The Listen to Lawrence Letter: Taxes and Trusts can be confusing

DAVIDOWLAW Blog Post

Dear Clients and Friends,
The topic of taxes and trusts is confusing, triggering the following questions:
CLIENT QUESTIONS:
Can you please explain inheritance tax, estate tax, and why trusts are important for tax reasons? I understand there is a Medicaid look back but people also say there is a tax reason to do a trust. Can spouses and children inherit in NY tax-free up to $6 million? I am not clear on the tax reason to do a trust. Can you also touch on the taxes for beneficiaries in brokerage accounts and retirement accounts?
MY RESPONSE:
Wow, there is a lot to unravel here. First, generally speaking, some states have an estate tax (a tax on the estate of a decedent) and some states have an inheritance tax (a tax on your beneficiaries when they inherit); New York has an estate tax.   New York’s estate tax has an exemption that hovers around $6 million and the federal exemption is close to $12 million. When a spouse inherits, there is never an estate tax. In any event, people with estates this big are never concerned with Medicaid planning; instead, they will create trusts to reduce their estate taxes, among other reasons. Rich people have enough money to pay for their care without going broke.
Medicaid trusts are reserved for working and middle-class people looking to protect their assets from long-term care costs, not estate taxes.   There are tax reasons to create an irrevocable trust but they have nothing to do with the estate taxes, but rather INCOME taxes. For example, we could protect your house from Medicaid by simply transferring it to your children, subject to the five-year look-back. However, when it is sold you will lose your step-up in tax basis (if sold after your death) or your $250,000 per person capital gain exclusion (if sold during your life). The trust is designed to be able to sell your house after your death or during your life with minimal tax (or complete elimination of tax). Also, the trust is designed to direct income taxes to be paid by you, rather than your children (who may be in higher tax brackets) or the trust itself. Trusts can own homes, brokerage accounts, and just about any other assets, but we must always analyze the income tax ramifications of creating a trust or not. Who will pay the tax must always be asked and answered. Retirement accounts, however, can not be put in trusts because it would trigger the income tax right now on the entire account.
I hope this helps! Please forward this information to your friends and relatives to share these informative answers to some very commonly asked questions.
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Until next time,
peace, health and happiness,
Lawrence Eric Davidow