Planning With Non-grantor Trusts After The OBBBA

Tax News You Can Use | For Professional Advisors

Jane Ditelberg, Director of Tax Planning

September 15, 2025

Three new elements of the tax code after the One Big Beautiful Bill Act (OBBBA) are (1) income limitations on some newly available deductions, (2) disallowance of a portion of charitable deductions for itemizers of all income levels, and (3) disallowance of a portion of all itemized deductions for those in the top income tax bracket. Qualifying for the deductions and minimizing disallowances requires careful management of income and deductions in each year — a process we refer to as bracket management. One element of bracket management is the use of non-grantor trusts.

What Are The Differences Between Grantor And Non-Grantor Trusts?

Since the 1990s, there has been an increasing focus on using grantor trusts in wealth planning. These trusts are treated as the same taxpayer as the person who created them. They have tax advantages in certain types of planning. For example, the payment of the trust’s income tax liabilities by the grantor is not considered an additional gift, so the trust assets can grow faster, further enhancing the gift to the trust and its beneficiaries. Moreover, transactions between the grantor and the trust, such as sales or loans, are disregarded for tax purposes. Some trusts, such as revocable trusts, lifetime trusts for your spouse, grantor retained annuity trusts (GRATs) and life insurance trusts, are automatically grantor trusts because of their terms. Other trusts such as dynasty trusts, trusts for children or other descendants, and charitable lead trusts (CLTs) can be grantor or non-grantor trusts, depending on the terms. All trusts are non-grantor trusts after the death of the grantor.

Non-grantor trusts are separate taxpayers, while grantor trusts are not. Income (and deductions) from a grantor trust is included on the grantor’s return. This means that a grantor trust impacts the grantor’s tax bracket. Non-grantor trusts are separate taxpayers that file their own tax returns (form 1041), keeping the items of income off the grantor’s return and taking their own deductions. The basic tax rules governing non-grantor trusts are similar to those for individuals, but there are important differences. For example, the haircut on itemized deductions applies to trusts as well as individuals, but the 0.5% floor of adjusted gross income (AGI) for charitable deductions does not.

How Can Non-Grantor Trusts Help In Bracket Management?

The choice between a grantor trust and a non-grantor trust can impact the grantor’s tax bracket and the aggregate tax paid. If a taxpayer is trying to stay under the income threshold for the cap on state and local tax deductions (the SALT cap) or the 37% tax bracket (where the benefit of all itemized deductions is reduced), this choice will determine whether the income from a trust is taxed to the grantor or a separate taxpayer trust.

Example 1:

Jordan, a single taxpayer, has income of $400,000 per year from a private equity investment and $300,000 per year from retirement plans and pensions. Jordan has $50,000 in state and local taxes and $10,000 in other itemized deductions. She decides to give the investment to a dynasty trust for her descendants. The following tables illustrate the tax implications of structuring the trust as a grantor trust or a non-grantor trust.

The income tax with a grantor trust is $209,020 while the aggregate income tax paid by Jordan and the non-grantor trust is $203,049. The savings from using a non-grantor trust is $5,971. The additional available deductions and a top marginal rate of 32% for Jordan’s personal taxes results in a lower overall tax bill. If, instead, Jordan had $400,000 in income and the trust had $300,000, then the grantor trust approach would lead to lower taxes (because Jordan’s top marginal rate would be 35% instead of 32%. This demonstrates that it pays to run the numbers.

How Do The QSBS Limits Apply To Non-Grantor Trusts?

For taxpayers owning Qualified Small Business Stock (QSBS)¹ that is eligible for the exclusion of up to $15 million in capital gains (if the shares were issued after July 4, 2025, and are held for a minimum of five years), non-grantor trusts can be especially advantageous. The potential $15 million exclusion from gain on the sale of QSBS is determined per taxpayer; therefore, giving QSBS to a non-grantor trust instead of a grantor trust can result in an additional $15 million of capital gains excluded from tax.

Example 2:

Nicholas and Ashely are the founders of a new business formed as a C corporation, the shares of which qualify as QSBS. Each invests $100,000 in the business in exchange for 50 shares. Ashley keeps 50 shares in her name. Nicholas gives 25 shares to a non-grantor trust for the benefit of his descendants. In year 10, a competitor offers $100 million for all the stock. Because the stock is QSBS:

• Ashley will be able to exclude $15 million, leaving her to pay tax on $34.95 million, resulting in tax of $8,318,100 (from a capital gains tax of 20% plus 3.8% net investment income tax).
• Nicholas will be able to exclude $15 million, leaving him to pay tax on $9,975,000, resulting in tax of $2,374,050.
• The non-grantor trust will also be able to exclude $15 million, leaving it to pay tax on $9,975,000, resulting in tax of $2,374,050.

If Nicholas had made the gift using a grantor trust, he would be in the same position as Ashley. By using a non-grantor trust for the gift, the total tax on his side of the ledger is $4,748,100, which is 43% lower than if he had used a grantor trust.

Can The Non-Grantor Trust Take Its Own Deductions?

The answer is yes. Most deductions available to an individual are also available to a trust if the trust has taxable income. For example, if a grantor gives property generating a portion of the income and deductions to a non-grantor trust, the overall tax bill could be lower.

Example 3:

Ross owns his primary residence and one vacation home that he also rents out. He has annual income of $1 million, including $50,000 of rental income from the vacation home. He pays state and local taxes of $150,000, $50,000 of which is attributable to the vacation home. He has $50,000 of other itemized deductions. The following tables compare the impact of Ross giving the vacation home to a grantor trust with giving it to a non-grantor trust:

In this case, because the non-grantor trust claims its own SALT deduction that qualifies for the higher cap, the non-grantor trust approach saves $16,521 in tax.

This result holds when creating a new trust or when tax planning with an existing grantor trust. In certain grantor trust situations, a change of trustee or a release of a power can turn a grantor trust into a non-grantor trust. For grantors who are close to not qualifying for the higher SALT cap, approaching a haircut on itemized deductions, or not qualifying for the senior citizen deduction, it is critical to review the income tax consequences of each approach.

Example 3:

In 2012, Sam created a Dynasty Trust. It is a grantor trust because Sam has the power to substitute assets and because Elaine, Sam’s wife, is trustee and is authorized to spray income and principal among the beneficiaries at her absolute discretion. Sam and Elaine turn 65 in 2026 and hope to qualify for the senior citizen deduction, the higher SALT cap, and to stay out of the 37% bracket so they do not have their itemized deductions reduced. 2026 is a year when they have flexibility about how much income they will recognize because they are both retiring and will not have to take any required minimum distributions from their retirement plans yet.

If the trust remains a grantor trust, Sam and Elaine will compute their tax based on the $700,000 in ordinary income and $62,000 in SALT deductions generated by the trust, in addition to the $200,000 in taxable income and $40,000 in SALT deductions generated by their own assets. The following tables compare their 2026 tax profile if the trust remains a grantor trust with what it would be if it became a non-grantor trust by having Elaine resign as trustee and appoint an independent trustee and having Sam release his power to substitute assets.

In this scenario, the total tax paid by Sam and Elaine with the grantor trust is $286,289. This is more than the aggregate of their tax plus the trust’s tax of $281,853 when using a non-grantor trust.

Do The Charitable Deduction Floor And Itemized Deduction Haircuts Apply To Non-Grantor Trusts?

While the disallowance of itemized deductions for those in the 37% bracket applies to trusts (and trusts hit the 37% bracket at $15,560), the floor that limits charitable contribution deductions to amounts that exceed 0.5% of the taxpayer’s MAGI does not apply to trusts. A different section of the tax code authorizes the charitable deduction for trusts. It provides that trusts get a charitable income tax deduction only if the terms of the trust agreement mandate the distribution to charity from income.

Charitable Lead Trusts Illustrate The Impact

For clients considering a charitable lead trust (CLT), these “shave and a haircut” rules will impact the decision whether to use a grantor or non-grantor lead trust. A CLT is a trust that pays an annuity to a charity for a fixed period (which may be a term of years or may be for an individual’s lifetime), and, at the end of that period, the assets pass to one or more individuals or non-charitable trusts.

CLTs are not tax-exempt, and income is taxed either to the donor (if a grantor trust) or to the trust (for a non-grantor trust). When a donor creates a grantor trust CLT, they get an income tax deduction in the year the trust is funded, while each year the grantor pays tax on the income earned inside the CLT with no deduction for the amounts paid to charity. On the other hand, a non-grantor trust CLT generates no upfront income tax charitable contribution deduction, but the trust pays its own income tax and can claim a charitable contribution deduction based on the amounts the trust agreement directs the trustee to pay to charity. The OBBBA rules may encourage taxpayers choosing a grantor trust CLT to complete the gift in 2025.

Example 4:

Mike and Jessica are both considering CLTs to fulfill their planning goals. Each of them has MAGI of $2 million and wants to make a $2 million gift to a CLT that pays a 10% annuity for five years to a cancer research foundation. After consulting with their respective advisors, Jessica creates a non-grantor trust CLT and Mike creates a grantor trust CLT. The following table compares the income tax charitable deduction projected for a gift in 2025 and a gift in 2026.

If Mike makes the gift in 2025, he gets his full charitable deduction based on the present value of the payments to charity as of the date of contribution. It is not reduced by the floor or the ceiling. If Jessica makes a gift in 2025 or 2026, her trust’s charitable deductions start no sooner than 2026, where the deduction for the $200,000 payment each year to charity is reduced by $9,965 due to the ceiling (but not the floor, which does not apply to trusts). However, Mike’s deduction for a gift in 2026 is reduced by $10,000, due to the charitable contribution floor, and by $46,486 from the itemized deduction ceiling, as Mike is in the 37% bracket. As the table illustrates, it makes a significant difference whether Mike makes the gift in 2025 or 2026. The same is not true for Jessica under these facts. Taxpayers will want to collaborate with their advisors to evaluate their own circumstances, tax rates, and the specific assets they wish to transfer to determine whether a grantor trust or non-grantor trust CLT is right for them. It is important to consider how the new rules impact the income tax deductions.