The Disconnect Between Tax Professionals and Trusts

There is a major disconnect between tax accountants and trusts. Some people think that it is the best taxable situation for a client, and others think that all trusts protect assets, which couldn’t be further from the truth. The information that I am going to give is general in nature. You may want to check with your particular state.

There are various trusts, but I will start with the basic Revocable Living Trust (RLT). A RLT is Grantor Trust. With any trust you have three parties, the Grantor or Trustmaker, this is the person creating the trust. The Trustee, this is the person that controls the assets, and the beneficiaries. These are the people that inherit the assets. When a RLT is formed, all assets need to be retitled to the Trust, in order for them to be considered an asset of the trust,

The term revocable means that the trust can be changed, Typically, the Grantor of the trust is also the trustee, until death. They are allowed to enjoy the assets in the trust during their lifetime. When they die, a contingent trustee would have been chosen and they will distribute the assets.

A RLT is taxed at the Grantor level, until death. When death comes, the RLT becomes irrevocable, and cannot be changed. Further, the trustee needs to apply for an Employer Identification Number. If the assets earn any money, the beneficiaries are given a K-1 Form from the trust.

The reason for a RLT is to avoid probate. A RLT cannot be contested, however, it is common to place all of the big assets in the RLT, and have a pour-over will for any other asset that was missed.

In most states, probate is a process where the proceedings are made public. Creditors and anyone that feels that they have a claim to the decedent’s assets can make a claim against the estate if there was only a will. A RLT avoids that entire process.

An Irrevocable Trust, on the other hand, is a trust that removes an asset from the Grantor of the trust. This action, for the most part protects the asset from most legal actions. It moves the asset from the grantor or grantor. Irrevocable means that it cant be changed and it’s a taxable entity. However, Irrevocable trusts are usually used to remove assets from a taxable estate. Irrevocable Life Insurance Trusts (ILIT), are very popular.

There are also grantor defective trusts, that are usually used to move a business from one generation to another. Another way to accomplish the same thing is through a Grantor Retained Annuity Trust (GRAT). This trust effectively sells the business to the next generation. The owner retains control until the end of the trust, and is paid an annuity for the life of the trust.

It is important to point out that not all taxable trusts are flow through entities. Complex trusts are allowed to accumulate income on their corpus[1]. This sets up a taxable event for the trust and the rates are less than favorable.

If the Taxable Income is	The Tax is
Not over $2500	10% of taxable income
Over $2500 but not over $9150	$255 + 24% of the amount over $2500
Over $9151 but not over $12,500	$1839 + 39% over the excess of $9151
Over $12,500	$3011.50 + 37% over the excess of $12,500

As you can see it isn’t the best situation to set up a complex trust.

There is a movement when people are faced with a potential lawsuit, to move their assets into am Irrevocable trust. However, that asset will not be protected, because moving an asset because of an actual or potential lawsuit is fraudulent conveyance.

Trusts can be helpful tools to avoid assets, or even to remove assets from a taxable estate. They can also be moved to protect the asset from creditors, provided the Grantor had no reason to believe that a lawsuit was pending or one could potentially happen.

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[1] The initial assets of the trust