President-elect Biden has a very thorough plan for what he’d like to do about taxes, but whether it makes it through Congress immediately will depend on what happens in January with the Senate races. One element of this is to restore the gift and estate tax exemption to the level it was at before The Tax Cuts and Jobs Act of 2017 doubled the exemption from previous levels. It is currently $11.58 million per person.
Whether or not legislation is passed to change it, the enhanced exemption is set to automatically sunset at the end of 2025 and return to $5 million, adjusted for inflation. If you are likely to be affected by this change, trusts are a great way to minimize taxes. Even if your estate doesn’t exceed the exemption, trusts are an extremely useful estate planning tool to maintain privacy, simplify the transfer of assets by removing them from the probate process, and provide for a legacy.
Breaking Down the Structure of Trusts: Control is Key
While trusts come in many types for many uses, they are all usually be set up so that the grantor either maintains control and keeps the assets in their estate or relinquishes control and the asset move outside the estate. There are benefits to each.
Revocable trust
Also known as a living trust, a revocable trust can help assets pass outside of probate yet allows you to retain control of the assets during your (the grantor’s) lifetime. It is flexible and can be dissolved at any time, should your circumstances or intentions change. A revocable trust typically becomes irrevocable upon the death of the grantor
Revocable trusts are usually still subject to estate taxes. They are also treated like any other asset you own from a creditor standpoint.
Irrevocable trust
An irrevocable trust typically transfers your assets out of your estate and potentially out of the reach of estate taxes and probate. The trade-off is that you relinquish control and cannot make changes after execution. The income generated by the trust also does not incur tax liability unless it is distributed. Assets in these types of trusts may also be protected from creditors.
A Brief Review of Trusts and their Functions
Bypass or “B” trust
Also known as credit shelter trust, this is a type of marital trust that can bypass the surviving spouse’s estate in order to make full use of any federal estate tax exemption for each spouse.
Charitable lead trust
Allows certain benefits to go to a charity and the remainder to your beneficiaries.
Charitable remainder trust
Allows you to receive an income stream for a defined period of time and stipulate that any remainder goes to a charity.
Generation-skipping trust
Using the generation-skipping tax exemption permits trust assets to be distributed to grandchildren or later generations without incurring either a generation-skipping tax or estate taxes on the subsequent death of your children.
Qualified Terminable Interest Property (QTIP) trust
They are used to provide income for a surviving spouse. Upon the spouse’s death, the assets then go to additional beneficiaries named by the deceased. Often used in second marriage situations, as well as to maximize estate and generation-skipping tax or estate tax planning flexibility.
Grantor Retained Annuity Trust (GRAT)
They are designed to shift future appreciation on quickly appreciating assets to the next generation during the grantor’s lifetime.
Bottom line
Trusts aren’t just an essential tool for planning the distribution of your assets; they can be used effectively to shield assets, provide income streams, create a legacy, and minimize taxes.
