Grantor Trusts in South Dakota: Preserving a Planning Tool to Maintain the State's Trust Friendly Status
Barrett, Beau C. T., South Dakota Law Review
Grantor trusts are a valuable estate planning tool for South Dakota legal practitioners. The rules that govern the types of and parameters for grantor trusts consist of a combination of federal statutes, regulations, and common law. Deciding where to create a grantor trust--the trust's situs--is influenced by state statutory treatment of trusts. South Dakota has set itself up as "trust friendly " by passing legislation that has repealed laws injurious to trusts, while also passing statutes that foster a favorable environment for creating them. Consequently, the South Dakota trust industry flourishes as wealthy clients from around the nation choose to situs their trusts in South Dakota. Additionally, grantor trusts are particularly beneficial for South Dakota residents, such as farmers or business owners, whose assets may be illiquid. Upon the death of the owner, the owner's survivors stand to lose the family business to the estate tax without the benefit of grantor trust planning. Nevertheless, many commentators feel that grantor trusts have outlived their usefulness. This scholarly disapproval has been echoed in recent years by Department of Treasury revenue proposals, which recommend imposing specific limitations on different types of grantor trusts. However, these recommendations would be detrimental to the South Dakota trust industry and its clients in that they eliminate or modify valuable estate planning tools. Therefore, South Dakota legal practitioners and estate planners must vigorously advocate to preserve these estate planning tools in order to sustain their use and, in turn, continue to support South Dakota's flourishing trust industry.
The world of grantor trusts gives rise to a wide variety of options for the estate planner, including those grantor trusts labeled GRITs, GRATs, GRUTs, QPRTs, ILITs, and IDGTs.' Despite this vast array of acronyms grantor trusts can generally--and more simply--be defined as trusts wherein the grantor, rather than the trust itself, is taxed on the trust's income. (2) These trusts have evolved with changes in the common law, regulations, and legislation, but the purpose of grantor trusts has always been reducing the tax burden on either the grantor, the beneficiaries, or both. (3)
While there is a split of opinions on the usefulness and future viability of grantor trusts, (4) they are, nonetheless, important tools for estate planners to help clients because grantor trusts may reduce or eliminate estate taxes upon the client's death by diminishing the amount of a client's taxable property. (5) Additionally, attainment of grantor trust status--given the current compressed marginal tax rates for trusts--has the effect of reducing the income tax paid on the assets placed in trust because the grantor, rather than the trust, will pay the income taxes. (6)
South Dakota has taken advantage of these benefits by passing legislation that creates a favorable atmosphere for those clients who situs their trusts in the state. (7) However, subsequent to an inversion of the income tax rates in 1986, (8) many commentators argue that grantor trusts have outlived their usefulness and should therefore be eliminated or drastically reformed. (9) The idea for reform has percolated through in recent years as Treasury Department proposals aimed at limiting or destroying the effectiveness of certain grantor trusts. (10) Therefore,
Irrevocable Life Insurance Trust ("ILIT") takes advantage of specific code provisions to remove from one's estate the value of that person's life insurance policy. Steinkamp, supra, at 78. Finally, an Intentionally Defective Grantor Trust ("IDGT") exploits the differences in estate and income tax through a grantor's sale of property to the trust in exchange for payments on a note. Mark S. Poker, Sales to Intentionally Defective Grantor Trusts: Here is How Defects Can Be Positives, Prac. Tax Law., Fall 2010, at 15, 15-16, 18. …