Imagine a case where parents set up an irrevocable defective trust for their one adult child with the terms of the trust being that when the parents die the original trust goes away and the money goes into a different trust with different rules for withdrawals for the benefit of the adult child.

Who is considered the grantor of the second trust? Under what circumstances would it be the adult child?

1 Answer 1


The second trust would be either a simple trust (if it is required to pay all income to the beneficiary each year) or a complex trust (if it is not), subject to the exception below. The parents would still be the settlors of the trust for non-tax purposes, but it would cease being a "defective" grantor trust for federal income tax purposes.

In a simple trust, all income of the trust passes through to the beneficiary for federal income tax purposes.

In a complex trust, all income of the trust is taxed to the trust at its compressed income tax rates, but this taxable income is reduced by the amount distributed in that year to the beneficiary, who gets income in the amount of the trust's taxable income up to the amount distributed. (There are some mildly complicated allocation of income type and loss related rules that modify this general rule.)

The second trust would only be a grantor trust with respect to the adult child is the child had sufficient powers over the trust (like a general power of appointment, i.e. the right to take money out on demand for personal use without any governing legal standard) to make it so. In most cases, this would defeat the purpose of having a trust at all.

It is hards to imagine a selection of powers that made it a grantor trust of the adult child without totally defeating the trust's purpose. This is because the standard for making a trust a grantor trust for tax purposes with a grantor the other than the original one is more strict than it is for the original grantor. The relevant statutes for those possibilities are 26 U.S.C. §§ 671-679. The main relevant provision is § 678(a) which states:

A person other than the grantor shall be treated as the owner of any portion of a trust with respect to which:

(1)such person has a power exercisable solely by himself to vest the corpus or the income therefrom in himself, or

(2)such person has previously partially released or otherwise modified such a power and after the release or modification retains such control as would, within the principles of sections 671 to 677, inclusive, subject a grantor of a trust to treatment as the owner thereof.

To comply this § 678(a) one would have to sacrifice the trust's estate tax benefits and its spendthrift trust benefits (i.e. the protection its assets receive from the beneficiary's creditors under state law).

Most people draft trusts like this so that they become complex trusts when the parents die, and focus on the non-tax considerations at that point.

  • So if the adult child had the right to take out all the money, does that mean the trust remains defective and the adult child is the grantor of the second trust?
    – Bob
    Dec 20, 2023 at 4:58
  • 1
    @Bob Yes. But for all intents and purposes, a trust that an adult child can take money out of on demand isn't a trust at all, it's just an investment account.
    – ohwilleke
    Dec 20, 2023 at 5:11

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