When it comes to estate planning, trusts offer incredible versatility and are an invaluable tool for achieving a variety of financial goals. A trust is a legal arrangement where you, as the grantor, transfer your assets to another person, called the trustee, who manages them for the benefit of someone else, called the beneficiary. Trusts have following benefits:
1. Management: Trusts are a strategic way to entrust assets to skilled professionals who has expertise in managing and investing in those assets. This ensures that the property is effectively handled to maximize its potential.
2. Protection: Certain trusts act as a shield to safeguard one's assets against potential creditor claims, while others are formed to provide protection in scenarios of the grantor's (or a beneficiary's) incapacity, recklessness, or lack of competence.
3. Timed Disposition: Trusts allow for carefully planned asset distribution. For example, instead of receiving their inheritance at 18, beneficiaries, whose inheritance was put in a trust, may need to wait till their 30s to receive the funds. By that age beneficiaries will be more financially reponsible and be able to handle assets responsibly.
4. Flexibility: Trust provisions can be customized to match specific circumstances, adapting to changing family dynamics and financial needs. For example, two beneficiaries may be equal in every way today; but ten years from today one beneficiary may have a greater need for trust income than the other beneficiary. Trust allows such modification.
5. Privacy: Unlike a will, which becomes part of the public record after the probate process, the details of an living trust can be kept confidential.
6. Probate Avoidance: living trusts are able to bypass probate, saving families from the delays, hassles, and costs associated with the probate process. While there are some costs at death with a living trust, it can avoid 90-95% of probate costs.
7. Long-Term Care & Conservatorship Avoidance: Trusts can be a lifeline for individuals with long-term care needs, ensuring financial stability without the need for a conservatorship.
If you are planning to create a trust, you should probably talk to a CPA and discuss the difference between grantor and non-grantor trusts for income tax purposes. The main difference is this: If the grantor holds substantial control and they can revoke or terminate the trust, then this trust is not a separate entity in the eye of the IRS and it does not require a separate return. Any taxable income earned by the trust is taxed on the grantor's personal tax return under their social security number.
However, when the grantor relinquishes all control of the trust, the trust becomes a separate taxpayer and it is now required to file a separate tax return and pay its own tax. This is so called non-grantor trust. When the trust makes a distribution to a beneficiary, the beneficiary becomes liable for the taxable ordinary income on their personal income tax return. The CPA prepares form 1041 and Schedule K-1 and provides it to the beneficiary, with the instructions to include that K-1 with trust's income to the personal return (form 1040).
The grantor vs non grantor status is primarily related to the tax treatment of the trust rather than its flexibility or modification options. Flexibility is reflected in types of trust: Revocable vs irrevocable trusts. A revocable trust is a trust that can be modified or terminated by the grantor at any time, and it is usually a grantor trust for income tax purposes. An irrevocable trust is a trust that cannot be modified or terminated by the grantor without the consent of the beneficiaries or a court order. An irrevocable trust can be either a grantor or a non-grantor trust for income tax purposes, depending on whether the grantor retains certain powers or rights over the trust. For example, an irrevocable life insurance trust (ILIT) is usually a non-grantor trust, while an intentionally defective grantor trust (IDGT) is a grantor trust.
The tax law allows to include revocable trust in the deceased person’s estate for Federal income tax. This elective treatment holds from the decedent's death date until two years later (if no estate tax return is needed), or, if later, six months after the final estate tax liability determination (if an estate tax return is needed). Both the executor of the decedent's estate (if applicable) and the revocable trust's trustee must make this election no later than the income tax return filing deadline for the estate's first taxable year.
Trusts are powerful tools in estate planning that require expert advice. A CPA can help individuals make smart choices that match their financial goals and family needs. By using trusts, individuals can ensure that their wealth is transferred to their loved ones in the best way possible.