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Estate Planning and Taxes

Living Trusts and Taxes

You, Your Trust and Taxes

We talk a lot about Living Trusts as an important part of estate planning. What we don’t talk about is a Trust and your taxes. But if you’re creating a Trust, thinking about transferring property, or naming a Successor Trustee, taxes are an important consideration. This is about your, your Trust and your taxes.

A Living Trust is typically a Revocable Trust, meaning that the person who’s creating it, the Grantor, may add or remove the Trust’s assets and beneficiaries at any time. The Grantor may even terminate or revoke the Trust at any time. Many people want to know about the tax implications of a Trust before they move forward with creating one.

 The Trust is in the Grantor’s name and will be recorded in his taxes

Because the Trust is in the Grantor’s name, he remains entitled to receive the income and the principal of the Trust during his lifetime. As a result, the IRS still taxes the Grantor on the Trust’s income. Because this is still in the Grantor’s name, it uses his social security number to establish investments and bank accounts, so all of the Trust’s income is recorded on the Grantor’s tax return. It is not necessary to have a separate tax return for the Trust because everything is still in one person’s name—the Grantor’s.

 Having a Trust means your heirs will avoid Probate

However, while the Grantor is taxed on the Trust income, the Trust’s assets are legally held by the Trust, which will survive the Grantor’s death. For this reason, the assets in the Trust do not need to go through the Probate process when the Grantor dies. This is one of the reasons we encourage everyone to create a Living Trust. You will be sparing your heirs the expense and the time-consuming process of going through Probate.

Special circumstances during Grantor’s life

If the Grantor becomes mentally incapacitated, the Successor Trustee designated in the Trust documents may choose to obtain a separate tax ID number for the Trust. This number is called a “Federal Tax ID Number”, an “Employer Identification Number”, or an “EIN”.

A Successor Trust may choose to obtain an EIN for the Trust in order to limit his own liability for the Trust’s income tax or to help fulfill his fiduciary duties. If the Trust is using an EIN, a separate tax return for the Trust will be required for each year. The Trust’s taxes will be filed on Form 1041 and would be filed by the same date as personal taxes. If it’s a simple estate, this may not be necessary. But even in straightforward situations, it often takes a year or more to settle the estate. There are cases where the Grantor is not incapacitated and still may choose to establish an EIN for the Trust.

If the Grantor has complex personal taxes and would prefer not to report the income and losses of the Trust on his own tax return. He would still pay taxes on the income of the Trust but he would be paying those taxes under the Trusts EIN number.

Living Trust tax after Grantor’s death

After the Grantor’s death, the Trust remains in place and continues to hold legal ownership of all the Trust’s assets. If you’re the Successor Trustee, the Trust holds all of the assets that you inherit and you will be responsible for dividing among your family members, as per the Trust. The tax implications impact the outcome of both the Grantor and the beneficiaries.

  • The Grantor’s final tax return is filed by the Trustee or Executor of the Grantor’s Estate, and it declares all the income earned by the Grantor through the Grantor’s death.
  • However, any income earned by the Trust assets or principal after the date of the Grantor’s death is reported in a separate tax return for the Trust.

After death, the Trust converts from a Revocable to an Irrevocable Trust

The requirement that the Trust files its own tax return is a result of the Trust changing from a Revocable Trust during the Grantor’s life to an Irrevocable Trust upon the Grantor’s death. This makes perfect sense because it was Revocable before death—meaning that the Grantor can revoke, or make changes to the assets and beneficiaries. After death, of course, the Grantor can no longer make changes. The result: The Trust must file its own tax return each year.

 What about estate taxes?

Thanks to changes in the estate tax laws, only those estates worth more than $11.4 million will owe federal estate taxes.

Estate Planning

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A Lesson in Estate Planning

A Lesson in Estate Planning from David Bowie

Few pop stars have endured or left a legacy as diverse and successful as that of David Bowie. He died last week of liver cancer, just two days after his 69th birthday and the release of his latest album, Blackstar. He was inventive and cutting edge; the fans who transcended generations adored him. Those who didn’t know what to make of the androgynous pop star nevertheless remained fascinated by his ever-evolving, iconic personas. Over more than 50 years, he produced an extraordinary body of work that spanned music and film.

Bowie amassed considerable wealth

Bowie died a very wealthy man—his estate is worth an estimated $100M—and that’s before the inevitable spike in sales that will continue with his death. (In the 6 years since Michael Jackson’s death, his estate has grossed nearly $2B.) Yet in the 70s and 80s, Bowie struggled financially, reportedly nearing bankruptcy.

A brilliant plan for creating—and sustaining–wealth: Bowie Bonds

With the help of an investment banker, Bowie developed a brilliant plan for creating and sustaining wealth: Bowie sold a stake in his catalog of music. Instead of outright selling his songwriting, performance and licensing rights to his many successful songs, Bowie created “Bowie Bonds.” These allowed him to sell – for $55M– a 10-year investment, which operated like an annuity, providing a fixed-rate of return of 7.9%. The payouts were secured by all of his royalties and copyrights from the music. Prudential Insurance purchased the Bowie Bonds and was paid off in full during the 10-year timeframe. The Bowie Bonds transaction provided tax savings and ensured that his estate would benefit from his music catalogue.

Apparently Bowie was motivated by the desire to protect his family—his wife, Iman, their daughter, and a son from a former marriage. He had apparently always been interested in estate planning and wanted to make sure his assets passed on to his loved ones.

Bowie likely used one or more Revocable or Irrevocable Trusts

Given Bowie’s careful attention to financial planning, it’s likely that he used one or more Revocable or Irrevocable Trusts. In this way, he could have maximized the value of assets with the lowest tax consequences, but his assets could also pass privately, without the public scrutiny that accompanies Probate Court, which is the case with those who do not create a Living Trust.

Bowie’s final wishes

It was just revealed that Bowie’s $100M fortune will be distributed among his family and several loyal employees. Iman will receive half of his fortune as well as their Soho apartment; his children will each receive an estimated $25M. Bowie was a longtime Buddhist and requested that he be cremated in Bali in accordance with Buddhist rituals. He noted that if that was not practical, he could be cremated elsewhere, with his ashes scattered in Bali. The Bali cremation may have been problematic, for Bowie was cremated in New Jersey, but we can assume that his family scattered his ashes in Bali, according to Bowie’s final wishes.

A Living Trust ensures that your heirs will not have to deal with Probate and that your estate will remain a private matter. We assist our clients through every step of the Living Trust process.