Federal Trust Planning Taxes

This post covers five federal tax concepts to carefully consider when planning your estate: Grantor Trust Status; Estate Inclusion; Completed Gift; Basis Adjustment; and Generation Skipping Transfer Tax.

I. Grantor Trust Status (Income Tax)

“Grantor Trust Status” is an income tax concept.

Trusts pay higher taxes than most individuals. All trust income above $14,450 is taxed at 37%. In many cases, you do not want your trust to pay taxes. “Grantor Trust Status” means that the IRS deems the grantor who set up the trust as the owner of the trust for income tax purposes. There are several powers or interests in the assets of the trust that will, if kept by the Grantor, cause Grantor Trust Status. For example, in part because the grantors retain total control over the assets in their revocable living trusts, such trusts are grantor trusts.

II. Estate Inclusion (Estate Tax)

“Estate Inclusion” is an estate tax concept.

For large estates, the federal estate tax can be huge: it is up to 40% of the assets over the estate tax exemption amount. The estate tax is based on the value of one’s gross estate at the time of death – which includes all kinds of property, wherever it is situated in the world. Estate Inclusion causes property to be given its value at the date of death for estate tax calculations. For this reason, high net-worth taxpayers may gift property out of their estates while they are living, so an increase in value is not included in their estates. But what if the property has decreased in value at the time of death? Then a carefully designed trust can empower the trustee to trigger estate inclusion.

III. Completed Gift (Gift Tax)

“Completed Gift” is a gift tax concept.

The federal Gift Tax it is up to 40% of the value of property gifted over the Lifetime Gift Tax Exclusion amount. The Gift Tax and the Estate Tax are fundamentally one tax – the difference being whether gifts are made during life or at death. Gifts under the Annual Gift Tax Exclusion amount may also be excluded from the Gift Tax. Above these amounts, the tax applies to a complete gift of any kind of property, no matter how it is transferred. A gift is complete when the giver “has so parted with dominion and control as [have] no power to change its” distribution

A trust can cause a Complete Gift and enable Estate Inclusion at the same time.

IV. Basis Adjustment (Capital Gains / Income Tax)

“Basis Adjustment” is an income tax concept.

The federal long-term Capital Gains Tax is, broadly speaking, up to 23.8% of the gain on the property when it is sold. A beneficiary receiving property from the grantor’s Gross Estate at the grantor’s death receives a basis adjustment. For Capital Gains Tax purposes, the property receives a new basis, which is its fair market value at or around the time of the grantor’s death. This is often a step-up in basis, which can result in significant capital gains tax savings and therefore be a major planning consideration. Estate Inclusion causes a basis adjustment, although Grantor Trust status does not.

V. Generation Skipping Transfer Tax (GSTT)

“Generation Skipping Transfer Tax” is an additional tax for transfers to younger generations.

The Generation Skipping Transfer Tax (GSTT) is a federal tax imposed when property is transferred by gift or inheritance to a beneficiary (other than a spouse) who is at least 37½ years younger than the donor. The tax is a flat 40% on transfers over the lifetime GST Tax Exemption amount.

GSTT is tricky because it can apply to direct or indirect transfers and may be triggered by a transfer through a trust. Furthermore, the same transfer can be subject to both estate or gift tax and GSTT.

A careful planner may use a Dynasty Trusts to leverage the GST Tax Exemption for future generations.