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Hammer out tax benefits for defective trusts

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in Small Business Tax

We wouldn’t tell you to use a defective product in your workshop or on the job. But it’s safe to recommend at least one estate-planning tool that has a built-in defect.

Strategy: Set up an “intentionally defective”grant or trust. In simple terms, you can have the trust document drafted so it fails to meet the tax requirements for treatment as a separate legal entity. This will cause you to personally owe income tax on the trust’s earnings.

Why would you purposely flunk the tax-law test? Here are three good reasons to go against the grain:

1. No gift tax is due on the tax payments, which effectively become gifts to the trust beneficiaries (usually, your children).

2. No estate tax is due on the trust assets passing to the beneficiaries.

3. The income tax you’ll pay probably will be less than the tab the trust would have had to pay in comparison.

Thanks to a 2004 IRS ruling, you can pass even more wealth tax-free to your heirs when you use this technique. (IRS Revenue Ruling 2004-64)

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