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Posted: December 18, 2012

The hot new thing in wealth planning isn’t new

But it does give you flexibility and power

Mira Finé

Here is the twist: One can change the type of trust based on how you treat it on a year-to-year basis. In an irrevocable trust, if the grantor borrows principal or income and has not repaid it before the end of the year, the trust will be a grantor trust for that year. So, you could borrow on Dec. 31 and not repay it until Jan. 1 and the trust would be deemed to be a grantor trust. However, this will not occur if the loan provides for adequate interest and security assuming the loan was made by the trustee to her rather than the grantor or related parties.

• Lower Taxes. The federal income tax paid by the grantor is likely to be less because the trust tax brackets are higher than individual ones. For a trust, the 35 percent tax bracket starts at $11,000 of income. The personal income tax paid by the grantor does not hit 35 percent until it reaches $300,000. So you can pull the tax payment out of the trust and it is paid by the grantor.

• Asset Substitutions. Trust assets can be substituted with like-valued assets in either a grantor or defective trust. A non-fiduciary power to switch assets should not cause inclusion of trust assets in a grantor’s estate because there is not a diminishment of the assets. However, the values of the exchanged assets need to be identical; you cannot substitute a Chevy for a Mercedes. You also must have appraisals or some agreement providing that if the values do not work, there will be a make-up of the value. This often comes up when a grantor puts land into a trust and didn’t realize that titling and development issues would arise with consolidating land around the trust.

Real-World Case
Why and when would someone borrow from their own trust? Let’s look at a real-life example of a case I am familiar with. A mom sets up an irrevocable, or non-grantor trust that the mom doesn’t have control over. Her daughter is the beneficiary but doesn’t know about it. Mom is also the trustee of the trust, and develops a bad gambling habit. She spends all her money gambling and now doesn’t want to tell her daughter that the trust existed.

Mom borrows money from the trust, which she can approve because she herself is the trustee. The trusts still exist, however, and the daughter can sue her mom, preventing her from regaining control over the trust assets and to make her repay the loan from the trust. The daughter could argue that under normal rules, the trust would not have loaned mom the money unsecured. If you were in mom’s place, you’d argue that it was a grantor trust all the time. The case hasn’t been decided by the court yet.

This happens a lot; people thinking they will avoid estate problems and then everything falls apart on them. If the mom in our example had established a grantor trust, then she’d have had a better argument against the daughter’s lawsuit because in a grantor trust, she’d generally have control (under certain circumstances) of the assets as long as she paid the correct taxes, though she might not be able to avoid estate tax.

There is no right and wrong way to create a trust or to designate what type of trust it is. The type of trust you choose depends on your situation. The positive is that you have a lot of flexibility and power.

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Mira Finé, CPA, is the national director of tax operations for Hein & Associates LLP, a full-service public accounting and advisory firm with offices in Denver, Houston, Dallas, and Southern California. She specializes in succession planning and can be reached at or 303.298.9600.

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