July 3, 2012

Living Trusts Taxation

The following is an excerpt from a recent California Court of Appeal decision:

"Before Beckwith presented the will to MacGinnis, he called Dahl to tell her about the will and e-mailed her a copy. Later that night, Dahl responded to Beckwith's e-mail stating: `"I really think we should look into a Trust for [MacGinnis ]. There are far less regulations and it does not go through probate. The house and all property would be in our names and if something should happen to [MacGinnis] we could make decisions without it going to probate and the taxes are less on a trust rather than the normal inheritance tax."

Beckwith v. Dahl (2012) ___ CA4th ___

The phrase in italics is a common fallacy held by many people. A revocable trust is a tax neutral document, i.e. it will neither increase nor decrease taxes.  Dahl was acting under this erroneous belief when she emailed Beckwith above. Regardless if the decedent wrote a will or revocable trust, the taxation of their estate would be unaffected by the drafting of either instrument. The principal reason for this is because reducing or eliminating the estate tax, "inheritance tax" is a colloquialism, is determined by the recipient of the property, e.g. a spouse or a charity, as opposed to what instrument is used.

However, it should be noted that other types of trusts are created to avoid or reduce taxes. For example, a disclaimer, A/B and charitable trusts are all examples of trust specifically designed for such. Still, each of these trusts utilize beneficiaries that are considered allowable deductions for estate tax purposes. For example, if a person passes away with a $100M estate, they can devise it entirely to charity and their estate will not have any estate tax liability.