By Nancy Burner, Esq.
For many clients the idea of creating and funding an irrevocable trust with an end goal of protecting assets should the need for long-term care arise raises questions and concerns about the potential tax implications.
Specifically, questions surrounding taxation of the assets that are transferred to the trust and concerns about losing property tax exemptions such as STAR and Enhanced STAR are common in our practice.
Although there is some truth to the idea that there could be negative higher taxation when income is earned on assets held in a trust, the grantor trust rules of the Internal Revenue Code provide that where a trust is created as a grantor trust, following the rules set forth under the IRC Sections 671 through 678, the income earned and assets held within will be treated for tax purposes as if they are still owned by the grantor. As a result, any income earned by the trust will be taxed at the (presumably) lower rate of the grantor and all tax abatements can be retained as the grantor will typically retain beneficial ownership of the property.
Although grantor trusts are subject to the same general rule for tax reporting as other trusts, specifically trusts with gross income that exceeds $600 are required to report, the method of reporting is far less complicated than you may expect. The trust may file a form 1041, U.S. Income Tax for Estates and Trusts form. In this case we refer to the 1041 as an “information only” return, listing the name of the trust, the tax identification number and the address used for notices on the trust.
By doing this the IRS is placed on notice that the trust exists, and that all income and any other relevant information will be reported on the grantor’s personal return. This provides that the grantor will be treated as the owner of the assets held in the trust; and, accordingly, all income earned from the trust is reportable on the grantor’s personal tax return. Although there are alternate reporting methods available, we have found this method to be the most convenient for most of our clients.
With respect to the transfer of real property to an irrevocable grantor trust, because the grantor is considered the beneficial owner of the trust all tax benefits that flow to individual owners of real property will continue on uninterrupted. Where the homeowner benefits from tax reductions through the STAR or Enhanced STAR program, veteran’s benefits or any other tax rebate, transfers into a properly drafted irrevocable grantor trust will allow those benefits to continue.
Finally, because the assets are still considered part of the grantor’s estate for tax purposes, upon the death of the grantor, the beneficiaries will benefit from a full step-up in basis on the value of the home or any other appreciated asset, eliminating any concerns about capital gains implications.
By creating and funding an irrevocable grantor trust, the grantor is able to protect assets if the need for long-term care arises while preserving grantor tax status and tax advantages and exemptions.
Nancy Burner, Esq. practices elder law and estate planning from her East Setauket office.