“You can’t have your cake and eat it too” is usually good advice. Grantor trusts are the exception: properly structured, they let a client move assets out of their taxable estate while still being treated as the owner for income tax purposes, and that combination works in the family’s favor.
Key takeaways
- Assets in a properly drafted grantor trust are outside the grantor’s taxable estate, including all future growth.
- The grantor pays the trust’s income tax, which lets trust assets grow untouched and is effectively an additional tax-free gift.
- Grantor trusts also offer creditor protection and, through a spouse’s interest, indirect access to trust property.
Every dollar of income tax the grantor pays on the trust’s behalf is, in effect, an extra gift to the heirs — with no gift tax.
The estate tax side
Property in the trust isn’t included in the grantor’s taxable estate, so both the original gift and all appreciation after the transfer escape estate tax. For clients above the $15 million exemption, that growth can be worth far more than the original gift.
The income tax side
For income tax purposes, the trust’s income, gains, and losses flow through to the grantor’s personal return. That has two advantages: the grantor can manage the tax using their own tax position, and trust assets aren’t depleted to pay taxes. Paying the trust’s tax is effectively a gift to the beneficiaries that doesn’t use any annual exclusion or lifetime exemption.
Other benefits
- Trust assets are protected from the grantor’s creditors.
- A married grantor can keep indirect access to trust property by giving the spouse a lifetime interest.
- Grantor trusts are well suited to owning life insurance and to sales of appreciated assets. See how sales to grantor trusts work with life insurance.
The catch: no step-up in basis
The IRS confirmed in 2023 (Revenue Ruling 2023-2) that assets in a grantor trust that aren’t included in the grantor’s estate don’t receive a step-up in basis at death. Heirs inherit the original basis, so highly appreciated assets may carry a built-in capital gain. Some trusts include a power to swap assets back to address this, which should be planned with the client’s attorney.
Frequently asked questions
What is a grantor trust?
A trust in which the creator is treated as the owner for income tax purposes, while the assets can still be outside their taxable estate if properly structured.
Why would a grantor want to pay the trust’s income taxes?
Paying the tax lets trust assets grow untouched and is effectively an extra gift to beneficiaries that isn’t subject to gift tax.
Do grantor trust assets get a step-up in basis at death?
Not if they’re excluded from the grantor’s estate. The IRS confirmed this in Revenue Ruling 2023-2.
Reviewed by Tim Fuller on 2026-09-25
Tim Fuller
President, SRS Inc.
Tim leads SRS Inc., a full-service IMO (Independent Marketing Organization) and BGA (Brokerage General Agency), connecting independent financial professionals with life, annuity, disability income, and long-term care solutions from 60+ carrier partners.
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