So You Want a Trust, Part 3: Trusts and Taxes

Posted by Stephen Williams

If you are contemplating a revocable or "living" trust as part of your estate plan, you should make sure that you aware of the tax consequences of the creation and funding of that trust.

• Income Taxes. This type of trust is a disregarded entity for tax purposes. You are treated as the "owner" of the trust property (which remains subject to your complete control) for both income and estate tax purposes. While you serve as trustee, it is not necessary to file a separate tax return for the trust: All holdings are listed under Social Security Number for information reporting (Form 1099 and K-1) purposes. This affords simplicity and economy.

• Gift Taxes. If a trust is revocable by the grantor, it is not a "completed gift", and there is therefore no gift tax consequence to the creation or funding of the trust. If the trust is not revocable, or if the ability of the grantor to revoke the trust is in some way conditional, there may be gift tax consequences that you should consider very carefully, with professional guidance.

• Estate Taxes. The creation of a revocable trust will generally not incur or avoid estate taxes on its own. However, a revocable trust can be an effective tool in structuring the way in which your wealth passes, so as to optimally coordinate marital deductions and exemptions and minimize or eliminate estate taxes. But don't let the tail wag the dog: given the current levels of estate tax exemptions, many people need not be concerned with structuring a trust in order to minimize or avoid estate taxes. Before setting out to create a "credit shelter" or "marital" trust for that sake of tax planning, you should give the matter careful consideration with professional guidance.

Note, as well, that the discussion above it peculiar to trusts which are revocable. If you are contemplating creating a trust that is irrevocable, the tax (and other) consequences may be very different.

Also, the above characteristics are generic: A trust can be "customized" in innumerable ways. For example, some prefer to have investment management by naming a bank or trust company as trustee. And, the trust can continue beyond the life of the person creating it. This affords the ability to protect beneficiaries against claims of their creditors or, in some instances, spendthrift habits. It offers the ability to control interim management as well as eventual disposition of the underlying wealth. Interim benefits can be paid to one or more beneficiaries, with ultimate distribution to other beneficiaries whom you have designated.