Defective Trust Law and Legal Definition

Defective trusts are irrevocable trusts that are treated as an entity same as the grantor for income tax purposes. Typically a trust is an independent entity that is taxed separately from the settlor. Trust income is usually taxed at higher rates than individual income. Therefore the settlor may intentionally create a defect in the trust terms so that the trust's income will be taxable to the grantor. This can be done by violating the grantor-trust rules of Internal Revenue Code §§ 671–677 in a way that does not affect the completeness of the gift under Internal Revenue Code §§ 2035–2042. Such violations make the trust defective because the settlor must recognize the income even if the settlor does not actually receive it. However, for estate-tax purposes such trusts are treated as an entity separate from the grantor.