Tax Tips to take to Minimize income and estate taxes in Trusts and Estate Planning

1. Consider distributions to beneficiaries

Because the maximum ordinary tax rate (39.6 percent) and the net investment income tax (3.8 percent) apply to trust income at a much lower threshold than they do for individuals, trustees of discretionary trusts should consider distributions to carry out ordinary income and possibly capital gains to beneficiaries who are in lower tax brackets than the trust. Married individuals filing jointly hit the maximum income tax rate at $457,600 and the net investment income tax at $250,000. By contrast, those rates apply to trust income above $12,150 (2014). Other factors to consider include: the taxable estate of the beneficiary, the grantor’s desire to motivate a beneficiary to provide his own support and the asset protection of funds

2. Use annual exclusions

Many of our clients don’t use their annual gift tax exclusions of $14,000 (2014–but may increase with inflation in later years), Because this is annual “free” gift, you will lose the annual exclusion in any year that it is not used. In addition, there is an unlimited gift exclusion for most medical or educational expenses that are paid directly to the provider.

3. Consider not mandating a credit shelter or family trust in a married couple’s estate plan

Traditionally, our planning for married couple require that a mandatory credit shelter trust (which we sometimes call a family trust) be funded at the death of the first spouse. This was prudent to do when there was a possibility of federal and state taxes. With the current $5.34 million applicable exclusion for estate tax in 2014 (and no North Carolina estate tax), couples with less than a combined $10.68 million wouldn’t save any estate tax. In addition, they could actually end up paying more in income tax because the assets in the credit shelter trust created by the first spouse generally don’t get a step-up in basis on the death of the second spouse. With the advent of portability(a new flexible feature that allows unused exemption to be transferred to a surviving spouse if certain conditions are met), the current thinking is to provide maximum flexibility in the document by postponing the decision of whether to fund a credit shelter trust until the death of the first spouse. In other words, consider changing the mandatory formula to a more flexible one that allows a choice at the first death. Please remember there are many good reasons to fund a credit shelter trust for other tax reasons—creditor and divorce protection of beneficiaries, to name a few.

4. Take advantage of intentionally defective grantor trusts

This powerful tool can “freeze,” for estate tax purposes, discounted assets gifted or sold to the trust and shrink the donor’s estate by the payment of income taxes on the trust income by the donor. Use this estate-planning tool while it’s still available; it’s been on the government’s target list for years.

5. Trust Advisor Provisions solve many income tax issues

A Trust Advisor (sometimes called a Trust Protector) can be a useful addition to estate planning documents. By the trustmaker naming a person to make certain decisions, even a credit shelter or family trust can get a second step up in income tax basis. Also, the compressed marginal tax rates in trusts can be avoided by the Trust Advisor being able to grant a right of withdrawal to the beneficiary. The Trust Advisor can also resolve non-tax issues by resolving trustee issues (deadlocks, vacancies, etc.) adding in administrative provisions. The Trust advisor should not be a beneficiary.