Back to Tax Home

Dolinka VanNoord & Company can answer many of your questions regarding trusts and their related tax returns. These trusts include simple trusts, complex trusts, and charitable remainder annuity and unitrusts. We have professionals who specialize in trust reporting and prepare many of these returns each year. Our professionals can help if you are planning to do any of the following:

· Setting up a trust

· Changing the trust beneficiaries

· Calculating the beneficiaries income

· Funding of a trust

Click here for Trust Basics
Click her for Transferring Wealth With Trusts

TRUST BASICS

Types of Trusts

Trusts come in three main forms: simple, complex, and grantor. A simple trust requires all the current year income to flow through to the beneficiary and be taxed at the individual’s rates. A complex trust does not require distributions and funds are distributed per the trust agreement. Sometimes the trust agreement does not require any distributions and leaves it up to the discretion of the trustee and others will set up yearly amounts for the beneficiary or specific instances when they can receive funds. The grantor trust is one where the person who funds the trust (the grantor) retains control of the assets until his/her death and receives all of the income from the trust while living. For tax purposes, a grantor trust does not exist. All income is reported on the grantor’s personal income tax return.

Types of Income

For tax purposes, income is broken up into two categories. Capital gain dividends and gains & losses from sales are considered part of the trust corpus or principle and stay within the trust unless the trust document states they are to be distributed to the beneficiary. These items will be taxed to the trust and paid at the trust income tax rates, which reach 35% for income over $10,700. Other income, including interest and dividends, is not considered to be part of trust corpus and can be distributed to the beneficiary and taxed at the beneficiary’s personal income tax rates. The wider tax brackets for individuals and the lower tax on capital gains makes this a better option if the trust is funded with income producing property.

Income Treatment

When income flows through a trust to the beneficiary, it retains the same characteristics it had in the trust. So interest income is still interest income and capital gain dividends are still capital gain dividends on the beneficiary’s personal income tax return.

Tax Rates
Taxable Income

TRANSFERRING WEALTH WITH TRUSTS

Trusts are a good way to transfer wealth from one generation to the next. A grandparent or parent can place assets in the trusts for their children or grandchildren. The assets placed in the trusts are generally income producing stocks or other property, such as a partnership interest.

The first step is identifying what you want to accomplish through the use of the trust. There are several questions that can help define the trust to accomplish this. Here are a few:

· What is your main reason for transferring the assets to the beneficiary?

· Do you want to retain any of the income generated from the property?

· Do you want any control of the assets after placing them in the trust?

· Do you want the beneficiary to receive the income now or later?

· Do you want any of the remaining assets to go to charity?

Trusts are taxed at different rates than individuals and businesses, so you need to consider how much income and gains you want to remain in the trust. Please see Trust Basics for the tax rate schedule. You can see that although the highest tax rate for trusts is the same as individuals at 35% it starts at a much lower income level of $10,700 compared to over $350,000 for most individuals.

The trust can be set up to retain all income and gains generated or to pass these through to the beneficiary to taxation. For example, a parent can place a partnership interest in a trust for their child. The partnership income flows to the trust and then through to the child’s tax return. The partnership income can be offset by the expenses of the trusts and then the net income after trust expenses will flow through to the child’s individual return. This allows the parent to pass income through to the child without giving the child control of the partnership entity. It also reduces the taxes paid on the partnership income by offsetting them against the trust administration costs and having them taxed at the child’s lower tax rate.

The above example works well for transferring interests to children who are not ready to have an active role in running a business. The trust can be set up to terminate at a specific age and distribute the partnership interest to the child at that time.

If your main goal is to leave money to charity while retaining an income stream for awhile, then you should consider a charitable remainder trust or a charitable lead trust. Charitable remainder trusts are generally funded with readily tradable stocks and bonds. Once funded a portion of the yearly income is paid to the grantor and the remainder is reinvested into the trust. At the end of the trust term, the remaining assets are donated to the charities selected by the grantor when setting up the trust. The grantor receives a charitable deduction on his/her tax return the year the assets are donated to the trust and can effectively remove highly appreciated stock from their portfolio without paying capital gains taxes.

Charitable lead trusts work similar to an annuity, with the charity receiving the annuity payments for the life of the annuity and the remainder passing through to your chosen beneficiary. You receive a charitable deduction for the value of the income stream provided to the charity. As with the charitable remainder trust, this is a good vehicle to remove highly appreciated stock from your portfolio.

Another way to transfer wealth from one generation to the next is to set up a partnership or limited liability company (LLC) with trusts for your children or grandchildren as the partners or members. This way you can start transferring ownership at an early age without giving them control of the assets until they are older. For example, a grandparent can transfer assets to an LLC and then gift ownership up to the annual gift tax exclusion each year. For 2008, a gift of up to $12,000 is excludable from gift taxes. This works well with assets that will appreciate in value, but do not have much current income to tax.

There are many possibilities with trusts and they make a great addition to your estate planning. It is best to sit down with a good trust lawyer to work out the details. We can help you focus on what you want to accomplish and help you define your plan for transferring your assets to the next generation.

Please contact DVC to learn more about how trusts can play an integral role in transferring your wealth to the future with the least amount of taxes due.