If you’re looking for an estate planning option that is straightforward, a simple trust could be the right solution for you. Unlike a complex trust, a simple trust doesn’t offer as much flexibility when it comes to asset distribution and tax implications. However, there are some definite advantages to using this type of trust. Let’s take a closer look at simple trusts and discuss how they can help protect your assets.
What is a Simple Trust?
A simple trust is an estate planning tool that you can use to distribute assets and income. Simple trusts are often less expensive to set up and maintain than other trusts. A simple trust can allow you to specify how and when your beneficiaries will receive distributions from the trust. You can also choose to have the distributions made based on specific events, such as the beneficiary reaching a certain age or getting married.
Simple trusts can be an excellent way to protect your assets from creditors. If you are concerned about creditors claiming your assets after your death, placing them in a simple trust can help keep them safe. The assets in a simple trust stay safe because they are not subject to probate. Probate is the legal process through which creditors can make claims against an estate.
While simple trusts offer many advantages, you may also want to consider some potential drawbacks. One downside of simple trusts is that they may not provide as much protection from estate taxes as other trusts. However, North Carolina does not have an estate tax, so there are no worries.
How a Simple Trust Works
A simple trust is a type of tax designation. It differs from a complex trust in that it:
- Annually distributes any income it earns to the beneficiaries
- Does NOT distribute the trust principal to the beneficiaries
- Does NOT make distributions to charitable organizations
When a trust does not follow these guidelines, it becomes a “complex” trust for that tax year.
You create a simple trust with your attorney when you transfer assets into the trust’s legal framework. You can do this during your lifetime or at death. The trustee is then responsible for managing the assets in the trust and making distributions to the beneficiaries according to your instructions.
Individuals often use simple trusts to hold property, such as real estate or investments. The trustee can manage these assets and make distributions from them as needed. For example, if you have a rental property in the trust, the trustee can use rental income to distribute payments to beneficiaries.
It’s important to note that simple trusts are not required to file their own tax return. Instead, the trust’s income shows up on the beneficiaries’ individual tax returns. This method of taxation can be advantageous because it allows you to control how and when the assets in the trust are taxed.
Beneficiaries of a Simple Trust
Generally, anyone can be a beneficiary of a simple trust, including family members, friends, charities, or other organizations. You can also name yourself as a beneficiary. One thing to keep in mind is that the design of a simple trust is not for it to last forever. Typically, you set up a simple trust so that the trustee distributes the assets to beneficiaries after a particular event occurs.
For example, you may set up a simple trust to provide income for your spouse during their lifetime and then distribute the remaining assets to your children when you die. Or, you may set up a simple trust to hold property until your child reaches age 21 and then transfer ownership of the property to them.
What Happens to the Assets in a Simple Trust When the Creator Dies?
When the creator (also called “grantor”) of a simple trust dies, the trustee distributes the assets in the trust to the beneficiaries. The trustee uses the instructions in the trust document to guide the distributions.
At the grantor’s death, the trustee manages the assets and makes distributions to beneficiaries. If you have named yourself as a beneficiary of your simple trust, someone will notify the trustee of your death so that they can begin distributing assets according to your wishes.
While simple trusts offer many advantages, it’s important to weigh them against potential drawbacks before deciding whether or not to create one.
Simple trusts are:
- Reasonably straightforward with how the trust distributes assets and income and how taxes work for those distributions.
- Offer LESS flexibility in terms of estate planning if you have a sizable estate or numerous beneficiaries.
- Not subject to probate, which is the legal process through which creditors can make claims against an estate.
- May not provide as much protection from estate taxes as a complex trust.
Tax implications of a Simple Trust
Simple trusts are not subject to probate, the legal process through which creditors can make claims against an estate. Avoiding probate can be advantageous because it allows you to control how and when the assets in the trust are taxed.
According to the IRS, “A simple trust must distribute all its income currently. Generally, it cannot accumulate income… or pay money for charitable purposes. If a trust distributes during a year, as in the year it terminates, the trust becomes a complex trust for that year. Whether a trust is simple or complex determines the amount of the personal exemption.”
The trustee reports all trust income and capital gains on Form 1041. The filing uses this form whether the trust keeps the income or gives it to beneficiaries. However, the trust can reduce its taxable income with deductions, just like individuals can.
The primary way a trust avoids double taxation is by taking the income distribution deduction. This deduction lets the trust reduce the amount of money it reports as income by how much it gives to beneficiaries. This deduction is why beneficiaries report these distributions on their personal tax returns.
In other words, simple trusts are subject to income taxes, so you’ll need to be careful about how much money you put into the trust each year. You may also want to consult with an asset protection attorney to help you understand the tax implications of a simple trust before setting one up. (2)
We Can Help
As with any trust, it’s essential to carefully consider the pros and cons before deciding whether or not a simple trust is right for you. Talk with us at Vail Gardner Law if you have questions about how a simple trust could impact your estate plan. We focus on asset protection strategies for your future.
Whether you want to protect your assets from creditors, family members, long-term care costs, or bankruptcy, we are here to help you set up a plan. Our proven strategies shield your assets from future hazards to your bottom line. Contact us today and find out how we can help.
References:
- https://www.irs.gov/pub/irs-tege/eotopicf01.pdf
- https://pocketsense.com/taxes-money-distributed-trust-12129208.html