Tax Increases Hit Trusts Hard

While most of the tax increases in American Tax Relief Act of 2012 (ATRA) were meant to affect the wealthiest citizens in this country, the recent tax increases have hit trusts hard. The first tax was the Obamacare Surtax, which added a 3.8% tax on net investment income. Now, ATRA will increase the both the top income tax rate from 35% to 39.6% and the capital gains rate will increase from 15% to 20%. The problem that trust owners face is that top rate is applicable for all income that exceeds $11,950 instead of the $400,000 ATRA and $200,000 thresholds for individuals. The result is that the government will begin to tax those that it never intended to tax. So all trust, including the relatively small trusts, will likely have to pay the 23.8% capital gains tax on the money within the trust. This is more a nuance for wealthy clients, but could become a major problem for middle class people who have trusts in place as part of their basic estate planning documents. Those who use bypass trusts, marital trusts, or even special needs trusts for estate planning purposes will likely be more at risk. 

Times like these will be particularly difficult for the trustees of trusts. It is their time to decide whether or not to release more funds to current generations of beneficiaries or to hold on to trusts assets for future generations and pay the higher tax. If a trustee is considering making more distributions to the beneficiaries of their trusts, it is important to note that IRS is allowing a 65-day grace period to make distributions. If a distribution is made within that period, the distribution will be treated as if the distribution was made in 2012 when the tax rates were more favorable. Still, the basic questions that every trustee is probably asking is “how much income is to be distributed, who are the beneficiaries and their tax rates and what are their needs?” These questions can only be truly answered by the trustee because every situation will be different. It might even be feasible under some circumstances to dissolve a trust entirely for tax purposes. It is times at these that remind us that flexibility is a key to trust making. You will never know when it might become feasible to terminate a trust.

See Ashlea Ebeling, Tax Hikes Hit Trusts Hard, Beneficiaries Pull Money Out, Forbes, Jan. 9, 2013.

Special thanks to Brian Cohan (Attorney at Law, Law Offices of Brian J. Cohan, P.C.) for bringing this article to my attention.