03 Aug Do trusts have disadvantages?

Q. What are some disadvantages of using a trust to protect your assets?
— Thinking about it

A. We often tout the benefits of trusts, but yes, there are some disadvantages.

First, know that trusts can serve many purposes and help achieve the goals of the trust creator, often referred to as the “grantor” of the trust.

There are, however, other characteristics of trusts that you should consider before deciding that the use of trusts is right for you.

While trusts can be helpful in appropriate circumstances to save estate taxes, trusts generally are subject to higher rates of income taxation than the rates to which an individual taxpayer is subject, said Frederick Schoenbrodt, an estate planning attorney with Bressler Amery Ross in Florham Park.

“Trusts, like people, are subject to income taxes on the income generated by the assets held in trust,” he said. “Trusts reach the highest income tax bracket at a very low income threshold, $12,400 of taxable income in 2016, while the top income tax bracket for an individual doesn’t apply until income exceeds $415,050.”

Further, Schoenbrodt said, the additional 3.8 percent net investment income tax applies at similarly low thresholds.

As a result, when a trust is being used for estate tax planning purposes, it is wise to measure the estate tax efficiency of the trust against the potential income tax inefficiencies of the trust, Schoenbrodt said.

He said that these tax rules apply when the trust pays its own taxes.

“In certain cases, a trust will be a `grantor trust,’ meaning that the grantor of the trust continues to be treated as the owner of the trust’s assets for income tax purposes,” he said. “In that case, since the income of the trust is taxed to the grantor, the lower tax thresholds will generally not apply.”

From a non-tax perspective, Schoenbrodt said, it’s important to remember that the use of trusts for tax or asset protection purposes generally requires sacrificing the absolute control over the trust’s assets that would apply if the assets were owned by the grantor or the beneficiaries.

The trustee of the trust will make investment and distribution decisions, he said. While the trustee will often be a family member and, if properly drafted, can be the beneficiary of the trust, neither the grantor nor the beneficiary will have the same level of access that either would have if the assets were owned outright and outside of a trust.

“This sacrifice of absolute control can often be mitigated without sacrificing the protective characteristics of a trust,” he said. “The rules in this area are often fairly complex, so the drafting of such a trust with those ends in mind should be done by a knowledgeable trust and estate attorney.”

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This post was first published in August 2016.