Trusts and Taxes.
The issue frequently comes up—how can a trust help me save on taxes? First, let’s look at the two different types of trusts:
Revocable Living Trust
A revocable living trust is the most used form of trust in estate planning. While you are living, there is absolutely no tax impact of creating a living trust.
A living trust is simply an agreement between a person who gives assets to a trustee to hold for the benefit of one or more beneficiaries. Because a living trust is revocable, you can take the assets back at any time or “revoke” the trust.
In most scenarios, the person making the trust serves in all three roles while he or she is alive. They are the grantor, the trustee, and the beneficiary. Because they can do what they want with the assets, the living trust is not a separate entity for tax purposes and is not a separately taxable entity.
Irrevocable Trust
An irrevocable trust is created when assets are given to a trustee to hold for the benefit of one or more beneficiaries. However, unlike a revocable living trust, the gift placed in an irrevocable trust cannot be taken back or revoked. When you transfer assets into an irrevocable trust, you relinquish all ownership of those assets, and your chosen trustee takes total control of the assets transferred into the name of the trust. That means those assets are no longer considered part of your estate, and as long as the trust has been properly maintained, the assets held by the trust are also protected from lawsuits, creditors, divorce, accidents, and even bankruptcy.
An irrevocable trust can be made either during your lifetime or at death through a testamentary trust or a revocable trust. If you have a revocable living trust, it becomes irrevocable upon your death. One of the first things your trustee will do is apply for a tax ID number for the trust. At that point, the trust becomes a taxable entity and any income earned inside the trust that is not distributed in that year would be subject to income taxes at the taxable rates of the trust, or at the tax rates of the beneficiaries, if income is distributed to beneficiaries.
As of 2022, the income earned by an irrevocable trust is taxed at the highest individual tax bracket of 37% as soon as the undistributed taxable income reaches more than $13,450. To avoid this high tax rate, in some cases, an irrevocable trust can be prepared so that the tax consequences pass through to the beneficiary and are taxed at his or her rates, which are typically much lower. I often set up a trust this way when creating an irrevocable trust for a beneficiary. When set up like this, the trust can provide the beneficiary with protection from common life events, such as serious debt, divorce, accidents, lawsuits, and bankruptcy.
Estate Tax
As of 2022, the federal estate tax exemption is $12.06 million for individuals. That will increase to $12.92 million for individuals in 2023, adjusted for inflation. However, those rates are set to expire on January 1, 2026, and return to its previous level of $5 million for individuals.
Assets exceeding the federal estate tax exemption are taxed at a whopping 40% tax rate.
You can reduce your estate tax liability—or even eliminate it—by using various estate planning strategies. Some of these strategies are complex, but completely worth it to save your family a massive tax bill.
As you can see by the above numbers, the estate tax exemption is often politically driven, is always in flux, and we can never predict what it will be at the time of your death. If you plan with me, we will ensure that we put in place planning strategies to protect your estate from estate taxes, regardless of the amount of the estate tax exemption or the size of your assets.
I Can Help.
If you are trying to decide whether the many benefits of using trust-based estate planning will work for you and your family, set up an appointment with me so we can design a plan that will provide you with the right solution and will work when you need it. You want a plan that will provide the maximum benefit for the people you love most while paying the least amount of taxes possible.
