How The Bridge Trust Qualifies as a Grantor Trust Under IRC §677

The Bridge Trust^®, an advanced tool in asset protection planning, allows the settlor to retain control and enjoy the benefits of trust assets while protecting those assets from creditors. A key feature that makes this trust attractive is its qualification as a grantor trust under Internal Revenue Code (IRC) §677. 

Most practitioners are likely more familiar with IRC §675, which uses retained powers of the Grantor, such as the power to substitute trust assets, or the power to borrow from the trust without adequate security.  This is common in Irrevocable trusts in which the Grantor retains no direct interest in the trust assets and is not a named beneficiary.  However, in an asset protection trust, such as The Bridge Trust, since the Grantors are also the sole present beneficiaries of the Trust, Grantor trust status is attained through IRC §677.

The Role of IRC §677 in Grantor Trust Status

IRC §677(a) states that the grantor of a trust will be treated as the owner of the trust for income tax purposes if the income from the trust:

1. Is distributed to the grantor or the grantor's spouse,
2. Is held or accumulated for future distribution to the grantor or the grantor's spouse, or
3. Is used to pay premiums on life insurance policies for the grantor or the grantor's spouse.

In essence, if the grantor retains the right to receive income from the trust, the IRS considers the grantor to be the owner of the trust's assets for income tax purposes, making it a "grantor trust."

How the Bridge Trust Meets IRC §677 Criteria

In a Bridge Trust, the grantor typically serves both as the trustee and a beneficiary, creating a unique dynamic where the trust remains irrevocable, yet the grantor retains significant rights and benefits. Specifically, the Bridge Trust qualifies as a grantor trust under IRC §677 for the following reasons:

1. Grantors are Sole Present Beneficiaries:

   • The grantors are the sole present beneficiary of the Bridge Trust, meaning that they are entitled to receive income and principal distributions from the trust. Since the income can be distributed to the grantor, the trust automatically meets the criteria outlined in IRC §677(a)(1).

2. Income Held or Accumulated for Grantor:

   • If the trust's income is not immediately distributed, it is typically held or accumulated for the future benefit of the grantor. This aligns with IRC § 677(a)(2), which states that income held for future distribution to the grantor qualifies the trust as a grantor trust.

3. Income Applied for the Benefit of the Grantor:

   • Even if the income is not directly distributed to the grantor, if it is used in a manner that benefits the grantor—such as paying premiums on a life insurance policy owned by the grantor—the trust still qualifies as a grantor trust under IRC § 677(a)(3).

The Implications of Grantor Trust Status

By qualifying as a grantor trust under IRC §677, the Bridge Trust allows the grantor to be treated as the owner of the trust's assets for income tax purposes. This means that the income generated by the trust is taxable to the grantor, rather than to the trust or beneficiaries. This can be advantageous in several ways:

• Tax Deductibility: The grantor may deduct trust-related expenses on their personal tax return.
• Income Reporting: The grantor reports the trust's income on their personal tax return, simplifying the trust’s tax filing obligations.

Conclusion

The Bridge Trust's structure, where the grantor is both the trustee and the sole present beneficiary, ensures that it qualifies as a grantor trust under IRC §677. This qualification is crucial for maintaining the trust's tax efficiency while providing robust asset protection. By understanding how these provisions work together, individuals can strategically use the Bridge Trust to safeguard their assets while retaining favorable tax treatment. 

See here for additional details on the Tax Compliance of the Bridge Trust.