- 1 Dynasty Trusts Can be Effective Estate Tax Planning Tools
- 2 What is a Dynasty Trust?
- 3 Basic Dynasty Trust Concept 101
- 4 Income Tax in a Dynasty Trust is Still Taxable
- 5 But a Dynasty Trust is An Effective Estate Tax Planning Tool
- 6 Are Dynasty Trusts Irrevocable or Revocable?
- 7 Negatives to a Dynasty Trust
- 8 Golding & Golding: About Our International Tax Law Firm
Dynasty Trusts Can be Effective Estate Tax Planning Tools
Dynasty Trusts can be Powerful Estate Planning Tools: Today we are going to sidestep a bit from international tax specifically — and discuss Dynasty Trusts — since that is a common question we receive from high-net worth taxpayers with global assets — and there are many tax misconceptions involving the Dynasty Trust. Sure, they can be a great estate tax planning tool (but not of course without limitations) — but estate tax and income tax are not same thing. From an income tax perspective, the most important thing to remember about a Dynasty Trust is that it does not exempt the assets within the trust from income tax — and the assets become immobile. Oftentimes, US Taxpayers with international assets and overseas accounts turn to estate planning in order to try to minimize tax liabilities for future generations. And, depending on which state the taxpayer either resides in or has property in — there are various different types of trusts that the taxpayer may use to protect or shield their assets — and facilitate generational wealth. What makes the dynasty trust one of the more preferred types of planning tools is that it can last for a significant amount of time — so that it can help protect future generations. But, it is an irrevocable trust with rigid requirements and income tax implications. Let’s take a look at the Dynasty Trust:
What is a Dynasty Trust?
A dynasty trust is a preferred estate planning tool for taxpayers who have significant wealth and expect that wealth to compound in value overtime — and over multiple generations. The main benefit of the dynasty trust is the idea of paying taxes now at the time the asset(s) are contributed into the trust, in order to limit or minimize potential estate tax implications down the line for future generations. In California, these trusts can last for many decades — in accordance with the uniform statutory rule against perpetuities (USRAP).
Basic Dynasty Trust Concept 101
Taxpayer contributes assets to the trust “now” with an immediate tax implication based on the value of the contribution. Then with each new generation who inherits — there is no additional estate tax on the increased value of the assets. Conversely, in the all-too-common scenario, a parent leaves a significant amount of money to a child — beyond the exemption amount — outside of the trust, which is then taxed at the death of the parent. Thereafter, the value of the inherited estate grows significantly and fast-forward down the line and then when the adult child passes away, that same money is going to be taxed again — which can be minimized or avoided with a dynasty trust.
Income Tax in a Dynasty Trust is Still Taxable
The income that is generated by the assets within the dynasty trust is still taxable in the present dat. This is a very important point, because some Taxpayers are under the misimpression that by simply tossing their assets into a dynasty trust, that they are no longer subject to any tax — but this is not the case. This is why it is important to evaluate the different assets before placing them into the trust so that the taxpayer gets the best bang for the buck for the specific assets placed into the trust. If you are in California, you should speak with a Board-Certified Estate Planning Specialist.
But a Dynasty Trust is An Effective Estate Tax Planning Tool
The main concept of the dynasty trust is to pay tax now on contributions into the trust in order to avoid estate taxation at a later date after the asset has (hopefully) increased in value. As with any good tax planning tool, there are tax limitations which should be considered before just jumping in and forming a dynasty trust in hopes of avoiding tax in perpetuity (read: it doesn’t work that way). Otherwise, if you happen to put in assets into the Dynasty trust that generate annual income (and may compound as the value of the assets increase) you may be in for a big tax surprise — when you thought that anything mixed into the dynasty trust part was simply not taxable again.
Are Dynasty Trusts Irrevocable or Revocable?
Since dynasty trusts are irrevocable, once they become established there are rigid rules limiting what can be done to modify the trust after it has been created. Dynasty trusts can sometimes be modified (or have specific trustee powers implemented) so that the income generated within the trust is treated as a grantor trust — which should not impact the estate tax benefits.
Negatives to a Dynasty Trust
There are some negatives with the Dynasty Trust, including:
Minimal Control over the Asset
The intended recipients of the trust benefits are limited in their ability to control what happens to the asset. At the time the trust is created (as with most parents) the concern is leaving a mound of cash to their children, unrestricted — which may be too much of a responsibility at the time the children inherit it, even for the most responsible child. But down the line, these same children who are now (responsible) adults with their own family — and will be limited in what they can do with the asset.
Change of Heart?
The trust is irrevocable, so once the trusts are placed into the dynasty trust, for all intents and purposes — there is not much that can be done in modifying the trust asset (although decanting may be an option in some states). Of course with proper planning, Taxpayers may be able to create or carve-out certain limitations or exemptions from the outset.
Pick a Very Good Trustee
The Trustee is the person in charge of overseeing the trust. Therefore, Taxpayers should designate a significant amount of time and thought into who they believe would be the best person(s) to oversee their dynasty trust wealth for generations to come.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
Contact our firm for assistance.