A living trust is the ideal estate planning tool for a wide range of different people. We are going to look at the tax implications in this post. Before we get there, however, we will explain some of the benefits living trusts provide.
Simplified Estate Administration
Many people think the estate administration process is very simple when you use a will. They also believe trusts are extremely complicated. In reality, nothing could be further from the truth.
If you use a will, you name an executor in the document to serve as the administrator. This individual would not be able to act independently without supervision.
The will would be admitted to probate, and the probate court would preside over the proceeding. This would involve a process called proving of the will. This process involves an examination of the document to determine its validity. Creditors are notified to ensure final debts are paid. Creditors are given time to submit a claim.
During this process, the executor will identify and inventory the assets and prepare them for distribution to the heirs. This can involve appraisals and liquidation of property. It can sometimes be a lengthy process.
All things considered, it will usually take between eight and 18 months for probate to run its course. Inheritances are not being distributed during probate. Expenses are continuing to accumulate while the clock is running.
A living trust creates an entirely different dynamic. During the administration of the trust, the trustee can distribute assets outside of probate. As a result, all of these negatives never enter the picture.
Ongoing Control and Flexibility
If you establish a living trust, you would act as the trustee while you are alive. You would maintain ongoing control of your assets. If you want to change the terms, you can do so at any time. You can even revoke the trust while you are living.
Asset Protection for the Beneficiaries
You can include a spendthrift provision when you establish a revocable living trust. After your passing, the trust would become irrevocable.
The trustee would control the purse strings in accordance with your wishes. Beneficiaries would not have direct access to the assets. Therefore, the inheritance would be out of the reach of the beneficiary. This same dynamic would apply to the beneficiary’s creditors.
Assets distributes to the beneficiaries would be available to creditors. To account for this, and to limit the beneficiary’s ability to spend too freely, you can instruct the trustee to provide limited distributions on an ongoing basis.
Taxes on Distributions
Now that we have provided a general overview, we can get to the specific point of this post. The principal in your trust at the time of your passing, are assets you paid taxes on throughout your life. If distributions of the principal were taxed, it would be double taxation.
This would not be fair. Therefore, distributions of the principal are not reported as income. However, distributed interest earnings would be taxable to the beneficiary. The trust would also be required to pay taxes on undistributed appreciation.
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