in the estate and shifting future appreciation to the beneficiaries. |
| Grantor retained annuity trust (GRAT) | The grantor transfers assets to the trust and keeps an annuity for a fixed term. If the assets appreciate faster than the IRS Section 7520 rate, the excess passes to the beneficiaries free of gift and estate tax. Attractive in low-interest-rate environments and for assets expected to appreciate significantly. |
| Spousal lifetime access trust (SLAT) | An irrevocable grantor trust created by one spouse for the benefit of the other. The family uses the federal gift and estate tax exemption while keeping indirect access to the assets through the beneficiary spouse. |
| Qualified personal residence trust (QPRT) | Transfers a primary or vacation residence to a trust at a reduced gift tax value while the grantor keeps the right to live there for a set period. Popular for valuable New York City apartments and Hamptons homes. |
| Irrevocable life insurance trust (ILIT) | Holds life insurance outside the grantor’s estate, so the death benefit passes to the beneficiaries free of estate tax and provides liquidity to pay whatever tax remains. |
New York Tax Considerations
New York generally follows the federal grantor trust rules for income tax, so the trust’s income is reported on the grantor’s New York personal income tax return. The estate tax is where the state departs from federal law. New York’s exemption differs from the federal exemption, and the state’s cliff means that an estate exceeding 105% of the exemption amount can face a dramatically higher tax. Grantor trusts are one of the main ways families stay below that line.
New York also has its own rules on resident and nonresident trusts. A trust may qualify as a New York exempt resident trust if it has no New York trustees, no New York-source income and no New York-situs property. Exempt status can produce significant state income tax savings, but it requires careful structuring at the outset and attention during administration so that the trust does not lose it.
Who Should Consider a Grantor Trust?
Grantor trusts are not only for the very wealthy. They suit business owners transferring ownership interests to the next generation, real estate investors with appreciating New York property, professionals concerned about liability exposure, families with significant life insurance, individuals approaching the New York estate tax exemption threshold, and parents and grandparents planning for children with special needs or asset protection concerns.
How We Help
Grantor trust planning sits where estate, gift, income and generation-skipping transfer tax law meet, and the work spans the life of the trust. We evaluate the family’s estate, income and gift tax position under New York and federal law, recommend the structure that fits, and draft the trust agreement around the family and the assets. We coordinate gift tax returns, valuations and qualified appraisals, structure sales, loans and other transactions between grantor and trust, and advise trustees and beneficiaries on ongoing administration. Where an existing trust no longer fits the law or the family, we modify or decant it, working alongside the family’s accountants, financial advisors and insurance professionals. To discuss whether a grantor trust belongs in your plan, call us at 212-233-1233 or email [email protected].
