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Trust Fund Loophole?

Posted by Gregory Poulos | Jan 19, 2015 | 2 Comments

What Is President Obama talking About?

President Obama is going to give his State of the Union address on Tuesday January 19, 2015. He has announced several initiatives including  free community college and paid leave. He knows that the number 1 question is where is that money going to come from? Well most of it  — $210 billion — is proposed to come from a capital-gains tax hike and a change in the way the tax code treats the appreciated value of inherited assets. Under the proposal, inherited assets would be taxed according to their value when they were purchased. That means the capital gains on those assets during a person's lifetime, now shielded from taxation, would be subject to tax at the time of the bequest.

Who is that going to affect?

Well not you and me. The proposal, which does not apply to charitable gifts, would fall almost entirely on the top 1 percent of taxpayers. It would apply to capital gains of $200,000 or more per couple, with an additional $500,000 exemption for personal residences. Well that is quite a big number. The changes on trust funds and capital gains, along with the fee on financial firms, would generate about $320 billion over 10 years, which would more than pay for benefits Obama wants to provide for the middle class, the official said.(Reuters) But in all likelihood these proposals won't make it past the Republican-run Congress, who directly oppose any tax increase on the wealthy. 

What is the Trust Loophole?

In usual circumstances if you buy a capital good, for example stock shares, and then sell the more than a year later, you will pay capital gains tax on any profit you make. Most middle-income taxpayers pay the 15% rate. For example, if you buy stock for $10,000 and it grows to $20,000, if you sell it you pay capital gains tax on the $10,000 of gain. If you are in the 15% bracket, you owe federal tax of $1,500 plus your state tax.As the amount goes up so does the tax rate. Sometimes as high as 39%

BUT, the rules are a little different when it comes to passing money to your beneficiaries of your trust. With some good tax and trust planning, it is possible to  legally shelter significant portions of their estates from capitol gains taxes. For those who oppose the estate tax and call it the “death tax” and have fought for repeal, saying it is a form of double taxation, this is probably a good thing.

So what is the loophole? If you plan your estate properly though the use of different trusts, you can transfer assets to your beneficiaries at the value when that transfer occurs, not at your cost in buying the asset. What does that mean? There is no capital gains tax. In estate tax speak it is called a “step-up in basis.” So to continue the example, if you transfer the $20,000 from the sale into a a special type of trust during your lifetime or at your death, there is no estate tax and the beneficiaries of the trusts will receive the stock at a value of $20,000. This means that your beneficiaries will only potentially pay tax when they sell on the increase from when they get the property, not for what the parent paid. Closing that loophole will mean “every American, even the wealthiest ones, actually pay taxes on the gains,” the officials said, adding that 99 percent of the impact of this action would affect only the top 1 percent of taxpayers.

Under the current Tax Code, administration officials say, someone who inherits $50 million in stock — in a portfolio that was originally worth $10 million — doesn't have to pay income tax on the $40 million capital gain. Because of that rule, “hundreds of billions” of dollars of capital gains go untaxed, administration officials say. While philosphies can differ about whether there should be an estate tax or not.

That sure is a lot of money for a very few number of people.

Gregory C. Poulos, J.D., M.B.A..
Poulos Law Firm, P.L.L.C.
11120 N. Tatum Blvd, Suite 101
Phoenix, Arizona 85028
Phone 623-252-0292

About the Author

Gregory Poulos

Meet Greg PoulosAn Experienced Estate Planning & Business Attorney serving the Phoenix AreaGregory Poulos counsels clients on the best strategies for accomplishing their estate planning and business goals. Greg starts by “Putting His Clients at Legal Ease” so that they understand the legal issues...


Ann Dugan Reply

Posted Apr 13, 2023 at 18:52:18

I did a revocable trust years ago. I bought a condo and put it into the trust. My son has lived there for three years and has health issues so he never paid rent. Now I need to sell it but will have a capital gain. If I can quitclaim it to him and he sees it, he will not have a gain.? Is that something that I could do with you? I really need to update my trust since it is just a general one.

Gregory Poulos Reply

Posted Apr 13, 2023 at 19:28:19

If you quit claim it to him you are just passing on the capital gains to him. You probably want to discuss this with your accountant. If you are interested in a trust review and are in Arizona let me know.

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