Many people, to provide shelter and protection of the wealth and assets of their families, have used the tax benefits of a family trust. A family trust refers to the right of an individual or group of people to perform legal acts for property in which another person has legal title. Generally, a trust is set up to operate a family-owned business enterprise and to protect the family's interest. These trusts provide not only tax benefits, but also asset protection and estate planning.
A family trust creates a legal contract that outlines the management and distribution of the trust's assets. Taking advantage of the tax benefits of a family trust is just one of the reasons for forming the legal entity. Also called a revocable living trust, it is commonly used to avoid probate, create privacy and manage financial matters. The terms and conditions of a family trust are usually spelt out in a trust deed. A family trust can own property as well as other assets. Ownership of property can be transferred directly into the trust. The various parties to the family trust are also named in the document.
There are three parties to a family trust: the granter or settlor, trustee and beneficiary. The granter transfers the rights to the property or assets, to be held for the benefit of the beneficiaries, over to the trustee. Once the granter signs the trust deed, he usually has no other act to perform as granter. The trustee is the person trusted by the granter to maintain the property and use the property for the benefit of the beneficiary. It is permissible for one person to set up a trust and become the granter, trustee and beneficiary all at the same time. Most family trusts give the role of trustee to a family member.
Most families use family trusts to minimise the inheritance taxes associated with the transfer of wealth from parents to children. In the United States, one of the primary tax benefits of a family trust is that beneficiaries are not required to pay income tax on income that is distributed from the trust. Income may be distributed in such a way as to enable all beneficiaries to take advantage of the tax-free income thresholds. The trust must pay income taxes on undistributed income that remains after the taxable year. Trustees have the authority to distribute the trust's income to the maximum number of beneficiaries. They must also consider the beneficiary's ability to maximise the tax advantages of his marginal tax rate. Beneficiaries are responsible for settling taxes due on all income, including distributions.
The trustee has the fiduciary responsibility of managing the trust as well as the assets. This latitude gives her the power to conduct the business of the trust on a day-to-day basis and make important decisions regarding management of the assets. In many family trusts, the granter may also take on the role of the trustee. In many cases, married couples act as co-trustees. Many trust deeds include provisions for naming trustees in case of deaths. To take advantage of the tax benefits of a family trust, the trustee must have a good understanding of the tax codes as they relate to the family trust, or retain the services of tax professionals. The trustee has the legal capacity to make decisions on how and when to distribute the trust's income in a manner that best preserves the trust's assets.
Besides the tax benefits of a family trust, there are many other reasons for creating a family trust, including ensuring that family members are provided for, especially disabled children. Trusts are also formed to provide children income from the family's assets while the parents typically remain in control of the property. Some trusts are created specifically for the purpose of protecting assets from creditors or build a lasting structure for the family's wealth.
Trustees must make certain that all distributions are only made to family members qualified to receive distributions under the terms and conditions of the trust. If distributions are made outside the family group, the income may be taxed at the maximum marginal tax rate for individuals. Since this is a conversion of trust income, recipients of the distributions could also be liable for Medicare and Social Security taxes.
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