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Practical Uses for Irrevocable Trusts

Unlike the revocable living trust, which can be changed or cancelled at any time during your life, most trusts created as part of an estate plan are irrevocable and cannot be changed by the trustee or the beneficiaries.

Your will or revocable living trust can direct that all or part of your estate be held in an irrevocable trust for one or more beneficiaries, rather than being distributed outright to the beneficiaries.  For example, you could leave part of your estate to a trust that would pay one beneficiary all income earned by the trust, plus whatever principal he or she needed for support, for his or her life.  You may then direct that the trust property be divided equally among other designated beneficiaries at the death of the primary beneficiary.

There are several relatively common situations where an irrevocable trust could be a very practical part of your estate plan:

  • You want to provide for a beneficiary who is, or at your death may be, infirmed, disabled, inexperienced in handling financial affairs or a spendthrift.  A trust can effectively separate the management of property from the enjoyment of the property.

  • You want to provide for a beneficiary but you want to be sure the property will pass to persons or charities of your choosing at the death of the primary beneficiary.  With a trust, you can effectively control property for several generations of beneficiaries.

  • You want to give a beneficiary the enjoyment of property but prevent the property from being subject to estate tax at the beneficiary’s death.  Because the trust will own the property, it generally will not be subject to estate taxation at the death of the beneficiary.

  • You want to leave your entire estate to family members and still make a major contribution to charity.  A special form of trust — the charitable remainder trust — permits you to accomplish this objective with favorable tax consequences.

Home Sweet Home: Where’s Yours?

There are many reasons for owning two residences: to take advantage of a different climate, maintain roots near the family home, run a business in a second location or just to get away from it all.  Whatever the reason, some people find themselves spending more of their time at their “home away from home” as they near retirement.

If you own a second home, make sure you don’t unintentionally “move” by spending too much time there.  Such a relocation could be detrimental to the health of your estate plans and end up costing unnecessary expenses.

It’s important to know your domicile — your usual place of residence.  It’s possible to have several homes, but you can have only one domicile.  This is the state whose laws will govern the distribution of your estate at death.  If that state happens to have its own estate tax or inheritance tax (Connecticut, Washington D.C., Delaware, Hawaii, Illinois, Iowa, Kentucky, Maine, Maryland, Massachusetts, Minnesota, Nebraska, New Jersey, New York, Oregon, Pennsylvania, Rhode Island, Vermont, Washington), it could mean less for your beneficiaries.  And if your will doesn’t comply with the probate laws in your state of domicile, your assets may pass under state laws for those dying without a will.

There are a number of factors used to determine domicile: where you spend the most time, are registered to vote, licensed to drive, own real estate, file income tax returns.  Check with your attorney if you have any questions about where you’re domiciled or the consequences of spending more time at a second home.

What a Problem to Have!

Your investments outperformed your broker’s most optimistic predictions this year, leaving you with a capital gains-laden portfolio.  What can you do with your windfall?  You can sell investments to realize your profits. (Check first with your tax adviser to make sure your estimated taxes and withholding are adequate to avoid an underwithholding penalty next April.)  But if you sell your stock or liquidate mutual fund shares, you’ll lose 15%, or more, of the profit that you’ve earned to capital gains taxes.  However, there are several alternatives that offer tax savings and include assistance for the charities you support financially.

Outright gifts
Your gift of appreciated stock or mutual fund shares held for more than one year entitle you to a charitable deduction for the full fair market value — and you don’t recognize the gain that has accrued.  For example, Charlie, a taxpayer in the 28% tax bracket, saves $2,800 in income tax by contributing stock worth $10,000.  If the shares originally cost $2,500, there is an additional savings of $1,125 in capital gains taxes that would have been paid if the shares had been sold.  Charlie is able to make a $10,000 gift at a cost of only $6,075 ($10,000 - $2,800 - $1,125).  The savings are even higher for taxpayers in the 39.6% income tax bracket, who pay a 20% capital gains tax rate, and for those who are subject to the 3.8% net-investment income tax (adjusted gross income in excess of $200,000 for single taxpayers and $250,000 for joint filers).

Gifts that pay you income
Your appreciated stock also can be used to fund one of several gift arrangements that provide you — or you and another — with payments for life.  In addition to the income tax charitable deduction for a portion of the value of the shares, your gift also offers capital gains tax savings, potential estate tax savings and the satisfaction of making a generous contribution to favorite charities.  Your gift even can be arranged to begin payments at a later date — retirement, for example — to augment other retirement plans.

The Best Things in Life Are “Free”

“Free gift” is a phrase that crops up so often in advertising that we forget it’s redundant (by definition, a gift must be “free”).  But certain charitable gifts — and the deductions they generate — can almost seem free to donors.  The trick is to choose a gift technique that lets you “have your cake and eat it, too.”  Here are some appealing ways to boost charitable deductions for 2017:

A gift to charity of an undivided interest in a vacation home — Lorraine and Pete own a summer home that their family uses only four months of the year.  They could contribute a 25% undivided interest in the home to charity and take an income tax deduction for about one-fourth of the home’s value.  The family can continue using the home for most of the year.  Charity is technically entitled to use the home for three months, but its real benefit comes when the home is eventually sold.  At that time, charity would be entitled to 25% of the sale proceeds.

A gift of closely held stock — Linda is the owner of a small company (a C corporation).  She can give stock in her company — worth $5,000, for example.  The charity would seek to sell the shares, probably back to the company.  The company pays the charity $5,000 and retires the shares.  Linda would be allowed a deduction on her personal tax return, even though the cash actually comes out of her corporation, provided the charity is not required to sell the shares back to the company.  She remains the owner of the company.

A remainder interest in a home or farm — Howard owns a condo where he spends the winter.  He planned to leave the condo to charity at his death.  Instead, he can transfer the unit now, reserving the right to use the condo during his lifetime, and take a current charitable deduction.  The amount of his deduction depends on his age on the date of the gift and the value of the condo.

Gifts with retained income — Chester and Sue own appreciated stock worth $300,000 that pays only 2% dividends.  They’d like to boost their income, but would owe capital gains tax if they sold the stock and reinvested the proceeds.  They can use the stock to fund a charitable remainder trust that will pay them a higher income (at least 5% of the stock’s value) for their lifetimes.  In addition to the increased income, immediate capital gains tax avoidance and the charitable deduction, they have the satisfaction of knowing that at their deaths, the trust will benefit their favorite charity.