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George F. Bearup, J.D. Senior Legal Trust Advisor

19-Jan-21

Grantor Trusts Holding Retirement Accounts

Take-Away: The IRS has yet to rule on whether the owner of an inherited IRA can transfer that IRA to a grantor trust established by the inheritor. Such a grantor trust might be a revocable grantor trust.

Background: Under the grantor trust rules, the settlor of the trust, if he/she holds certain powers or interests, and is a U.S. citizen or resident, will be treated for federal income tax purposes as the owner of the trust’s assets. The transactions between an individual and a  grantor trust, if all of its assets are deemed owned by such individual, are not taxable transactions because a transaction cannot be recognized as a sale for federal income tax purposes if the same person is treated as owning the purported consideration both before and after the transaction. [Revenue Ruling 85-13.]

Transfers to Living Trusts: An IRA owner’s transfer of his or her IRA to a trust that is entirely a grantor trust as to the grantor should not be treated as an ‘assignment’ of the IRA since the owner and his or her grantor trust are deemed to be in effect the same person. [Revenue Ruling  85-13.] However, no person other than the IRA owner can receive distributions from the trust during the owner’s life and the owner retains the right to remove the IRA from the grantor trust. The trust into which the IRA is transferred would be named as both owner and beneficiary of the IRA. Choate, Life and Death Planning for Retirement Benefits, Section 6.1.06. 

Inconsistent Private Letter Rulings: Yet, there are occasions when the IRS has suggested that the transfer of an IRA from the IRA owner to the owner’s revocable grantor trust results in a deemed distribution of the IRA which results in a taxable event to the IRA owner. The IRS has not been consistent on the ability of a living (revocable) trust to hold an IRA. One example is a private letter ruling where the IRA owner attempted to transfer her IRA into an IRA within a grantor trust of which she was the sole trust beneficiary. That attempted transfer of the IRA failed because the recipient IRA custodian “correctly determined that a grantor trust could not be the owner of an IRA.”  [Private Letter Ruling 2011-29045.] However, a year later, in another private letter ruling, the IRS approved of an IRA held in the name of an “established retirement benefit trust that was intended to benefit the grantor during his lifetime” [Private Letter Ruling 2012-45004.] There is no formal IRS announcement or ruling the expressly approves the transfer of an IRA owner’s IRA to the IRA owner’s revocable trust, which is a grantor trust. It would be nice if the IRS to provide IRA owners a clear statement that a living trust could (or could not) hold the grantor’s IRA.

Inherited IRA: Less clear are the tax consequences when the transfer is of an inherited IRA to a grantor trust. We know from the Supreme Court’s Rameker decision that inherited IRAs are treated as merely another asset of the individual who inherits the IRA (and also that the inherited IRA is not protected from the inheritor’s creditors.) As noted earlier, a transaction between an individual and a trust, all the assets of which are deemed owned by such individual under the grantor trust rules, is not a taxable transaction. [Revenue Ruling 85-13.] That is the result because a transaction cannot be recognized as a ‘sale’ for federal income tax purposes if the same person is treated as owning the purported consideration (the inherited IRA) both before and after the transaction. How the grantor trust rules are applied to the transfer of an inherited IRA to a grantor trust also remains unanswered by the IRS.

  • Income In Respect of a Decedent (IRD): If an individual inherits the right to receive distributions from an IRA, which is income in respect of a decedent (IRD), and he or she transfers that right to someone else, the IRD is immediately taxable to the transferor, not the transferee. [IRC 691(a)(2).] The distribution from a retirement plan account, like an IRA, is IRD. The retirement account itself is a right to receive IRD. Consequently, the transfer of an inherited IRA to a trust would appear to cause an immediate income tax result.

Example:  Iris inherits an IRA from her mother. Iris transfers that inherited IRA to a grantor trust that she creates. If Iris transfers the inherited IRA to a trust of which she is considered the grantor under IRC 678, that transfer is a nonevent for income tax reporting purposes. This should not create any tax problems for Iris so long as the IRA benefits are distributed to the grantor-beneficiary during  her lifetime. [IRC 691(a)(2).] However, the IRS has not formally held this to be the correct  result, or why the IRD rules do not apply; rather, it is just an interpretation of existing grantor trust rules.

  • Private Letter Rulings: The IRS has indirectly inferred this is the correct result, but only in private letter rulings, which cannot be cited as binding legal precedent. In one ruling the IRS held that a disabled beneficiary was permitted to transfer an inherited IRA to a special needs trust (a Medicaid pay-back trust, called a (d)(4)(A) Trust.) [Private Letter Ruling 2011-16005.] In another ruling the IRS held that a minor’s guardian was permitted to transfer an inherited IRA to an irrevocable trust for the minor’s benefit, which was created with the probate court’s approval. [Private Letter Ruling 2008-26008.]In each of these situations, the IRS held that the trusts were grantor trusts as to the transferring-IRA beneficiaries and therefore the transfers were not immediately taxable. [IRC 691(c).]

Conclusion: Arguments can be made based upon the existing tax laws that an IRA can be transferred to a revocable grantor trust for federal income tax purposes without causing the transfer to be an immediately taxable distribution to the IRA owner. The safest approach, in the absence of any definitive IRS ruling on the transfer of an IRA to a grantor trust, is to continue to hold the IRA in the name of its owner and rely on beneficiary designations to transfer the IRA’s assets when the owner dies. The same can be said for an inherited IRA. Maybe this rhetorical question will become moot if Congress gets around to eliminating the grantor trust rules as President Biden has proposed. In the meantime, it is best to play it safe and not retitle an IRA (traditional or inherited) in the name of a grantor trust.