Taxation of Trusts
Presented by:
Rupe S. Gill and Jennifer E. Dalman
Attorneys at Law
Walker Lambe Rhudy Costley & Gill, PLLC
For the Business of Your Life & the Life of Your Business
Rupe S. Gill
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Attorney at Law since 1993
University of North Carolina, Chapel Hill, BA
Juris Doctorate, Cleveland State University School of Law
Judge Advocate (JAG)
Retired Lieutenant Colonel - US Air Force
Durham-Orange Estate Planning Council
American Academy of Estate Planning Attorneys
North Carolina Bar & Pennsylvania Bar
Durham County Bar Association & US and AF Court of Military
Appeals
National Academy of Elder Law Attorneys
Board of Directors, Durham Center for Senior Life
Board of Directors, NC National Academy of Elder Law Attorneys
Jennifer E. Dalman
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Duke University, BA
Juris Doctorate with Honors, UNC Chapel Hill School of Law
Highest grades in law school class in Estate and Gift Taxation,
Partnership Taxation, and Family Wealth Management
Gressman-Pollitt Best Overall Oral Argument Award
Holderness Moot Court Client Counseling and Middle Temple
Appellate Advocacy Teams
North Carolina Bar
North Carolina Bar Association and Durham County Bar Association
Durham-Orange Estate Planning Council
American Academy of Estate Planning Attorneys
North Carolina Association of Women Attorneys
Board of Directors, COPE Eldercare
Overview
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Definition of a Trust
Parties to a Trust
Reasons to Establish a Trust
Different Types of Trusts
Tax Treatment of Trusts
What is a Trust?
A Trust is a legal entity that can
hold title to property for the
benefit of one or more persons
or entities
Parties to a Trust
• Grantor, Trustor, or Settlor: the person who
creates the Trust
• Trustee: the person (or institution) who
manages the trust assets and carries out the
instructions of the Trust
• Beneficiary: the person (or entity) that
benefits from the Trust
Why Establish a Trust?
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Avoid guardianship
Avoid probate
Maintain privacy
Impose restrictions on how and when
beneficiaries receive assets
• Make challenges to your wishes for distribution
of your property more difficult
• Estate and gift tax planning
• Medicaid and VA Aid & Attendance planning
Types of Trusts
• Basic distinctions:
– Testamentary or Non-Testamentary
• Testamentary: Created under a Will
• Non-Testamentary: Not Created under a Will
– Revocable or Irrevocable
• Revocable: Trust can be amended or revoked by the grantor
• Irrevocable: Trust cannot be amended or revoked
– Grantor or Non-Grantor
• Grantor: Trust Property is treated for income tax purposes as
being owned by the grantor of the Trust
• Non-Grantor: Trust is independent from the grantor for
income tax purposes
Revocable Trust
• Typically, the same individual occupies all
three roles – grantor, trustee, and beneficiary
• Becomes irrevocable when the grantor dies
• The grantor/trustee has complete access to
and control over trust assets during his or her
lifetime
• Used as a management tool during life and
provides for the efficient (and private)
administration of affairs at death
Supplemental Needs Trust
• Used to protect government benefits (especially
Medicaid and Supplemental Security Income (SSI)) for
disabled beneficiaries
• Imposes restrictions on use of trust assets – can be
used only for goods and services that the beneficiary
cannot receive from public support
• Can be set up by a third party or self-settled
– If set up by a third party, the grantor specifies who receives
the balance of the trust at the death of the beneficiary
– If self-settled, the balance of the trust goes to the state at
the death of the beneficiary
Medicaid Planning Trust
• Grantor transfers assets to the Trust in advance of
need for long-term care – starts the clock running
on the five-year look-back period for gifts under
the Medicaid rules.
• Typically, the grantor retains the right to receive
income and also the right to change beneficiaries
at the grantor’s death.
• Because the grantor has no right to access the
trust principal for himself, the principal will not
be a countable asset when determining Medicaid
eligibility.
Common Tax Planning Trusts
• Credit Shelter Trust (also called a Family Trust or Bypass Trust)
– Used by a married couple to fully utilize the estate tax exemption of both
spouses
• Grantor Retained Annuity Trust
– Grantor gets an annuity payment for a term of years, then the balance of the
Trust goes to the remainder beneficiaries (usually the grantor’s children)
• Qualified Personal Residence Trust
– Grantor transfers primary or vacation residence into the Trust but retains the
right to live there for a term of years
• Intentionally Defective Grantor Trust
– Treated as a grantor trust for income tax purposes but the assets are not
treated as being owned by the grantor for estate tax purposes
• Charitable Remainder Unitrust
– Grantor gets a unitrust payment for a term of years, then the balance goes to
charity
• Charitable Lead Annuity Trust
– Charity gets an annuity payment for a term of years, then the balance of the
Trust goes back to the grantor’s family
Grantor Trusts
• Trust is owned by the grantor for income tax purposes
– Note that the Trust isn’t necessarily owned by the grantor
for transfer tax (gift, estate, and generation-skipping)
purposes
• Federal income tax purposes: Internal Revenue Code
Sections 671-678
• NC income tax purposes: If the Trust is treated as a
grantor trust for federal income tax purposes, it will
similarly be treated as a grantor trust for state income
tax purposes and a separate tax return need not be
filed.
http://www.dor.state.nc.us/taxes/estates_trusts/grant
ortrust.html
Grantor Trusts – Code § 671
• The grantor of the trust (§ 673-677) or
another individual (§678) will be treated as
the owner if the trust contains any of the
features set forth in those code sections.
• If the grantor (or other individual) is treated
as the owner, then income from the Trust will
be taxed to the grantor (or other individual)
as if the Trust never existed.
Grantor Trusts – Code § 672
• Definitions and Rules
• Noteworthy:
– Adverse and nonadverse party
• A party is adverse if he/she has a substantial beneficial
interest in the Trust which would be adversely affected by
the exercise or nonexercise of the power which he or she
possesses
– Related or subordinate party
• Spouse, parent, issue, sibling, employee, corporation in
which the grantor has voting control, subordinate employee
of a corporation in which the grantor has voting control
Grantor Trusts – Code § 673
• Trust will be treated as a grantor trust if the grantor has
a reversionary interest and the value of the
reversionary interest exceeds 5% of the trust estate
• Example:
– I put $500,000 in Trust for my brother for his health,
education, maintenance, and support. If my brother dies
while I am still living, then the money in the Trust comes
back to me. If I’m not living when my brother dies, the
money in the Trust will instead be distributed to my
descendants.
– Because there is a substantial chance that my brother will
predecease me, the value of my reversionary interest
exceeds 5% and the Trust is treated as a grantor trust.
Grantor Trusts – Code § 674
• Trust will be treated as a grantor trust if the grantor is able to direct
beneficial enjoyment
• Key Exceptions:
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Power exercisable only by Will
Power to allocate among charitable beneficiaries
Power limited by an ascertainable standard
Power to withhold income temporarily or during disability of
beneficiary
• Example:
– I put $500,000 in Trust for my son, naming myself as Trustee. I, as
Trustee, can distribute income and principal to or for the benefit of my
son in my sole discretion.
– Because I, as Trustee, have the power to direct beneficial enjoyment,
the Trust is treated as a grantor trust.
– If, instead, I, as Trustee, could only make distributions for my son’s
health, education, maintenance, and support, this is limited by an
ascertainable standard and may not be a grantor trust, depending on
the other trust terms.
Grantor Trusts – Code § 675
• Administrative powers that will make a Trust a grantor
trust:
– Ability to dispose of trust assets for less than adequate
consideration
– Power to borrow without adequate interest or security
– Power to vote stock, control investments, or substitute property
• Example:
– I set up a Trust for the benefit of my parents. An independent
Trustee is appointed and I have no interest in the Trust.
However, I can substitute what assets constitute the trust
estate; for instance, I can demand that the Trustee give me the
real property in the Trust in exchange for cash.
– Because I can demand that the Trustee exchange or substitute
trust property, the Trust is treated as a grantor trust.
Grantor Trusts – Code § 676
• Trust will be treated as a grantor trust if the
grantor has the power to revest in the grantor
title to trust property
• Example:
– I transfer $500,000 into a Trust for my son, naming
an independent Trustee. However, I retain the
right to take the money back out of the Trust at
any time in the future.
– Because I can withdraw the trust fund, the Trust is
treated as a grantor trust.
Grantor Trusts – Code § 677
• Trust will be treated as a grantor trust if the grantor (or a
nonadverse party) can direct that trust income be:
– Distributed to the grantor or grantor’s spouse
– Held or accumulated for future distribution to grantor or
grantor’s spouse, or
– Applied to the payment of premiums on policies of insurance on
the life of grantor or grantor’s spouse
• Example:
– I I transfer $500,000 into a Trust for my son, naming an
independent Trustee. The Trust provides that principal can only
be used for the benefit of my son. However, the independent
Trustee may distribute income to me.
– Because the Trustee is nonadverse and can distribute income to
me, the Trust is treated as a grantor trust.
Grantor Trusts – Code § 678
• A person other than the grantor can be
treated as the owner of trust property for
income tax purposes if:
– The individual has an unfettered right to distribute
the trust corpus or income to himself or herself.
– The individual has released the unfettered right to
distribute the trust corpus or income to himself or
herself, but retains control or rights as described
in Code §§ 671 - 677.
Transfers to Trust
Gift & Estate Tax Consequences
• A transfer to a Revocable Trust will never be a
completed gift. Thus, all property held in a
Revocable Trust will be taxable in the estate of
the grantor.
• A transfer to an Irrevocable Trust may or may not
be a completed gift and may or may not be
includable in the grantor’s taxable estate.
• If gift is completed, donee takes carryover basis.
If gift is incomplete, donee gets a step up in basis
at death of donor.
Transfers to Trust
Gift & Estate Tax Consequences
• When a gift is completed: Treasury Reg. § 25.2511-2(c) and (d)
– Grantor retains the power to change beneficiaries (even if the grantor
is not a permissible beneficiary): incomplete gift – property included in
grantor’s taxable estate.
– Grantor retains only the power to change the manner or time of
enjoyment – completed gift
• Note: property also included in grantor’s taxable estate under Code § 2036
(though double taxation is avoided by Code § 2001)
• Inclusion in taxable estate:
– Code § 2035: transfers within three years of death
– Code § 2036: retained interests (grantor either retains (1) right to
income or (2) right to designate beneficiaries)
– Code § 2037: transfers geared to grantor’s life (grantor retains >5%
reversionary interest or beneficiary only gets possession/enjoyment of
property if survives grantor)
– Code § 2038: powers to alter, amend, revoke, or terminate
Powers of Appointment
• Limited Power of Appointment:
– Beneficiary may only appoint property to or for the benefit of
certain individuals or entities
– If exercised during lifetime, no gift tax consequences
– Property is not included in beneficiary’s taxable estate
– Because the property is not included in beneficiary’s taxable
estate, may be subject to generation skipping transfer taxes
• General Power of Appointment:
– Beneficiary may appoint property himself, his estate, his
creditors, or the creditors of his estate
– If exercised during lifetime, beneficiary is considered to have
made a completed gift
– Property is included in beneficiary’s taxable estate
Questions?
Rupe S. Gill, Esquire
RGill@WalkerLambe.com
Jennifer E. Dalman, Esquire
JDalman@WalkerLambe.com
Walker Lambe Rhudy Costley & Gill, PLLC
(919) 493-8411
www.walkerlambe.com