Trust Funding – Overlooked At One’s Own Peril

As an Estate Planner I often answer questions about the Mechanics of Trust Funding:

Some important concepts include:

  • Only Assets owned by or related to the Trust are controlled by the Trust Terms;
  • Common Trust funding Assets include: Real Estate, Bank Accounts, Brokerages, Business Shares, Intellectual Property, and Personal Items;
  • Common Assets to Relate to Trust include: Retirement Accounts (Pension, 401(K), IRAs) and Life Insurance.
  • The Schedule of Trust Assets is an important Information Sheet (usually at the back of the Trust Instrument);
  • Without the Schedule, an asset could become lost due to the Trust Beneficiaries being unaware of its existence;
  • A General Note of Assignment is used to transfer miscellaneous house objects and personal effects to the Trust;
  • Real Estate is transferred by retitling the Deed  into the name of the Trust and preparing Tax Forms.
  • Bank Accounts and Traditional Brokerages can be retitled into the name of the Trust;
  • Retirement Accounts, including IRAs, and Life Insurance, can rely on Beneficiary Designation. You can relate these to the Trust by naming the Trust as a beneficiary, often as a contingent beneficiary;
  • Beneficiary Designations may be inadequate as you cannot list or name a “Beneficiary Class”, i.e. a category of relatives, or your bloodline and heirs- at-law.

If an Asset is not owned or related to the Trust it will be handled outside of the Trust terms. Avoid having an Asset without a succession or inheritance mechanism. If no mechanism in place, it can be owned or related to the Trust, which avoids having to hire a lawyer to assist in its post death collection.

One often overlooked nuance is that you may want to relate tax deductions from the cost of the Tax Administration to taxable income. This means all taxable assets need to flow into the Trust directly (instead of listing an individual’s name in the beneficiary designation, meaning the income goes directly to the individual’s separate tax liability.)

Excess tax deductions from the Trust Administration, at its termination, can be carried over to the individual’s tax return and be claimed over time. This is not as ideal as direct offsets all within the trust.

Dislclaimer

Gift Tax: Advantage of Foreign Investment in U.S. Stocks and Bonds

One of the foreign investor’s favorite investments is U.S. real estate. However, from a tax planning perspective there are other asset categories to consider.

In the U.S. the “estate tax” refers to taxation upon death. The “gift tax” means transfer tax, and applies to gifts made while alive.

From a gift tax perspective, intangible assets such as U.S. stocks and bonds are a preferred asset.

In the U.S. the gift tax only applies to real property and tangible property. It does not apply to intangible property.

The advantage for a Non-Resident Alien (“NRA”) acquiring stocks and bonds is that it can be gifted to anyone, including other NRAs, family, or U.S. residents, all without incurring any U.S. tax liability. There may however still be a tax reporting requirement.

There is also an opportunity to avoid U.S. estate (“death”) taxation for the NRA. As long as the NRA investor holding the intangible property has advance notice and awareness of his or her failing health, he or she can gift the asset to the preferred recipient.

The NRA can also take precaution for a sudden or unexpected death. The most common solutions include life insurance and an Estate Plan, such as a Trust.

Disclaimer 

San Francisco Bay Area Housing Supply to Remain Low For Foreseeable Future

If you were already discouraged by low housing inventory and supply in the San Francisco Bay Area, there is little reason to hope that it will improve for the foreseeable future.

Some factors include:

  • The two percent (2%) per annum Proposition 13 tax cap that encourages long term holding of California Real Estate;
  • New Federal Tax Law limiting mortgage deduction to $750,000, but grandfathering in pre-existing home owners $1,000,000 mortgage deduction;
  • New Federal Tax Law limiting State and Municipal real property tax deduction to $10,000 per year;
  • Rising Interest Rates making mortgage financing more expensive.

Other factors influencing selling v. holding include suitability as rental property and estate planning desire to pass on the real property “in kind” to your children who may inherit the pre-existing lower tax base.

In summation, why sell your home, if buying another home in the same area will significantly increase your financing costs and taxes.

Disclaimer

 

Benefits of Establishing a Business Entity Just Got Better

With the recent passage of the Tax Cuts and Jobs Act small business owners can now obtain a 20% deduction for the business income.

Common types of pass through entities include the Limited Liability Company, Subchapter “S” Corporation, and Professional Corporation.

Other considerations and advantages for establishing a business entity include:

  • Creditor and Liability Protection;
  • Declaring bankruptcy for the business;
  • Raising capital and debt financing;
  • More organized and efficient management and control for adding partners, members, shareholders, or interested parties;
  • Tax optionality and planning opportunities;
  • Credibility as legitimate and thriving business enterprise;
  • Privacy and Anonymity;
  • Dissolution and wind up of the business.

It is ill-advised to enter into an informal business arrangement with two or more members or interested parties, only to confront the inevitable complications regarding legal, regulatory, and tax compliance, profit sharing, management, and control.

Disclaimer

 

 

Naming a Foreign Relative as Trustee for a U.S. Trust

Introduction

In Metropolitan areas, such as the San Francisco Bay Area, it is common to have an estate planning client inquire about naming a foreign relative as Trustee or Co-Trustee.

Naming a Non-Resident Alien (“NRA”) relative as Trustee can cause the U.S. Trust to be re-characterized, for U.S. tax purposes, as a foreign trust due to the NRA’s exercise of substantial control of the Trustee powers.

If the goal is to maintain the Trust as a U.S. domiciled trust the requirements of Treas. Reg. Section 301.7701-7 of “court test” and “control test” must be satisfied.

Court Test

For this test to be satisfied a court within the United States must be able to exercise primary supervision over the administration of the Trust. There is a safe harbor if the following three requirements are met:

  • The trust instrument does not direct that the trust be administered outside the United States;
  • The trust in fact is administered exclusively in the United States;
  • The trust is not subject to an automatic migration provision described in Treas. Reg. Section 301.7701-7(c)(4)(ii).

Control Test

This test requires that one or more U.S. persons have the authority to control all substantial decisions of the trust. Treas. Reg. Section 301.7701-7(d)(1)(ii).

“Control” means “the power, by vote or otherwise, to make all of the substantial decisions of the trust, with no other person having the power to veto any of the substantial decisions.”

Tax Impact of Foreign Trust Status

Depending on the circumstances, capital gain realization may be imposed on the transfer of property to the “now foreign trust”, i.e. forced sale treatment.

One Year Period to Cure Unintended Loss of U.S. Trust Status

If a U.S. Trust becomes a Foreign Trust due to the nomination of a NRA Trustee, the Trust has 12 months from the date of cessation of U.S. Trust status to reassert U.S. status by satisfying the aforementioned requirements of the “court test” and “control test”.

Conclusion

While it is not impossible to have a NRA relative act as Co-Trustee, the NRA relative should never be nominated as sole acting Trustee.

Even if a NRA relative is nominated as Co-Trustee, the Trust terms must make clear that any tie breaking decision is made by the U.S. Co-Trustee.

Disclaimer