Grantor vs Non-Grantor Trust – Choose the Right Structure

Introduction

Estate planners and high-net-worth individuals frequently encounter challenges in selecting the appropriate trust structure, where the choice between grantor and non-grantor trusts can profoundly influence income tax liabilities, estate inclusion, and overall wealth preservation. Inexperienced advisors may overlook nuances such as compressed trust tax brackets or state-specific implications, resulting in suboptimal tax outcomes or unintended estate tax exposure. Are you confident your trust aligns with the updated 2025 tax framework to minimize burdens while achieving your planning objectives?

At Kewal Krishan & Co, our expert tax advisors assist clients in saving an average of $50,000 annually, potentially accumulating to $1 million over a decade through precise trust structuring. This blog delineates the distinctions between grantor and non-grantor trusts for 2025, incorporating Internal Revenue Code (IRC) provisions and enhancements from the One Big Beautiful Bill Act (OBBBA), signed July 4, 2025.

With detailed examples and compliance steps, we address income taxation, estate implications, and strategic selection criteria. Transitioning to the core analysis, understanding these structures empowers informed decisions to safeguard your legacy.

Understanding Grantor vs Non-Grantor Trusts

Trusts serve as vehicles for asset protection, income distribution, and estate planning, but their tax treatment varies based on grantor status.

Grantor Trusts

Under IRC §§ 671-679, grantor trusts are disregarded for income tax purposes, with the grantor (creator) reporting all trust income, deductions, and credits on their personal return (Form 1040). This occurs if the grantor retains certain powers, such as the ability to revoke the trust or substitute assets. No separate trust return (Form 1041) is typically required, simplifying administration.

For 2025, income is taxed at the grantor’s individual rates, reaching 37% above $626,351 for single filers ($751,600 joint). The 3.8% Net Investment Income Tax (NIIT) under IRC § 1411 applies if modified adjusted gross income exceeds $200,000 single/$250,000 joint. Estate inclusion depends on retained powers; if powers trigger inclusion under IRC § 2036-2038, assets are part of the grantor’s taxable estate, qualifying for step-up basis at death (IRC § 1014). OBBBA increases the estate tax exemption to $13.99 million in 2025 ($15 million from 2026), reducing exposure for many.

Non-Grantor Trusts

Non-grantor trusts are separate taxpayers under IRC § 641, filing Form 1041. Retained income is taxed at trust rates, while distributions shift tax to beneficiaries via Schedule K-1. Compressed brackets apply: 37% on income over $15,650 in 2025, with NIIT at 3.8% above $14,450.

Assets are generally excluded from the grantor’s estate, avoiding estate tax but forgoing step-up basis unless distributed pre-death. OBBBA allows non-grantor trusts a $40,000 SALT deduction (2025-2029) under IRC § 164, potentially multiplied across multiple trusts, phasing out above certain income levels.

For details, consult IRS Publication 559.

Key Forms for Reporting

• Form 1041: For non-grantor trusts to report income and distributions.
• Schedule K-1 (Form 1041): Allocates income to beneficiaries.
• Form 1040: Grantor reports trust items directly.

Detailed Example: Tax Outcomes of Grantor vs Non-Grantor Trusts

Consider a grantor establishing a trust with $2 million in assets generating $100,000 annual income in 2025, with the grantor in the 37% bracket and modified AGI over $250,000.

Grantor Trust Scenario

• Income Tax: Grantor reports $100,000 on Form 1040, taxed at 37% ($37,000) plus 3.8% NIIT ($3,800), totaling $40,800.
• Estate Inclusion: If powers retained, $2 million included in estate, but with $13.99 million exemption, no estate tax; heirs receive step-up basis.
• SALT Deduction: Limited to grantor’s personal $40,000 cap under IRC § 164.

Net tax: $40,800, with potential asset sales tax-free to trust (no gain recognition).

Non-Grantor Trust Scenario

• Income Tax: If retained, $100,000 taxed at trust rates: 37% on amount over $15,650 (~$33,000) plus 3.8% NIIT ($3,800), totaling $36,800. If distributed, beneficiary taxed at their rate (e.g., 24%: $24,000 + NIIT if applicable).
• Estate Inclusion: Excluded, no step-up basis; future sales taxed on original basis.
• SALT Deduction: $40,000 available to trust, potentially stacking with additional trusts.

If distributed, savings ~$12,800 vs. grantor; retained, $4,000 savings but compressed brackets limit for higher income.

Under OBBBA, multiple non-grantor trusts could quadruple SALT deductions to $160,000, saving ~$59,200 at 37%.

Alternative Scenario

For a $5 million trust with $250,000 income: Non-grantor retention incurs $90,500 tax (37% bracket quickly), vs. grantor’s $92,500 + NIIT; distribution shifts to lower-bracket beneficiaries, saving substantially.

Step-by-Step Guide for Taxpayer Compliance

To select and maintain the appropriate trust structure for 2025, adhere to these steps:

1. Define Objectives: Assess needs for income shifting, estate exclusion, or tax-free growth.
2. Draft Trust Document: Incorporate grantor powers (IRC §§ 671-679) for grantor status or avoid for non-grantor; consult attorney.
3. Fund Trust: Transfer assets, obtaining appraisals for valuation (IRC § 1014 basis).
4. Determine Tax Status: Confirm grantor via powers; file Form 1041 if non-grantor.
5. Report Income: Grantor includes on Form 1040; non-grantor files Form 1041 by April 15, 2026, issuing K-1s.
6. Claim Deductions: Apply $40,000 SALT per non-grantor trust; monitor NIIT.
7. File Extensions: Use Form 7004 for trusts if needed.
8. Retain Records: Maintain trust agreements, income statements, and distributions for three years (IRC § 6001).

For irrevocable trusts, explore Our Estate Planning Services.

Common Pitfalls to Avoid

• Unintended Grantor Status: Retaining excess powers includes assets in estate (IRC § 2036).
• Compressed Brackets: Retaining income in non-grantor trusts accelerates to 37% rate.
• SALT Stacking Oversight: Failing to create multiple non-grantor trusts misses multiplied deductions under OBBBA.
• Basis Errors: Non-grantor exclusion forfeits step-up; plan distributions accordingly (IRC § 1014).

Why Work with a Tax Expert?

Distinguishing grantor and non-grantor trusts involves intricate IRC analysis, especially with OBBBA’s SALT enhancements and bracket adjustments for 2025. Generic advisors may misclassify status or overlook estate implications, resulting in higher taxes or lost deductions. Kewal Krishan & Co provides rigorous trust reviews under IRC §§ 671-679, optimizing for income, estate, and SALT benefits while ensuring compliance. Our strategies avert common errors, as detailed in Our Tax Litigation Services.

Conclusion

The choice between grantor and non-grantor trusts in 2025 hinges on balancing income tax burdens, estate exclusion, and OBBBA’s SALT advantages, with grantor trusts offering simplicity and step-up basis, while non-grantor structures enable income shifting and multiplied deductions. Compressed trust brackets and NIIT necessitate careful planning to align with your goals. Proactive selection and compliance are paramount—evaluate your trust structure promptly to enhance tax efficiency and preserve wealth.

Call to Action

Schedule a consultation with Anshul Goyal, CPA EA FCA, a licensed U.S. CPA and Enrolled Agent, admitted to practice before the IRS, specializing in tax litigation and cross-border tax for U.S. businesses and Indians in the U.S. Contact us at Kewal Krishan & Co to determine the optimal trust structure for your needs.

About Our CPA

Anshul Goyal, CPA EA FCA, is a licensed U.S. CPA and Enrolled Agent, representing clients in IRS tax litigation and assisting with cross-border tax compliance for U.S. businesses and Indians in the U.S. His expertise ensures tailored strategies that maximize savings and ensure compliance.

Disclaimer

This blog provides general information for educational purposes only and does not constitute tax, legal, or financial advice. Tax laws change frequently, and individual circumstances vary. Consult a qualified tax professional before making decisions. The author and firm disclaim liability for actions taken based on this content.

FAQs

1. What defines a grantor trust?

Trusts where the grantor retains powers under IRC §§ 671-679, taxing income to the grantor.

2. How are non-grantor trusts taxed in 2025?

At trust rates, 37% over $15,650, or to beneficiaries if distributed (IRC § 641).

3. Does OBBBA affect trusts?

Enables $40,000 SALT deduction per non-grantor trust (2025-2029) under IRC § 164.

4. Are grantor trust assets included in estate?

Yes, if powers trigger inclusion (IRC §§ 2036-2038); otherwise, excluded.

5. What’s NIIT for trusts?

3.8% on investment income over $14,450 (IRC § 1411).