An irrevocable dynasty trust is a gifting vehicle that offers a way to shift future appreciation of assets to others while fixing the gift tax cost at today’s asset values. It also can be structured to last for generations. Using this strategy, you could create a trust with assets equal in value to your remaining applicable exclusion amount. The value of the gift is the fair market value of the assets transferred to the trust as of the date of transfer. In addition, it is possible that a married couple will allocate enough of their available generation-skipping transfer tax exemptions (currently $5 million in 2011 and 2012) to the initial contribution to make the trust fully exempt from the generation skipping transfer tax, i.e., “GSTT Exempt.” You cannot be a beneficiary of this trust.
Because it is contemplated that this trust and distributions from the trust will not be subject to generation-skipping transfer taxes, additional contributions to the trust by you should be made only to the extent that you have enough unused generation-skipping transfer tax exemption to allocate to the future contributions. This will be necessary for the trust to remain fully “GSTT Exempt” following the additional contributions.
The tax results of such a transfer are as follows:
1. Appreciation of the value in trust assets will not be subject to gift tax or generation-skipping transfer taxes. Because you will use tax credits currently, the best type of asset to contribute to such a trust is an asset that is more likely than not to increase in value. Of course, some assets that have potential for significant appreciation could instead decline in value after having been transferred to the trust. Please note that your unified credit is not restored in such a case.
2. Assuming no gift tax is paid because the value transferred is within your remaining unified credit, the trust’s income tax basis in the assets transferred to it is the same as your basis in those assets as of the date of transfer. Care should be taken to examine income tax consequences if an asset transferred to the trust is subject to any debt, if it has been depreciated, or, it was stock acquired through the exercise of incentive stock options.
3. During your lifetime, you can retain the power to reacquire any portion of the trust property by substituting property of an equivalent value. Under current law, your retention of this power in a nonfiduciary capacity should result in your being treated as the owner of the property for federal income tax purposes. As a result, the trust should be taxable as a “grantor” trust with respect to you for federal income tax purposes, and you will be responsible for all income taxes attributable to the trust (both ordinary income and capital gains). The benefit of this arrangement is that you will not treat your payment of taxes on trust income as additional taxable gifts to the trust. You may elect to terminate this power, which would result in the trust being treated as the taxpayer from that date forward.
The trustees will hold the trust fund for the benefit of your grandchildren and their descendants. The trustees will have broad discretion to distribute income and principal of the trust to and among your children and their descendants, and the trustees will be encouraged to make distributions principally for purposes of education, purchases of a primary residence, health needs, and the like. The trust can last until 21 years after the death of the last descendant of yours living at the time the trust is created.
The trust also contains comprehensive administrative and tax provisions that give the trustees the flexibility and management powers necessary to manage property effectively, respond to the needs of the beneficiaries, and minimize taxes.