IRS Provides Some Relief for Post-Divorce Grantor Trust Rule Issues

During happy days, one spouse (call him or her the “Donor Spouse”) sets up an irrevocable trust for the benefit of the other spouse (call him or her the “Donee Spouse”). Under Code §672(e)(1)(A), a grantor of a trust is treated as holding any power or interest in a trust that is held by an individual who was the spouse of the grantor at the time of the creation of such power or interest. This typically results in grantor trust status for the trust since the Donor Spouse is treated as having retained rights to income and principal in the trust – with the Donor Spouse being taxable on some or all of the trust income.Fast forward, and the happy couple is not so happy. They divorce, but the trust lives on. Since the testing under Code §672(e)(1)(A) of the spousal relationship that gives rise to the grantor trust status looks to the time of the creation of the trust, not the status in any later tax year, the Donor Spouse continues to be taxable to…

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