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The section below is the main part of the tax code that we use to explain how the IRS applies capital gains and passive income within our unique specialized spendthrift trust. In short, there are no capital gains tax on investment gains if the gains stay in the trust corpus and are not distributed to beneficiaries.
Internal Revenue TITLE 26, Subtitle A, CHAPTER 1, Subchapter J, PART I, Subpart A, Sec 643 (a)(3),(4),(7) and (b) states: “(3) Capital gains and losses. Gains from the sale or exchange of capital assets shall be excluded to the extent that such gains are allocated to corpus and are not (A) paid, credited, or required to be distributed to any beneficiary during the taxable year, or (B) paid, permanently set aside, or to be used for the purposes specified in section 642(c). Losses from the sale or exchange of capital assets shall be excluded, except to the extent such losses are taken into account in determining the amount of gains from the sale or exchange of capital assets which are paid, credited, or required to be distributed to any beneficiary during the taxable year. The exclusion under section 1202 shall not be taken into account. (4) Extraordinary dividends and taxable stock dividends for purposes only of subpart B (relating to trusts which distribute current income only), there shall be excluded those items of gross income constituting extraordinary dividends or taxable stock dividends which the fiduciary, acting in good faith, does not pay or credit to any beneficiary by reason of his determination that such dividends are allocable to corpus under the terms of the governing instrument and applicable local law. (7) Abusive transactions The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this part, including regulations to prevent avoidance of such purposes. If the estate or trust is allowed a deduction under section 642(c), the amount of the modifications specified in paragraphs (5) and (6) shall be reduced to the extent that the amount of income which is paid, permanently set aside, or to be used for the purposes specified in section 642(c) is deemed to consist of items specified in those paragraphs. For this purpose, such amount shall (in the absence of specific provisions in the governing instrument) be deemed to consist of the same proportion of each class of items of income of the estate or trust as the total of each class bears to the total of all classes. (b) Income for purposes of this subpart and subparts B, C, and D, the term “income”, when not preceded by the words “taxable”, “distributable net”, “undistributed net”, or “gross”, means the amount of income of the estate or trust for the taxable year determined under the terms of the governing instrument and applicable local law. Items of gross income constituting extraordinary dividends or taxable stock dividends which the fiduciary, acting in good faith, determines to be allocable to corpus under the terms of the governing instrument and applicable local law shall not be considered income.”
The Non-Grantor Provision in the Nexxess Trust separates the creator/settlor from the corpus of the trust and exempts the trust from any “Alter Ego” status. In a Grantor Trust, the client (the grantor) asks an attorney to originate a trust for the client, and the attorney honors the request and originates a trust. A grantor trust type trust does avoid probate; however, it does not have any Tax Benefit or Asset Protection. The grantor status can give an attorney or judge just cause to investigate and overturn that trust as an alter ego. Grantor trusts essentially allow access to the assets by the court. One last thing to consider about grantor trusts is that the IRS labels all “abusive tax schemes” as either “grantor trusts or foreign trusts.” This one fact alone would be enough to never operate from a grantor trust position.
The Irrevocable Provision offers potential tax advantages and legal protection from all liability, if properly constructed and executed. Irrevocable trusts do not pay taxes on capitalization, and endowments are generally beyond the reach of creditors and judgments. To have asset protection, the trust must be irrevocable and non-grantor.
The Complex Provision allows the trust to be exempt from the requirement to distribute any of its income to beneficiaries. A simple trust must pay all income to the named beneficiary or beneficiaries annually. However, the complex provision gives our trust the best of both worlds. While it can distribute the income to the beneficiaries if the trustee wants, it is not required to do so either. The trustee has the discretion to hold the income and not pay or credit a beneficiary.
The Discretionary Provision is to insure the absolute and sole discretionary power of the Trustee in determining the distribution of the corpus assets to the beneficiaries. If any single percent of the corpus is designated to be held or distributed to any one or more beneficiaries, the discretionary designation of the trust becomes invalid. This in no way affects the asset protection; however, could adversely affect the taxable structure of the Trust.
The Spendthrift Provision of the Trust is the critical element of the document, in that, no spendthrift trust corpus may be penetrated to reach the assets of that corpus. Case law upholds this and has upheld this for hundreds of years and will continue to uphold it. No judge or court may issue a turnover order against any asset in a properly constructed spendthrift trust. This one provision is likely to be the most powerful of all the provisions of the trust. In fact, this provision is so powerful, that we will talk in much greater detail about how this is not only a Specialized Spendthrift Trust, but it’s known as a Spendthrift Trust Organization.
