Converting to Nongrantor Trusts to Minimize Income Tax: Maximizing Increased Exemption Benefits

The new tax law provisions increase the estate tax exemption, reducing or eliminating certain deductions, and accelerates the need for estate planners to revisit existing wealth transfer structures. Individuals using grantor trusts to minimize estate tax exposure may be better served transferring assets to nongrantor trusts to reduce income tax. This planning can also create additional income tax deductions under the new pass-through business rules.

The estate tax exemption amount of $22.8 million for married couples, for 2019 ($23.16 million for 2020), eliminates estate tax concerns for even higher net worth taxpayers, at least until the exemption sunsets. However, lost deductions will hit many taxpayers much harder, increasing the federal and state income tax burden on many income-generating assets. Grantor trusts, long the preferred vehicle for settlors looking to minimize or defer wealth transfer taxes, will be less impactful.

Planners should consider restructuring existing grantor trust vehicles to convert trusts holding assets such as real estate to nongrantor trusts. Additionally, certain spousal trusts may benefit from conversion to nongrantor trust status through the inclusion of an "adverse party" with the right of approval over marital distributions.

Listen as our experienced panel provides a practical guide to migrating assets from grantor trusts to nongrantor trusts to minimize income tax on trust assets and use up the temporarily increased estate exemption amounts.