The downside of simple trusts
Distribution rigidity: The inflexible distribution requirements of simple trusts may hinder trustees' ability to adapt to changing circumstances or adequately address beneficiaries' evolving needs.
Typically, you set up a simple trust so that the trustee distributes the assets to beneficiaries after a particular event occurs. For example, you may set up a simple trust to provide income for your spouse during their lifetime and then distribute the remaining assets to your children when you die.
Simple trusts are required to distribute all of their income to beneficiaries, and as such, the beneficiary is responsible for paying any taxes on that income. In contrast, complex trusts are allowed to retain some of their income and are thus responsible for paying any taxes on that income.
That's true even if they don't withdraw income from the trust. The trust reports income to the IRS annually and it's allowed to take a deduction for any amounts distributed to beneficiaries. The trust itself is required to pay capital gains tax on earnings. A simple trust is also permitted to take a $300 exemption.
Grantor Trusts
If a trust is considered a grantor trust for income tax purposes, all items of income, deduction and credit are not taxed at the trust level but rather are reported on the personal income tax return of the individual who is considered the grantor of the trust for income tax purposes.
Simple trust is one of three general types of trust that must meet three requirements set by the IRS: all the income must be distributed to the beneficiaries yearly, the trust fund must not payout any of its corpus (better known as principal), and cannot make charitable contributions.
Cost of Setting Up a Trust
Setting one up in California typically ranges from $1,500 to $2,500, depending on the complexity and the attorney's fees. While initially costly, it can save money by avoiding probate. Irrevocable Trust: Unlike a revocable trust, an irrevocable trust cannot be changed once established.
For estates with assets that have tremendous appreciation, a Joint-Exempt Step-Up Trust (JEST) or an Estate Trust could allow surviving spouses to sell assets while avoiding capital gains.
This rule generally prohibits the IRS from levying any assets that you placed into an irrevocable trust because you have relinquished control of them. It is critical to your financial health that you consider the tax and legal obligations associated with trusts before committing your assets to a trust.
Undistributed net income is generally subject to income tax at the trust level. The trust is responsible for paying taxes on its income, even if it doesn't distribute that income to beneficiaries.
Revocable trusts are the simplest of all trust arrangements from an income tax standpoint. Any income generated by a revocable trust is taxable to the trust's creator (who is often also referred to as a settlor, trustor, or grantor) during the trust creator's lifetime.
Some trusts are 20 to 40+ pages in length due to all of the provisions, definitions, and contingencies that align with the goals of the person making the trust which may not be able to accomplish these goals if they are not included.
Since the trust fully owns the property, any earnings on the property are trust income. Deductions, including property taxes, can be taken against this income, reducing the trust's net income.
There are two basic categories of non-grantor trusts, “simple” and “complex.” Under the terms of its instrument, a simple trust is required to distribute all of its annual income to its beneficiary, is not able to contribute to a charity and has made no distributions of trust principal during the year.
Trusts offer amazing benefits, but they also come with potential downsides like loss of control, limited access to assets, costs, and recordkeeping difficulties.
The trust fund loophole refers to the “stepped-up basis rule” in U.S. tax law. The rule is a tax exemption that lets you use a trust to transfer appreciated assets to the trust's beneficiaries without paying the capital gains tax. Your “basis” in an asset is the price you paid for the asset.
Inheriting a trust comes with certain tax implications. The rules can be complex, but generally speaking, only the earnings of a trust are taxed, not the principal. A financial advisor can help you minimize inheritance tax by creating an estate plan for you and your family.
Upon the death of the grantor, grantor trust status terminates, and all pre-death trust activity must be reported on the grantor's final income tax return. As mentioned earlier, the once-revocable grantor trust will now be considered a separate taxpayer, with its own income tax reporting responsibility.
One of the biggest mistakes parents make when setting up a trust fund is choosing the wrong trustee to oversee and manage the trust. This crucial decision can open the door to potential theft, mismanagement of assets, and family conflict that derails your child's financial future.
A living trust, unlike a will, can keep your assets out of probate proceedings. A trustor names a trustee to manage the assets of the trust indefinitely. Wills name an executor to manage the assets of the probate estate only until probate closes.
There is no minimum. You can create a trust with any amount of assets, as long as they have some value and can be transferred to the trust. However, just because you can doesn't necessarily mean you should. Trusts can be complicated.
Selecting an individual trustee
Choosing a friend or family member to administer your trust has one definite benefit: That person is likely to have immediate appreciation of your financial philosophies and wishes. They'll know you and your beneficiaries.
Many advisors and attorneys recommend a $100K minimum net worth for a living trust. However, there are other factors to consider depending on your personal situation. What is your age, marital status, and earning potential?
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