How Do Trusts Get Taxed? Basics of Trust Taxation & Can They Pay No Tax?

Summary

In 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

00:00

📚 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.

05:01

🏦 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.

10:01

🔄 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.

Keywords

💡Trusts

Trusts are legal arrangements where one party, known as the trustee, holds and manages assets for the benefit of another, the beneficiary. In the video, the concept of trusts is central to the discussion on taxation. The script explains that trusts are not necessarily legal entities but are relationships between parties, with the grantor, trustee, and beneficiary playing key roles.

💡Taxation

Taxation refers to the compulsory financial charge or some other type of levy imposed by a governmental organization on an individual or a legal entity. The video script delves into the complexities of how trusts are taxed, emphasizing that the tax implications depend on the type of trust and the jurisdiction in which it operates.

💡Settlor or Grantor

The settlor or grantor is the person who creates the trust and transfers assets into it. The script mentions that in the case of a revocable trust, the assets are generally taxed to the grantor, as they can be taken back, indicating the grantor's continued connection to the assets for tax purposes.

💡Trustee

A trustee is the individual or institution that holds legal title to the property placed in trust and is responsible for managing it for the benefit of the beneficiaries. The script explains that the trustee's role is crucial in determining the tax implications of the trust's assets.

💡Beneficiaries

Beneficiaries are the individuals or entities that benefit from the assets held in trust. The video script discusses how the tax treatment of trust assets can depend on whether the assets are distributed to the beneficiaries or retained within the trust.

💡Revocable Trust

A revocable trust is one where the grantor retains the power to revoke or change the trust. The script uses this term to illustrate that assets in a revocable trust are typically taxed to the grantor because the grantor can undo the trust and reclaim the assets.

💡Irrevocable Trust

An irrevocable trust is one where the grantor gives up control over the assets and cannot change or revoke the trust. The script explains that the tax implications of an irrevocable trust can be different from those of a revocable trust, particularly regarding who is taxed on the trust's income or gains.

💡Capital Gains

Capital gains refer to the profit made from the sale of an asset or property that has increased in value. The video script discusses how capital gains within a trust can impact taxation, either at the trust level or the beneficiary level, depending on the trust's structure and the distribution of gains.

💡Corpus of the Trust

The corpus of a trust refers to the principal or the body of assets that form the trust. The script mentions that if gains within the trust are not immediately distributed but are added to the corpus, they may be taxed at the trust level, potentially leading to a deferral of tax.

💡Deferral

Deferral in the context of taxation refers to the postponement of tax liability to a future date. The script explains that certain trust structures can allow for tax deferral, where the tax on gains within the trust is not paid until the assets are distributed to the beneficiaries.

💡Anti-Avoidance Rules

Anti-avoidance rules are legislative measures designed to prevent taxpayers from using legal means to avoid or reduce their tax liability. The video script refers to these rules in the context of trusts, particularly in Australia, where they aim to ensure that tax is paid on trust income or gains, even if the trust attempts to defer or avoid tax liability.

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

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then by all means reach out to us you

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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

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i'm big on liking subscribers

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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