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TAX CLINIC

A special election under Regs. Sec. effective estate plan to ensure beneficia- Planning point: Be aware that if
1.642(c)-1(b) allows a trustee to treat ries receive a benefit consistent with the the trustee is required to reimburse the
contributions made in the subsequent grantor’s intentions. grantor or has a prearranged agreement
year as a current-year charitable deduc- Planning point: If the simple trust to do so, the assets of the trust are likely
tion, allowing for additional flexibility has taxable income and the beneficiaries includible in the grantor’s estate.
in income tax planning. For example, receive distributions, the beneficiaries
a trust filing a 2022 tax return with $1 will have personal income tax conse- 9. What is the potential impact of
million of gross income can make a $1 quences related to the distributions they divorce on a trust created for the
million charitable contribution before receive. Make sure the beneficiaries un- benefit of a spouse?
Dec. 31, 2023, and elect to treat it as derstand the impact of the distributions Trusts for the benefit of a spouse and
a 2022 deduction to reduce its gross to avoid surprises. descendants are typically structured
income to $0. as irrevocable grantor trusts, and the
Planning point: Creating and 8. How might the flexibility of grantor is personally taxed on the in-
funding a trust for charitable purposes irrevocable grantor trusts factor come because distributions may be made
can help to maximize deductions and into planning? to the grantor’s spouse. In the event of
contribute to a broader set of organiza- An irrevocable grantor trust is a trust a divorce, the grantor may still be liable
tions. Generally, no AGI limitation is created and funded during life in which to pay the tax on the income earned by
applied to gifts to charity on the fidu- the grantor retains an element of control a trust set up for the benefit of a now
ciary income tax return. This means that over the assets, which results in taxation ex-spouse. Possible post-divorce solu-
a trust created for charitable purposes of the trust income and calculation of tions include modifying the trust agree-
may be able to take a deduction of up to related deductions and credits on the ment, terminating the trust, distributing
100% of its gross income. grantor’s individual income tax return. the assets to the spouse, or creating an
The assets of the trust are not taxed as agreement as part of the divorce settle-
7. Will beneficiaries receive what part of the grantor’s estate, and the pay- ment to have the ex-spouse reimburse
is intended from a ‘simple’ trust? ment of income taxes on behalf of the the grantor for the taxes paid.
Simple trusts require that beneficiaries trust further reduces the grantor’s estate Planning point: Taxpayers typically
receive distributions of all the trust’s in- without gift tax consequences. do not set up trusts for the benefit of a
come at least annually; the definition of In addition, there is flexibility if the spouse when contemplating a divorce. In
income can depend on the trust agree- payment of income taxes on behalf of the event of divorce, the trust should be
ment or state law. the trust becomes too burdensome. First, carefully considered in the divorce pro-
Consider how the income gener- if the trustee has the discretion to reim- ceedings and the divorce agreement to
ated by a simple trust will be treated burse the grantor for income taxes paid, ensure the spouses understand the trust’s
for trust distribution purposes. For the trustee can reimburse the grantor income tax impact.
example, if the trust holds an interest without the assets of the trust being in-
in a flowthrough entity, the income cluded in the grantor’s estate. However, 10. What type of planning should
from the entity is generally ignored, if the trustee is required to reimburse the there be for an illiquid estate?
and only actual distributions made from grantor or has a prearranged agreement If an estate is made up mostly of illiquid
the entity are “income” for fiduciary ac- to do so, the assets of the trust are likely assets, how will the executor find the
counting distribution purposes. If the includible in the grantor’s estate. Sec- cash to pay the income and estate tax?
trust holds flowthrough entities that ond, the trust agreement may allow the To prevent the executor from having
rarely make distributions, the beneficiary grantor to make a change to the powers to rely on a quick sale, the purchase of
may not receive as much benefit as the the grantor retained and effectively “turn life insurance may be a simple solution.
grantor had originally intended. This off” the grantor trust status. This would Generally, if the policy is structured
structure, however, may be perceived as cause the trust to pay its own income tax properly, the death benefit will not be
a benefit in other planning scenarios liability from trust funds. subject to income taxes or be includ-
in which the flowthrough entity’s dis- Carefully consider state income tax ible in the individual’s estate, and the
tributions control the trust’s ability to elections that allow the payment of state cash may be available to pay taxes or to
make distributions. income taxes via an entity owned by the benefit heirs. Life insurance may be an
Understanding how these types of trust instead of by the grantor, as the income and estate tax–friendly method
trusts operate for distribution and in- grantor may then be treated as making a of wealth replacement for a family. For
come tax purposes can help facilitate an gift if they reimburse the trust. example, a first-to-die life insurance

14 April 2023 The Tax Adviser