Insight on Estate Planning - August/September 2013: Estate Planning Pitfall - You haven’t reviewed your trusts this year

If your estate plan includes one or more trusts, it’s a good idea to review them in light of recent tax law changes. Higher income taxes — on individuals as well as trusts — may lead you to rethink the way your trusts are structured.

This year, several tax hikes take effect for “high earners.” They include:

  • A top income tax rate of 39.6% (up from 35%) on taxable income above $400,000 for single filers ($450,000 for joint filers),
  • A 20% rate (up from 15%) on long-term capital gains and qualified dividends for taxpayers in the top bracket, and
  • A new 3.8% tax on some or all net investment income for taxpayers with modified adjusted gross income over $200,000 for single filers ($250,000 for joint filers).

Trusts are also subject to these tax increases, but the income threshold is only $11,950 in 2013. With a grantor trust, you’re treated as the owner for income tax purposes, even though your contributions are considered “completed gifts” for estate tax purposes. So you avoid the low trust threshold for these tax hikes. In addition, by paying the income taxes, you allow the trust to grow tax-free, leaving more for your heirs. And you can sell assets to the trust without tax consequences.

Despite these advantages, if tax hikes on your own income will be a burden, you might consider converting a grantor trust to a nongrantor trust to shift tax liability to the trust. You can reduce the tax bite on the trust by 1) shifting trust assets into tax-exempt or tax-deferred investments, or 2) distributing trust income to beneficiaries in lower tax brackets. (Generally, trusts are taxed only on undistributed income.) But you should weigh potential tax savings against the benefits of keeping assets in the trust — including creditor protection and wealth preservation.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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