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Trust Law/Level V · Tax and legacy/5.1 Estate and gift tax/Lesson 7

The Clifford trust and the history of income shifting

How Helvering v. Clifford, the 10-year trusts that followed and the Tax Reform Act of 1986 shaped the US grantor trust rules.

Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. A short reversionary trust no longer shifts income: for transfers after 1 March 1986, a reversion worth over 5% makes the grantor the owner (IRC §673); the lawful equivalent is a completed gift with no reversion, which also moves future growth out of the estate.
  2. Paying a child a real wage for real work shifts income lawfully: a child under 18 in a parent’s sole proprietorship owes no Social Security or Medicare tax, and a dependent’s 2026 standard deduction is earned income plus $450, up to $16,100; document reasonable pay.
  3. Earned income also lets a child fund an IRA, including a Roth IRA, up to the lesser of earnings or $7,500 in 2026; the kiddie tax still taxes a child’s unearned income above $2,700 at the parent’s rate (IRC §1(g)).
  4. Gifting appreciated assets to an adult child past kiddie-tax age lets the child sell in the 0% long-term gains band, up to $49,450 of 2026 taxable income if single; the kiddie tax reaches some dependants under 24, and gifts over $19,000 need Form 709.

MaterialsThe text of IRC §§671–679, the grantor trust rules, free on law.cornell.eduThe Supreme Court’s opinion in Helvering v. Clifford, 309 U.S. 331 (1940)The text of IRC §673 and IRC §1(g), with the notes on the 1986 amendments

Wonder

  1. Why did a 5-year trust for a wife lead the Supreme Court to tax its income to the husband who created it?
  2. How does the ‘kiddie tax’ differ from the rule that ended the Clifford trust?
  3. Which retained powers make a trust a grantor trust today?

Explore

  1. Helvering v. Clifford, 309 U.S. 331 (1940), arose from a trust created in 1934. The taxpayer declared himself trustee of securities for 5 years, with the net income paid to his wife and the property returning to him at the end. As trustee he kept broad control: he could vote the shares, sell or pledge them and invest as he chose. The Supreme Court held that he remained the owner for income tax purposes under §22(a) of the Revenue Act of 1934, so the trust income was taxed to him.
  2. Clifford set no fixed test, so Treasury followed it with regulations, known as the Clifford regulations, on when a grantor should be taxed as owner. Congress then wrote the grantor trust rules into the Internal Revenue Code of 1954. One rule, in §673, treated the grantor as owner if the trust property or income would, or might reasonably be expected to, return to the grantor within 10 years. A trust lasting longer than 10 years could therefore have its income taxed to the beneficiary even though the property later came back.
  3. Advisers used this rule for decades. A short-term reversionary trust, often called a Clifford trust or 10-year trust, paid income to a child or other relative in a lower tax bracket for slightly more than 10 years, then returned the property to the grantor. The income was taxed at the beneficiary’s lower rate, and the grantor got the property back later. The arrangement worked only if the grantor kept no other interest or power that the grantor trust rules treated as ownership, such as control over who benefited.
  4. The Tax Reform Act of 1986 ended this. For transfers in trust made after 1 March 1986, §673 treats the grantor as owner of any portion of a trust in which the grantor has a reversionary interest worth more than 5% of that portion when it is created. A reversion that takes effect only if a lineal-descendant beneficiary dies before age 21 is excepted. Because a reversion after about 10 years is worth far more than 5%, the classic Clifford trust stopped shifting income for new trusts.
  5. The same Act added the ‘kiddie tax’ (IRC §1(g)). It closed a different route: giving property outright to a child so that investment income would be taxed at the child’s lower rate. As first enacted, the unearned income of a child under 14 above a small threshold was taxed at the parent’s rate. Unlike §673, it looks at the child’s age and type of income, not at any trust term or reversion. Congress has since raised the age limits and changed the rates, so check the rules for the year in question.
  6. Today’s grantor trust rules, IRC §§671–679, reflect this history. They tax the grantor on trust income when the grantor keeps certain interests or powers: for example a reversion worth more than 5% (§673), power to control who benefits (§674), certain administrative powers such as borrowing without adequate interest or security or reacquiring trust property by substituting assets of equal value (§675), a power to revoke (§676) or a right to income (§677). Planners now sometimes create grantor status on purpose (lesson 5.1.5).

Key facts

  • Helvering v. Clifford, 309 U.S. 331 (1940), taxed a grantor on the income of a 5-year trust for his wife because he kept broad control as trustee.
  • From the 1954 Code until 1986, §673 let a trust lasting more than 10 years shift income to the beneficiary even though the property later returned to the grantor.
  • For transfers in trust after 1 March 1986, §673 treats the grantor as owner if a reversionary interest is worth more than 5% at the trust’s start (Tax Reform Act of 1986).
  • The Tax Reform Act of 1986 also created the ‘kiddie tax’ (IRC §1(g)), originally taxing a child under 14’s unearned income above a threshold at the parent’s rate.
  • IRC §§671–679 define the modern rules for when a trust is treated as a grantor trust for federal income tax purposes.
  • A reversionary interest is the right for trust assets to return to the settlor after a specified period or event.

Exercise nine, six, three, one

9CollectList up to 9 features of a trust you are reading about, historical or modern (some lists are shorter), such as its term, who receives the income, whether property returns to the settlor, who is trustee and what powers the settlor kept.
6ClusterSort them into 6 categories: trust term, income beneficiaries, reversionary interests, powers over who benefits, administrative powers, and powers to revoke.
3DistillReduce the 6 categories to 3 groups: features that mattered under the pre-1986 10-year rule, features that matter under today’s grantor trust rules, and features you are unsure about.
1CrystallizeWrite 1 sentence explaining, in your own words, why Congress replaced the 10-year test with a 5% reversion test in 1986.

Fact check

Dates, figures and claims checked against the published sources listed below.

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