Some Types of Irrevocable Trusts

Written by Jim Worthington on October 29, 2018

Last week’s post discussed the differences between revocable and irrevocable trusts. This week, we turn our attention to types of irrevocable trusts. There are too many to describe here but some of the most popular follow:

  • GRATs are trusts in which a grantor gives an asset away but retains the right to an annuity payment for a number of years. The IRS recognizes this technique as a way to reduce the value of the gift—by the value of the retained interest. If the asset appreciates, that appreciation escapes transfer tax. Some practitioners make the value of the annuity so high that the value of the gift is close to or equal to zero.
  • IDGTs are intentionally made to be grantor trusts, i.e., the trust’s income is taxed to the grantor. This “defect” leads to the acronym for Intentionally Defective Grantor Trust. They operate similarly to a GRAT. An asset is sold to the trust in exchange for a promissory note. To the extent the asset is sold, it is not a gift. Moreover, because the grantor stands on both sides of the transaction tax-wise, there is no capital gain recognition.
  • A QPRT is a Qualified Personal Residence Trust, which allows the grantor to make a gift of a residence to the trust but to retain the right to its use for a set number of years. As with the GRAT, the retained right reduces the value of the gift. And, if the residence increases in value, that increase escapes transfer tax. Also like the GRAT, the QPRT is expressly recognized by the IRS.
  • A CRT is a Charitable Remainder Trust. The grantor of the trust transfers an asset to a trust with a charity as the remainder beneficiary. The grantor retains the right for a specified term of years or lifetime to either a unitrust amount (a percentage of the asset’s value) in a CRUT or a fixed annuity in a CRAT. The grantor gets an immediate charitable income tax deduction for the actuarial value of the remainder interest and installment-sale type tax treatment for the unitrust or annuity payments.
  • A CLT is a Charitable Lead Trust. The charity receives the unitrust (a CLUT) or annuity (a CLAT) payment for a set time or lifetime and the remainder goes to a person such as a family member. Whether the grantor receives a charitable income tax deduction depends on whether the trust income is taxed to the grantor, i.e., whether it is a grantor trust.

These five irrevocable trusts are some of the most popular. Another popular irrevocable trust is the Domestic Asset Protection Trust, which will be the topic of next week’s post.