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Dynasty Trusts: A Quick Summary of How the Rich Save on Gratuitous Transfer Taxes - YouTube
Channel: WCS Money Tutorials
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Welcome to WCS Money Tutorials. Today’s topic is
a quick summary of dynasty trusts, which may save
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wealthy taxpayers millions, maybe even billions,
of dollars of gratuitous transfer taxes.
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A trust is a legal entity that holds and manages
property of the grantor, who creates the trust.
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The trust is created when
property is transferred to it.
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A trust is managed by a trustee,
who is often the grantor, but may
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be a corporation or other type of business.
A revocable trust is controlled by the grantor
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and can be changed at any time by the grantor.
An irrevocable trust is managed by the trustee
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according to the trust document
used to create the trust.
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However, the grantor maintains dead hand control
over the trust through the trust document. All
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dynasty trusts are irrevocable trusts since the
grantor eventually dies or may already be dead.
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A trust is often used for estate planning
because it allows dead hand control
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and avoids the high cost and time of
probate. It may also reduce taxes.
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Dead hand control is the additional requirements
for a bequest that must be satisfied before
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the beneficiary may receive the gift.
Probate is the court administered process of
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allowing creditors of the decedent to file claims
for payment, to distribute property according to
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the will, and to resolve any disputes.
Since the trust owns the property,
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its assets may be protected against
creditors, such as divorced spouses.
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A dynasty trust, also known as a
perpetual trust or a descendants’ trust,
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is a type of trust created primarily to
save on gratuitous transfer taxes over
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several generations while also having the other
benefits of trusts, such as asset protection,
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probate avoidance, and dead hand control.
The unified tax credit allows individuals
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to transfer $11.7 million of property to
heirs without incurring any federal taxes;
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a couple may transfer double that, or $23.4
million, without federal taxation. This value is
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indexed for inflation, but this recently doubled
credit will drop to half its value in 2023.
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Since the primary purpose of dynasty
trusts is to save on estate and GST taxes,
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these trusts are mostly useful for people
whose estates exceed the unified tax credit.
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Irrevocable trusts, such as dynasty trusts,
are separate taxable entities, so the trustees
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must file their tax returns annually.
The main purpose of the dynasty trust
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is to save on gratuitous transfer taxes,
equal to 40% of the property value.
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Without estate planning, when each generation
dies, their estate would have to pay an
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estate tax on the transferred
property. So by the 4th generation,
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the estate tax would have been paid 3 times, as
illustrated in the 1st column in this diagram.
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If the 1st generation tried to save on
estate taxes by transferring property
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directly to grandchildren or later
generations, then they would have to pay
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both an estate tax plus a generation-skipping
transfer tax on the transferred value. Both tax
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rates equal 40%, which would yield a tax almost
as much as value of the transferred bequest.
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The dynasty trust saves on both estate and GST
taxes by owning the property, then paying out the
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income earned by the trust to beneficiaries
or to allow them to use the property,
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such as real estate. The estate tax must be paid
on the transferred value to the dynasty trust
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when it is 1st created and the GST tax will also
have to be paid when the trust finally terminates,
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since the beneficiaries will be more than one
generation removed from the grantor of the
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dynasty trust. However, no other estate or GST
taxes will be due as long as the trust exists.
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State law governing the trust situs determines
the asset protection provided by the trust
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and the term limits of the trust.
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The situs also governs other
legal requirements for the trust.
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Federal law governs the taxation
of trusts, so estate planning to
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save taxes depends on federal law.
States may also tax trusts. However,
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there is a competition to attract as
many trusts as possible to a state,
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so desirable states do not tax trusts and
offer more flexibility in managing the trust.
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In previous years, the terms of trusts were
limited by the Rule against Perpetuities, but many
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states have abolished the rule or modified it to
greatly lengthen the allowable terms of trusts.
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The Uniform Statutory Rule Against Perpetuities,
which some states have adopted, permits a
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trust to last at least 90 years.
According to the Pandora Papers,
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South Dakota has the most trusts that also
holds much foreign money and other assets.
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Trusts do have some disadvantages,
including a high tax rate on low incomes
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and the dilution of wealth
through successive generations.
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Moreover, the beneficiaries do not receive the
full benefit of the value held by the trust, since
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they mainly receive income earned by the trust and
the use of some property, such as real estate.
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As you can see from this
2021 tax table for trusts,
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trust income is subject to the same marginal tax
rates as individuals, but at much lower incomes.
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For instance, income above $13,050 is taxed at the
highest tax bracket of 37%. This is why almost all
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trust income is distributed to beneficiaries, so
that it will be taxed at the beneficiaries’ rate.
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Another disadvantage is that the
value of the trust per beneficiary
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diminishes with each successive generation.
If each descendant has 2 children, then by the
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6th generation, there will be 64 heirs.
By then, the value of the trust for each
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heir as well as the relationship of the
heir to the grantor will only be 1.6%.
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Another disadvantage is that both state and
federal law governing trusts can change at
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any time and change is likely over the long
terms of dynasty trusts. Since many people
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are clamoring for the rich to pay more in
taxes, one change that may occur which would
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reduce or nullify the benefit of dynasty trusts
is a federal wealth tax on irrevocable trusts.
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Some people have questioned the constitutionality
of wealth taxes enacted by the federal government,
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because there is a provision in the United States
Constitution that direct taxes, which apply only
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to people, be apportioned according to the
state population recorded by the US Census.
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However, since irrevocable trusts are separate
taxable entities and they are obviously not
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people, there would be no constitutional problem
in applying wealth taxes to irrevocable trusts.
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Thank you very much for your time. If
you liked my video, please SUBSCRIBE!
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on personal finance, investments, and economics.
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Thank you.
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