How Do Trusts Get Taxed? Basics of Trust Taxation & Can They Pay No Tax?
Summary
TLDRIn this video, Michael from Offshore Citizen discusses the often misunderstood topic of trust taxation. He clarifies that trusts are not legal entities in many parts of the world, which complicates tax implications. Michael explains the roles within a trust and how taxation can vary depending on whether the trust is revocable or irrevocable, the nature of asset distribution, and the specific tax laws of the jurisdiction involved. He debunks the myth that trusts are not taxable and emphasizes the importance of understanding the tax consequences of trust setups for effective financial planning.
Takeaways
- 😀 The video discusses the taxation of trusts, a topic that may not attract many views but is important for certain individuals and has been subject to misconceptions and misleading schemes.
- 🏦 Trusts are not always recognized as legal entities, especially in countries like Spain, which complicates tax implications.
- 🔑 In a trust, there are three key roles: the settler or grantor, the trustee, and the beneficiaries, each with different potential tax liabilities.
- 🔄 The tax treatment of a trust can vary greatly depending on whether the trust is revocable or irrevocable, and the nature of the assets and their distribution.
- 💼 If a trust is revocable, the assets are generally still considered taxable to the grantor, as they can be taken back.
- 🎁 In some jurisdictions, transferring assets into a trust can be treated as a gift, which may have tax implications based on the grantor's gift tax exemption.
- 💼 In jurisdictions without trusts, like Spain, the tax system may treat a trust as a partnership, focusing on when the transfer of assets actually took place for tax purposes.
- 💰 The tax treatment of income within a trust is typically 'flow-through', meaning the nature of the income (e.g., capital gains) is preserved and passed to beneficiaries.
- 📈 If assets within a trust generate gains and these gains are distributed immediately to beneficiaries, they are usually taxed at the beneficiary level.
- 🏦 If gains are not distributed immediately but are kept within the trust, they are typically taxed at the trust level, which could lead to deferral of tax until distribution.
- 🚫 The common misconception is that trusts are not taxable, but in reality, trusts often have their own tax obligations unless there is specific tax exemption or deferral.
Q & A
What is the main subject of the video?
-The main subject of the video is the taxation of trusts and how they are perceived and taxed in different jurisdictions.
What is a trust and why is its tax status complex?
-A trust is a relationship between parties where one party holds assets for the benefit of another. Its tax status is complex because it is not a legal entity in many parts of the world and its tax treatment depends on the specific setup and jurisdiction.
What are the three main roles in a trust?
-The three main roles in a trust are the settler or grantor (the person who sets up the trust), the trustee (who holds and manages the assets), and the beneficiaries (those who benefit from the trust).
What is the difference between a revocable and an irrevocable trust in terms of taxation?
-In a revocable trust, the assets are generally taxable to the grantor since they can be taken back. In an irrevocable trust, the assets are not taxable to the grantor, but the tax treatment depends on whether the trust is recognized in the jurisdiction and how the assets are distributed.
Why is it important to understand the nature of asset distribution within a trust for taxation purposes?
-Understanding the nature of asset distribution is important because it determines whether the income or gains are taxable at the trust level, the beneficiary level, or the grantor level, and whether there is a deferral of taxation.
What is the misconception about trusts and taxation that the video aims to clarify?
-The misconception is that as long as the assets in a trust are not paid out, there is no taxable event. The video clarifies that this is often not true and that taxability depends on various factors, including the type of trust and the nature of the assets.
Can a trust be used for tax deferral?
-Yes, a trust can be used for tax deferral, especially if the trust is in a jurisdiction without tax consequences and the assets grow without tax implications. However, this depends on the specific rules and anti-avoidance measures in place.
How does the tax treatment of a trust differ from that of a corporation?
-A corporation pays tax on its income and then distributes after-tax profits to shareholders, who may also be taxed on the distribution. In contrast, a trust typically 'flows through' the income, taxing it at the trust level if applicable, and not at the beneficiary level unless specific conditions are met.
What is an example of a country where trusts are treated differently for tax purposes?
-Spain is an example where trusts are treated like partnerships, and the tax treatment focuses on determining when the transfer of assets took place, which affects whether the grantor or the beneficiaries are taxed.
What are some scenarios where a trust might not be taxable?
-A trust might not be taxable in jurisdictions where trusts are not recognized, or if the trust is used for charitable purposes and qualifies for tax exemptions, or if specific tax planning strategies are employed to defer taxation.
How can one get help with trust taxation and related matters?
-One can reach out to the video creator at clarity.michael or book a call through the provided website links, offshorecitizen.net or offshorecapitalist.com, for personalized assistance and consultation.
Outlines
📚 Introduction to Trust Taxation
Michael from Offshore Citizen introduces a discussion on trust taxation, a topic he acknowledges may not attract many views but is important for a specific audience. He aims to clarify misconceptions and address schemes that are not valid, using Spain as an example of a country without trusts, which treats them like partnerships. The video promises to explore who is responsible for tax in trusts: the settler, trustee, or beneficiaries, and how different trust types, such as revocable and irrevocable trusts, affect taxation.
🏦 Trust Taxation Scenarios and Misconceptions
This paragraph delves into the taxation scenarios for trusts, focusing on whether the grantor remains taxable and the conditions under which a transfer is considered to have taken place, as illustrated by Spanish tax law. It also discusses the potential for trusts to be treated as gifts, with reference to U.S. gift tax rules, and how the nature of income within a trust is preserved, unlike in corporations. The paragraph addresses common misconceptions about trusts and taxation, emphasizing that trusts are not inherently tax-exempt and that tax implications depend on the trust's structure and the nature of the assets involved.
🔄 Trust Taxation: Gains, Distributions, and Deferral
The final paragraph discusses the tax implications of gains within a trust and how they are treated when distributed to beneficiaries or retained within the trust corpus. It highlights the potential for tax deferral in certain trust structures and the importance of understanding the tax rules in different jurisdictions, such as Australia's anti-avoidance rules for trusts. The paragraph also contrasts the tax treatment of trusts with that of corporations, emphasizing that trusts are designed to flow through income without double taxation, and ends with an invitation for viewers to engage with the content and reach out for assistance.
Mindmap
Keywords
💡Trusts
💡Taxation
💡Settlor or Grantor
💡Trustee
💡Beneficiaries
💡Revocable Trust
💡Irrevocable Trust
💡Capital Gains
💡Corpus of the Trust
💡Deferral
💡Anti-Avoidance Rules
Highlights
The video discusses misconceptions about trust taxation and aims to clarify the subject for a specific audience.
Trusts are not always recognized as legal entities, which complicates taxation.
In a trust, there are three key roles: the settlor/grantor, the trustee, and the beneficiary.
Taxation of trusts depends on whether the trust is revocable or irrevocable.
Revocable trusts typically remain taxable to the grantor since they can be undone.
Irrevocable trusts may still be taxable to the grantor if the transfer is not deemed complete.
The nature of income within a trust is preserved and flows through to beneficiaries.
Gains within a trust can be taxed at the trust level if not immediately distributed.
Spain treats trusts like partnerships and focuses on when the transfer of assets takes place for tax purposes.
A trust can be considered a gift, which may have tax implications depending on the jurisdiction's gift tax rules.
Common law jurisdictions often allow the characteristic of income to flow through trusts to beneficiaries.
If trust gains are paid out immediately to beneficiaries, they are typically taxed at the beneficiary level.
Accumulated gains within a trust can lead to deferral of taxation until distribution.
Australia has anti-avoidance rules that may tax deferred trust income upon distribution.
Trusts are not immune to taxation; they often have their own taxability depending on jurisdiction and setup.
Trusts can be part of tax planning strategies, especially in jurisdictions with favorable tax laws.
The video emphasizes the importance of understanding trust taxation for effective financial planning.
Transcripts
welcome back everyone michael here with
offshore citizen
today i'm going to dive into a subject
which is you know probably not going to
get me the most views it's probably not
gonna go viral or something like that
but i think is important for a certain
group of people and it's something that
i see misconceptions about in fact i've
seen
uh some kind of schemes marketed uh
which are not
valid uh lately and so i wanted to dive
into it and that is the subject of
how trusts are taxed okay so we're going
to dive into this quickly
before we get into that and i'll try to
go through all the details for you so
again stick around
and tell me what you think at the end
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offshorecapitalist.com okay
let's go so what is the situation
when it comes to how trusts are taxed so
this is a little bit of a confusing
thing
for a lot of people in part because of
the fact that a trust
as i've talked about you can check about
some of our other videos where i kind of
explain a little bit about how trusts
work
but they're not necessarily a legal
entity it's more like a relationship
between parties they're sometimes
treated as a legal entity but
it's not a trust is not intrinsically in
a lot of parts of the world
illegal entity in fact in a lot of parts
of the world the trust is not recognized
at all
and so this becomes fairly important
in order to regard what taxation takes
place and so just to
recap for you in a trust there are
basically three meaningful roles okay
there is
the settler or grantor who is the person
who sets up the trust and puts the
assets in initially
there's the trustee who holds those
assets and manages them in trust
for the purposes of the beneficiary okay
beneficiaries are the people where it
ultimately goes to
now as you can see because there's three
people you might
think okay well where is that taxable is
it taxable at the beneficiary level
is it taxable at the trustee level
uh which is typically kind of the
trustee is the trust right when we're
saying that we're referring really to
the trust because it's the trust assets
usually are taxable
paying that out or is it at the settler
grantor level okay
now this
is a little bit interesting because of
the fact that
it depends on the way the trust is set
up in most cases okay so let's use an
example
if i put assets into trust and the trust
is what's called revocable meaning that
i can basically undo the trust i can
take them back
then generally those assets are taxable
to me okay i'm making some
generalizations here you have to look
country by country as i said in some
countries they don't have tax
trusts so then you have to kind of look
at case law to figure out how it is that
they're taxed for instance spain
right and we'll use spain as an example
as we go forward
because it's kind of relevant so that's
one one scenario right
another is we say okay it's irrevocable
meaning i'm putting the assets into
trust
and okay great they're they're in trust
i can't take them out right
well does that mean that they're still
taxable to me does that mean that they
are taxable to
the trustee does it mean they're
trackable to the beneficiary how does
that work
right they and now we start to get into
the next part which is
okay do the assets clearly pay out
some sort of uh like a return
to the beneficiaries directly or do
those assets
accumulate in trust and then get
distributed later
okay that's kind of the the nature of it
and you might kind of go through the
last part which is
if you have multiple beneficiaries is it
clear are they clearly divided between
say three people
or is it that they're uh discretionary
like it can vary it could be more to one
and less to another and
then to somebody else okay those factors
are
generally speaking what we're going to
look at when we pay attention to how it
is that they're taxed
okay and the misnomer the fallacy that i
hear people talk about
is they kind of have this idea that it's
like oh hey so long as
it's not paid out there's no taxable
event
and that's very often not true it might
be true
right but most of the a lot of the time
it's not true
okay so here we go
there are typically
two scenarios under which the grantor or
the settler
would remain taxable okay the first is
if it's a revocable trust
then typically it would remain taxable
to the grand tour settlement not always
right i don't want to
the reality is there's lots of countries
in the world right lots of ways that
trust can be interpreted
but generally speaking in that scenario
it could be
could be taxable to the grantor okay
the next scenario is that under which it
could be taxable to the grantor
is if it is somehow deemed that a
transfer has not taken place yet
okay so i'm going to give you the
example of spain here spain
because there are no trusts in spain
treats a trust
like a partnership okay and so the key
distinction
in spanish rules is they're trying to
figure out
when did the transfer take place
basically what they do is they remove
the trust
okay so they basically just have the two
parties the grantor
or the settler and the beneficiaries and
they say okay
when did the transfer actually take
place when the transfer took place
uh if it you know hasn't taken place yet
then it's taxable to the grantor settler
if it has taken place then it's taxable
to the beneficiaries and that's
kind of the general idea if you go and
read up on the case law how about it
okay
all right perfect so that's the the
other scenario
now then we have the scenarios where you
say okay great
uh what was what would often happen is
that
a trust the transfer into a trust might
be considered a gift
okay so we could use for example the u.s
rules right
under the u.s rules there's a certain
for an american
or from u.s citizens there is a lifetime
limit on how much gift can be gifts can
be given okay
so typically if i take that money as a
grantor
and i put it into trust right let's just
say it was five million dollars okay and
say
i haven't used up my my gift limit
anywhere else
uh if that if it's just that principle
that gets paid out to the beneficiaries
then there shouldn't be any tax why is
that well because that's after tax money
okay it's just it's like i was giving
you a gift so
the trust is basically controlling how
long that takes what the process is by
which that happens
but it doesn't change the material
nature
of the transaction so generally speaking
when we're looking at
common law jurisdictions where they do
have trusts the
characteristic of the income is
maintained
okay so a trust kind of flows it through
so if for instance you have a capital
gain
that takes place it's not like it goes
in whereas if it was a corporation
corporation has a capital gain they
realize the gain then they pay out money
that's a dividend or they pay out money
as say a wage
the capital gains nature of it is not
preserved in this case it is preserved
it flows through
okay so the trust holds a property the
property gets sold
that money flows through to the
beneficiaries the characteristic of it
which is capital gains income
flows through to the beneficiaries okay
make sense
all right now
there's two scenarios that we can have
here right the one scenario
is we say okay uh or well let's start
with
as i mentioned the whole thing is if
it's just money has been put into trust
there's no gains and it just gets paid
out then it's fairly clear
right it's basically just a transfer
from one to the other so
you know again you can figure out okay
when did it get transferred but more or
less it's just a transfer
where we get into complications is when
we put assets
that grow into a trust okay so maybe i'm
going to put in stocks
maybe i'm going to put in businesses
maybe i'm going to put in
property gold maybe i'm going to put in
cash but then the cash is going to be
used to buy these things etc
right so there's some sort of actual
profitability
that is happening within this trust okay
all right fair enough
so now there's gains so now the question
becomes
all right what if those gains
are paid straight out to the
beneficiaries well then generally
speaking not always but generally
speaking if they're immediately paid out
to the beneficiaries
especially this will typically be
determined by
the rules of the trust then in that
scenario
it's going to be taxable to the
beneficiaries okay
the flip side is that you say okay it's
not
paid out immediately to the
beneficiaries it's
kept in the corporate it's basically
added to the corpus of the trust the
corpus being
kind of the body the assets of the trust
in that case it would typically be
taxable
at the trust level okay now
what the consequences of this are is
that potentially this could lead to some
sort of a deferral arrangement
okay and if that's the case then
sometimes
you're going to end up in a situation
where as those assets add up
within the trust when they do get
distributed they may still be taxable
to the beneficiaries okay so this would
be a really common thing if we look at
the anti-avoidance rules
around trusts in australia there's quite
i think it's four or five
anti-avoidance regimes related to these
types of entities
in australia and in those there's almost
no scenarios there's basically one
scenario under which you can defer
okay if you defer
under that scenario then it's going to
be taxable
when it's received okay and then you
know we can kind of deal with the other
scenarios uh
as they as they rise so i just wanted to
mention this to you
because of the fact that it's noteworthy
that in tax in general like
income is going to get taxed so usually
the idea is if income has already been
taxed
okay at like a personal level then a
transfer
often will have some sort of a limit
under which it's not taxed
we've talked about gifts as a big
exemption and that's kind of why right
if i receive money from my company i pay
all my tax on it the companies paid
their tax
then whether i give that money like
whether i'm spending that on somebody
else or whether i'm spending it on
myself
really doesn't matter right it's kind of
immaterial if we're in a situation where
the tax has not been paid right then the
fact that it
flows from a to b to c
and it's not paid at b then it's going
to make sense that it's paid at uh
c right the fallacy that some people
seem to have
is they seem to have this idea that it's
like oh hey uh
what about this part in the middle in
the part in the middle hey a trust a lot
of people seem to have some idea that
trusts somehow aren't taxable
most of the time trusts function
and have kind of a taxability on their
own so in the absence of some other
taxability
a trust could be taxed now of course
if you're in a jurisdiction with no tax
then that's not the case right
so you have to dive into the specifics
here and so there is certainly some
really good tax planning you can do
where you can say okay great there may
be a foreign trust and that trust is in
a jurisdiction without
tax consequences and the assets are in a
place that they're
you know growing without tax
consequences and so
you know you can defer there perpetually
it's also true that trusts are often
used as charities
and so then the charity may not have tax
consequences or there are some
other specially designed trusts we
sometimes use this in u.s domestic tax
planning
where uh there's specific reasons why
you're able to defer that income and
therefore there isn't tax
until kind of the end event so there are
some cases like that
but generally speaking the way that it
works is there's not double tax so this
is like the difference i would say
between uh a corporation
right so a corporation receives the
income it pays tax then it pays out a
distribution
after tax right and that after tax
distribution
then becomes taxable in the hands of the
shareholder who receives it
in the case of a trust the income flows
in
it's not tax if it is taxable at the
trust level that it's not taxable
usually at the beneficiary level
whereas if it isn't taxable or if it is
taxable the beneficiary level then it's
usually not taxable
at the trust hole so it's again designed
to kind of flow through
so anyway i hope that kind of gives a
sense i hope i was fairly clear there if
you have questions please put them in
the comments
if you liked the video please click the
like button i mean click the subscribe
button if you haven't done so already in
general
i'm big on liking subscribers
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at uh you're wonderful anyway uh if you
want help with any of this kind of thing
please reach out to me
clarity.michaelrosmer you can
book a call with me uh check out our
website offshorecitizen.net
offshorecapitalist.com share these
things
with anyone who might might need some
assistance and
i'm going to look forward to seeing you
guys on the next video
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