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What Your CPA Wants You to Know
67. Do You Need a Trust? Here's What You Need to Know About Trusts & Estates!
Ever wondered how you could safeguard your financial legacy with a trust? Why do people set up a trust? How do they work?
That's what this episode is all about!
In this episode we explain the nuances of trusts, and there are a lot! We start by explaining exactly what a trust is, how it is used, and the various types of trusts.
We also explain the tax implications for the various types of trusts (of course)!
We discuss the many reasons why establishing a trust could be a wise move for you. Not only do trusts offer a robust shield for your assets from unforeseen legal challenges, but they are also pivotal in estate tax planning and planning the distribution of your wealth.
Whether you're looking to preserve a family business, ensure future care for a loved one with special needs, or simply lay a solid foundation for personal financial planning, this episode is your guide.
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what is the benefit to using a trust? I mean, you see lots of wealthy people using these and recommending them, but are they getting some sort of tax benefit from using a trust, or is it simply just protecting their assets? So people want to know do they need a trust? Why would they have one?
Speaker 2:Welcome to what your CPA Wants you To Know.
Speaker 1:Tax and accounting help can be expensive, so we've created this podcast to help guide you through it all and make you feel like you have a CPA in your back pocket.
Speaker 2:I'm Carson Sands.
Speaker 1:And I'm Taryn Sands.
Speaker 2:I'm a CPA with over 10 years of experience helping people start and grow their businesses.
Speaker 1:And I'm an MBA with a specialization in marketing and entrepreneurship. Taxes suck and we want to make sure you don't pay more than your fair share.
Speaker 2:We're here to share everything your CPA wants you to know.
Speaker 1:In a fun and easy to understand way.
Speaker 2:Let's get started.
Speaker 1:Let's do it easy to understand way. Let's get started, let's do it. Today's episode is all about trust and estates and Carson is actually the go-to guy here for estates and trust and we had a lot of questions come in about them so we wanted to do an episode. After looking at all the questions, we figured we should do actually two short episodes on this. So this is going to be the first of our Trust and Estates episodes and we will try our best not to bore you but give you the information that you need.
Speaker 2:Trust me, this won't be near as boring as you're afraid. See what I did there.
Speaker 1:Yes, I did, and I almost forgot to laugh. So the very first question, let's just cover what is a trust?
Speaker 2:So I knew you were going to ask that and I realized that I don't actually have a great definition, even though I know what it is and I work with them very regularly. I don't have a great definition, so I did go to trusty dusty investopedia, which says that a trust is a legal entity with separate and distinct rights similar to a person or corporation. In a trust, a party known as a trustor, gives another party, the trustee, the right to hold title and manage property or assets for the benefit of a third party, the beneficiary. Okay, so if you didn't fall asleep during that, let me just break that down a little bit.
Speaker 2:The trustor, sometimes called the grantor, is the person that has money or things that they want to give or let someone else use. The trustee is not the person they give it to. That's the person that manages the trust. They make sure that all the rules that were set up when the money or assets were put into the trust are followed up when the money or assets were put into the trust are followed, and that the beneficiary who's the third person here, that's the person that gets the benefit of the money or assets that were put into the trust the beneficiary is well taken care of and the things that are in his best interest are done. The trustee makes sure that that happens.
Speaker 1:So when you're setting one of these up let's just make it very simple Basically you are paying money and doing some paperwork, similar to if you were filing an LLC. You're filing something that has all of these rules and there are different types of trusts and they're all going to have different rules.
Speaker 2:Yes, there's a lot of different types of trusts and a lot of different rules, both legally and tax-wise. So when you're looking at trusts, some of the types of trusts, it really only matters for legal purposes the differences between them, and I'm not a lawyer. We're not going to talk about those as much. I can just mention that there are several types, including special needs trusts, irrevocable trusts, living trusts, medical trusts. There's charitable remainder trusts and charitable annuity trusts. These are different types of trusts that you set up for charitable purposes. Anyway, there's a lot of those kinds of things. We won't go into the details on all of those. If you're at the point where you need one of those specialized types of trusts, you're probably talking to an attorney and an accountant already, and so that's something that we won't cover today.
Speaker 1:Yeah, the main purpose of this episode is to go over the main types of trusts that people are using for tax reasons or that you're going to hear more often, and how are they used. So what are the main types of trusts and how are they taxed, because obviously this is a podcast about taxes.
Speaker 2:Right. So while some of the various intricate details of the different trusts might change the tax situation slightly, for the most part there's four ways to look at trusts for income tax purposes. One of these is estate, but just keep in mind we're not talking about the estate tax, which is the tax you pay on all the stuff you have when you die. We might talk about that in another episode, but today we're talking about the income tax that an estate pays whenever its assets are making money, before they're all distributed out to everyone. The reason they're lumped together is that an estate and a trust are pretty much the same thing. For tax purposes, they're filed on the same form, which is form 1041. And for tax purposes, they operate very similarly.
Speaker 2:So, without further ado, the first trust, a revocable trust, sometimes called a living trust. Oftentimes this is something that's set up where the grantor or the trustor and the trustee and the beneficiary are all the same person, which is you. You put all of your assets into this living trust and it provides you a certain level of legal protection. If something happens and you get sued, then it turns out you don't actually own anything. I don't know what all the rules and hoops you have to jump through to have all that protection are. That's for a lawyer to tell you, but for the tax purposes of that it's pretty much just ignored. All of the income that's earned by that kind of trust still is reported directly on the individual's tax return, right on your 1040. And oftentimes they don't even have their own tax identification number. Just your social security number is used for that.
Speaker 1:But you do have to file a separate tax return yearly.
Speaker 2:No, not for the living trust. Okay, that's what a lot of people want to know. For a revocable or living trust of that sort, you would just completely disregard it. It might even say Carson Sands Trust, but you would see that the social security number is still used on the tax forms, and so that's where the income is reported on my personal tax return.
Speaker 1:Okay, so what's the next simple type of trust that you see?
Speaker 2:So after you have revocable living trust, you have grantor trust, which a revocable trust can also be a type of grantor trust. But there's other types of grantor trust whereor trust, which a revocable trust can also be a type of grantor trust. But there's other types of grantor trust where the trust does have a separate tax ID and in that situation you have a couple of options. Sometimes people do file a 1041 for the trust, which is the income tax return for the trust, but all of the income is still reported on what's called a grantor letter and it's still reported directly to the individual on their tax return. And the IRS allows you to completely skip filing that and, like with the revocable trust, just report all the income directly on the social security number holder's tax return. So the third type I want to talk about is an irrevocable trust tax return. So the third type I want to talk about is an irrevocable trust, which is a non-grantor irrevocable trust that is going to file a tax return as a simple trust. When you have a simple trust you do file the form 1041 and report all the income and deductions to the trust there, but all of the income, after deductions are taken into account, is reported on a K-1 to the beneficiaries, and this just means that the income flows out on a form that summarizes that the beneficiary needs to report this much interest income, this much dividend income, this many capital gains and so on. And so you can't have a simple trust paying tax.
Speaker 2:Now on to the real kind of trust that actually pays tax, and things are different. An irrevocable complex trust is when you file a trust return which is Form 1041, and you report all of the income and deductions for that trust. But not all of the income is distributed to the beneficiary. So in these situations some or all of the income will be left in the trust and then the trust pays the tax. So we'll talk about later how the tax rates work for trust versus individuals. This isn't always ideal for tax purposes, but sometimes there's other good reasons to have it set up this way. And an estate operates just like a complex trust. You can have all the income distributed to the beneficiaries the people that are inheriting from the estate and then they report the income on their return and pay the tax, or the estate can actually pay the tax on that income. You have some choices there, but those are the main different types of trust and how they're taxed.
Speaker 1:But what people really want to know is what is the benefit to using a trust? I mean, you see lots of wealthy people using these and recommending them, but are they getting some sort of tax benefit from using a trust, or is it simply just protecting their assets? So people want to know do they need a trust? Why would they have one?
Speaker 2:That's a great question. So there are several reasons you would set up a trust. Legal protection of your assets is definitely one of them. If you own a lot of things, having them in the trust can definitely help protect you if something crazy happens and you get sued. Another reason is inheritance tax.
Speaker 2:Let's say that you have over 10 or, if you're married, over $20 million in net worth, and that means that you're going to pay the estate tax which I said we're not gonna talk a lot about, but let's just say it's a lot, it's a really high amount, and so you could set up a trust.
Speaker 2:The reason you would use the trust is that during your life, you're going to start offloading some of your wealth to your children, grandchildren, nieces and nephews, if you want, whoever. Whoever your beneficiaries are, but maybe some of them aren't old enough or responsible enough to manage that money safely right now and so you set up trust for everyone and you start offloading every year, because there's an amount you can give to each person in a year that doesn't go into your estate tax deduction. So, in other words, just for estate tax planning purposes, it might make sense to give people money a little bit at a time, every single year for your life until you die, instead of waiting all the way until you die. But you might not want them to have full control over that, to go blow it on cocaine or something crazy.
Speaker 1:Wow, still X-rated.
Speaker 2:So, or whatever their vices are, or hey, you know, just blow it on a crazy car, but Putting it in the trust allows you to still have control over it while you're alive. But you put the money in there and it's an irrevocable trust, so you get credit for having given them the money in the current year and all the tax benefits that come with it. So that would be another reason to do that.
Speaker 1:So you can stash your money and then you can put some rules on it. I think we've all seen that where the person can't have it until they are a certain age, or just any role that you put in the trust.
Speaker 2:Yes, and you can put almost anything. There's some crazy stuff out there. It might be until they have their first full-time job, or until three years after they have their first full-time job, or until they get married. There's so many different options for that. But that's an option, and in a very similar way, maybe not to avoid inheritance tax, but just to protect the assets from young people or naive people A lot of people have these trusts that they get set up the moment you die, so that all of your assets go into trusts that are divvied up among your various beneficiaries so that they can't go blow it all the day that you die.
Speaker 2:Some other reasons you might set one up are charitable trusts. There's different reasons you would do that. For example, even charities aren't always the best at dealing with a giant influx of cash all at the same time. So a lot of times people will set up a trust that is invested and it pays out a certain amount of money to a charity over the course of time. Or maybe they have a big heart for parks in local towns and so they would set up that charitable trust so that there's enough money to keep the maintenance up and everything on the park.
Speaker 2:There's a lot of other reasons, but two other reasons that I want to go to. The first one control of assets after your death. This is very important to people that have businesses or especially family farms. You might see that if you've been watching Yellowstone, maybe that land is worth a lot more than it's worth if you farm it or ranch on it. But it's very important to the owner that it always is farmland or ranch land and you don't want it to be sold to become a shopping mall.
Speaker 2:Well, that'd be another reason. You can put that in the trust where your heirs or your beneficiaries can use it. They can ranch on it, but they cannot sell it. It can never be sold and you can have that trust last until the end of time. So that's another good reason. And one final one that I think is really important or anyone you know has special needs children. You know things have changed a lot, but you can set up special needs trusts where they're taken care of, even if they outlive you, especially children with Down syndrome. They used to have a life expectancy of 25 years and now it's 60. People are having kids later and later in life and so there's a good chance a kid with Down syndrome might outlive their parents, so that would be a great reason to set up a trust, just to make sure that there's money to take care of them after you're gone up a trust just to make sure that there's money to take care of them after you're gone.
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Speaker 1:Now back to the show. So we just wanted to cover the basics in this episode. So if any of these trusts sound good to you and you've been thinking about it, the first step would be to talk to your attorney to set something like this up, and then you would absolutely want to talk to your CPA about the tax consequences of the type of trust that you chose and, as you can tell, there are a lot of rules, and so you would need a little bit of teaching if you're and, as you can tell, there are a lot of rules, and so you would need a little bit of teaching if you're going to and you're not familiar with trust.
Speaker 2:Yes, and you'll hear us on this podcast talk all the time about things we think you can DIY. If you want to try to do it yourself to save money or just to be more involved, this isn't one of them. If you have a trust or need a trust, then have a lawyer, have a CPA. It's going to be worth it.
Speaker 1:Absolutely, and we will have a follow-up episode. We will talk more about the estate things and estate planning, getting rid of some of that income, like Carson mentioned a little bit earlier. So if you have more questions about these topics, please send us a DM. And until next time, thank you so much for listening to what your CPA Wants you to Know. Podcast.
Speaker 2:This podcast is intended to provide accounting and tax information for educational purposes only. All tax situations are unique and should be handled with the assistance of a tax professional.