Considering a trust?

Blog, Tax Services

Trusts are an essential financial planning tool for anyone, as there are numerous benefits in establishing a trust, such as: no probate court, potential tax benefits, specificity, valid while you’re living and in some cases, offers flexibility. Life is unpredictable, a trust acts as a highly versatile instrument that can be used for various purposes to achieve specific goals. They ensure your assets will be managed according to your wishes both during your lifetime and after you have passed. By having a thorough understanding of the complex key components and common uses for trusts, it can add value, depending on the particular situation. A few instances (among others) are:

  • An individual wants to safeguard assets so the individual can generate income for future generations.
  • An individual that has a disabled relative who will need help after they are no longer around.
  • An individual wants to protect assets from creditors while using those assets to generate current income.
  • A business owner with no employees wants to accumulate retirement funds while reducing business income and related taxes.

Grantor Trusts

A grantor trust is a trust in which the individual who creates the trust is the owner of the assets and property for income and estate tax purposes. These particular trusts have gained popularity among others for a couple of reasons. They can be used to hold the stock of an S corporation, which protects ownership of the S corporation should an S shareholder be sued. Additionally, they can be either revocable or irrevocable, with the latter providing greater asset protection from creditors. The grantor trust rules are applicable to a variety of other trusts.

Recently, depending on the situation at hand, the ability of a grantor’s estate to receive a step-up in basis of the assets in a grantor trust upon death was put in doubt when the IRS issued Rev. Rul. 2023-2. During this ruling, the IRS determined that the assets in an irrevocable grantor trust do not receive a stepped-up basis upon the grantor’s death if the assets are not included in the grantor’s gross estate. With that said, this recent ruling will likely be challenged in court; however, until the courts rule on the matter, tax professionals may consider continuing to use these types of grantor trusts to assist in protecting assets, but as to whether a step-up in basis is available for the trust’s assets on the estate tax return is to be discussed accordingly. This potential situation could be handled in one of three possible ways: by taking no step-up in basis, incurring potential penalties by taking the step-up and going against the guidance in Rev. Rul. 2023-2, or by taking no step-up on the original estate return and then filing an amended return with the step-up in basis and, if the IRS rejects the amended return, taking it to court.

Special-Needs Trusts

A special-needs trust is a popular strategy for someone with a disabled relative, who receives governmental benefits (such as Social Security disability benefits). This type of trust allows for additional financial support of an individual without potentially jeopardizing the benefits provided by public assistance programs (as there are certain income and asset restrictions and trust funding is not counted towards these qualifications). Such trusts involve working with a tax professional and others to draft the trust, choose assets to fund it, and create an investment plan. The outcome would then be used to construct a portfolio that will produce current income to support the individual with the disability while also preserving capital for such individual’s anticipated life expectancy. Although this is a common use of a trust, it comes with complexity and exorbitant costs to maintain it. A tax professional can then assist with the ongoing bookkeeping services for the trust while working closely with the trustee in processing, accounting, and reporting distributions to the beneficiary.

Domestic Asset Protection Trusts

Domestic asset protection trusts (DAPTs) have been gaining popularity since Alaska first enacted a DAPT statute in 1997. They offer the most flexible asset-protection laws in the United States. However, they are only available in presently 17 states that have authorized them, with some of the biggest states (Florida, California, New York, and Texas) are still not permitted. The primary purpose of DAPTs is asset protection and, in some cases, minimizing transfer taxes. You can use a DAPT to transfer a variety of assets, such as cash, real estate, securities and business interest. States have taken differing approaches to these statutes. A DAPT can be a good alternative to using an offshore foreign trust because some individuals may not be comfortable with the possibility than a foreign government could potentially exercise control over their assets at some point.

Trusts for Solo 401(k)s

A solo 401(k), also referred to as a “retirement trust,” is a 401(k) plan covering a business owner (and potentially a spouse) when the business employs no other individuals. This might be the most advantageous or attractive option for business owners since not only would it offer significant tax advantages but also provide an opportunity to build a retirement nest egg by setting up a solo 401(k), which involves creating a trust. Solo 401(k) Rules state that plan assets must be held in a trust, and a trustee must be designated to hold the assets. For 2023, the maximum amount that can be contributed is $66,000 ($73,500 if age 50 or over) or double that amount for a married couple. Additionally, the business benefits from being able to take a deduction for its contribution to the plan. An owner may act as the trustee of the solo 401(k) rather than having an independent trustee – giving them control to make all investment choices and decisions.

Although the four briefly outlined here are categorized as common uses of trusts; there are a multitude of trusts available to choose from. As always, it is recommended to speak with your tax professional to confirm which type of trust would be best suited for you and your needs.

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