Opinion: The widespread use of trusts

With estate tax avoidance taking a back seat to other significant planning opportunities, the use of trusts in estate planning is still an important consideration for the majority of the population.

According to a recent CNBC survey, 38 percent of families with net investable assets over $1 million have not established an estate plan. How long has it been since you’ve reviewed your plan with an adviser?

In January 2013, President Barack Obama signed the American Taxpayer Relief Act that set the federal estate tax exclusion at $5 million. You might not be aware, but this amount is indexed for inflation which translates to a federal estate tax exclusion of $5.43 million in 2015, or almost $11 million per married couple. Based on government estimates, this means less than a half of 1 percent of all estates will actually owe federal estate tax.

Next generation
Trusts always will remain relevant for beneficiaries that are simply not suited to handle large outright distributions, but with the focus shifted away from federal estate tax avoidance, what should we concentrate on now?

Many clients feel outright distributions to fiscally responsible descendants make the most sense. What if I told you that if you are willing to consider lifetime trusts, your children could enjoy creditor protection for their inheritance?

Based on national divorce rates hovering around 50 percent, the most financially responsible child who has never carried a credit card could find themselves with a creditor.

Consider, also, your child may be in a high-risk profession – a physician, contractor, land developer or even a small business owner – or maybe your son throws the best Fourth of July party with the biggest fireworks display in three counties. If drafted correctly, the child can even serve as sole trustee of his or her own trust.

If you’re concerned about losing flexibility by locking up funds in trust, consider the use of a testamentary limited power of appointment that would allow your child to designate remainder beneficiaries.

Portability matters
When Congress introduced portability, allowing the unused exemption from the deceased spouse to simply pass to the survivor, it left many wondering if it was necessary to do any trust planning at the first death. While portability addresses the federal estate tax exemption, it does not address the generation-skipping tax exemption.

The GST is a federal tax imposed on transfers to an individual who is more than one generation below. In the lifetime trust example above, when the child dies, any share passing to descendants would be subject to GST as a result of the taxable termination.

Without the use of a credit shelter trust or a GST exempt qualified trust to apply the deceased spouse’s exemption, a married couple with $9 million could have inadvertently generated a GST bill in the amount of $1.4 million. That’s a very costly mistake for something that could have easily been addressed, but might be missed in the name of simplicity and convenience by relying solely on portability.

Taxing thresholds
With highly compressed marginal tax brackets, a trust with taxable income in excess of $12,150 already has reached the maximum marginal rate of 39.6 percent, or more importantly, the 20 percent rate on long-term capital gains.

Single taxpayers do not reach those maximum brackets until adjusted gross income is over $406,750.

Also, with the introduction of the net investment tax – often referred to as the 3.8 percent  Medicare surtax – trusts and estates are compared to a similar $12,150 threshold, whereas a single taxpayer faces a threshold of $200,000. Because the surtax is charged on the lesser of the net investment income – interest, dividends, annuities, royalties, gross income from passive activities and capital gains – or the excess of adjusted gross income over these thresholds, you can see the likelihood of a trust paying the Medicare surtax is significantly higher.

With an income distribution deduction reducing the amount of income taxed at the trust level, trust distributions to beneficiaries are often taxed at lower rates. Obviously, the terms of the trust always will dictate whether a distribution is made but tax-planning considerations could be incorporated into the drafting of distribution language.

If capital gains are left to be characterized as principal, they are not eligible for the income distribution deduction and by definition will always be trapped in the trust.

Simply defining capital gains as income for trust accounting purposes or giving the trustee the flexibility to characterize them as such in the trust document itself can greatly reduce total income tax paid by the trust and its beneficiaries.

Steven Kamienski is an attorney and a vice president and relationship manager for Central Trust Co. in Springfield. He can be reached at steven.kamienski@centraltrust.net.[[In-content Ad]]