You hear about them on TV, your friends have one, and you read an article on how the rich use them, so what’s the hype about trusts? What types of trusts are there? Should you set one up? Are trusts just for people with wads of money?
While any prudent individual should discuss these questions with their attorney, sometimes it’s hard to know which questions to ask or where to get started. Hopefully, this article can be that starting point for you.
Types of Trusts
Commonly, we hear of people using trusts to protect their assets. Perhaps a trust would be helpful to this end, but we need to further define: protect which assets from what? A living revocable trust may protect your primary residence from probate court in your passing, while a domestic asset protection trust protects assets from future creditors, and a minor’s trust protects an inheritance from imprudent beneficiaries until a child reaches a specified age.
Wills are certainly cheaper than setting up a trust, at least initially. Average probate fees start around 4% of the estate value and the whole process can easily take up to 18 months before funds are able to be disbursed to your heirs. A properly setup trust can avoid these costs and delays.
I once had someone ask if they should setup a trust to avoid paying estate “death” taxes. While estate taxes are based on the fair market value of the assets at the time of your passing and the highest estate tax rate is 40%, don’t forget that each spouse has a $5.45 Million dollar exemption.
Transferring Personal Property to a LLC
Less commonly, individuals may transfer personal property to a family LLC for protection. But LLC’s are meant for business activities and if the property is not used as a business asset, a court in lawsuit proceedings may deem the house a personal asset and pierce the corporate veil, which would put the LLC’s other assets at risk as well. Any LLC or company can have its asset-protection “rights” rejected in court (called “piercing the corporate veil”) for various reasons, but primarily for co-mingling personal items with business.
Furthermore, the legal transfer of certain property, such as your primary residence, often requires a clear title – most banks prohibit transfers of mortgaged property into a business entity.
Using Trusts as a Tax Shelter
Back in the day, many wealthy individuals attempted to use trusts as a way to avoid income taxes. But today, trusts have the highest income tax rates, which discourage the use of trusts as tax shelters. In fact, most trusts today are setup as living revocable grantor trusts which are “disregarded” for income tax purposes, meaning any income generated by assets of the trust is treated as being reportable and taxable on your personal income tax return.
Lastly, most states provide “safe haven” amounts for a primary residence and other assets if your intention is to protect your assets from creditors. For example, California provides Homestead Exemptions up to certain amounts, up to $175,000 of equity. But as with any of these topics, make sure to seek the competent advice of your attorney.