Effective Uses of Trusts in Estate & Gift Tax Planning

Alan L. Olsen, CPA, MBA (tax)By Alan L. Olsen, CPA MBA (tax)
Managing Partner
Greenstein Rogoff Olsen & Co. LLP

Function of Estates

An estate is a legal entity that originates upon the death of an individual. An estate is set up to administer all legal affairs of the decedent to be settled and to distribute the assets owned by the decedent. Once all estate legal requirements are satisfied, all property is distributed and the estate terminates. An estate is a taxable entity that generally lasts only for a few years.

However, they can continue for several years if the correct distribution of the decedent's wealth is in question. If an estate's administration is unreasonably prolonged, the IRS can terminate the estate for tax purposes (Reg. 1.641 (b)-3(a)).

Function of Trusts

The primary purpose for a trust being established is to protect and preserve assets f or the benefit of the beneficiaries. Although there are many types of trusts, all trusts generally have the same elements. These elements are:
  1. The Grantor: Person who creates the trust and transfers legal ownership of assets to one party.
  2. The Trustee (fiduciary): Person who receives the assets and protects and administers the trust according to the trust instrument.
  3. The beneficiary (ies) : Person (s) to whom the trust assets are designated.
  4. Trust Property: Also known as corpus or principal. Property legally owned by trust.

A trust may contain real and/or personal property. A trust cannot operate an active trade or business. A trust that becomes involved in an active, profit-making business runs the risk of being classified as an association for federal tax purposes. This association will be taxed the same as a corporation (see Morrissey v. Comm., 36-1 USTC 9020, 16 AFTR 1274, 296 U.S. 344 (USSC, 1936)).

Two broad categories of trusts are the inter vivos and testamentary trusts. Inter vivos trusts (living trusts) take effect during the settler's lifetime, and are created through a gift of property by a living settlor to a trustee, for the uses and purposes specified in the trust instrument. A testamentary trust (created by a will) is a disposition of property which takes effect at the grantor's death.

Trust Beneficiaries

An individual (the grantor) that establishes a trust has virtually unlimited discretion as to the identity of the trust beneficiaries and the interest in the trust given to each beneficiary. The grantor can specify one beneficiary to receive a lifetime right to the trust income (income beneficiary) and another beneficiary the right to the trust corpus at some future date. A beneficiary that has rights to the corpus (or principal) is sometimes called a remainderman.

A beneficiary who receives a distribution from a trust will receive a summary of the tax consequences of the distribution in the form of a Schedule K-1 from the executor or trustee. The K-1 will tell the beneficiary the amounts and character of the various items of income that must be reported and taxed on the beneficiary’s return. A beneficiary also may be entitled to depreciation or depletion deductions and tax credits because of fiduciary income.

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