When you create a trust to hold assets, will you or your heirs enjoy tax benefits? Perhaps. Some types of trusts are designed to reduce gift tax or move assets from your taxable estate. Not every trust is designed to be a tax shelter, though. Moreover, even when tax breaks are available, you need to avoid making mistakes.

The rewards of revocable trusts
With revocable trusts (which can be cancelled), you usually can be both the trustee and the trust beneficiary. Thus, you'll control the trust assets and you'll be able you use the investment income.
Advantages to revocable trusts include:

• Incapacity protection. If you become incompetent, a successor trustee will step in to manage the trust assets.

• Probate avoidance. Trust assets will go to designated heirs without the time and expense of a probate, a process that's burdensome in some states.

The downside to revocable trusts? They have no tax advantages. While you can enjoy investment income from assets held in a revocable trust, you'll owe tax on that income. In addition, assets that you have transferred to a revocable trust will be included in your estate, subject to estate tax. Many people have revocable trusts and seem pleased with the results. However, you shouldn't be misled into thinking that they offer any tax shelter.

Employing the exclusion
When you create any type of trust during your lifetime, you'll achieve benefits only if you transfer assets into it. The IRS may treat transfers to irrevocable trusts as taxable gifts. Under current law, you are allowed to make up to $1 million worth of lifetime gifts without owing gift tax. (Such gifts will trim your estate tax exemption, however.) Above $1 million, lifetime gifts now are taxed at 41%-45%.

However, there is also an annual gift tax exclusion that avoids any gift tax consequences. In 2008, the exclusion allows you to give up to $12,000 worth of assets to any number of recipients. Married couples can give up to $24,000 to each recipient.

Example #1: Dave and Diane Robinson have a son, Nick, and a daughter, Natalie. They can give $24,000 to Nick this year and $24,000 to Natalie, without worrying about the gift tax. However, suppose the Robinsons create an irrevocable trust and name Natalie and Nick as trust beneficiaries. Can they make $48,000 worth of gifts to this trust instead, under the gift tax exclusion?

Perhaps they can, but it's not a simple task. For the gifts to qualify for the gift tax exclusion, the recipients must have a "present interest" in them. Transfers to irrevocable trusts usually are out of the trust beneficiaries' reach, often for many years. So the annual gift tax exclusion may not apply, and gift tax consequences might be triggered. To counter this problem, the trustee can send a particular notice to each trust beneficiary after assets have been moved to the trust. In this example, the trustee's notice will inform Nick and Natalie that each has the right to withdraw as much as $24,000 from the trust within a given time period (30 days, for instance).

In a landmark case (the Crummey decision), the United States Tax Court ruled that this process gives the beneficiaries a present interest, so the transfers into the trust qualify for the annual gift tax exclusion. If the 30 days lapse without any withdrawals, the trustee can invest the money, buy life insurance, etc.

Supporting the survivor
Just as dealing with trusts can create gift tax problems, estate tax issues also may arise. For instance, you may leave assets to a trust for your surviving spouse, knowing that bequests to a spouse avoid estate tax. For property left to a trust to qualify for this tax break, all of the trust income must be payable to the surviving spouse, at least annually. While this may seem simple enough, drafting a trust agreement that satisfies the requirements of both the federal estate tax laws and state trust laws is not an easy matter. The god news is that you can avoid this situation with a well-drafted trust. Our office can help you protect your spouse while avoiding a significant estate tax hit.

Income Tax Rates, Estates and Trusts -- 2008
Taxable income:		Tax:
Over	But not over	Amount	+%	On amount over
$0	$2,200	$0	15%	$0
$2,200	$5,150	$330	25%	$2,200
$5,150	$7,850	$1,067	28%	$5,150
$7,850	$10,700	$1,823	33%	$7,850
$10,700	-------	$2,764	35%	$10,700
Source: smbiz.com

 

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