Part 2 of a 2-Part Series
Last week, we started a two-part series about a Non-Grantor trust. Click here to read part one of the series. This week, we conclude by examining the pros and cons of non-grantor trusts.
Why would a trust maker choose to create a nongrantor trust? A nongrantor trust has the following tax advantages:
The court does not tax the trust maker based on a non-grantor trust’s income
This helps the trust maker who does not want financial responsibility for the trust. For example, a trust maker may create a trust for an ex-spouse or children from a previous marriage. They may want to avoid paying future income taxes on the trust’s accounts or property.
What if the non-grantor trust beneficiaries’ tax positions are lower than the trust maker?
If the court distributes trust income to the beneficiaries, the income is taxed at the beneficiary’s lower income tax rate. This results in a lower tax burden than if it were taxed at the trust maker’s (or the trust’s) tax rate.
A Non-grantor Trust Workaround to Avoid the Current State and Local Taxes (SALT) Deduction Limit.
An annual itemized deduction is available for payment of state and local property, income, and sales taxes. This deduction cannot exceed $10,000, however. As a separate taxpayer, a nongrantor trust has its own SALT deduction, apart from the trust maker’s SALT deduction. A taxpayer could divide ownership of real property among one or more nongrantor trusts to maximize potential tax savings.
A Non-grantor Trust can Maximize the Qualified Business Income (QBI) Deduction.
The QBI deduction allows eligible business owners to deduct the lesser of 20 percent of their qualified business income. On the other hand, they can deduct 20 percent of taxable income (more than net capital gains if their income is below the allowed threshold.) If a trust maker’s income exceeds the limits to qualify for the QBI deduction, they could divide the ownership of their business assets and income. They would distribute it among one or more nongrantor trusts (as separate taxpaying entities). This would qualify for the QBI deduction. this strategy, consider which portion of the trust’s income is composed of capital gains. What’s more, ensure that the trust remains within the same income threshold to qualify for the QBI deduction.
Downsides of a Nongrantor Trust
There are some disadvantages to nongrantor trusts. First, remember that to qualify as a nongrantor trust, the trust maker must give up all power over the trust and have no right to any of the trust’s accounts or property. Some trust makers are uncomfortable with giving up control over what happens to the trust and its accounts and property. In addition, because the trust maker and the nongrantor trust are separate taxpaying entities, then certain transactions, including the movement of accounts, property, or income between the trust maker and the trust, are taxable events. For example, if the trust maker purchases property from a nongrantor trust that has increased in value, then the trust would have to pay tax on the gain. If, however, the trust was a grantor trust, then no gain would be realized.
While a nongrantor trust can be beneficial in certain circumstances, there are also some drawbacks to using a nongrantor trust. Qualified estate planning attorneys like us can help you determine whether a nongrantor trust is right for your estate planning and tax situation. To learn more, call us to schedule your appointment.
About Skvarna Law Firm in Glendora and Upland, California
A skilled attorney can assist with your estate plan. Contact us today to learn about your options (909) 608-7671. We operate offices in Glendora and Upland, California. We provide legal services for individuals living in San Bernardino, Los Angeles, Orange, and Riverside Counties. This includes the cities of Upland, Ontario, Rancho Cucamonga, Fontana, Colton, Rialto, Chino, Chino Hills, Glendora, Claremont, Montclair, Pomona, La Verne, San Dimas, Azusa, Covina, West Covina, Diamond Bar, Walnut, La Puente, Corona, Norco & Mira Loma. Visit SkvarnaLaw.com to learn more.
