Irrevocable trusts cannot be revoked or modified by the settlor after they have been established. By adding a second degree of separation from wealth holder (not only are the assets no longer owned by the wealth holder, but they also cannot be reclaimed), irrevocable trusts are stronger protectors of assets than their revocable counterparts. As well, transfers to irrevocable trusts constitute a gift for gift tax purposes.
Beneficial interest: The profit, distribution, or other benefit of a contract or, in this case, a trust.
Power of appointment: The power to assign trust corpus (the body of assets within the trust) to certain persons.
For example, if the settlor is entitled to income from a trust, the settlor’s creditors can usually reach that income, even if the trust instrument contains a clause stating otherwise. Where the settlor also retains an unlimited power of appointment—that is, the settlor can reassign trust corpus at his discretion—creditors can reach the entire corpus.
Unlimited power of appointment
Irrevocable trusts provide the greatest benefit to settlors who retain the least control over and interest in the transferred property; that is, the assets are best protected if settlors have no power of appointment and no beneficial interest. They provide the least protection to those who retain the most control and interest. In other words, irrevocable trusts are the least effective when the settlors have unlimited power of appointment and much beneficial interest.
However, to account for the settlor’s future possible impoverishment while still providing asset protection, the trust deed could provide that the trustee may at his discretion make a distribution to the settlor.
Last year, Alan created the AW Trust, this time an irrevocable trust that serves as part of his overall asset protection plan. This trust was designed for Alan to take interest income for life, giving a special power of appointment to his children: Stan, Shelly, and Jonathan.
The trustee, Marcus, was given discretionary power to distribute the trust corpus to the three children, but the trust deed prohibited him from distributing any money from the trust to satisfy creditors of Alan.
When Alan injures Brett in an auto accident, Brett is awarded a $10,000,000 settlement. Alan’s insurance covers $5,000,000 of the judgment, leaving Alan’s creditor, Brett, unpaid to the tune of $5,000,000. However, Brett cannot legally access any of the corpus of the trust, which is protected for Stan, Shelly, and Jonathan. Instead, Brett is able to access only the interest income that is paid to Alan from the AW Trust.
Though transfers to irrevocable trusts constitute a gift for gift tax purposes, an irrevocable “granto
trust” will be taxed to the settlor as if she earned the income herself, regardless of whether the trust instruments gives her any entitlement to that income. Grantor trusts exist in the following situations:
1) The settlor or the settlor’s spouse has more than a 5 percent interest in the trust corpus or income.
2) The settlor retains the power to control the distribution of the trust without the consent of a non-adverse party, with certain exceptions.
3) The settlor, the settlor’s spouse, or any other non-adverse person holds certain administrative powers.
4) The trust’s income is or may be distributed to the settlor or the settlor’s spouse, or used to pay their life insurance policy premiums, without an adverse party’s consent, with certain exceptions.
5) The trust is a foreign trust, which has or could have a direct or indirect beneficiary who is a U.S. citizen or resident alien. (This rule has several exceptions, including an exception for transfers of property to foreign trusts for an exchange of value.)
A decedent’s gross estate will include the value of the property transferred to an irrevocable trust if:
1) The trust deed provides that the decedent (also the settlor) reserved the right to use, possess, or enjoy the property;
2) The trust deed provides that the decedent reserved the right to receive the income from the property; or
3) The trust deed provides that the decedent reserved the right, either alone or in conjunction with another, to designate the persons who should possess or enjoy the property or the income.
The estate will also include trust corpus if
· The trust deed discharges the settlor’s legal obligations to another;
· A reciprocal trust arrangement is found to exist;
· State law requires the trustee of a discretionary trust to apply income from the trust to discharge the settlor’s debts;
· A prearranged collateral agreement requires an irrevocable, discretionary trust to be distributed to the settlor;
· The beneficiary can only be vested in his trust interest by surviving the settlor or by the expiration of a term of years;
· The settlor retains a reversionary interest worth more than 5 percent of the value of the property immediately before the settler’s death; or
Trusts without spendthrift clauses
May allow distributions to the beneficiaries’ creditors
Trusts with spendthrift clauses
Prevent distributions to the beneficiaries’ creditors
The settlor retained a right to alter, amend, revoke or terminate or effect beneficial enjoyment, either alone or in conjunction with another, or where the settlor had such power but relinquished it in anticipation of death, with some exceptions.
For the purposes of wealth protection, irrevocable trusts are the first line of defense for a client. If you cannot access the asset, the creditor most likely will be unable to access the asset either. A great deal of care needs to be taken to ensure the trust is designed to maximize the benefits of protecting wealth and can be useful to minimize estate taxes
Spendthrift trusts are intended to protect trust assets from beneficiaries’ creditors. Trusts written with spendthrift provision language provide that beneficiaries cannot transfer or assign their beneficial interest and that creditors cannot seize the beneficiaries’ future interests to satisfy claims.
Spendthrift trust deed specifying that…
Distributions are made directly to beneficiary
Creditor seizes distribution
Spendthrift trust deed specifying that….
Trust distributes can be made on behalf of beneficiary to pay mortgage, health insurance premiums, college tuition, and other bills
No distribution for creditor to seize
A spendthrift trust does not protect distributions already made to a beneficiary; once the money has been given to a person, this distribution is as accessible as any other funds found within a personal savings or checking account. Therefore, smart spendthrift agreements provide that the trustee can distribute funds on behalf of the beneficiary. For instance, a trustee could pay the beneficiary’s mortgage payment on his behalf, circumventing a direct distribution to the beneficiary and avoiding the creditor’s reach.
Assume Alan Whitmore establishes a trust with a valid spendthrift provision for the benefit of his children. Each year the trust distributes $100,000 to Jonathan, Shelly, and Stan.
This time, Jonathan runs a light and hits Brett’s car, injuring Brett. Brett successfully wins a $1,000,000 judgment. Brett is unable to access the trust for any money owed by Jonathan and is only able to access the $100,000 distributions paid to Jonathan.
Let’s suppose the spendthrift provision was drafted in such a way as to allow the trust to distribute income either: 1) To the children, or 2) on the children’s behalf. Upon Brett’s successful lawsuit, the trustee could pay $100,000 toward Jonathan’s mortgage, credit cards, auto payments, and the like instead of making distributions directly to Jonathan. Brett could not reach any of the distributions paid on Jonathan’s behalf, obviously much more favorable than paying the distribution directly to Jonathan and subjecting those distributions to his creditors.
As the name implies, discretionary trusts leave distributions to the discretion of the trustee. Beneficiaries have no right to trust income or principal, and the trustee can withhold distributions at his or her discretion. The beneficiary’s only remedy against the trustee is if it can be shown that the trustee abused her discretion.
Discretionary trusts become useful when clients live in jurisdictions that do not recognize spendthrift trusts. Like a spendthrift trust, they keep creditors from seizing a beneficiary’s interest, and they prevent beneficiaries from assigning their interest to a creditor. As with spendthrift trusts, once funds have been deposited into a beneficiary’s personal accounts, they can be reached by creditors.
Alan Whitmore’s son, Jonathan, lives in a state without valid spendthrift provisions, so Jonathan sets up a discretionary trust for the benefit of his daughter, Julia. He assigns Marcus as the trustee of the trust. The trust is drafted to include language that says the trustee may at his discretion distribute money to the beneficiary. Each year Marcus distributes $100,000 to Julia. When Julia becomes an adult, she becomes a drug addict, eventually hitting another driver while under the influence of drugs and alcohol. Though both drivers live, the driver of the other car is awarded a $1,000,000 judgment.
As in the above example, the trustee has to have complete discretion over how, when, and what form distributions are made. To maintain complete protection, the trustee must have all control. This means that trustees do not have to distribute money to the beneficiary.
Assume all of the facts are the same as in the previous case study, but with one seemingly tiny change. In an attempt to guarantee his daughter will benefit from trust, Jonathan asked his attorney to include language in the trust deed that dictates that the trust is to provide money at the discretion of the trustee, but also to provide money to Julia for her health, education, maintenance, and support. Because distribution of the trust is no longer at the discretion of the trustee—that is, its language includes directions to the trustee on use of the funds—Julia’s creditor can now gain access to the trust assets when she is awarded the $1,000,000 claim for the car accident initiated by Julia.
Mandatory support trusts require the trustee to provide income or principal as necessary for the education and support of its beneficiaries, but only to the extent required to achieve those ends and only to the extent that trust distributions can accomplish such goal. Because the trustee can only make distributions commensurate with those goals, neither creditors nor the beneficiary’s assignees can reach the beneficiary’s interest, even where the trust is not a spendthrift trust or in states that do not enforce spendthrift provisions. These are commonly used in jurisdictions where no valid spendthrift provision exists.
If the trust requires distribution of a fixed amount or fixed percentage, it will not be considered a true support trust, and the assets may be reached by creditors unless it contains a valid spendthrift provision. In other words, if the trust requires distribution of $100,000 annually, it will be ineffective. A trust that requires distribution of monies equal to the cost of the beneficiary’s health, education, maintenance, and support will be considered a true support trust.
Deborah, Alan Whitmore’s first wife, lives in a state without a valid spendthrift provision. She wants to provide for her granddaughter, Julia. Because Deborah lives in a state that does not allow spendthrift language, she creates a support trust that will provide for Julia’s health, education, maintenance, and support. Because the distribution amounts are commensurate with Julia’s support-related costs, the assets are protected from Julia’s creditors.
When the driver Julia hits while under the influence of drugs and alcohol is awarded a $1,000,000 judgment, the trust is protected as its funds are to be used directly for support-related expenses.
Charitable remainder trusts (“CRTs”) provide for specified distributions at least annually to one or more beneficiaries, one of which must not be a charity, for life or for a term of years not exceeding twenty years, with an irrevocable remainder interest to a charity.
To provide for the contingency that the chosen charity might not qualify when the life/term expires, the trust instrument may allow the settlor to choose another qualified charity.
To qualify as a CRT, the trust must be:
· Established so that the settlor cannot retain a power to invade, alter, amend, or revoke (except to revoke or terminate the life/term interest of a noncharitable beneficiary).
· Establish that although the settlor may serve as the trustee of his own CRT, he cannot retain the power to remove, substitute, or add trustees. Both institutional trustees and the charitable remainder beneficiary may serve as the trustee.
The tax consequences of CRTs extend to include the settlor, beneficiary, and the trust itself.
Alan Whitmore owns a property valued is $1,000,000. Alan establishes a Charitable Remainder Trust where he transfers the property to the trust. The trust sells the property for $1,000,000, meaning the trust now has $1,000,000.
Alan is the beneficiary of the trust and will receive 5 percent of the corpus (or $50,000) each year. At the end of the 20 years, the remainder goes to a qualified charity of his choice. The result of this transaction is that Alan has:
1) Protected the proceeds of the sale from creditors;
2) Received a charitable deduction for tax purposes
of $339,740; and
3) Achieved this with no gift or estate tax on the
Let’s also consider that Josephine Whitmore, wife of Jonathan, owns a corporation. This sole asset constitutes the bulk of her estate, and she wants to diversify. If she sells the corporation, the funds available to purchase diversified portfolio will be reduced by the capital gains tax she pays on the sale of the corporation. Instead, Josephine donates the corporation to a CRT, retaining a 5 percent payout for 20 years with the remainder to go to her favorite charity.
Josephine receives an income tax charitable contribution deduction in the year of the transfer. The CRT sells the stock without having to pay any capital gains tax, because it is exempt, and invests in a diversified portfolio worth the same amount as the corporation. Josephine receives an income stream annually from that portfolio, on which she will pay taxes.
Qualified Personal Residence Trusts
1) The QPRT must hold only the term holder’s principal residence, another residence owned by the term holder, or an undivided fractional interest in one of the homes.
2) The residence must be used primarily as the term-holder’s residence when she occupies it. This does not prohibit trade activities in the house (other than hotel-type services) so long as they are secondary to its use as a residence.
3) The QPRT must be required to distribute, at least annually, any trust income to the term holder.
4) The QPRT must prohibit corpus distributions to any beneficiary other than the settlor before the retained term of years expires.
5) The QPRT must not hold cash greater than certain amounts allowed to cover trust expenses, to improve the residence, to buy the residence in the first place, or to buy a replacement residence.
6) The QPRT must prohibit prepayment (commutation) of the term holder’s interest.
7) The QPRT must terminate the trust if the settlor stops using the residence as her personal residence.
8) The QPRT must be required to dispose of trust assets in a specified manner when the settlor stops using the residence as her personal residence.
9) The QPRT must prohibit the resale of the house to the settlor or his or her spouse.
Alan decides to form a QPRT and transfer his primary residence into the trust. The value of the home at the time of transfer is $1,000,000. Alan lives in a state where the homestead exemption is $7,500. The QPRT is designed to hold the home for ten years or until Alan’s death, whichever occurs first. At that time, the QPRT would terminate and the property would transfer to his children.
When the home is transferred to the trust, the assumed value of the home for gift tax purposes is $610,000. He uses his unified credit to offset gift taxes, so no taxes are due.
Transfers the home to the trust
Retains the right to live in the home for 10 years
Home transfers to the children at the end of the QPRT term
QPRTs are useful in long-term asset protection planning because they allow a person to transfer a home to heirs while still using the home and while removing it from the reach of creditors.
Foreign Asset Protection Trusts
As we discussed earlier, fraudulent conveyance to protect assets from a pending judgment is illegal, dangerous, and should never be considered as a strategy for wealth protection and risk management. Instead, fraudulent conveyance should be a risk that your protection plan eliminates entirely. To avoid the appearance to suggesting anything illegal or morally questionable, we will hereinafter use the term “foreign asset protection trusts” (or FAPT) when addressing offshore trusts used to protect your wealth from risks.
After the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 foreign asset protection trusts became much more attractive. If properly structured, a FAPT will provide asset protection unrivaled by any other vehicle. Generally FAPTs are better for the following reasons:
1. No foreign jurisdiction anywhere in the world will automatically recognize judgment creditors from the
United States. Instead, judgment creditors must re-litigate their cases in the jurisdiction that houses the trust. Unlike the rules of a basic trust, this would force creditors to travel to a foreign jurisdiction.
2. Most foreign jurisdictions prohibit contingency fee arrangements. Whereas the litigator of a creditor suing a domestic trust can be paid based on outcome, a plaintiff of a foreign trust must pay upfront for the entire litigation. This requirement might stop some creditors from pursuing a lawsuit.
3. Foreign jurisdictions often (if not always) require legal counsel to be licensed in the jurisdiction of re-litigation. This adds time and expense to the process because of the time and expense in retaining local counsel.
4. The judicial systems of foreign jurisdictions look favorably toward trust defendants and unfavorably towards plaintiffs. Foreign jurisdictions require a higher level of proof in a civil case outside of the United States. Many jurisdictions require proof that is beyond a reasonable doubt.
5. In many jurisdictions, filing a lawsuit against a trust that has been in existence after a statute of limitations is illegal. The statute of limitations varies from domicile to domicile. For example, Nevis bans challenges to trust assets that have been in existence longer than one year.
6. If able to bring a suit against a trust, plaintiffs often are required to post a cash bond to bring the lawsuit. The bond must cover the cost of the court and the cost of the plaintiffs’ legal bills. If the plaintiffs are unsuccessful in the lawsuit, they will have to pay the defendant’s attorney’s fees as well as the court’s costs.
7. Many offshore jurisdictions allow the trust to be re-domiciled in their jurisdiction without having to re-satisfy the statute of limitations, thus causing more headaches for the plaintiff. If a plaintiff is successful in filing a lawsuit in Nevis, the trust could be “flown” to the Cook Islands, causing the plaintiff to chase the assets there.
· Are useful in estate planning.
· Allow a settlor to “complete” the gift for taxation purposes while still being the beneficiary of the trust, which is difficult (if not impossible) to achieve domestically.
· Can be used to invest in, or own outright foreign investments.
· Are useful in premarital planning
· Offer charging order protection similar to that offered by some domestic LLCs and LPs. Some foreign asset protection trusts ban creditors from seizing or voting a beneficiary’s interest. The creditor can only benefit from its charging order if distributions are made.
In 2005, Jonathan Whitmore assessed his risk liabilities, realizing he has a high vulnerability to litigation. At the time, his net worth was $20 million, which included a business valued at $3 million, a home worth $2 million (that carried a $1.8 million mortgage), and cash and other securities valued at $15 million.
His team of advisors counseled Jonathan to create a foreign asset protection trust (FAPT) in
Nevis. His advisors recommended he move $12 million of his liquid assets to the FAPT. Nevis governs the administration and interpretation of all of laws regarding the FAPT, which works in Jonathan’s favor when he loses a $15 million lawsuit a few years late
Cash & Securities valued at $12 million inside of the FAPT
Cash & Securities valued at $3 million left easy to reach
Corporation run formally valued at $3 million.
The creditor was not interested in reaching the home; after foreclosure, it would have been worth only the $200,000 in equity. Jonathan’s business structures were top-notch, so the creditors could not touch the corporate veil. As a result, Jonathan’s creditors had to settle for the $3 million intentionally left “easy to reach.”
Feeling slighted, the creditor flew to
Nevis to seek justice in the foreign courts. She quickly learned that she must re-litigate her claim in the local courts. She contacts a few attorneys who refuse to take her case because they know Nevis’s laws will not construe trust assets as a fraudulent conveyance. The attorneys inform the creditor that even if she could file a lawsuit to enforce the judgment, the trust includes a provision that would allow the trust assets to be transferred to another jurisdiction where she would have to start the process all over again. This leaves her with few options but to return the United States ‘hat in hand.’
Nevis as just one of the many valid jurisdictions to use. Appendix A lists various domiciles and the similarities and differences between them.
Let’s take a look at an example:
Domestic Limited Partnership
Foreign Asset Protection Trust
In this case, the Limited Partnership’s general partners are a husband and wife; the limited partner is an offshore irrevocable trust that has the strongest possible protection from creditor attacks. We use the partnership to separate the ownership from control. The foreign trust is the majority owner of the assets, but the 1 percent general partner of the Limited Partnership controls the assets. Since the general partner controls the partnership, the foreign trustee has no control, is disenfranchised and left without power.
United States inside the limited partnership. If created while financial seas are calm, the trust avoids the appearance of fraudulent conveyance. A domestic bank account will hold and invest the money, but a small amount of assets should be placed within a safe bank in the domicile of the foreign trust. It should be in a bank with no U.S. affiliations to prevent an overzealous judge from forcing the U.S. branch to re-domesticate the money to the United States.
 Before this happens, the limited partnership will be liquidated, moving most of the assets into the trust. Because civil litigation often takes years, most defendants have months or even years after the hint of duress to plan this move. And remember that no country in the world will enforce a judgment of a U.S. court in matters dealing with a civil tax matter.
U.S. co-trustees. The powers of the protector now become critically important, and the husband and wife would hire a professional protector skilled in international litigation to co-sign as protector of the trust.
The term “grantor” refers to the person who created the trust and pays its taxes.
 Someone other than the settlor may be treated as the settlor if that person holds a power, exercisable alone, to demand distribution of the trust corpus or income. If both the settlor and a third person hold powers that trigger grantor trust rules, only the settlor must pay taxes on the trust assets.
 If the settlor dies during the term of years, the estate must include the full value of the transferred residence. However, the settlor is no worse off, except for transaction costs, than had she not created the QPRT because she gets credit for any gift tax previously imposed.
 Note that this is not true if the creditor/plaintiff is a government agency, in which case it will likely seize assets first and ask questions later. Unfortunately, not a lot can be done about litigation from the government, or activist judges who will be are granting more and more prejudgment attachments of assets that allow a governmental agency to seize assets before the defendant is even served papers.
This structure creates a safeguard whereby the protectors’ duties cannot be abused since the husband/wife team remains a co-protector, and the legal expertise of the professional protector encourage creditors to abandon the pursuit of protected assets. With the appropriate structures and good advisors, the foreign protected liquid assets are virtually impossible to reach, and creditors will instead by forced to settle for the 1 percent easy-to-reach assets distributed to the husband and wife.
The husband and wife then resign as the
The process looks like this: After a creditor armed with a judgment attacks the limited partnership in a local court, the defendant (in this case, the Limited Partnership with the husband and wife acting as 1 percent general partners) terminates the LP, distributing 99 percent of the assets to the limited partner, the FAPT that owns 99 percent of the businss. The remaining 1 percent is distributed to the general partner (husband and wife).
In normal civil cases, assets will not be in jeopardy without litigation. A creditor must sue and obtain a judgment before it can tie up assets.
When the seas are calm, the duties of the protector go largely unutilized, and it is appropriate for the husband or wife to serve as protector. However, if a creditor attack is imminent, the process changes.
This foreign trust has a trust protector. As explained earlier, trust protectors are not found in the American legal system, but foreign trusts have a trust protector to monitor and police the trustee. Many of the decisions that could impact the trust in any material fashion must be approved by the protector. The protector also has unilateral and uninhibited power to remove a trustee, appoint a new trustee, appoint a new protector, or resign.
The husband and wife are also the co-trustees of the foreign trust with a professional trustee in the jurisdiction. Since they established the account, they have 100 percent control over the little amount of money that is put in the foreign bank.
When there is no imminent danger of creditor attack, the assets stay in the
Many foreign jurisdictions are suitable to serve as the jurisdiction for a trust. The above example uses
Home, valued at $2 million, but with only $200,000 of equity
Jonathan’s Assets When Judgment Was Issued
If a creditor did decide to file a lawsuit against a business owned in part by a foreign asset protection trust, let’s take a look at how it would play out.
Foreign trusts often have a trust protector, a concept foreign to the American legal system. The protector provides the backstop and safety for the foreign trust, and the protector can remove and appoint new trustees and usually has veto power over the trustee. The purpose of the protector is to monitor and police the trustee. Many of the decisions that could impact the trust in any material fashion must be approved by the protector. In addition the trust protector will have the unilateral and uninhibited power to remove a trustee, appoint a new trustee, appoint a new protector, and resign. The protector of the trust can be the settlor, trustee, or the beneficiary of the trust. In most cases, the duties of the protector go largely unused so when no lawsuits are eminent it is appropriate for you to serve as your own protector.
As well, FAPTs:
In other words, when trying to seize assets within an FAPT, plaintiffs must re-litigate the case using foreign counsel in the foreign jurisdiction, which generally has tougher standards of proof and requires payment in full in advance (as well as an expensive bond). The plaintiff must accomplish all of this within the first year or two of a trust’s formation or the case will not be heard.
Offshore planning is used by millions of Americans to protect trillions of legally earned and legitimate dollars.
The term “offshore banking” may conjure images of corrupt and greedy businessmen who earn their wealth by lying, cheating, and stealing, and therefore need foreign asset protection to keep the money sheltered from its rightful owners. But because many foreign jurisdictions have favorable tax, privacy, and asset protection laws, offshore planning is used by millions of Americans to protect trillions of legally earned and legitimate dollars. To be clear, offshore planning does not hide money, nor does it stop a person’s obligation to pay
A decade later, the home transfers to the children. The home’s value is now $2,000,000, which falls outside the value of the estate. Five years earlier, Alan was sued and has a judgment against him. His creditors cannot reach his home, only the value of his use of the home for five years. When the QPRT expires, the home passes to his children, thus protecting Alan’s personal residence.
The value of the transfer into the QPRT is the value of the residence minus the value of the retained right to live in that residence for the term of years specified. The resultant effect is that once the home is gifted to the beneficiary, its value is heavily discounted. Additionally, if the settlor survives the term of years for which she has retained a right to live in the residence, all appreciation that has accrued inures to the beneficiaries and is not included in the settlor’s estate.
QPRTs are grantor trusts, so the settlor pays income tax on trust income during the term of years. No part of the gift of the personal residence qualifies for the annual gift tax exclusion because it is a gift of a future interest.
QPRTs have interesting asset protection implications. Theoretically, the settlor’s creditors may reach her interest. However, that interest is limited to the right to reside in the home for a term of years. If the creditors tried to reach that interest, and the settlor ceased living in the house, the QPRT would cease to qualify. In such case, the trustee would either have to distribute trust assets outright to the term holder or convert the assets into a qualified annuity, either in the trustee’s discretion or as required by the trust instrument. It is generally preferable to require conversion into an annuity, as this will protect the remainder interest from creditors while only allowing the annuity interest to be reached. An outright distribution to the settlor in a jurisdiction with no homestead exemption would allow the residence to be reached in its entirety.
Nine requirements must be met before forming a QPRT:
Qualified personal residence trusts (QPRTs) provide asset protection for a home where alternative protections, such as homestead exemptions are not available. QPRTs are irrevocable trusts to which clients transfer their residence, while retaining the right to personally use the residence for a specified term of years. One or more beneficiaries are designated to receive the residence after the trust term ends.
The non-charitable life/term beneficiaries will pay taxes on their income distributions, and the trust itself is exempt from income tax except for years in which it has unrelated business taxable income or debt-financed income, in which case it will pay taxes that year as a complex trust. The CRT must file tax returns annually.
The CRT results in no gift tax consequences if only the settlor receives an income interest or if the CRT gives an income interest to the settlor’s spouse (qualifies for the gift tax marital deduction). However, if the CRT gives an income interest to someone other than the settlor’s wife, a gift tax is imposed, subject to the annual exclusion.
First, the settlor may claim a deduction for charitable contribution from his income tax for the year of the contribution to the CRT, based on the present value of the remainder interest going to the charity.
Charitable remainder trusts allow the settlor a charitable contribution deduction for income tax purposes for the year of the transfer of the property into the CRT. They may also provide the settlor with a gift or estate tax charitable contribution deduction. They provide the non-charitable life/term beneficiaries with a stream of income for the beneficiary’s life or for a term not to exceed twenty years. They allow the settlor to avoid taxable gain on the sale of appreciated property, and they can also reduce federal estate taxes without lowering the amount of assets transferred to the family when used with an irrevocable life insurance trust.
· Governed by a trustee who is free to invest the assets transferred into the CRT to realize reasonable annual income.
In jurisdictions where no valid spendthrift provision exists, support trusts can be used for the purpose of supporting family members’ health, education, maintenance, and support.
Let me repeat: Instructions as to the use of money in a discretionary trust cannot be included. When this language is included, which unfortunately happens more often expected, it invalidates the intended purpose of the trust.
Because funds are distributed at Marcus’s discretion, Marcus decides not to allow Jonathan’s hard-earned money to be used to support drug- or alcohol-related expenses. Fortunately, the discretionary trust prevents Julia from assigning her interest to a creditor. Coupled with Marcus’s ability to use discretion as to when and whether he will make distributions, this protects the trust funds from Julia’s irresponsible behavior.
For the trust terms to be valid, discretionary trust deed language must not contain any language stating or implying instructions concerning the trustee’s distribution decisions. Distributions under a discretionary trust are wholly at the trustee’s discretion, with no instruction allowed from the settlor or beneficiary.
Though extreme care must be taken in choosing a trustee, discretionary trusts have a heightened level of asset protection in that the beneficiaries cannot assign their interests and creditors cannot reach trust assets.