28 April 2017

The Argot of Trusts

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Always a rarefied space, the world of trusts is now awash in Washington-style shorthand. Unlike with that alphabet soup of government agency jargon, spelling out the names of these acronyms does not necessarily make it clear what the trust does. A Grat, for example, is a grantor-retained annuity trust, but it has nothing to do with annuities or insurance of any kind.

Saying no won’t hurt most people. After all, most people do not have the kind of wealth or complicated assets that require a trust. On the other hand, the people who could benefit from a Ning or a Crat may not realize what the risks are or how much money and time need to be put into creating one to make it worthwhile.

Once a relatively straightforward legal structure to hold and transfer assets among the generations, trusts have grown in complexity along with the tax code they can shelter assets from and the financial instruments and investment vehicles they hold. Yet their very complexity means they carry the added risk of scrutiny from the Internal Revenue Service or of just not working as planned.

So what are these oddly named trusts and what do people who need them need to know? 

Grats are a way to transfer the appreciation of an asset, above a currently small interest rate, to a beneficiary tax-free. They are often used for closely held businesses or stock in a company that is about to go public. Their power comes in having a duration as short as two years. Yet for a Grat to be worthwhile, the asset has to appreciate significantly. If it goes down in value — or to zero — then the person who set it up has wasted time and money in legal fees and trust costs.

Crats (charitable remainder annuity trusts) are like Grats for charitably minded people. A person puts an asset into such a trust and designates a charity that will eventually receive it. If that asset has appreciated greatly over the years, the person avoids paying capital gains on it.

A Crut, or charitable remainder unitrust, is a Crat with a different way of making the annual payment. James L. Kronenberg, chief fiduciary counsel at Bessemer Trust, put it simply: an annuity trust like a Crat makes a fixed payment; a unitrust like a Crut gets revalued each year and the payment is a percentage of that amount. At the end of the term, charities benefit.

Ilits — or irrevocable life insurance trusts — are something that Mr. Kesten said he tried to talk many clients out of using. Life insurance is paid to the beneficiary free of income tax, and most people will spend the money on living expenses. An Ilit is useful for someone who has such a large policy or so many other assets that the beneficiary will have money left over that will be subject to the estate tax when it passes to heirs.

For those looking to protect the assets that pass to their children, there are Qtips — qualified terminable interest property trusts — and Qprts — qualified personal residence trusts. A Qtip is typically used when a surviving spouse and children are not from the same marriage. Spouse No. 2 (or 3) would receive interest or a percentage of the principal of the trust, while the children would be entitled to the principal when the spouse died. Qprts are a different attempt at family harmony — or disharmony. They allow a home to be left in trust for heirs, which guarantees all the children will get a share of it — but often says nothing about who will get to use that beach house over the Fourth of July weekend.

The more controversial trusts that people are using aim to avoid state income taxes. So-called Nings and Dings, which stand for Nevada (or Delaware) incomplete nongrantor trusts, work by making the trust, not the person who set it up, the taxpayer. A New Yorker at the highest marginal tax bracket would face an income tax of 8.82 percent; that person’s Ning or Ding would pay no state income tax.

The risks here are huge. In New York, Gov. Andrew M. Cuomo is trying to legislate out a New York resident’s ability to use them, and he is not alone. But for that class — people with a large asset base subject to a lot of income tax — the risk and cost of finding a lawyer well versed in them might be worth the payoff.

Yet with any of these trusts the desire to shield assets from taxes or protect them from creditors may cloud someone’s better judgment. That might have been the case at the end of 2012, when many advisers were predicting a reduction in the estate tax exemption. As a hedge, some people set up Slats — spousal lifetime access trusts. These trusts shielded assets from estate taxes, but they could also give a spouse access to the money if it was needed later. But then the opposite happened: The exemption went up. And that is why solid planning, more than fancy trusts, is what counts.

Click here to access the full article on The New York Times.

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