once said only two things are certain in life: death and taxes. Unfortunately, he
did not live to see the Internal Revenue Service (IRS) recognize and permit
the use of trusts to reduce Americans' tax liability.
There are various forms of trusts a taxpayer can use to save on their tax
bill. The following three trusts represent popular methods of wealth management
to reduce tax liability.
1. Incomplete-Gift Non-Grantor Trust (ING trust)
The ING trust is a useful tool for Californians and residents of other
states with high income tax rates. An ING trust can reduce your tax liability
by placing high income-yielding assets in the trust and designating a
state with no state income tax as the domicile of the trust. Then, the
income earned on those assets held in trust is not taxed.
Example: A California resident creates an ING trust domiciled in Wyoming and places
his high-yield bonds in the trust. If the bonds earn $2,000 in a year,
those earnings will not be taxed because Wyoming does not have income
tax. Without the ING trust, the California resident would owe income tax
at the California rate on the $2,000 earnings.
2. Qualified Personal Residence Trust (QRPT)
The QRPT is
recognized by the IRS as a legal method of reducing the value of one's estate and
thus escape the dreaded estate tax.
By placing your home in a QRPT, the value of the house can be removed from
your estate for tax purposes. A carefully drafted trust agreement will
allow you to remain in the home rent-free for a specified term and designate
beneficiaries for the home.
A unique aspect of a QRPT is that the ownership of your home should transfer
before your death. This means that if you, the grantor, wish to remain
in the home after the specified term, you must pay fair market rent to
the beneficiaries. The amount of rent paid is then deducted from the value
of your estate at death.
3. Charitable Remainder Trusts
A charitable remainder trust reduces your tax liability by taking advantage of the
charitable contribution deduction.
Charitable trusts allow individuals to place assets into a trust and appoint
themselves as lifetime beneficiary with the remainder passing to a charitable
organization upon their death. The value of the assets that pass to the
charitable organization is deducted from the value of the individual's
estate tax valuation.
Charitable trusts come in various sizes and structures. The structure of
your charitable trust should depend on your current need for income from
the assets placed in trust.
Give us a call if you'd like to explore the use of IRS-recognized trusts to reduce your tax liability.