Question 1

What is a grantor trust and how does it work for New York estate planning?

Accepted Answer

A grantor trust is a trust in which the grantor — the person who creates and typically funds the trust — retains certain powers or interests that cause the trust's income to be taxed to the grantor for federal income tax purposes under IRC §§671–679, rather than to the trust or its beneficiaries. The grantor trust rules create a fascinating planning opportunity: for estate tax purposes, a trust can be structured so that the assets transferred to it are outside the grantor's estate, while for income tax purposes the grantor is still treated as the owner and pays the trust's income taxes personally. This means the grantor is essentially making additional tax-free gifts to the trust equal to the income taxes paid each year, because the trust assets grow without being depleted by income tax that the grantor pays from outside resources. New York generally follows federal grantor trust rules, though New York does not always conform to all federal grantor trust elections — particularly for New York source income. Common grantor trust powers that cause grantor trust status include the power to substitute assets of equivalent value, the ability to borrow trust assets without adequate interest or security, the retention of certain administrative powers, and the use of income to pay premiums on insurance on the grantor's life. Russel Morgan, Esq. designs grantor trust structures for New York clients that achieve their estate planning objectives while carefully coordinating federal and New York income and estate tax consequences.

Question 2

What is an intentionally defective grantor trust (IDGT) and how is it used in New York?

Accepted Answer

An intentionally defective grantor trust (IDGT) is one of the most powerful estate planning tools available to high-net-worth New York clients. The term 'intentionally defective' refers to the trust being intentionally structured to be a grantor trust for income tax purposes (so that the grantor pays the income taxes) while being outside the grantor's estate for estate tax purposes (so that the assets are not subject to estate tax at the grantor's death). There are two primary ways to use an IDGT. The first is an outright gift to the trust using the grantor's gift tax exemption, after which the trust grows outside the estate and the grantor pays the income taxes, effectively making additional tax-free gifts to the trust beneficiaries each year. The second — and often more powerful — strategy is an installment sale to the IDGT, in which the grantor sells highly appreciated or high-growth assets to the trust in exchange for a promissory note at the applicable federal rate (AFR). Because the sale is between the grantor and a trust treated as the grantor for income tax purposes, no gain is recognized on the sale. The trust then holds the assets and all future appreciation, paying only the note (principal plus modest interest) back to the grantor. This strategy removes the full sale price — and all future appreciation — from the grantor's estate using minimal gift tax exemption (only the seeding gift used to capitalize the trust before the sale). For New York clients holding closely held business interests, investment real estate, or other appreciating assets, installment sales to IDGTs represent a highly efficient mechanism to transfer wealth to the next generation at minimal transfer tax cost.

Question 3

How does a GRAT work and when is it most effective for New York families?

Accepted Answer

A grantor retained annuity trust (GRAT) is a trust to which the grantor transfers assets and retains the right to receive fixed annuity payments for a specified term — typically two to ten years. At the end of the term, any assets remaining in the trust (after paying the annuity) pass to the trust beneficiaries free of additional gift or estate tax. The taxable gift upon funding the GRAT is reduced by the present value of the retained annuity interest, calculated using the IRS's §7520 rate. If the grantor structures the annuity so that its present value equals the full contribution (a 'zeroed-out' GRAT), the gift is essentially zero. The GRAT succeeds for estate planning purposes if the assets in the trust grow at a rate exceeding the §7520 hurdle rate — because all appreciation above the hurdle rate passes to beneficiaries free of gift and estate tax. GRATs are most effective in two situations: first, when the §7520 rate is low (because the hurdle rate is lower, making it easier to outperform); and second, when the contributed assets are expected to appreciate significantly in the near term — such as closely held business interests before a sale, concentrated stock positions before an earnings announcement, or real estate before a development project completion. For New York clients, GRATs must be structured carefully because New York does not conform to federal law with respect to certain income tax aspects of trust taxation, and the grantor's death during the GRAT term causes the trust assets to be pulled back into the estate. Morgan Legal Group designs rolling GRAT programs and coordinates GRAT strategy with the client's investment and tax advisors.

Question 4

What is a spousal lifetime access trust (SLAT) and is it appropriate for New York clients?

Accepted Answer

A spousal lifetime access trust (SLAT) is an irrevocable trust created by one spouse for the benefit of the other spouse (and often other family members), funded using the donor spouse's gift tax exemption. The primary purpose of a SLAT is to remove assets from the donor spouse's taxable estate while maintaining some indirect access to the trust through the beneficiary spouse's ability to receive distributions. For New York clients with large estates, particularly those who want to use the temporarily elevated federal exemption — set to be reduced by approximately 50% after December 31, 2025, unless Congress acts — a SLAT offers a way to lock in the full exemption before the sunset while keeping the assets accessible through the beneficiary spouse. However, SLATs come with significant risks that New York clients must understand. The primary risk is the 'divorce trap': if the marriage ends in divorce, the donor spouse loses access to the trust assets entirely because the beneficiary spouse — now an ex — retains the beneficial interest. Additionally, if both spouses create SLATs for each other (a strategy called 'reciprocal SLATs'), the IRS may apply the reciprocal trust doctrine to pull both trusts back into the estates if the trusts are too similar in structure and timing. To avoid this doctrine, each SLAT must be distinguishable from the other in terms of trustees, beneficiaries, distribution standards, and timing. Morgan Legal Group designs SLATs for New York married couples with careful attention to the reciprocal trust rules, divorce protections, and New York-specific tax consequences.

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