The Grantor Trust Rules Should Be Repealed

Abstract:     
The grantor trust rules once served a crucial role. They limited taxpayers’ ability to gain income tax advantages from creating certain types of inter vivos trusts, by denying them separate taxpayer status and providing that their income was taxable directly to the grantor. But times change. In 1986, Congress dramatically compressed the tax brackets in section 1(e), thereby imposing a flat tax, at the highest marginal rate, on essentially all trust income. It is now impossible for a settlor to derive any substantial income tax advantage from subjecting trust income to taxation at the trust’s own rates, because neither the settlor nor any of the trust beneficiaries is ever going to be in a higher tax bracket than the trust, as to any meaningful amount of income. Yet that is precisely the fact pattern that gave rise to the grantor trust rules. The grantor trust rules are, therefore, obsolete. Indeed, taxpayers and their advisors now gleefully stand the grantor trust rules on their head, creating so-called "intentionally defective grantor trusts," and laugh about it all the way to the bank. All that remains of the grantor trust rules are their complexity and the opportunities they provide to game the system. They are both obsolete and counter-productive, and they ought to be repealed.

Number of Pages in PDF File: 56

Keywords: grantor trust rules

JEL Classification: H24

Accepted Paper Series