Alabama Termination of Grantor Retained Annuity Trust in Favor of Existing Life Insurance Trust
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FAQ
For all practical purposes, the trust is invisible to the Internal Revenue Service (IRS). As long as the assets are sold at fair market value, there will be no reportable gain, loss or gift tax assessed on the sale. There will also be no income tax on any payments paid to the grantor from a sale.
Is an irrevocable life insurance trust (ILIT) a grantor trust? A13. Usually, yes. Most ILITs are grantor trusts since these trust instruments typically provide that income may be applied toward the payment of premiums on policies insuring the grantor's life (or the grantor's spouse's life).
In other words, if the grantor (or a non-adverse party) has the power to revoke any part of a trust and reclaim the trust assets, then the grantor will be taxed on the trust income.
A grantor trust is considered a disregarded entity for income tax purposes. Therefore, any taxable income or deduction earned by the trust will be taxed on the grantor's tax return.
In most cases, the person who funds the trust is identified in the trust agreement as the person who created the trust (i.e. the settlor/grantor). However, for federal tax purposes, the criterion for determining who the grantor is is who funded the trust, not who is identified as the grantor in the trust agreement.
If an irrevocable trust has its own tax ID number, then the IRS requires the trust to file its own income tax return, which is IRS form 1041. During the lifetime of the grantor, any interest, dividends, or realized gains on the assets of the trust are taxable on the grantor's 1040 individual income tax return.
If a trust is a grantor trust, then the grantor is treated as the owner of the assets, the trust is disregarded as a separate tax entity, and all income is taxed to the grantor.
Since a GRAT is a grantor trust for income tax purposes, you will report the trust's taxable income and deductions on your personal income tax return as if you still owned the trust assets directly. A grantor trust is disregarded for income tax purposes and will not pay taxes.
Thus, the trustee cannot terminate the GRAT before expiration of the term of the grantor's qualified interest by distributing to the grantor and the remainder beneficiaries the actuarial value of their term and remainder interests, respectively.
A grantor retained annuity trust is a type of irrevocable gifting trust that allows a grantor or trustmaker to potentially pass a significant amount of wealth to the next generation with little or no gift tax cost. GRATs are established for a specific number of years.