A grantor trust is a trust where you retain enough control or benefits that the IRS treats you as the owner for income tax purposes. You report all trust income on your personal tax return, not on a separate trust return. In New Jersey, grantor trusts can help you avoid probate, reduce estate taxes, plan for Medicaid, and transfer wealth to your beneficiaries. However, you must pay income taxes on trust earnings even if you receive no distributions, and some irrevocable grantor trusts limit your access to assets once transferred.
Ocean County trust attorney Christine Matus has helped families throughout New Jersey use grantor trusts to secure assets, simplify estate administration, and protect wealth for the next generation. At The Matus Law Group, our estate planning attorneys guide clients through every step of creating and funding these trusts.
This guide explains what a grantor trust is, how it works for tax purposes, what types are available, what powers trigger grantor trust status, the benefits and drawbacks, who should consider this strategy, and how to set one up in New Jersey. Call (732) 281-0060 to schedule a consultation.
What Is a Grantor Trust?
A grantor trust is a trust where you keep enough control or benefits that the IRS treats you as the owner for tax purposes. This means all income the trust earns is reported on your personal tax return, not on a separate trust return.
The key feature is retained control. You may retain the power to revoke the trust, change beneficiaries, manage investments, or reclaim trust assets. Under the Internal Revenue Code, these powers make you the “substantial owner” of the trust.
In New Jersey, grantor trusts are governed by the New Jersey Revised Statutes Title 3B, which regulates trust creation and administration. The Ocean County Surrogate’s Court at 118 Washington Street in Toms River handles trust-related matters and estate administration for Ocean County residents.
Key Takeaway: A grantor trust is one where you retain enough control that the IRS treats you as the owner for income tax purposes. All trust income appears on your personal tax return, and in New Jersey, these trusts are governed by N.J. Revised Statutes Title 3B.
How Does a Grantor Trust Work for Tax Purposes?
You report all trust income on your personal tax return as if you earned it directly. The trust itself does not pay income taxes. This includes interest, dividends, capital gains, and any other income the trust generates.
For New Jersey residents, this means filing both federal and state tax returns that include the trust’s income. If the trust is treated as a grantor trust for federal purposes, the income is typically reported on your personal return for New Jersey as well. A Form NJ-1041 may still need to be filed, showing income as distributed to the grantor.
What Types of Grantor Trusts Are Available?
Different types of grantor trusts serve different estate planning goals. Each offers specific advantages for tax planning, asset protection, or wealth transfer:
- Revocable Living Trust: You can change or cancel this trust anytime during your life. It helps avoid probate in the New Jersey Superior Court, Chancery Division, Probate Part, which can take six months to over a year. The trust becomes irrevocable when you die, at which point it distributes assets according to your instructions.
- Irrevocable Life Insurance Trust (ILIT): This trust owns your life insurance policy and keeps the death benefit out of your taxable estate. While New Jersey no longer has an estate tax, removing life insurance proceeds from your taxable estate can reduce federal estate taxes and may also help limit exposure to New Jersey inheritance tax, depending on who receives the proceeds.
- Grantor Retained Annuity Trust (GRAT): You transfer assets into the trust but receive annuity payments for a set period. Any appreciation above the IRS assumed rate passes to beneficiaries tax-free. This works well for assets expected to grow significantly, such as business interests or real estate.
- Spousal Lifetime Access Trust (SLAT): You transfer assets to this trust for your spouse’s benefit, using your estate tax exemption while you are alive. Your spouse can access trust assets if needed, but the assets stay outside both of your taxable estates. This strategy works well for married couples in Ocean County looking to secure their exemptions.
- Beneficiary Deemed Owner Trust (BDOT): The beneficiary is treated as the trust owner for tax purposes, which can shift income tax liability strategically. This allows income splitting between you and the beneficiary, potentially lowering overall taxes.
Key Takeaway: The five main types of grantor trusts serve different purposes. Revocable trusts for probate avoidance, ILITs for estate tax reduction, GRATs for wealth transfer, SLATs for using exemptions, and BDOTs for income tax planning.
What Powers Make a Trust a Grantor Trust?
Specific powers you retain trigger grantor trust status under the Internal Revenue Code. Understanding these powers helps you structure a trust that achieves your goals.
Control and Management Powers
You control the trust if you can revoke it, change its terms, direct investments, or substitute assets with others of equal value. You also control it if you can borrow from the trust without adequate interest or security. Serving as a trustee gives you direct management authority, which reinforces grantor trust treatment.
Beneficial Powers
You have beneficial powers if you can receive trust income without restriction or if trust income can be used to pay your life insurance premiums. The power to use trust assets to support your legal dependents also creates grantor trust status. These powers show that you retain economic benefit from the trust.
Distribution and Beneficiary Powers
If you control when and how much beneficiaries receive, or if you can change who the beneficiaries are, the trust qualifies as a grantor trust. The power to add or remove beneficiaries gives you continued influence over the trust’s ultimate disposition.
What Are the Benefits of a Grantor Trust?
Grantor trusts provide significant benefits: tax-free wealth transfer to beneficiaries, Medicaid planning opportunities, and potential step-up in basis at death.
Your payment of income taxes on trust assets effectively makes tax-free gifts to your beneficiaries each year. The trust also grows without being reduced by tax payments. Because most people pay lower tax rates than trusts (which reach the top federal rate at just over $15,650 of income), you save money overall.
Grantor trusts help with Medicaid planning by moving assets out of your name while you remain responsible for taxes. New Jersey has a five-year lookback period for Medicaid, so transferring assets to an irrevocable grantor trust five years before needing long-term care can protect those assets while you qualify for benefits. This strategy requires careful timing and legal guidance.
Assets included in your taxable estate, such as those in a revocable trust, generally receive a step-up in basis at death. However, some irrevocable trusts designed to remove assets from your estate may not provide this benefit.
Trust Attorney in New Jersey – The Matus Law Group
Christine Matus
Christine Matus is a dedicated New Jersey trusts and estates attorney who has been serving individuals and families since 1995. As the founder of The Matus Law Group, she combines deep legal knowledge with genuine compassion to help clients create tailored estate plans, including revocable and irrevocable trusts. Christine holds a J.D. from Touro College and a B.A. in Economics from Douglass College, Rutgers University. Her extensive public speaking and publications on estate planning and elder law reflect her commitment to educating the community on securing their financial futures.
A lifelong advocate for service, Christine is active in numerous organizations, including the Ocean County Bar Association, where she serves as Secretary of the Board of Trustees. She is also involved with nonprofits supporting individuals with disabilities, caregivers, and the Filipino-American community. Clients value her thoughtful approach and deep roots in Ocean County, where she helps families preserve their legacies with personalized legal strategies.
What Are the Drawbacks of a Grantor Trust?
Grantor trusts come with responsibilities and risks that require careful planning and ongoing financial management.
You must pay income taxes on all trust earnings, even if you do not receive any distributions from the trust. If the trust sells an asset with a large capital gain, you owe the full tax on that gain. This can create cash flow problems if you do not have funds outside the trust to cover the tax bill.
Proposed federal legislation could change how grantor trusts are taxed, potentially requiring trust assets to be included in your taxable estate at death. While existing trusts may be grandfathered under current law, future changes could affect assets transferred into these trusts. This legislative uncertainty makes it important to monitor tax law developments.
Managing a grantor trust requires careful record-keeping and coordination with your tax advisor. You must track all trust income and report it correctly on both federal and New Jersey tax returns. Mistakes can result in penalties from the IRS and the New Jersey Division of Taxation.
Some grantor trusts, particularly irrevocable ones, limit your access to assets once transferred. You cannot take back assets from an ILIT or GRAT, even if your financial situation changes. This loss of flexibility is the tradeoff for the tax benefits these trusts provide.
Key Takeaway: Grantor trusts require you to pay taxes on income you may not receive, face potential legislative changes, demand careful tax reporting, and limit flexibility by restricting access to transferred assets.
Who Should Consider a Grantor Trust?
A grantor trust makes sense if you want to preserve wealth for your beneficiaries while managing your tax liability strategically. This strategy works best for people who can afford to pay income taxes on trust earnings from their other assets.
You should consider a grantor trust if you have significant assets and want to manage estate planning, tax exposure, or probate avoidance. While New Jersey no longer has an estate tax, residents may still face federal estate tax or New Jersey inheritance tax, depending on who inherits the assets. Ocean County residents with valuable real estate, family businesses, or substantial investment portfolios often benefit from using grantor trusts to preserve wealth, reduce administrative burden, and support long-term planning goals.
Grantor trusts also help if you want to avoid probate in the New Jersey Superior Court system. A revocable living trust transfers assets to beneficiaries without court involvement, saving time and maintaining privacy. Toms River families often use these trusts to simplify estate administration for their heirs.
If you need Medicaid planning but want to preserve assets for your children, an irrevocable grantor trust can help. By transferring assets at least five years before needing care, you can qualify for New Jersey Medicaid benefits while protecting your home and savings.
| Importance of Grantor Trusts | Description |
|---|---|
| Continued Control Over Assets | The grantor can manage and make decisions regarding trust assets. |
| Tax Efficiency | The grantor pays taxes on trust income, potentially lowering overall liability. |
| Compliance with NJ Tax Laws | Structured to meet New Jersey’s specific tax filing requirements. |
| Flexibility in Estate Planning | Allows adjustments to the trust as circumstances change. |
How Do You Set Up a Grantor Trust in New Jersey?
Setting up a grantor trust requires careful drafting to achieve your goals while complying with New Jersey trust law under N.J. Stat. § 3B:31-2 and federal tax requirements.
Your attorney drafts a trust document that specifies the trust’s terms, names the trustee and beneficiaries, and includes provisions that create grantor trust status. The document must clearly state which powers you retain, such as the right to revoke, amend, or control investments. If you want the trust to become irrevocable at your death, the document should specify this transition.
You then transfer assets into the trust by changing the title from your name to the trust’s name. For real estate, this means recording a new deed with the Ocean County Clerk’s office. For bank accounts and investment accounts, you provide the trust document to the financial institution and request new account titles.
Even though the trust income is reported on your personal return, the trust may still obtain its own Employer Identification Number (EIN), depending on how financial institutions require accounts to be titled.
You must maintain detailed records of all trust income and transactions. Your tax preparer needs this information to correctly report trust income on your personal returns and to file the required New Jersey trust forms with the Division of Taxation.
Speak With an Experienced New Jersey Trust Lawyer Today
Creating a grantor trust requires careful legal drafting and coordination with your tax advisor. The right trust structure depends on your goals, whether you want to avoid probate, reduce estate taxes, plan for Medicaid, or transfer wealth to your beneficiaries.
Ocean County trust attorney Christine Matus has helped families throughout Toms River and across New Jersey establish grantor trusts that achieve their estate planning objectives. At The Matus Law Group, we guide clients through trust creation, asset transfers, and ongoing tax compliance.
Call (732) 281-0060 today to schedule a consultation and discuss whether a grantor trust fits your estate plan.
