The Dynasty Trust is an Effective Estate & GST Tax Planning Tool

The Dynasty Trust is a Powerful Estate & GST Tax Planning Tool

What is a Dynasty Trust?

Trusts are used by Taxpayers to plan for gifts and inheritances — along with other types of tax planning. While there are many different types of trusts, the Dynasty Trust is one of the most powerful tools when it comes generational wealth gift and estate tax planning. The Dynasty Trust provides for an up-front tax at the time of contribution, in order to avoid estate tax further down the line when the assets and income are transferred to future generations. Unfortunately, there are many tax misconceptions involving the Dynasty Trust. For example, there are still income tax implications with a Dynastry Trust — notably, it does not exempt the assets within the trust from income tax. In addition, the assets become immobile (Subject to decanting rules). Oftentimes, US Taxpayers with international assets and overseas accounts turn to estate planning in order to try to minimize tax liabilities for future generations.. Let’s take a look at the Dynasty Trust:

What is a Dynasty Trust?

A dynasty trust is a preferred estate planning tool for taxpayers who have significant wealth and expect that wealth to compound in value overtime — and over multiple generations. The main benefit of this type of trust is the idea of paying taxes now at the time the asset(s) are contributed into the trust, in order to limit or minimize potential estate tax implications down the line for future generations. In California, these trusts can last for many decades — in accordance with the uniform statutory rule against perpetuities (USRAP).

Basic Dynasty Trust Concept  101

Taxpayer contributes assets to the trust “now” with an immediate tax implication based on the value of the contribution. Then with each new generation who inherits — there is no additional estate tax on the increased value of the assets. Conversely, in the all-too-common scenario, a parent leaves a significant amount of money to a child — beyond the exemption amount — outside of the trust, which is then taxed at the death of the parent. Thereafter, the value of the inherited estate grows significantly and fast-forward down the line and then when the adult child passes away, that same money is going to be taxed again — which can be minimized or avoided with a dynasty trust.

Income Tax in a Dynasty Trust is Still Taxable

The income that is generated by the assets within the trust is still taxable in the present dat. This is a very important point, because some Taxpayers are under the misimpression that by simply tossing their assets into a trust, that they are no longer subject to any tax — but this is not the case. This is why it is important to evaluate the different assets before placing them into the trust so that the taxpayer gets the best bang for the buck for the specific assets placed into the trust. If you are in California, you should speak with a Board-Certified Estate Planning Specialist. 

But a Dynasty Trust is An Effective Estate Tax Planning Tool

The main concept of the dynasty trust is to pay tax now on contributions into the trust in order to avoid estate taxation at a later date after the asset has (hopefully) increased in value. As with any good tax planning tool, there are tax limitations which should be considered before just jumping in and forming a trust in hopes of avoiding tax in perpetuity (read: it doesn’t work that way).  Otherwise, if you happen to put in assets into the Dynasty trust that generate annual income (and may compound as the value of the assets increase) you may be in for a big tax surprise — when you thought that anything mixed into the dynasty trust part was simply not taxable again.

Are Dynasty Trusts Irrevocable or Revocable?

Since dynasty trusts are irrevocable, once they become established there are rigid rules limiting what can be done to modify the trust after it has been created. Dynasty trusts can sometimes be modified (or have specific trustee powers implemented) so that the income generated within the trust is treated as a grantor trust — which should not impact the estate tax benefits.

Negatives to a Dynasty Trust

There are some negatives with this type ofTrust, including:

Minimal Control over the Asset

The intended recipients of the trust benefits are limited in their ability to control what happens to the asset.  At the time the trust is created (as with most parents) the concern is leaving a mound of cash to their children, unrestricted — which may be too much of a responsibility at the time the children inherit it, even for the most responsible child. But down the line, these same children who are now (responsible) adults with their own family — and will be limited in what they can do with the asset.

Change of Heart?

The trust is irrevocable, so once the trusts are placed into the dynasty trust, for all intents and purposes — there is not much that can be done in modifying the trust asset (although decanting may be an option in some states). Of course with proper planning, Taxpayers may be able to create or carve-out certain limitations or exemptions from the outset.

Pick a Very Good Trustee

The Trustee is the person in charge of overseeing the trust. Therefore, Taxpayers should designate a significant amount of time and thought into who they believe would be the best person(s) to oversee their trust wealth for generations to come.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure. 

Contact our firm for assistance.