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What Is A 2053(c) Trust?. A 2503(c) Trust enables a grantor to make a gift to a minor in trust and still obtain the gift tax annual exclusion. When Is Use Of A 2053(c) Trust Appropriate?. When a client wishes to make a gift to a minor and:
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What Is A 2053(c) Trust? • A 2503(c) Trust enables a grantor to make a gift to a minor in trust and still obtain the gift tax annual exclusion
When Is Use Of A 2053(c) Trust Appropriate? • When a client wishes to make a gift to a minor and: • Client’s income tax bracket is high and the minor’s is relatively low • Note: the trust is subject to “Kiddie Tax” rules • Asset likely to appreciate substantially and client does not want the appreciation includable in his gross estate • Use of gift tax annual exclusion is desirable
What Are the Requirements? • Gift to 2503(c) Trust considered gift of present interest if • Income and principal is available for distribution to or on behalf of the beneficiary at any time prior to age 21 • Income and principal must be distributable to the beneficiary at age 21
What Are the Requirements? (cont’d) • No mandatory forced distribution at age 21 • Permissible to allow trust to continue beyond age 21, as long as beneficiary can obtain the property • If beneficiary dies prior to age 21 • Accumulated trust income and corpus must go to minor’s estate or appointee pursuant to a general power of appointment • Transfer will not fail for lack of minor’s capacity to exercise a power or execute a will
Disadvantages • Expenses for drafting the trust • Expenses for filing tax returns and estimated quarterly payments • Trust has only one beneficiary and cannot be transferred from one child to another • Assets must be made available for distribution to the beneficiary at age 21 • The trust is irrevocable requiring the grantor to relinquish total control
How Is It Done? • Example of Section 2053(c) Trust: • Jeff Mandell transfers stock in his closely held corporation to three Section 2503(c) trusts for his three minor boys • Transfer is irrevocable • Transfer qualifies as gift of a present interest for annual exclusion ($13,000 in 2011) • Minimize or eliminate gift taxes • Gifts reduce Jeff’s estate • Gifts reduce Jeff’s income from dividends paid on the stock • Income is taxed to the boys if distributed or to the trusts if accumulated
Tax Implications of Section 2503(c) Trust • Income distributed is taxed to the beneficiary • Income accumulated in the trust is taxed to the trust • Gifts constitute gifts of a present interest and qualify for the annual gift tax exclusion • Taxable gifts exceeding the annual exclusion amount are added back in the estate tax computation as “adjusted taxable gifts” valued as of the date of transfer • Appreciation on the gifts is out of the donor’s estate and not included in the estate tax calculation
Tax Implications of 2503(c) Trust (cont’d) • If grantor is trustee of the Section 2503(c) trust at death, then the entire value of the trust will be included in the grantor’s estate • The trust value may also be includible in grantor’s estate if income is used to satisfy grantor-parent’s duty to support the beneficiary
Issues In Community Property States • Gifts of community property to 2503(c) Trust are considered as being ½ from each spouse as grantor • Important that neither spouse be named trustee or successor trustee, so trust not included in their estates • States may require written consent of non-donor spouse for gift of community property to a 3rd party or gift may be set aside
2503(c) Trust With S Corp Stock • Section 2503(c) Trust is not eligible to hold S Corp stock unless it also qualifies as a: • Qualified subchapter S trust (QSST) or • Grantor trust under IRC Section 678
2503(c) Trust With QSST Provision • QSST defined as one that: • Owns stock in one or more S corporations (and may hold other assets) • Can distribute income only to one individual (who must be a US resident or citizen)
2503(c) Trust With QSST Provision (cont’d) • QSST defined as one that (cont’d): • Has trust terms requiring that: • There can be only one beneficiary at any given time • If corpus is distributed must be distributed only to current trust income beneficiary • If an income beneficiary dies, income interest itself will end at death or upon earlier termination of the trust • If the trust ends before the income beneficiary dies, all assets of the trust must be distributed to the income beneficiary • Requires an election to be made by the income beneficiary to have trust qualify as QSST
2503(c) Trust With QSST Provision (cont’d) • Advantages of QSST • Gift of S Corp stock can be made to minor without incurring disadvantages of outright ownership • Split income among family members and also eliminate the gift from inclusion in grantor’s estate • QSST can last beyond age 21 for as long as grantor directed it to last • Trust may continue if minor dies and pass to successive income beneficiaries • No forced distribution to estate of deceased income beneficiary
2503(c) Trust With QSST Provision (cont’d) • Gift Tax Implications • Gift to trust considered a completed gift • Gift can qualify for gift tax annual exclusion by meeting 2503(c) requirements • Estate Tax Implications • If beneficiary given only income rights, the remaining assets in trust will not be includable in the beneficiary’s estate
Section 678 Trust For S Corp Stock • Beneficiary must have unrestricted power exercisable solely by himself to vest the corpus or the income • Beneficiary has right to take income and principal whenever desired • Beneficiary taxed on income from S Corp held by trust • No restrictions on beneficiary’s right to exercise withdrawal power • Or, beneficiary has not exercised Crummey Power to withdraw and has retained certain powers • Beneficiary is trustee • Trustee has discretionary power to distribute income either alone or with adverse party
Section 678 Trust For S Corp Stock (cont’d) • Gift Tax Implications • Gift to trust considered a completed gift • Gift can qualify for gift tax annual exclusion by meeting 2503(c) requirements or including a Crummey withdrawal power
Section 678 Trust For S Corp Stock (cont’d) • Estate Tax Implications • Depends on how the trust became qualified under Section 678 • General Power of Appointment (power of withdrawal) over all or part of the trust, that portion over which beneficiary had power at death will be includable in the beneficiary’s estate • If beneficiary exercised or released the power and retained an interest in the trust (e.g. life estate), the property is includable in the powerholder’s estate • Lapse of a Crummey withdrawal power is not treated as a release if the lapse does not exceed $5,000 or 5% of the property subject to the power
What Is A 2053(b) Trust? • Requires mandatory distribution of trust income to the beneficiary or beneficiaries at least annually • Gifts qualify as gifts of present interest and are eligible for the gift tax annual exclusion • Trust must deny right of trustee to invest in non-income producing assets • Gifts are divided into two portions: • Income, eligible for the annual exclusion ($13,000 in 2011) and • Principal (the remainder), considered a gift of a future interest
What Is A 2053(b) Trust? (cont’d) • Does not require distribution of corpus at age 21 • Trust can last for lifetime of beneficiary • Trust principal does not need to go to income beneficiary • Principal can go to different beneficiary specified in the trust or • A person specified by the income beneficiary • Income is taxed to the beneficiary, unless used to discharge legal obligation of grantor-parent
Holding Assets In Trust Past Age 21? (cont’d) • Crummey Power • Donee has immediate, unfettered and ascertainable legal right at the time the gift is made to take out the amount of the current gift • Qualifies gift as gift of a present interest for gift tax annual exclusion Note: Failing to exercise the power to take the gift out of the trust (where trust goes on to someone else) is a gift by the beneficiary-donee to the extent the value goes on to someone else (5 or 5 exception)
Holding Assets In Trust Past Age 21? (cont’d) • Crummey Power (cont’d) Exception: Gift tax consequence of donee ignored where power to appoint to oneself is no more than the greater of $5,000 or 5% of the trust corpus • Remember the $5,000 limit is less than the annual exclusion amount