The tax law requires that income on a trust established by a grantor be taxed to the grantor under certain conditions. That type of trust is called a “grantor trust.” The grantor of a grantor trust has no choice but to pay the income tax on that trust for at least as long as the trust is in existence and the grantor is still living. Historically, the IRS has never treated this incident of the tax law as a gift.
By placing property in trust, and paying the income tax outside the trust, the trust grows at a compounded rate, as if tax free. If $2 million is given to a trust on which someone else pays the taxes, earning approximately 10% per annum, the trust will be worth close to $15 million 20 years later, and will be worth $42 million in 30 years. The $15 million to $42 million in the trust can be sheltered from generation skipping and estate taxes for about 100 years or more.