Research Paper on "Tax Law"

Research Paper 4 pages (1453 words) Sources: 4

[EXCERPT] . . . .

This provision places two limitations on trust property. First, the trust cannot simply take effect upon the death of the client in order to avoid tax liability; trusts established at death do not provide tax benefits, though they can be useful when the overall amount of an estate falls below the estate-tax triggers. Second, it shows that a decedent has to have taken a step away from the trust in order to avoid taxes.

26 U.S.C.S. § 2038 specifically discusses revocable transfers and how they impact tax liability. Basically, trust property will be included in the value of the gross estate if the decedent retained the power, whether solely or in conjunction with someone, to change the terms of the trust. These changes could include amendments, revocations or terminations. However, a trust can be established as a revocable trust and its property protected, as long as the decedent relinquishes the power to alter the trust more than three years prior to his death. This is true even if the power to alter the trust is dependent upon the decedent giving notice of intent to alter, which did not occur. Furthermore, even if the changes are future-based, they will be considered changes making the trust revocable.

Taken together, what these statutes make clear is that simply putting assets in a trust is not sufficient to protect those assets from inheritance taxes. Instead, the trust must meet several important considerations in order to be sufficient to protect assets. The trust needs to be established more than three years prior to a decedent's death. What this means is that trust formation should be a part of estate planning, even for clients who are not elderly or ill. The trust needs to be irrevocable, with the decedent unable to control or change certain elements of the trust after establishing it. Furthermore, the trust needs to be for the benefit of someone other than the decedent. While trusts can pay interest to the decedent, if a decedent was able to access the corpus of the trust within three years of death, then the trust will be insufficient to meet the standards outlined in the statutes. Furthermore, the decedent must not be able to practice actual control over the trust assets; one of the standards for the trust examines the amount of control that the decedent exercised over the assets in the trust.

Trusts are a popular way to reduce estate taxes. One of the drawbacks of a trust is that they are expensive, generally costing thousands of dollars to establish. However, given that trusts are used to prevent a very high tax rate (approximately 45%) on estates worth millions of dollars, the cost to establish a trust is generally a more acceptable alternative than failing to establish a trust. For trusts to avoid inheritance taxes, they need to be irrevocable trusts. "One popular form is the grantor-retained annuity trust, or GRAT. With a GRAT, you transfer assets into a trust that has a set life, typically five years. You receive annual payments from the trust, based on an interest rate set by the IRS. The payments are calculated so that the trust "zeroes out" by the end of the term, which means you will have gotten back your original assets plus the IRS rate of interest on them. Any appreciation above that interest rate goes tax-free to the beneficiaries of the trust, such as children and grandchildren" (Morrissey, 2009). The GRAT is only one example of a trust that can avoid tax liability; most other irrevocable trusts can perform similar functions. The most important thing is that the distributions to the trust comply with the rules found in 26 U.S.C.S. § 2035-2038. Furthermore, while trusts can protect assets, they are not the only way of doing so. Any estate planning session should also include a discussion of life insurance, gifts up to the excludable gift amount, and even outright lifetime gifts, in order to ascertain the combination that best avoids tax liability.

References

26 U.S.C.S. § 2035.

26 U.S.C.S. § 2036.

26 U.S.C.S. § 2037.

26 U.S.C.S. § 2038.

Morrissey, J. (2009, June 4). How to avoid the 'death tax.' Retrieved January 31, 2014 from CNN website: http://money.cnn.com/2009/06/03/pf/Death_tax_morrissey.fortune/ READ MORE

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