Many Indiana adults include trusts in their estate plans to avoid probate, reduce federal estate taxes and ensure that their assets are distributed according to their wishes after they pass away. Trusts were once commonly used to divide income among several beneficiaries to avoid paying higher rates of tax. To prevent this and other forms of misuse, the Internal Revenue Service introduced what are called grantor trust rules.
Grantor trust rules
A grantor is the party that creates a trust and usually owns the assets that are placed into a trust. The IRS grantor trust rules apply when this party retains control of the assets in a trust and can make changes to the trust. The IRS considers all revocable trusts to be grantor trusts. The income generated by these trusts is taxed at the grantor’s personal tax rate even if it is divided among beneficiaries. Revocable trusts can be used to avoid the probate process, but they do not provide estate tax benefits.
Irrevocable trusts cannot be changed once they have been created, and they are taxed as a separate legal entity. However, this rarely provides any benefit because trusts pay the highest tax rate, which is currently 37%, after generating just $14,450 in income. An individual would have to earn $578,125 before they started paying this rate of tax. However, irrevocable trusts do provide estate tax benefits because the assets placed into them are no longer owned by the grantor.
Understanding the rules
Trusts have many uses in estate planning, but the structure of a trust determines what kind of benefits it provides. The IRS has strict rules in place to prevent trusts from being misused, and it is important to understand these rules before deciding what type of trust to use for any given purpose.