Residents of the United States have discovered that setting up a trust as part of estate planning can help protect personal wealth and reduce tax liability for heirs and tax obligations for the grantor while living. However, removing the assets from a trust can have immediate tax implications, depending on the type of asset. In particular, stocks put into trusts and later removed can subject the owner to more than one federal tax.
State laws vary by jurisdiction. A number of states have adopted the Uniform Trust Code, or UTC. These standardized statutes pertain mainly to how trusts should be structured and rules concerning what can and cannot be included in a trust. Even so, states can add or strike particular regulations from the UTC to suit specific state legislatures. On the federal level, the Internal Revenue Code determines federal tax implications of removing stocks from a trust.
In a revocable trust, the grantor can also be the beneficiary of the trust during his lifetime. When stocks are added to the assets of a trust, the grantor may give up ownership yet still reap the rewards of earnings in the form of dividends. However, if the stocks are removed from the trust and ownership reverts to the grantor who created the trust, income taxes on capital gains and dividend earnings must be considered.
Initials gains from taking ownership of stocks from a trust are figured on the basis of the asset. For example, assume a U.S. taxpayer gifted $10,500 in stocks to a trust three years ago for which he paid $10,000 at the time of purchase two years earlier. When ownership reverts to him from the trust, assume the stocks have a current market value of $11,800. Subtract the cost basis from the market value, which results in a $1,800 gain. Under IRS regulations, the taxpayer has received an immediate capital gain of $1,800, which is considered taxable income.
Fair Market Value
According to the IRS, if property is inherited, the basis of the asset is its fair market value when received. In other situations where a taxpayer takes ownership of stock from a trust that someone else purchased, the basis equals either the fair market value or the adjusted basis of the prior owner. Taxes are then computed on the gains.
In some situations, the assets of an irrevocable trust can be modified with the permission of the beneficiary. However, in most situations where the trust structure is set up as irrevocable, regulations prohibit a grantor from removing assets, such as stocks. The IRS has strict rules for adding or removing assets from an established trust in order to gain the most favorable tax situation. According to IRS regulations, gains, regardless of form, received from a trust are generally considered taxable income. An expert trust attorney should be consulted when in doubt.
- Cornell University Law School: United States Code Title 26,671 Trust Income, Deductions, and Credits Attributable to Grantors and Others as Substantial Owners
- Internal Revenue Service: Grantor Trust Reporting Requirements
- Internal Revenue Service: Publication 550, Investment Income and Expenses
- Internal Revenue Service: Publication 551, Basis of Assets
- University of Pennsylvania Law School: Uniform Trust Code
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