In my last tax planning post (TRUST Me, Tax Planning Isn’t Just for Income Tax – Part I), I briefly addressed some techniques that can be done at any time using trusts, which could keep more money in your estate instead of giving it to the government. While income taxes are the primary concern for most people because they occur constantly during our life, thought should be given to estate and gift taxes which can take a hefty chunk from heirs.
Given the many types of trusts, I was only able to address some of the trusts out there in the previous post. Today I finish with the remainder:
- Intentionally Defective Grantor Trust(s) (IDGT) – Sales to an IDGT are completed transfers for gift and estate tax purposes, but are ignored for income tax purposes. Here’s how it works:
- Grantor gifts and sells highly-appreciating assets to the trust for the benefit of his or her descendants.
- Grantor takes back an installment note.
- The sale price is equal to the full fair market value of the assets sold so that there is no taxable gift on the sale.
- The interest rate on the note is set at the lowest rate allowed Tax benefit.
- If the total return on the assets sold exceeds the interest rate on the note, assets are transferred tax-free to beneficiaries.
- Domestic Asset Protection Trust(s) (DAPT) – An irrevocable trust that relies on the state in which it is created. Here’s how it works:
- Created in a state that has a law allowing self-settled spendthrift trusts.
- The trust is irrevocable, and the Trustee has absolute discretion to make distributions to the settlor.
- The trust includes a spendthrift clause prohibiting payments to most of the settlor’s creditors.
- The trustee is independent of the settlor, and must be a resident of the selected DAPT state; some or all of the trust assets also must be located in the DAPT state.
- Certain special creditors can reach the trust assets.
- Enables taxpayers to give away assets and remove future appreciation from their estate while retaining the benefit of the assets if needed.
- Nevada Incomplete Gift, Non-Grantor (NING) Trust(s) – Taxpayers in high tax states should consider transferring assets to a trust in a state that does not tax trust income to avoid income tax in their home state. Here’s how it works:
- The trust must be created in a state that does not tax trust income.
- The income from the trust must not be taxable by the grantor’s home state.
- The trust must allow discretionary distributions to the settlor without making the trust a grantor trust.
- Transfers to the trust must be incomplete gifts for federal gift tax purposes without making the trust a grantor trust; however, the permanent increase in the applicable exclusion amount and emergence of DAPTs may allow for completed gifts.
- Trusts as S Corporation Shareholders – An Electing Small Business Trust (ESBT) provides greater flexibility while a Qualified Subchapter S Trust (QSST) generally has more favorable tax treatment. Here’s how they work:
- Electing Small Business Trusts (ESBT)
- Trust income distributions are discretionary.
- Unlimited number of current income beneficiaries allowed.
- Trust income is recognized at the trust level and is taxed at a flat rate equal to the highest marginal rate for corporations.
- Qualified Subchapter S Trusts (QSST)
- All trust income must be distributed.
- Only one current income beneficiary allowed.
- Trust income passes through to the income beneficiary and is taxed at the beneficiary’s tax rate.
- Electing Small Business Trusts (ESBT)
- Spousal Limited Access Trust(s) (SLAT) – An irrevocable trust established by one spouse for the benefit of the other spouse, with the remainder interest passing to the couple’s children. Here’s how it works:
- Takes advantage of the high applicable exclusion amount.
- Removes substantial amounts of appreciation from the estate.
- Donor spouse indirectly retains the ability to access the funds if necessary through distributions to the spouse. (Caveat: Reciprocal Trust Doctrine)
- If both spouses set up a SLAT for the benefit of the other, make the SLATs sufficiently different from each other.
The content of this article is intended to provide a general guide to the subject matter; specialist advice should be sought about your specific circumstances.
IRS CIRCULAR 230 DISCLOSURE: To comply with requirements imposed by the Department of the Treasury, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written by the practitioner to be used, and that it cannot be used by any taxpayer, for the purpose of (i) avoiding penalties that may be imposed on the taxpayer, and (ii) supporting the promotion or marketing of any transactions or matters addressed herein.