Distribution of Liabilities from a Grantor Trust Likely Causes the Grantor to Recognize Gain
T. Zaragoza, Esq. and Sonja
K. Johnson, Esq.
A so-called "grantor trust" is a trust that is disregarded
for income tax purposes. Because the
income and gratuitous transfer tax laws are not completely consistent with each
other, it is possible for an irrevocable trust to be a grantor trust for income
tax purposes but not for gratuitous transfer tax purposes. In a grantor trust, the grantor is taxable
with respect to the trust's taxable income, which results in a tax-free gift by
the grantor to the trust each year in the amount equal to the income tax
liability attributable to the trust's taxable income. This grantor trust feature also enables the grantor
to deal with the trust on an arm's length basis without adverse income tax consequences,
which can further enhance the value of the trust.