Most trustees know that they have to make an accounting and pay taxes on at least a quarterly basis. While accounting itself may seem like a relatively simple theoretical proposition, the truth is much different. The devil is in the details. Allocation of each line of income to specific taxes, each with its own tax forms, requires that the trustee account for every penny that comes in, how it is earned, how it is treated under both federal and state tax laws and how it is distributed is a full time job to say the least. Once a trust is funded, it generally does not act simply as a bank account simply holding the money for later distribution.

Often the money is invested in a diverse portfolio of stocks, bonds and other financial instruments. It is not uncommon for a trust to include ownership of real estate assets that produce income in the form of rent or mineral royalties or perhaps even intellectual property which can produce a different source of income. Whatever the source, most trusts are now subject to a 3.8% net investment income tax on any undistributed income that is not distributed to beneficiaries or given to charities. While this figure may be low it is a consideration that needs to be taken into account when determining whether to pay out certain monies to beneficiaries, from what source that money comes from, whether it is from principal, capital gains or dividends.

Any income generated via capital gains is still taxed at the capital gains rate, which is currently anywhere from 15% to 40% depending on the total amount of income and whether or not the investment is a short term or long term investment. Since whatever money is paid out from the trust is income to the beneficiary and the trustee must as a fiduciary for the beneficiary, this tax is a material consideration. Is it better to wait to pay out and continue to pay the overall 3.8% tax and wait for tax rates for the beneficiary to go down or pay now?

While such considerations play into whether or not to create a traditional trust to lower tax liabilities, it must be kept in mind that there may be better vehicles to transfer your wealth. Depending on the purpose for creating your trust it may be best to create a Roth IRA, a traditional IRA, an ABLE account or a 529 account, or any number of other types of accounts that allow for tax free growth. It is a multifaceted decision. It depends on whether there will be cash going into the account or trust versus an asset. It also depends on whether or not the asset or cash is intended to accomplish a specific goal, such as to serve as a financial safety net for perhaps a special needs child.

As with any complex decision, it is always best to talk to an expert. Speak with an experienced estate planning attorney to help what the best estate planning strategy is.  

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