What makes a trust a Non-Grantor Trust — and how does it differ from a Grantor Trust?

The IRS has specific rules under IRC §§ 671–678 that determine whether a trust is a 'grantor trust' for income tax purposes. If the grantor does not retain any of the powers that trigger grantor trust status, the trust is a Non-Grantor Trust — a separate taxpayer. Key differences: Grantor Trust: • Grantor pays income tax on all trust earnings on their personal Form 1040 • Trust does not file its own income tax return • Trust assets may receive a step-up in cost basis at the grantor's death • Grantor's payment of income taxes is itself a tax-free gift to the trust beneficiaries Non-Grantor Trust: • Trust is a separate taxpayer — files Form 1041 annually • Trust pays income tax at compressed trust rates on retained income • Distributions of income to beneficiaries are taxable to the beneficiary at their individual rate • Trust assets generally do not receive a step-up in cost basis at the grantor's death • Grantor has no ongoing income tax obligation related to trust earnings

What are the compressed tax brackets for Non-Grantor Irrevocable Trusts?

An irrevocable trust is a separate legal and tax entity. The trustee must obtain a separate Employer Identification Number (EIN) and file Form 1041 annually. Compressed Federal Income Tax Brackets for Irrevocable Trusts (2025 — taxes paid in 2026): Taxable Income Tax Rate ───────────────────────────────── $0 – $3,150 10% $3,150 – $11,450 24% $11,450 – $15,650 35% Over $15,650 37% For comparison: the top individual rate of 37% applies to single filers with income over $626,350 in 2025. A trust hits that same 37% rate at just $15,650 of retained income. Long-Term Capital Gains Tax Rates for Trusts (2025): Capital Gains Rate ───────────────────────────────── Up to $3,250 0% $3,250 – $15,900 15% Over $15,900 20% Important rules: • These compressed rates apply only to income retained in the trust — not distributed to beneficiaries • Distributions of income are taxable to the beneficiary at their individual rate • Distributions of principal are not subject to income tax • Trusts may also be subject to the Net Investment Income Tax (NIIT) of 3.8%

What is the 65-Day Rule — and how does it help manage trust income taxes?

The 65-Day Rule is a key planning tool for Non-Grantor Trusts. The trustee can elect to treat distributions made within the first 65 days of the new tax year as if they were made in the prior tax year. This is valuable when the trust is in a higher tax bracket than the beneficiaries — the trustee can shift income to beneficiaries who may be taxed at lower individual rates, reducing the overall tax burden on the trust and its beneficiaries. This election is made on Form 1041 and must be made by the due date of the trust's tax return for the prior year.

What is a Domestic Asset Protection Trust (DAPT)?

A Domestic Asset Protection Trust (DAPT) is a self-settled irrevocable trust in which the grantor is also a permissible beneficiary — yet the assets are protected from the grantor's creditors. Not all states permit DAPTs; Washington State does not currently have a DAPT statute. States that permit DAPTs include Nevada, South Dakota, Delaware, and Alaska. A Washington resident can create a DAPT in one of these states, but the protection is not guaranteed — Washington courts may not recognize the asset protection if the grantor is a Washington resident. For Washington residents seeking asset protection, the more reliable approach is: 1. Irrevocable Trusts for the benefit of family members (not the grantor) 2. Family LLCs with proper operating agreements 3. Retirement accounts (fully exempt from creditors in Washington) 4. Homestead exemption (approximately $729,600 in King County)

Who are Non-Grantor Irrevocable Trusts appropriate for?

Non-Grantor Irrevocable Trusts are for people with a net worth in excess of $3 million and no debt — using the estate planning definition of net worth. Net worth for this purpose specifically excludes your paid-off primary residence, your fully funded retirement accounts, your paid-off primary vehicle, and six months of personal emergency cash savings — because all of those are needed for you to live now and in the future. The Washington Estate Tax planning that creates the $9 million shelter is available for $1,500 via Zelle. The Irrevocable Life Insurance Trust (ILIT) adds an additional $3,000 for estates above $9 million.

Christopher S. Mulvaney, Esq. — Attorney-and-Counselor-at-Law — Professionalism with Integrity — WSBA#33595 — Licensed Only in Washington State

[email protected]Bellevue, WA

Non-Grantor Irrevocable Asset Protection Trusts

Trusts Overview

Advanced Estate Tax Planning

A separate tax entity — with its own EIN, its own return, and its own compressed tax brackets.

A Non-Grantor Irrevocable Trust is a separate legal and tax entity. Unlike a Grantor Trust, the grantor does not pay income tax on trust earnings — the trust pays its own income tax at compressed trust rates, or distributes income to beneficiaries who pay at their individual rates. Assets transferred in are removed from the grantor's taxable estate. Appropriate for clients with a net worth in excess of $3 million and no debt.

Reference Links

Grantor Irrevocable Asset Protection Trusts Tax Treatment of Trusts Family LLCs Trusts Overview Schedule a Free Zoom Consultation

Ready to Protect Your Family?

MetLife Legal Plans accepted. No-cost, no-obligation Zoom consultation with Christopher Mulvaney.

Schedule a Free Zoom Consultation Trusts Overview