Some advisers are moving low-basis assets out of grantor trusts by swapping in high-basis assets. For years wealthy investors have used grantor trusts to minimize their potential federal estate taxes. But today those same investors now have to worry about the growing income-tax liability the trusts are generating. As a result, some financial advisers say planning for income taxes has caused some rethinking regarding how to best use the trusts, specifically the intentionally defective grantor trust and grantor-retained annuity trust.
Intentionally defective grantor trusts ("IDGTs") have become very popular in estate planning because they allow the grantor to move assets out of his or her taxable estate. This lowers their potential estate taxes, while remaining responsible for the income taxes, so that the income tax burden isn’t transferred to heirs. However, the Wall Street Journal's article, titled "Rethinking Some Grantor Trusts," says that the latest bull market created potentially substantial taxable gains for individuals—and with the top federal rate on long-term capital gains at nearly 24%, as compared to 15% in 2012—there's a concern that some people may have a harder time paying that income tax bill.
Increasing income tax rates means that it becomes more expensive for a grantor to maintain the grantor trust status of a trust they’ve set up. One way around this is a clause that allows grantors to essentially turn off the grantor status of the trust. This means the trust must pay its own income taxes going forward. But this election can only be made once—the grantor can’t switch back and forth from paying to not paying the income taxes—so there needs to be some careful consideration of this decision.
Higher income taxes have prompted some to take a closer look at the assets held in grantor-retained annuity trusts ("GRATs"), which allow individuals to put some of an asset’s future profits to heirs free of gift or estate tax. Most of this planning revolves around the “step-up” in cost basis, which helps eliminate the long-term capital-gains tax on assets that are held until death by raising the owner’s cost basis for these assets to the full market value. However, in a GRAT, the assets transferred to beneficiaries usually doesn’t receive that step-up at death, so to cut down on capital-gains taxes, the original article says that it's better to have higher basis assets in the GRAT because those assets won’t get a step-up in basis.
In addition, the original article suggests swapping out low-basis assets that have recorded gains in the trust with high-basis assets, like cash, and this swapping can also be implemented with IDGTs that still have their grantor status.
Sound a little tricky? Your estate planning attorney can help you sort through this and find the best strategies for your situation.
For more information about how 30-years of expertise as a Certified Public Accountant AND a Certified Financial Planner, matched with my dual specializations from the Florida Bar (Board Certified Attorney in Elder Law and in Wills, Trusts & Estate Law) can help YOU, please visit my website.
Reference: Wall Street Journal (October 29, 2014) "Rethinking Some Grantor Trusts"