LUTZ BUSINESS INSIGHTS
types of trusts and when to use them
hannah goscha, tax manager
The right trust offers many advantages over traditional mechanisms for protecting and passing on assets. However, determining which trust will best meet one’s needs requires professional expertise. In this article, we will review the various types of situations that are well-served by the creation of a trust, as well as a description of some of the more popular trusts available.
Why Use a Trust?
1. Estate Planning
A trust can be a useful vehicle for those who wish to remove their taxable assets from their estate so that assets are passed to specific recipients without interference from government bodies such as the IRS.
2. Succession Planning
Utilizing a trust for succession planning purposes helps define how business assets should be distributed upon one’s death. This may include instructions on who is to assume positions or titles within a company upon the passing of a business owner(s).
3. Asset Protection
Some states allow trusts to be designed in such a way as to protect one’s cash and other property from creditors. An asset trust can transfer ownership of property and/or cash to a trustee. Since the assets are owned by someone else, they can’t be seized by creditors of the deceased.
4. Income Tax Planning
Income and estate taxes can eat away significant portions of a deceased person’s assets. Trusts can be set up to avoid incurring excessive amounts of taxes against one’s estate or business.
5. Charitable Planning
Charitable trusts such as CRATs, CRUTs, and CLATs allow philanthropic individuals to set aside appreciable assets in order to benefit a designated charity, and in some cases, eventually a beneficiary. For example, Charitable lead trusts (CLTs) donate charitable payments from the trust for a certain period of time, after which the remaining assets are given to the designated beneficiaries.
Another option includes charitable remainder trusts (CRTs), which provide the following benefits:
- Asset distributions go to beneficiaries, with the remainder going to charity.
- Grantor receives a tax deduction upon funding a CRT trust.
- No estate taxes are paid at the time of death.
- Possible accumulating income, which can then be passed to named beneficiaries.
Types of Trusts
1. REVOCABLE VS. IRREVOCABLE TRUST
Most people have heard of revocable and irrevocable trusts but may not be familiar with some of the differences between the two. A revocable trust is one whose provisions can be altered, modified, or removed. An irrevocable trust is one whose provisions that make up the trust can’t be modified, altered, or terminated, except perhaps under specific circumstances. While a revocable trust is convenient and fairly simple for alterations such as adding a beneficiary, an irrevocable trust is protected from creditors. It’s important to understand the pros and cons of each type of trust to select the one that best meets your financial planning goals.
2. GRANTOR RETAINED ANNUITY TRUST (GRAT)
With a Grantor Retained Annuity Trust (GRAT), a grantor can contribute assets to the trust and receive annuity payments for a specified term. At the end of the trust, the remaining assets are transferred to the beneficiary. If the grantor passes away before the trust’s assets expire, the assets within the trust become part of their taxable estate, after which the beneficiary receives none of the assets within the trust.
3. IRREVOCABLE LIFE INSURANCE TRUST (ILIT)
As its name implies, this type of trust is irrevocable. An ILIT holds life insurance policies as its chief assets. It also directs the distribution of assets upon a person’s death and is not considered part of their taxable estate.
4. INTENTIONALLY DEFECTIVE GRANTOR TRUST (IDGT)
In an Intentionally Defective Grantor Trust (IDGT), assets are transferred from an individual for estate tax purposes, but not income tax. The grantor continues to pay tax on the trust income, allowing the assets within the trust to grow tax-free. With this type of trust, grantors can swap assets held in the trust with other assets of equal value.
5. SPOUSAL LIFETIME ACCESS TRUST (SLAT)
This type of irrevocable trust involves gifting assets from one spouse to another. One advantage is that the originating spouse retains indirect access to the assets within the trust in case they are ever needed. Another advantage is that the trust allows for the transfer of wealth outside the couple’s combined estate. Complications can occur if the couple decides to divorce or if the non-donor spouse passes away.
6. DYNASTY TRUST
The purpose of this trust is to pass wealth from generation to generation without incurring any transfer taxes along the way. Most states have rules to prevent the trust from existing indefinitely.
7. S-CORP TRUSTS
One type of S-Corp trust is the Qualified Subchapter S Trust or QSST. This type of trust treats the current income beneficiary as the owner of the S-corp. The trust is only allowed one beneficiary, and the beneficiary must pay any taxes at their marginal tax rate.
Another option is an Electing Small Business Trust or ESBT. This type of trust is actually treated as two trusts, although only one tax return is filed. One trust holds stock, while the other trust holds all the assets. While the trust does pay at the highest tax rate, it does allow for multiple beneficiaries, as long as they are eligible S-Corp shareholders.
In summary, business owners and individuals with substantial assets need to thoroughly understand all the options available to them for asset preservation. Consulting with a professional will enable you to select the trust that best meets your specific needs. If you have any questions or would like to learn more on this topic, please contact us. You can also read related articles on our accounting blog.
ABOUT THE AUTHOR
HANNAH GOSCHA + TAX MANAGER
Hannah Goscha is a Tax Manager at Lutz. She began her career in 2018. She is responsible for providing tax consulting and compliance services to clients with a focus on partnerships, corporations, nonprofits, trusts and estates.
AREAS OF FOCUS
- Accounting & Consulting
- Nonprofit Industry
AFFILIATIONS AND CREDENTIALS
- American Institute of Certified Public Accountants, Member
- Nebraska Society of Certified Public Accountants, Member
- Certified Public Accountant
- Master's in Accounting, University of Nebraska, Omaha, NE
- Lutz Gives Back, Co-President
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