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Trusts (continued - p2 of 2)

Common Types of Trusts

A testamentary trust takes effect after death, whereas a living trust is created during the lifetime of a grantor(s). A revocable trust may be changed during the lifetime of a grantor(s), while an irrevocable trust cannot be changed, and is for tax purposes considered to be a separate entity. A simple trust has no charitable beneficiaries and is required to distribute all income from the trust corpus the same year it is earned. Only retained income is taxed to the trust, and because a simple trust is often considered a grantor trust (owned by the grantor), gains and income (including that from dividends and interest) are taxed, but the principal/corpus of a simple trust is not. A complex trust usually distributes some or all of trust corpus or income to a charitable beneficiary(ies), it may accumulate income and is entitled to a 642(c) charitable deduction. A trust which is permitted, but not required to distribute principal is a complex trust but only in years when principal is actually distributed. All trusts are complex in their final year, as all of the principal (corpus) must be distributed when trusts terminate. Charitable trusts can sell shares and if irrevocable, they can be perpetual (i.e., last up to 99 years, with a renewable status).

Grantor Trusts

Grantors can also be trustees or even beneficiaries, but if the grantor retains control over or receives benefits from a trust (for example, if the grantor is also beneficiary or the trust is revocable), the trust is considered a grantor trust and the grantor is held liable for taxes related to it. Grantor trusts are disregarded for tax purposes unless an adverse party such as spendthrift provisions, trustees or other beneficiaries must consent to the exercise of a grantor's benefits from or control over trust assets. By including spendthrift provisions in trust documents, beneficiaries and/or grantors that benefit from an irrevocable trust are not in control of income or assets transferred to or from the trust (so long as the grantor is not also trustee), so trust income and assets are not considered property of the grantor; therefore such trusts are not considered grantor trusts. If however, a trustee attempts to hold property for his or her own benefit, the transfer is usually treated as void and a fraudulent conveyance under most state laws.

Spendthrift Provisions

A spendthrift provision is often included in an irrevocable trust agreement to prevent beneficiaries from dissolving or disposing of trust income or assets as and when they see fit. This gives full authority and spending decisions to the trustee(s), who is bound by terms and conditions set forth in a trust agreement. A spendthrift provision can also be applied to trustees so they too cannot sell, exchange, invest or otherwise dispose of trust corpus. An irrevocable trust with a spendthrift provision can even remove land from the speculative real estate market by preventing the future sale or exchange of property, or its use as collateral on loans. This may result in a significant reduction of property taxes, but will also likely reduce real estate market values. Hence, this may only be useful if real estate is to be held by a private or public Community Land Trust, a charitable organization, or if you plan on keeping property in the family.