Trusts Provide a Flexible Vehicle to Accomplish Many Different Beneficial Purposes4/4/2018 | By: David I. Faust, Esq. | GDB 2018 Spring Newsletter
Trusts can be used for a variety of beneficial purposes: estate and tax planning, avoidance of probate, continuity of a family business, provision for heirs who may not be able to take care of their own financial affairs or needs because of age or lack of capacity, charitable giving and asset protection.
A trust is created by a grantor. The beneficiaries of a trust are rarely involved in the preparation of the trust. They may not even know that a trust is being created for their benefit. This is the case with a common trust, created in a will which provides that an inheritance be delayed beyond legal adulthood. This kind of trust puts a special burden on the grantor, who must anticipate the needs of beneficiaries as well as the intent of the client who commissioned the trust. The grantor must decide what discretion the trustee should have regarding distributions of income or principal and at what age the beneficiary should receive his or her inheritance free of trust.
A common trust used for tax purposes is a life insurance trust. If an insurance policy is owned by the insured person, its benefits are included in the insured’s estate for estate tax purposes. A simple way to avoid this is to hold the policy in an insurance trust.
Two Basic Types of Charitable TrustsThere are two basic types of charitable trusts – GRITS and GRATS.
GRITS are Grantor Retained Interest Trusts: designated charities receive the income realized by the trust, with a guaranteed minimum return. At the end of the term of the trust, the remaining principal goes to persons designated by the grantor. The grantor gets a charitable deduction based on the current value of the bequest to charity and may have to pay a gift tax based on the value of the residual gift. But this could be a way to make charitable contributions and pass property expected to increase in value to one’s heirs without an estate tax.
GRATS are Grantor Retained Annuity Trusts. The grantor gets the income from the trust, again with a stated minimum return. On the grantor’s death or after a fixed term, the remaining principal goes to charity. In either event, on funding the trust the grantor gets a charitable deduction.
Trusts can be used to gift assets, which are expected to appreciate in value, thus transferring wealth or prospective wealth to children or grandchildren. A gift tax may be incurred but it would be on a much lesser value than the anticipated increased value of the assets put in trust.
Generally, with the exception of special rules for GRITS and GRATS, if the grantor retains an economic interest in, or management rights over, the trust, it will be treated as a grantor trust for tax purposes. This means that the income from the trust will be “passed-through” to the grantor who must report the income on his or her income tax return and pay any resulting taxes. It is also generally includable in the grantor’s estate on death. If the trust is not a grantor trust, then it is a separately taxable entity. Distributions of income to beneficiaries of a non-grantor trust are deductible from trust income – and taxable to the beneficiaries. However, tax rates for trusts are higher than those for individuals, so trusts are generally not good vehicles for accumulating income.
Asset Protection TrustsAsset protection trusts, as the name suggests, are vehicles to protect assets. Particularly in a litigation-prone society such as the United States, many people in high-risk professions or businesses want to insulate portions of their assets from potential claimants. People contemplating marriage, or who are married but contemplating divorce, may also seek to protect assets from a spouse.
With most asset protection trusts, the grantor wishes to retain beneficial use of the trust principal and its income. Trusts in which the grantor is a beneficiary are called “self-settled trusts.” The grantor of an asset protection trust typically also wants to maintain some degree of control over the assets of, and/or distributions from, the trust. Thus, a basic tension is created between the grantor’s desire to retain beneficial interests and control, and the essence of a trust, namely the separation of the legal and beneficial ownership of assets.
Asset protection trusts are typically formed outside the U.S. This is because most state laws do not provide for asset protection for self-settled trusts. Many offshore jurisdictions do provide such protection. Some states now offer such protection but their asset protection laws have yet to be fully tested.
The variety and flexibility of trusts provides many benefits, but their complexity requires that careful attention must be paid in structuring a trust.