Why You Should Hire A Tax Professional To Review Your Trust

• Published date: 09 December 2022
• Subject Matter: Tax, Income Tax
• Law Firm: Freeman Law
• Author: Mr Matthew Roberts

Trusts come in many variations, rendering them often difficult for non-attorneys to follow and comprehend. Indeed, this variation can often be seen in the nomenclature used for trust arrangements, which includes terms such as grantor and non-grantor, simple and complex, revocable and irrevocable, and discretionary or non-discretionary. In many instances, trusts may also have provisions designed to protect the trust principal from third-party creditors'such as spendthrift clauses'making trusts even more difficult for a layman to understand.

Of course, the many variations of trusts also give rise to income tax reporting complexity. Although the IRS has readily recognized that there is nothing unlawful in establishing a trust, it has also actively communicated that it will police trust arrangements to ensure that trusts and trust beneficiaries are complying with the federal income tax and reporting laws. Accordingly, taxpayers establishing trusts'and particularly those where the drafter intends to charge a large fee'should have the trust agreement carefully scrutinized by a tax professional to make sure that the trust complies with these tax laws.

What is a Trust?

Trusts are nothing more than an agreement between the settlor (or grantor) and the trustee in which the settlor transfers property to the trustee to hold in trust for the benefit of the trust beneficiaries. When a trust is settled, the trustee has fiduciary obligations to the trust beneficiaries, limited only by the terms of the trust agreement and governing state law.

Generally, trusts contain provisions whereby the beneficiaries receive specified distributions from the trust. For example, a trust provision may provide that the income beneficiaries receive income for life with the corpus (or principal of the trust) going to the principal beneficiaries. Because certain items have the hallmarks of both income and return of capital, there may often be disagreements amongst the beneficiaries as to the proper treatment of those items for trust purposes and fiduciary accounting income.

IRS Notice 97-24.

As indicated supra, there is nothing prohibiting taxpayers from conducting their personal or business affairs through trust arrangements. In fact, the IRS has readily conceded that taxpayers may utilize trusts for valid purposes, such as to protect assets or more easily transfer wealth to third parties. There is nothing nefarious about creating a trust. Rather, taxpayers run afoul with the IRS when the settlor, the trust, or the trust beneficiaries fail to properly report trust activities to the IRS when they are otherwise required to do...