- slide 1 of 3
Understanding Trust Terminology
When families are considering establishing a trust for tax or estate planning purposes, it is helpful to have a basic understanding of the most common trust terms. While this is not a complete list of the possible types of trust, it does contain the most common.
Revocable Trust - Families that wish to have the flexibility of moving assets out of a trust select a revocable trust. This allows the trustee to move assets in and out of the trust at any time. The beneficiaries of a revocable trust have no claim to the assets until such time as the trustee (or trustees) dies.
Irrevocable Trust - While similar to a revocable trust as far as sheltering assets, an irrevocable trust does not allow trustees to move assets out of the trust at will. Instead, the beneficiary must benefit from the transfer or the liquidation of assets from the trust.
While these two forms of trusts are most common, there is another trust that is set up specifically for tax purposes. Trusts are taxed at higher rates than natural persons meaning they are asset shelters versus tax shelters. Some people establish a grantor trust to allow them to pay a lower rate of taxes.
- slide 2 of 3
Why Choose a Grantor Trust?
For tax purposes, capital gains, additional income and other taxable events are taxed to a trust. When a trust is established, the trustee typically applies for a separate tax identification number. This means that a tax return is filed for the trust on an annual basis and the income is taxable and payable by the trust (through the trustee). Generally, trusts are taxed at a higher rate than people. This sometimes means that a trustee will establish a grantor trust to help reduce the tax burden on the trust.
When trustees set up this form of trust, they maintain an interest in the assets of the trust and fully control all of the assets that apply to that percentage. A traditional trust lists the name of a trustee and the t ype of trust. These trusts generally have deadlines, for example, of 10 years, which allows the income and assets of the trust to be taxed at the lower personal rate of the beneficiary (the trustee).
According to the Internal Revenue Service, "...all 'revocable trusts' are by definition grantor trusts. An 'irrevocable trust' can be treated as a grantor trust if any of the grantor trust definitions contained in Internal Code §§ 671, 673, 674, 675, 676, or 677 are met. If a trust is a grantor trust, then the grantor is treated as the owner of the assets, the trust is disregarded as a separate tax entity, and all income is taxed to the grantor."
Those considering setting up a trust need to make sure they speak with a qualified financial planner. The tax ramifications of trusts are a lot more challenging than some may think. Trusts are good for estate management, but they are not always beneficial for taxes.
- slide 3 of 3
1. Internal Revenue Service
- Abusive Trust Tax Evasion Schemes - Questions and Answers http://www.irs.gov/businesses/small/article/0,,id=106551,00.html
- Grantor Trust Rules: http://www.investopedia.com/terms/g/grantortrustrules.asp
- Irrevocable Trust: http://www.investopedia.com/terms/i/irrevocabletrust.asp
- Revocable Trust: http://www.investopedia.com/terms/r/revocabletrust.asp