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Burlington, VT office 802.540.0529
Hanover, NH office 603.643.6072
Rutland, VT office 802.773.3822
Woodstock, VT office 802.457.9492

March 14, 2013 Newsletter Archive


Trustees Beware: Navigating the New Trust Income Tax Landscape

For several years estate planning has been driven in large part by estate tax concerns. Interestingly, the recently passed American Taxpayer Relief Act of 2012 (the "2012 Act") provides much desired predictability about estate taxes. In large part the 2012 Act means that most Americans will not face an estate tax now because the individual estate tax exemption amount is $5.25 million for individuals, or $10.5 million for married couples.

However, not everyone is entirely spared tax consequences. Instead, three issues have combined to shift the focus from estate tax to income tax:

The difference between trust income tax rates and those for individuals is stark. As table A below illustrates, as opposed to individuals or married couples, a trust only needs to earn just under $12,000 to experience some fairly serious tax consequences.

Table A

 

Trust Income

Individuals

Married Couple

39.6% tax rate (Top Bracket)

$11,950

$400,000

$450,000

3.8% surtax applies under Affordable Health Care Act

$11,950

$200,000

$250,000

Capital Gains At 20%

$11,950

$400,000

$450,000



Considerations for Trustees
First, Trustees need to be very aware of the higher federal income tax rates now imposed on trust income. Additionally, trustees must be aware that state income tax rates can also be significant, with the combined state and federal income tax rates exceeding 50%.

It is important to note that this trust tax exposure is concerned with irrevocable trusts and not with the typical revocable trust used in estate planning while the creator of the trust is alive.

Protecting Your Trust from Income Tax Consequences
F ortunately, there are ways to lessen and even eliminate this trust income tax exposure. The simplest path is to distribute out to the trust beneficiaries all trust income in the year it was earned. For example, if the trust earned $20,000 of income and distributed to the trust beneficiaries all of that income in the same year, the trust would have no income tax exposure. The trust would file an income tax return imposing on the receiving trust beneficiaries the duty to report the income on their personal income tax returns, with such income taxed at the more favorable individual income tax brackets. (See Table A above.)

For some trust beneficiaries, such as those receiving government benefits, it may be problematic for the trust to pay all trust income out every year. In these cases, the trust investments should be configured in such a manner that the income is tax exempt or perhaps the assets are invested so that there is no income earned.

Ultimately, trustees need to be aware that trust income taxation has become a significant concern under the 2012 Act and needs to be managed as a critical fiduciary duty. Understanding fiduciary responsibilities is the first step to being a capable trustee.

To the extent that you have questions regarding the 2012 Act or other tax or estate planning matters, feel free to contact us at (603) 643-6072 or (802) 457-9492.

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Melendy Moritz PLLC is a client centered boutique firm. We focus on your unique needs by providing the individualized legal counseling and advising tailored to your specific situation.

We concentrate on the planning that matters to you.
Call us at 603.643.6072 or 802.457.9492

 

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