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Trusts 101

QUICK SUMMARY

For many small business owners, their company is their wealth. Instead of large bank and investment accounts, they often have their money tied up in an endeavor they've work a lifetime to build. This can create problems when heirs want to succeed or get top dollar on the open market for a company after the owner’s death. Either way, they could face a situation where they inherit mostly non-liquid business assets, but require liquid funds to pay estate and inheritance taxes. This can force a situation where heirs might conduct a “fire-sale,” of the company to meet the estate tax bill. Or, this tax nut may force them to sell to outsiders instead of continuing the business.

Many trusts can help reduce or eliminate estate taxes as part of an overall estate strategy, and all trusts offer an extra measure of control. Trusts are practical tools that may give heirs the opportunity to continue a family business, maintain a family home and/or keep other non-liquid assets, instead of selling them to pay estate taxes.

A Trustworthy Tool to Protect Your Business

Typically used for estate planning, trusts may accomplish much more than tax reduction. They can protect assets from an arduous stint in probate, shield assets from creditors and offer added control over them—both during and after your lifetime. This is crucial for small business owners who want their private business screened from competitors, their family to succeed them or another buyer to pay top price when the time comes to sell.

There are two types of trusts. Irrevocable trusts are often used as an estate tax-planning instrument. However, you cannot change its terms. A revocable trust offers more flexibility and greater control of assets. It offers no estate tax benefit, but you can change its terms at any time.

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Credit Shelter Trust: Use It or Lose It

Also known as a Bypass or AB Trust, a Credit Shelter Trust ensures that if you’re married, your estate gets what’s left of you and your spouse's entire estate tax exemptions. Without this trust, your estate loses any unused part of an exemption. The federal estate tax exemption now exceeds $5 million per person. State estate and inheritance taxes, however, are all over the board. Some states don’t have the tax, while others begin at much lower thresholds.

Whatever the tax situation, the surviving spouse controls the assets held in this revocable trust and can receive income from those assets. Upon the survivor’s death, the estate receives what’s left in the trust estate tax-free.

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Grantor Retained Annuity Trust: Income & More

A Grantor Retained Annuity Trust shields a business or other assets from some or all estate taxes. Irrevocable, a GRAT also provides an income from the trust’s assets during your lifetime. When the trust’s term ends, income payments end and beneficiaries receive a discounted value of the business interests held in the trust. The IRS will value the gift at the time of the creation of the trust, making this trust a natural one for assets expected to appreciate. As with most things related to trusts, you should consult an experienced estate planning attorney for the details.

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Life Insurance Trust: Taking the Tax Out of Life Insurance

A Life Insurance Trust is irrevocable. It is both owner and beneficiary of one or more life insurance policies. This type of trust, a common estate-tax reduction tool, is important because of how the Internal Revenue Service taxes life insurance. Although life insurance isn’t subject to federal income taxes, the IRS includes it as an estate-taxable asset. A Life Insurance Trust takes the insurance out of your taxable estate, giving heirs a tax-free source of funding to pay other estate taxes or to buy a business interest as part of a succession plan.

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Charitable Trusts: Altruism and Tax Breaks

Many business owners want to leave some of their assets to charity. To make the most of their charitable gifts, they might use one of two irrevocable charitable trusts. The assets in a Charitable Remainder Trust provide income over a fixed period of time to a person named in the trust. The remainder goes to a named charity upon the death of the person who created the trust. A Charitable Lead Trust does the opposite. The trust’s creator donates the trust’s income to charity while alive, and heirs get the remainder after the trust terminates. Both trusts help you lower income taxes.

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