I have been asked by many of my clients if they should have a trust. The question is usually something like this, “should I have a trust for tax purposes?” There are really two questions being asked there. Should I have a trust? And does it help me from a tax standpoint to have a trust?
The answer to both questions is, it depends. There are many different types of trusts, and frequently the reason to have a trust has nothing to do with taxation. In most cases, having a trust really won’t help with income taxes by itself. So the first question remains, and it is an important question for most people to ask of their financial advisor.
A trust is a legal construct involving three parties. The trust document is a set of instructions on how certain assets or income streams are to be treated. It can get confusing because the parties are not mutually exclusive from one another. The parties involved are the trust creator(s), sometimes referred to as the trustor or grantor, the trustee(s) and the trust beneficiary(ies). Notice that in each case, there can be more than one person acting in the capacity listed. Also note that one person could be all three of the parties, that is, in the case of a grantor trust, one person can be the trustor, the trustee, and the beneficiary.
There are many reasons to have a trust. One of the most common trust is what is called a revocable living trust. The purpose of these trusts is to handle an orderly transition of an individual’s estate in the case of either death or incapacity. While everyone does eventually die, a revocable living trust really serves well in the case of incapacity, either through illness or disability, or just through general old age needs. The RLT does not change anything for personal income taxes and does not alter any estate tax that may be due on the death of the trustor.
Another reason to have a trust is to protect beneficiaries from creditors, potential creditors or agencies that have requirements on income levels. Examples could be a trust created to protect children from creditors, or even ex-spouses of children. Another example is a trust established to provide for the needs of a child with disabilities that is receiving government aid. This trust can allow for some extras the government might not pay for or for a higher level of service that what the government provides.
You can also try to establish good habits in your potential heirs through a trust. For example, you could create a trust that provides for income to be distributed to your children providing they have gainful employment, or provided they have completed college. The one caveat is that you cannot require behavior that is either illegal, immoral, or against public good. So if you don’t like your child’s spouse, you cannot allow payouts to the child provided they divorce their spouse.
Trusts are very flexible vehicles. For most people, if they have a need for a trust, it will be evident with a discussion with their CPA, attorney, or other financial advisor. If you think you might need one, we would be happy to discuss this with you.
Chuck Harkins, CPA