Part III · Structures · No. 02

Trust structures

A trust is a separated bundle of legal and beneficial interests in property. The federal-tax architecture distinguishes grantor from non-grantor trusts; the estate-tax inclusion test asks who controls and who enjoys; and the choice of situs governs whose courts will administer the instrument over its life.

What the structure is

A trust separates legal title (held by the trustee) from beneficial enjoyment (held by the beneficiaries). The instrument — the trust agreement — defines the trustee's powers, the beneficiaries' rights, and the trust's duration. State law supplies the substantive law of trusts; federal tax law characterizes the trust for income, gift, estate, and generation-skipping tax purposes.

The tax problem it addresses

Trusts solve four recurring problems for luxury-asset holders:

• Estate-tax removal — assets transferred to an irrevocable trust during life are generally outside the grantor's gross estate at death.
• Generation-skipping — a properly structured trust with GST exemption allocated can serve successive generations free of further transfer tax. See dynasty trusts.
• Asset protection — the trust's assets are separate from the beneficiaries' personal estates and creditors.
• Governance and stewardship — a trust outlasts an individual and can carry instructions on how a collection or property is managed.

Mechanics

The principal taxonomy:

• Revocable vs. irrevocable. A revocable trust is ignored for transfer-tax purposes; the grantor's estate includes its assets at death. An irrevocable trust may or may not be in the grantor's estate, depending on the powers retained.
• Grantor vs. non-grantor. Under §§671-679, a trust is "grantor" if the grantor has retained any of the defined powers (revocation, beneficial enjoyment, control over administration, certain income or principal interests, etc.). A grantor trust's income is reported on the grantor's individual return. A non-grantor trust is a separate taxpayer, filing Form 1041 and taxed under a compressed rate schedule — for 2026 the 37% bracket begins at $16,000 of taxable income (Rev. Proc. 2025-32), and the 3.8% NIIT applies to undistributed net investment income above the same threshold.
• Domestic vs. foreign. Under §7701(a)(30) and the court-and-control tests of Treas. Reg. §301.7701-7, a trust is domestic if a U.S. court can exercise primary supervision and a U.S. person controls all substantial decisions. Foreign trusts face separate reporting (Form 3520 / 3520-A) and throwback-rule issues.

For luxury-asset trusts, the common patterns:

• Intentionally defective grantor trust (IDGT). Irrevocable and outside the estate for transfer-tax purposes but a grantor trust for income-tax purposes. The grantor pays the trust's income tax (further depleting the gross estate; Rev. Rul. 2004-64 confirms that payment is not a gift), and sales between grantor and trust are disregarded for income tax (Rev. Rul. 85-13).
• Dynasty trust. Long-duration trust funded with GST exemption.
• Charitable-remainder trust. Split-interest, with income to beneficiaries and remainder to charity.
• Spendthrift trust. Beneficiary's interest protected from creditors.
• Asset-protection trust. Self-settled spendthrift trust under Nevada, South Dakota, Delaware, Alaska, or analogous statutes.

The applicable statutes and authorities

• 26 U.S.C. §§641-685 (trust income tax).
• 26 U.S.C. §§671-679 (grantor trust rules).
• 26 U.S.C. §§2036, 2038, 2041, 2042 (estate inclusion).
• 26 U.S.C. §2702 (special valuation rules).
• 26 U.S.C. §§6048, 6677 (foreign-trust reporting).
• 26 U.S.C. §§643(i), 679 (special foreign-trust rules).
• State trust statutes — Delaware Code Title 12; South Dakota Codified Laws ch. 55; Nevada Revised Statutes ch. 166; Alaska Statutes ch. 13.

Substance and audit risk

Trust audits focus principally on:

• Estate-tax inclusion. Did the grantor retain a §2036 or §2038 power that pulls the trust assets back into the estate? Estate of Powell v. Commissioner, 148 T.C. 392 (2017), and the FLP/LLC trust-holding cases have continued the line of Strangi-style decisions.
• Foreign-trust reporting. Form 3520 / 3520-A penalties under §6677 are substantial — generally the greater of $10,000 or 35% of the gross reportable amount for Form 3520 failures (5% of trust assets for Form 3520-A), with continuation penalties. The IRS asserts these penalties routinely, and litigation over their assessment procedure and reasonable-cause defenses continues.
• Grantor-trust adequacy. The grantor must hold an actual §§671-679 power; nominal triggers may not suffice if the substantive economics deviate.
• State income tax. Connection-based state income tax on trusts has been the subject of North Carolina Department of Revenue v. Kaestner, 588 U.S. 262 (2019), which addressed due-process limits on state taxation of trust income based on beneficiary residence alone.

Cost and complexity

Drafting cost reflects the complexity of the dispositive provisions and the level of tax customization. A standard revocable living trust is relatively economical; an intentionally defective grantor dynasty trust with multiple subtrusts and trustee-removal mechanisms is materially more expensive. Trustees (institutional or individual) charge ongoing fees. Annual income-tax preparation for non-grantor trusts produces accounting cost. Trust accounting, beneficiary notifications, and Crummey-power administration add ongoing administrative cost.

Common combinations

• Dynasty trust holding a family LLC holding the assets. Two-layer structure with trust-level estate-tax planning and LLC-level liability shield and discount-eligible interests.
• IDGT funded with sale-to-trust note. Grantor sells appreciated assets to IDGT for a note; gain not recognized (grantor-trust transparency); appreciation moves to trust.
• CRUT funded with appreciated art or collectibles. Charitable structure for deferred recognition of large gain.
• SLAT (spousal lifetime access trust). Each spouse establishes a trust for the other; provides estate-tax-free access while preserving exemption use.
• Domestic asset-protection trust. Nevada, South Dakota, or Alaska self-settled trust with cooling-off period and statutory exemptions.

Recent developments

The scheduled end-2025 sunset of the doubled exclusion amount did not take effect: the One Big Beautiful Bill Act (Pub. L. 119-21, signed 4 July 2025) set the basic exclusion and GST exemption at $15,000,000 per person for 2026, indexed thereafter, with no sunset. Gifts made under the prior higher exclusion are protected in any event by the anti-clawback regulation, Treas. Reg. §20.2010-1(c). The annual gift-tax exclusion is $19,000 per donee for 2026 (Rev. Proc. 2025-32).

North Carolina Department of Revenue v. Kaestner, 588 U.S. 262 (2019), held that a state may not tax trust income based solely on the residence of an in-state beneficiary who received no distributions, had no right to demand them, and could not count on receiving them. The holding is narrow; states continue to tax trusts based on grantor residence, trustee location, or beneficiaries with present rights.

Under FinCEN's March 2025 interim final rule, domestic entities (including LLCs owned by trusts) are exempt from Corporate Transparency Act beneficial-ownership reporting; trusts themselves were never reporting companies. Reporting now reaches only foreign entities registered to do business in the United States.

Reviewed October 2026