Important Considerations for Irrevocable Income Only Trusts

August 10, 2011

This post is the second in a two part series covering the financial advantages of Irrevocable Income Only Trusts. Part One covered Using Trusts to Protect Assets from Nursing Homes.

Irrevocable Income Only Trusts must be very carefully and specifically drafted in order to shield assets from the nursing home and Medical Assistance or Medicaid.  All too regularly, Irrevocable Trusts are improperly drafted and thus fail to protect assets and fail to take advantage of tax provisions which can protect the creator and children from unnecessary taxation.  Care must be taken to ensure the trust complies both with the Wisconsin Medical Assistance, Family Care or nursing home laws, as well as complying with important tax laws.

Through proper planning and the use of a properly drafted Irrevocable Income Only Trust, we can accomplish the following objectives:

1. Protect Assets

Protect assets from the nursing home (Family Care, Medical Assistance, Medicaid, Creditors, etc.)

2. Provide Income

Allow the person setting up the trust to obtain income from the trust and to be taxed on the income just as they are now.  This is important because in many cases the person establishing the trust may have to pay less in taxes than if the trust were to be taxed on the trust income.  (At Wokwicz Law Offices, LLC, we utilize different techniques, depending upon the client’s situation, to take advantage of tax laws allowing the person creating the trust to be taxed on any trust income.  We often utilize Internal Revenue Code section 674(a) to take advantage of income tax provisions in the tax code that allows a “non-adverse” party to accumulate or direct income to the person setting up the trust.)

3. Control Trust Beneficiaries

Even though the trust is Irrevocable, it can be set up so that the creator can change who will receive the assets at death, through the retention of a “special power of appointment.”  Where appropriate, this can be a very useful feature for allowing the trust creator to change who the beneficiaries in the future.

4. Tax Basis Step-Up

Allow a tax “basis step-up” at death as if the person setting up the trust still owned the asset for tax purposes.  This is important as it can allow the children or other chosen beneficiaries of the trust to avoid capital gains taxes upon death. This is achieved by retaining the right to choose the beneficiaries of the trust even after the trust has been set up and made irrevocable.

5. Avoid Gift Tax

Avoid any gift tax on transfers to the trust.  Again, a properly drafted Irrevocable Income Only Trust will prevent the gift tax and prevent required filing of a gift tax return.

6. Retain House Tax Advantages

Preserve the lifetime home sale tax advantages for principal residences allowed to individuals under Internal Revenue Code section 121 to avoid capital gains up to $250,000.00 for a single person and up to $500,000.00 for a married couple on the sale of a principal residence.  This is important, so that if your principal house is sold during your lifetime, you will not be subject to any capital gains, as long as you meet the proper criteria.

7. Avoid Probate

The use of an Irrevocable Income Only Trust can be one of the tools utilized to help avoid probate at death.

It is important that attorneys drafting this type of trust be well versed in both the relevant nursing home laws (Medical Assistance, Medicaid, Family Care, Title 19, etc), as well as the relevant tax laws.  If the trust fails in either area, the assets of the trust could be lost to the nursing home, result in negative tax treatment, or both.

Prior planning is important to fully utilize the benefits of an Irrevocable Trust.  We encourage clients to plan ahead and not wait until it is too late to use an Irrevocable Trust.  Drafting and funding a properly drafted Income Only Trust is ideally completed at least five years before having to apply for Medical Assistance, Medicaid, Family Care and Title 19.

Please contact Wokwicz Law Offices to discuss if an Income Only Trust is the right choice for you.

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This article is intended as general legal information and not as legal advice to any particular client, nor is it intended as advice on any particular issue or matter. If you have any questions regarding the subject matter of this article, or wish to discuss how the subject matter of this article may apply to your situation, please contact us.