Trust Taxation Basics

General income tax rules. The typical revocable trust is not a separate entity for income tax purposes, and the grantor is taxed on trust income at individual tax rates. Subject to certain exceptions, the typical irrevocable trust is a separate entity for income tax purposes, and the trust pays income tax on undistributed income and on its capital gains at trust income tax rates. Another way to say this is that the trust receives a deduction for amounts distributed to trust beneficiaries.

Trust income tax rates are compressed. In fact, whereas an individual must earn in excess of $523,600 before the 37% tax rate kicks in, a trust must pay that rate on income in excess of just $13,050. Obviously, there is often an incentive for a trust to distribute income to beneficiaries.

Grantor trusts. All trusts, including irrevocable trusts, classified as grantor trusts are not separate entities and therefore pay no tax. Instead, the grantor pays the tax. Grantor trusts are trusts in which the grantor retains one or more specific powers or interests in a trust such as the power to revoke or amend the trust or the so-called swap power or power to substitute assets of equal value. When the grantor dies, these retained powers die with her. Thus, the trust becomes a taxable entity with its own tax ID.

Simple and Complex trusts. Simple trusts are trusts that distribute all income and do not distribute principal or make charitable contributions. All other trusts are complex trusts.

Estate tax planning. The terms to keep in mind here are “unlimited marital deduction,” “basic exclusion amount,” “bypass trust,”[1] and “qualified terminable interest trust” or “QTIP.” The unlimited marital deduction is the IRS’s gift to married couples because it allows couples to defer estate taxes until the death of the surviving spouse, unless 1. the surviving spouse is not a citizen of the U.S. or 2. the property interest that passed to the survivor is a terminable interest; that is, an interest that passes upon the survivor’s death.

The reason for the 2nd exception should be clear: the IRS wants to collect its pound of flesh sometime. Without the exception, there would be nothing left to tax when the spouse dies. The first exception is justified due to the worry the foreign spouse will die outside the U.S. and possibly pay not pay the estate tax bill. Non U.S. spouses do have an annual exemption of $159,000 on transfers and can defer estate taxes via a qualified domestic trust or QDOT, which is structured such that the estate tax will be paid on the 2nd death.

In addition to the marital deduction trust, the bypass trust is the other go-to tool for estate planners helping their wealthy clients avoid the estate tax. Simply put the bypass trust works like this: 1. Fund the trust with the basic exclusion amount of (currently) $11,700,000. This money/property can avoid the taxman—possibly forever. The remaining property goes into the marital trust, taking advantage of the decedent’s basic exclusion amount and ensuring the property will be taxed at the 2nd spouse’s death. This trust is often a QTIP or terminable interest trust that will qualify for the marital deduction and which will allow the grantor to take care of the surviving spouse until he dies. The trust will contain directions where the property will go after the spouse dies—typically to the children.

Disclaimer Trusts

There are disclaimers and then there are qualified disclaimers, disclaimers that don’t result in gift of estates taxes on the transfer. We’re interested in IRS qualified disclaimers.[2] To be qualified, a disclaimer must

  1. Be irrevocable and unqualified,
  2. Be in writing,
  3. Be received by the transferor, his legal representative, or holder of legal title no later than a date that is 9 months after the later of
    1. The day on which transfer is made or
    1. The day on which the transferee turns 21,
  4. Be given before the person disclaiming has accepted any interest or benefits, and
  5. Pass without any directions from the person disclaiming and pass either
    1. To the spouse of the decedent, or
    1. To a person other than the disclaimer.

Disclaimers are tool sto allow grantors and spouses to defer decision making where things are uncertain—and aren’t they almost always? For example, what if when planning was originally done, the estate was well below the threshold for application of the estate tax, where there might not have been a reason for funding a credit shelter trust. Instead, all the property either went into the marital trust or was distributed outright. Years later, the estate has grown substantially. When the grantor dies, the surviving spouse or some other beneficiary could disclaim, resulting in the disclaimed amount funding the credit shelter trust and thus saving estate taxes.

Of course, this approach has its drawbacks, chief among them being the reluctant beneficiary. Money talks after all.

Crummey Powers and the IRS

Crummey v. Commissioner[3] is the reason we have Crummey powers in our legal lexicon. The case involved a trust into which the Crummeys made annual gifts of $3,000 to each of their children (you can give %15,00 per child per year in 2021). The children, in turn, had the right to withdraw $3,000 each year from the trust. The Crummeys claimed that the withdrawal right qualified the yearly gifts as present interests and therefore eligible for the annual exclusion. Ultimately, the 9th Circuit agreed with them, even their argument that the gifts in trust to the two minor children were also present gifts, arguing that “We interpret that [that “the demand couldn’t be resisted”] to mean legally resisted and, going on that basis, we do not think the trustee would have any choice but to have a guardian appointed to take the property demanded.[4] In 1973, the IRS issued Rev. Rul. 73-405, which said

[A] gift in trust for the benefit of a minor should not be classified as a future interest merely because no guardian was in fact appointed. Accordingly, if there is no impediment under the trust or local law to the appointment of a guardian and the minor donee has a right to demand distribution, the transfer is a gift of a present interest that qualifies for the annual exclusion allowable under section 2503(b) of the Code.

Why is this important? Because using Crummey powers, people can remove assets from their estate via trusts. Because using Crummey powers, people can pay premiums on a life insurance policy in an ILIT (irrevocable life insurance trust). But remember, the Crummey power works because the donee of the power has the right to withdraw. Best practice dictates that donees receive a letter each time a gift to the trust is made, alerting them to the fact that they do have that right.

I Can Help

If you would like to explore these or other ideas further, schedule a virtual meeting with me by clicking on the red button in the lower right-hand corner of this webpage for a free consultation.


[1] Also referred to as the credit shelter trust or family trust or B trust.

[2] IRS Code §2518

[3]  397 F.2d 82 (9th Cir. 1968)

[4] Id 88

Ashton Kutcher Has a Good Idea?

He has, if you think leaving nothing to your children when you die is a good idea.

“My kids are living a really privileged life, and they don’t even know it,” Ashton said during an appearance on Dax Shepard’s podcast, Armchair Expert. “And they’ll never know it, because this is the only one that they’ll know.”
“I’m not setting up a trust for them,” he continued. “We’ll end up giving our money away to charity and to various things.”

We’ll see. It’s not like he and his wife Mila Kunis are cutting off their children entirely.

Rather than just giving his kids money, Ashton Kutcher, who is also an investor, said he’s planning to make his children work for a living. He said he’d be a potential backer for their future businesses, but they’d have to pitch him just like everyone else does.


“If my kids want to start a business, and they have a good business plan, I’ll invest in it. But they’re not getting trusts,” the 40-year-old actor confirmed.

The proof will be in whether the two stars actually treat their kids’s pitches “just like everyone else.” Either way, Ashton’s idea is not a bad idea; it’s simply one among many ideas about how best to treat our children when we die and if we’re rich enough that what we do with our money matters to our children.

Celebrity Estate Planning Mistakes that Keep on Giving–to the Wrong Person

My dad was a life insurance salesman. I remember rummaging around in his sales materials and finding a service he subscribed to that reported on the estate tax problems of the rich and famous and even the not-so-famous. He used the  reports to make the point that his prospective clients needed to do some estate and insurance planning, so their families wouldn’t face similar fates.

I was reminded of this when I stumbled upon this 2013 article from Forbes, “Monumental Estate Planning Blunders of 5 Celebrities.” The piece details the woes of rocker Jim Morrison, Rat Pack icon Sammy Davis Junior, hotelier Leona Helmsley,  QB Steve McNair, and, my favorite sad story, actress Marilyn Monroe:

Some celebrities have erred by not going far enough with their estate planning. For instance, famous actress and model Marilyn Monroe left most of her estate to her acting coach, Lee Strasberg.

“She left him three-fourths of her estate, and when he died, his interest in Marilyn’s estate went to his third wife, who did not even know Marilyn. Marilyn’s mistake was not putting her assets in trusts,” says Nass.

Strasberg’s third wife, Anna, eventually hired a company to license Monroe’s products, which involved hundreds of companies including Mercedes-Benz and Coca-Cola. In 1999, many of Monroe’s belongings were auctioned off, including the gown she wore to President John F. Kennedy’s birthday party, for more than $1 million. Strasberg ended up selling the remainder of the Monroe estate to another branding company for an estimated $20 million to $30 million, according to a remembrance of the star by NPR in 2012.

It’s unlikely Monroe would have wanted someone she didn’t know to profit so handsomely from her belongings. A trust would have provided for Strasberg while he was alive and then after his death could have directed the remainder of her estate to someone of her choosing.

Yes, I imagine was very unlikely that she wantedStrasberg’s 3rd wife to laugh all the way to and from the bank. But poor planning allowed that to happen.

Estate Planning Seminar at Pleasant Grove Library

I’ll be presenting a seminar on DIY — Do It Yourself — Estate Planning at the Pleasant Grove Library on Wednesday, March 8, 2017 at 7 PM. Come an enjoy the discussion. The address is 30 E Center St, Pleasant Grove.

If you have a question about wills, trusts, and other aspects of estate planning, maybe I can answer it.

Enforcing Charitable Pledges: Well, You Said You Would Give Them Money. What Did You Expect?

An interesting piece at Wealthmanagement.com about how and why charities seek to enforce charitable pledges and what theories courts use to accommodate their claims. The first two paragraphs are key:

In August, it was widely reported in the media that Duke University had filed a claim against the estate of Aubrey McClendon, the former CEO of Chesapeake Energy Corp., for payment of nearly $10 million in outstanding charitable pledges, once again raising the question of whether and to what extent charitable pledges are legally enforceable.

States typically rely on one of three theories to find that a charitable pledge is enforceable.  A pledge may be enforceable as a bilateral contract, as when a donor pledges a sum of money in exchange for the charity’s naming a building after the donor.1 A second theory treats a charitable pledge as a unilateral contract.  A donor offers to make a gift in the future that’s accepted when the charity incurs a liability in reliance on the offer.2When the charity provides no consideration for a contract, a pledge may be enforceable under the doctrine of promissory estoppel, an equitable remedy applied when a charity would suffer damages if the pledge weren’t enforced.

The rest of the piece is worth a read, especially if you’re interested in how the law is developing or in why charities should care about those developments.

Oh! Not Again! The Need for Ancillary Probate

As we’ve discussed elsewhere, in an almost knee jerk way, people want to avoid probate. And for some good reasons. But what if I told you there were a possibility your heirs might have to go through two or even three probates? It’s true. If you own titled property, especially real estate, in another state than the one you live and die in, your personal representative is probably going to have to file probate papers in all the states where that property is located. And with that comes the added expense of additional attorneys and such.

It’s called ancillary probate, ancillary because its subsidiary or supplementary to the larger probate, the one in your state of residence where presumably most of your property is located. You can avoid ancillary probate a variety of ways. If the out-of-state property is real estate, you could simply make sure that another person is on the deed with you with rights of survivorship. That way, when you die, the property passes automatically to that person, without probate.   Or you could title the property using a so-called transfer on death deed, which are allowed in a number of states. Or you could hold the property in a revocable or living trust.

The trust approach is my preferred method because, unlike the other methods, this one makes it easier to direct the property to where you want it to go once the property is held in the name of the trust.

Get Your (Valuation) Discounts Now!

Two weeks ago, the Treasury Department released proposed IRS Code Section 2704 valuation regulations that, as proposed, will dramatically change the discounts currently allowed, including so-called minority and marketability discounts. Thus, gift and estate tax planning strategies that rely on such discounts to transfer property from one individual to another via the use of limited liability companies, family limited partnerships, and other such entities may not work so well in the future.

The IRS has scheduled hearings on the proposed regulations for December 1, 2016. Sometime after that hearing the regulations will become final; thus, anyone planning on taking advantage of such discounts has little time to waste.

As I learn more about the proposed changes, I’ll follow-up on this blog. If you can’t wait that long, the AICPA has a number of helpful resources.

Trustees and Beneficiaries: More Good News than Bad?

I really like the idea behind “The Positive Story Project,” a new monthly column at Wealthmanagement.com. Here’ the first three paragraph from the opening salvo:

My goal in writing this column is to focus thinking within our community of practitioners—important players in the transfer of wealth to younger generations.   And, with so much at stake for our clients and their families—a good deal more than preservation of financial assets—let’s make this column a conversation.

Can the widespread dissatisfaction and all the talk of “problem” beneficiaries and “problem” trustees, give way to more creative and productive relationships?  I say:  “Absolutely.”  And, if your intuition is the same as mine, the harder question becomes “how do we get from here to there?”

To begin to find out, my colleague, Kathy Wiseman, and I have been going to the source—beneficiaries, trustees and their advisors—asking them for positive stories about moments in time when their relationships have worked well.  I’ll discuss what can be learned from these individuals and their stories in this column each month.

I look forward to more on this subject, both to help me as a practitioner and to inspire my clients and potential clients to use trusts to better carry out their wishes.

Happy Birthday to It

It doesn’t look a day over . . . : The estate tax turns 100.

Estate Planning? I Don’t Have Time . . .

Why doves cry. Half of Prince’s estate to go to government.

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