Adverse Enough to Be a Nongrantor Trust

By Justin T. Miller and W. Martin Behn¹

Synopsis: In this article, Miller and Behn analyze whether a trust will qualify as a nongrantor trust for federal tax purposes if an adverse party who is a close relative or subordinate employee of the grantor has the power to distribute trust assets to the grantor, and the grantor retains the right to determine whether that adverse party ever gets any assets from the trust.

I. INTRODUCTION

If a grantor² creates a nongrantor trust under Internal Revenue Code sections 671-679, subpart E of subchapter J (commonly referred to as the "grantor trust rules"), the grantor will not be subject to federal income taxes on the trust’s income and the trust will be a separate taxpayer for federal tax purposes, regardless of whether the transfer is a completed gift for estate and gift tax purposes.³ If the nongrantor trust is formed under the laws of a state such as Delaware or Nevada, the trust may receive better asset protection from creditors and may avoid being subject to state income taxes in the grantor’s home state. In addition, the nongrantor trust could receive the benefit of its own 20 percent deduction for qualified business income under section 199A, $10,000 deduction for state and local income taxes under section 164(b)(6), and $10,000,000 exclusion from capital gains for qualified small business stock under section 1202.⁴