What is a Non-Grantor Trust?

The Key Building Block for QSBS Stacking

Quick Overview

Non-grantor trusts are essential vehicles for effective QSBS stacking strategies because they're treated as separate taxpayers, each eligible for their own $10 million QSBS exclusion. Unlike grantor trusts (where the creator remains the taxpayer), non-grantor trusts shift both control and tax responsibility to the trust itself, creating a legitimate separate taxpaying entity. This article explains how non-grantor trusts work, why they're crucial for QSBS planning, how they differ from grantor trusts, and how to properly establish them as part of your comprehensive tax strategy.

Understanding Trust Fundamentals

Before diving into non-grantor trusts specifically, let me define some trust terminology (a.k.a legalese):

• Grantor: The person who creates and funds the trust (also called the settlor or trustor)

• Trustee: The person or entity who manages the trust assets and follows the trust instructions

• Beneficiaries: The individuals who receive benefits from the trust assets

• Trust corpus: The assets held by the trust (in QSBS stacking, typically company shares)

All trusts involve these basic elements, but how they're structured and taxed creates crucial differences that impact QSBS planning.

What Makes a Trust "Non-Grantor"?

The distinction between grantor and non-grantor trusts comes down to one primary question: Who is responsible for the income taxes generated by the trust assets?

In a grantor trust, the person who created the trust (the grantor) retains certain powers or benefits that cause them to remain the taxpayer for income tax purposes. All income, deductions, and credits flow through to the grantor's personal tax return, even if the assets are legally held by the trust.

In a non-grantor trust, the trust itself is treated as a separate taxpayer with its own tax identification number. The trust files its own tax returns and pays its own taxes on income that isn't distributed to beneficiaries.

This separation is critically important for QSBS stacking because Section 1202 benefits apply on a per-taxpayer basis.

Why Non-Grantor Trusts Are Critical for QSBS Stacking

For founders and early employees looking to maximize QSBS benefits, non-grantor trusts offer a powerful advantage: each properly structured non-grantor trust is treated as a separate taxpayer eligible for its own $10 million QSBS exclusion (or 10x basis, whichever is greater).

Here's a simple example to illustrate the power of this approach:

• Without trusts: A founder with $50 million in QSBS-eligible gains can exclude only $10 million, paying capital gains tax on the remaining $40 million.

• With five non-grantor trusts: The same founder could gift portions of QSBS shares to five separate non-grantor trusts (plus retaining some personally), potentially excluding the entire $50 million from capital gains tax when properly structured.

This multiplication of the exclusion amount is the essence of QSBS stacking. But it only works if each trust qualifies as a separate taxpayer—which requires non-grantor status.

Characteristics of Non-Grantor Trusts for QSBS Planning

For a trust to qualify as a non-grantor trust and serve as an effective QSBS stacking vehicle, it typically needs these characteristics:

1. Independent Trustee

The grantor should not serve as the sole trustee. Having an independent trustee (or at least co-trustee) helps establish separation between the grantor and the trust. A professional fiduciary like a trust company  often serves this role.

2. No Grantor Powers or Benefits

The grantor must avoid retaining certain powers that would trigger grantor trust status under IRC Sections 671-679, including:

• Power to revoke the trust

• Power to control beneficial enjoyment without an adverse party's approval

• Certain administrative powers like substituting assets

• Right to income without adequate consideration

• Certain powers to borrow from the trust

3. Irrevocable Structure

Non-grantor trusts used for QSBS stacking are typically irrevocable, meaning the grantor cannot simply change their mind and take back the assets. This permanence is a key element in establishing legitimate separation for tax purposes.

4. Separate Books, Records, and Accounts

Each non-grantor trust should maintain its own financial records, bank accounts, and formal accounting. Commingling assets or insufficient separation can undermine the trust's status as a separate taxpayer.

5. Legitimate and Different Beneficiaries

While not strictly required, having different beneficiaries for each trust strengthens the argument that each trust has a legitimate non-tax purpose. For example, one trust might benefit a spouse, another a child, and others future generations.

Establishing a Non-Grantor Trust for QSBS: Practical Steps

At Promissory non-grantor trusts are a part of every QSBS stacking strategy, here's a practical roadmap:

1. Timing Considerations

Establish trusts early—ideally when your company valuation is still relatively low. This allows you to:

• Gift more shares within gift tax exemption limits

• Create clear separation well before any liquidity event

• Avoid the appearance of last-minute tax planning

2. Jurisdiction Selection

Some states offer particularly favorable trust laws. Promissory has selected Nevada as our jurisdiction for a number of reasons, including the following:

• No state income tax

• Strong asset protection

• Privacy protections

• Dynasty trust provisions (allowing trusts to last for generations)

3. Trustee Selection

Choose trustees carefully. Options include:

• Professional fiduciaries or trust companies

• Trusted advisors with financial experience

• Family members with sufficient independence from the grantor

• Combinations of the above as co-trustees

At Promissory, we help connect you directly with reputable professional trustees in Nevada.

4. Proper Documentation

Maintaining the legitimacy of non-grantor trusts requires meticulous documentation:

• Formal trust agreements drafted by qualified attorneys

• Gift tax returns filed when shares are transferred to the trust

• Separate trust financial records and accounts

• Proper trust administration with documented trustee actions

All of the above are included when you work with Promissory.

5. Funding the Trust

When transferring QSBS shares to the trust:

• Document the fair market value of shares at transfer with a professional valuation

• Consider gift tax implications and lifetime exemption usage

• Ensure the transfer is a completed gift for tax purposes

• Maintain records of stock certificates and transfer documentation

Pro Tip: Consider establishing multiple trusts with different beneficiaries and varying distribution provisions to strengthen their treatment as separate taxpayers.

Common Pitfalls With Non-Grantor Trusts

Pitfall #1: Inadvertent Grantor Trust Provisions

The tax code includes numerous provisions that can trigger grantor trust status. Having an attorney experienced with non-grantor trusts is essential to avoid these technical traps.

Pitfall #2: Inadequate Separation

Failing to maintain proper separation between yourself and the trust can undermine its non-grantor status. This includes:

• Commingling personal and trust assets

• Treating trust assets as your own

• Controlling trust investments or distributions directly

• Using trust assets for personal obligations

Pitfall #3: Last-Minute Planning

Creating multiple non-grantor trusts immediately before a liquidity event may appear to be a tax avoidance scheme. Establishing trusts well in advance of any sale strengthens their legitimacy.

Pitfall #4: Failing to File Gift Tax Returns

Even if no gift tax is due (because you're under the lifetime exemption), you should file gift tax returns when funding non-grantor trusts with QSBS shares. This starts the statute of limitations clock on the IRS challenging the value of the gift.

Real-World Example: QSBS Stacking with Non-Grantor Trusts

A tech founder I spoke with had built a company valued at about $40 million, with his share worth approximately $25 million. His basis in the shares was relatively low, so the standard $10 million QSBS exclusion would leave a significant portion of his potential gain exposed to capital gains tax.

He implemented a strategy that included:

• Retaining $10 million worth of shares personally (covered by his personal QSBS exclusion)

• Creating a SLANT for his spouse's benefit with approximately $5 million in shares

• Establishing separate non-grantor trusts for each of his three children with approximately $3.3 million in shares each

Each trust had:

• A different beneficiary or set of beneficiaries

• A Nevada-based professional trustee

• Unique distribution provisions tailored to each beneficiary's needs

• Its own trust account and record-keeping

When the company was acquired three years later (after the founder's five-year holding period was met), this structure allowed the family to exclude almost the entire gain from capital gains taxation—saving approximately $5.7 million in federal taxes alone.

Balancing Control and Tax Benefits

One of the biggest challenges with non-grantor trusts is balancing the tax benefits with the reality that you're permanently giving away assets. At Promissory, we've found most founders prefer to gift 30-50% of their QSBS shares to trusts, retaining the majority directly.

This balanced approach:

• Provides significant tax savings on a portion of your gains

• Maintains direct control over most of your assets

• Creates legacy planning for family members

• Doesn't require uprooting your life to a different state

Remember that once you transfer shares to a non-grantor trust, those assets belong to the trust—not to you. While you might be able to benefit indirectly (through a spouse's SLANT, for example), the separation must be real and respected.

Key Takeaways

• Non-grantor trusts are separate taxpayers eligible for their own QSBS exclusions

• Each properly structured trust can exclude up to $10 million in QSBS gains

• Effective non-grantor trusts require independence from the grantor

• Jurisdiction matters—states like Nevada offer significant advantages

• Professional trustees help establish legitimacy and proper administration

• Documentation and separation are crucial for withstanding potential IRS scrutiny

• Early implementation strengthens the planning from both tax and practical perspectives

• Most founders balance direct ownership with trust planning rather than giving away all shares

Disclaimer

Tax laws are complex and constantly evolving. While this article provides general information about non-grantor trusts for QSBS planning, it should not be considered legal or tax advice. Each situation is unique, and tax treatment can vary based on individual circumstances. Always consult with qualified tax and legal professionals before making decisions based on the information provided here.

Ready to explore how non-grantor trusts could fit into your QSBS strategy? Promissory streamlines the entire process from trust creation to Nevada trust custody and QSBS tracking—all in one platform for a fraction of the cost of traditional attorney services. Create an account today and maximize your future tax savings.