Intentionally Income Tax Defective Trusts

A Trust written in such a way to exclude it from the grantor’s estate but with a power reserved by the grantor (such as giving a nonadverse party the power to add beneficiaries other than adopted or after-born children), so that the Trust is taxed under the grantor trust rules of IRC Section 675.

Advantage

When the grantor funds the trust, the value of the assets are fixed for gift tax purposes and any appreciation is kept out of the estate. In addition, the grantor makes, in effect, gift tax free gifts by paying tax on the income and gains from the Trust which he/she does not receive.

Caution

However, the IRS may take the stand that the income taxes paid are in fact subject to gift taxes because the Trust is liable according to property law.

Disadvantage

The major disadvantage is the relinquishment of control and enjoyment of the assets.
 

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