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I am tasked with setting up a trust or trust-like instrument for a relative. The bulk of the funds will be held about 15 years, until the beneficiary reaches a normal retirement age. The funds can be held in trust, but the tax rates are really unfavorable should the trust realize gains.

2018 Estate and Trust Income Tax Rates:

  • Not over $2,550 10% of taxable income
  • Over $2,550 but not over $9,150 $255 plus 24% of the excess over $2,550
  • Over $9,150 but not over $12,500 $1,839 plus 35% of the excess over $9,150
  • Over $12,500 $3,011.50 plus 37% of the excess over $12,500

The trust will be funded with an inheritance, so basis is not a problem. But the earnings will face the above high tax rates. Part of the inheritance available is in the form of an IRA. If gifted directly to the recipient, the lower personal rates would apply.

So the question is: is there any way to hold earnings away from misuse by a beneficiary, yet pass through the earnings for taxation at the more favorable personal tax rates?

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Is there going to be a custodian/manager of the trust or are you simply setting up the legal instrument itself? If the trust is being managed, you can work with the manager to structure the trust agreement language in a way that disbursements to a beneficiary are to be used for X, Y, and Z purposes alone. As far as tax rates go, the simplest way would be to disburse any income the trust receives to the beneficiary(ies).That way the income would be taxed at their personal ordinary rate and not at the egregious trust income tax rates.

The advantage of a living revocable trust is that you can transfer the trust income to the beneficiary without actually transferring them the funds. The IRS will require that the bene claim this income on their return (and pay taxes on it at the ordinary rate), but the money itself can still be held in the trust and the manager can disburse it as laid out in the trust agreement.

My advice is to ask an estate/probate attorney about your desired trust structure and see what they say. There may be some way you can write the trust agreement that allows you to act as the manager and thus you won't have to pay a bank or trust company to be an active manager.

Source: I work in the trust department at a large financial institution.

  • I will have access to a trust attorney and a professional fiduciary, and will set up a family steering committee to adjust the written guidance over time. The settlor is much older than the beneficiary. – Bryce May 2 '18 at 20:16
  • The individual exists on a cash basis, and can't be counted on to file correct tax returns. – Bryce May 2 '18 at 20:17

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