Trusts: A Creative Guide to Tax Planning
By Morgan Norris
A common misconception about trusts is that they are only useful for the ultra-wealthy, but that’s not true! Trusts provide a wide range of estate planning opportunities, making them something that many people should consider. Whether your goal is to have control over how assets are ultimately disbursed at your death, to provide for the wellbeing of a widowed spouse or disabled child, to ensure creditor protection, or to safeguard your estate to avoid the probate process upon death, a properly drafted trust can carry out your intentions appropriately and with favorable tax treatment. Trusts can be established and funded during your lifetime (inter vivos) or they can take effect at the death of the grantor (testamentary). There are many types of trusts to consider, and each serves a unique purpose.
Revocable trusts are common and known for their ease of administration. Established during the lifetime of the grantor, these trusts are simple to set up. The grantor lays out certain provisions in a trust agreement and then funds the trust by titling personal assets in the name of the trust. The trustee and future beneficiary(ies) are identified in the trust agreement. The terms in the revocable trust agreement can be easily amended during the lifetime of the grantor, making this trust favorable to those who haven’t yet finalized plans for beneficiaries or asset distribution. A revocable trust allows for revisions to be made during your lifetime as life events evolve; perhaps your family is still growing, you’ve experienced a divorce or a second marriage, or you aren’t sure if all of your grandchildren will attend college.
A revocable trust usually does not require a separate tax return filing while the grantor is living, because the trust income and deductions will be reported on the grantor’s individual tax return. This simplifies tax return filings and usually results in a lower tax rate compared with a trust tax return. In 2022, the top trust tax rate is 37% imposed on just $13,451 ($14,451 in 2023) of taxable income, while married individuals filing joint returns are subject to the same 37% top rate when reporting more than $647,851 ($693,751 in 2023) of taxable income.
Upon the death of the grantor, the revocable trust will automatically become irrevocable, meaning the trust agreement cannot be altered. The trust agreement will determine how assets and trust income are distributed, and a separate tax filing may be necessary. Income tax reporting will be required for the life of the trust until all assets are disbursed.
Irrevocable trusts can also be established during an individual’s lifetime. There are various types of irrevocable trusts, each set up for a particular purpose. Some examples include charitable trusts, special needs trusts, and life insurance trusts. The names of each allude to the beneficiary or purpose of the trust. A charitable lead trust is established to pay a specified amount to a charitable organization either for a term of years or for the lifetime of designated individuals, and the residual is distributed to a noncharitable beneficiary. Special needs trusts are typically formed on behalf of an elderly or disabled beneficiary to provide benefits beyond those available through governmental programs while protecting those benefits from being reduced. Life insurance trusts hold life insurance policies separate from the estate of the insured individual, safeguarding the proceeds from being taxable to the estate upon death.
Trusts can be useful tools in tax planning, and with all of the avenues offered through the various trust types, you’re sure to find at least one that will benefit your family and tax planning goals. Consult your tax advisor if you would like more information!
The information contained in this article is for informative purposes only and should not be relied on when making any business, legal, or other decisions. This information may be updated without notice and/or may not contain the most current information that is available related to this topic. Please consult with your advisor to determine how this information applies to your specific facts and circumstances.