If you’re familiar with any of the various types of trusts, you probably know them as an estate planning tool.  But another aspect of trusts that is not as well known has to do with the tax implications of holding your assets “in trust.”  While there are many different types of trusts that work toward a broad range of objectives, these unique planning vehicles can also be used to help manage your tax bill and even reduce the amount you send in to the IRS.

One of the most important functions of an estate plan is to manage the estate tax burden your heirs could face.  Estate tax rates can easily erode your hard-earned wealth, meaning much of what you planned to leave to your heirs ends up in the hands of the government instead.  For 2007, these taxes could claim as much as 45% of an estate.  You should keep in mind that while the estate tax is scheduled to be repealed for 2010, it is currently scheduled to return in 2011 with a top rate of 55%, barring any additional legislation from Congress.

To help avoid these costly taxes, you can transfer assets to one or more irrevocable trusts during your lifetime and in doing so you may be able to remove them from your taxable estate.  This shields them from estate taxes, allowing you to preserve more for your heirs.

Trusts also help you achieve other estate planning goals.  Using trusts, you can avoid the costs, delays, fees and even publicity associated with probate.  You still maintain control of how your assets will be managed and who will receive them.  Trusts also let you make arrangements for the continued management of your assets when you are no longer able to manage them yourself, or when you simply don’t want to have that burden.  Finally, you can also benefit your favorite charity through the use of trusts in your estate plan.

Interestingly, managing estate taxes is just one of the tax advantages trusts can provide.  You might also be able to reduce or sometimes avoid capital gains taxes, gift taxes, or even income taxes, depending on the type of trust you use.  Unfortunately, placing assets in a trust does not free you from paying all taxes.  One thing worth noting is that the trust and trust beneficiaries are considered separate entities.

Just like an individual or a business, a trust must pay taxes on the income it generates and retains each year.  A trust is also subject to the same tax brackets as individuals, with one main difference: the tax rates apply at much lower income levels for trusts than for individual taxpayers.  Trusts also incur capital gains taxes when assets held in the trust are sold.  However, these gains are taxed at the same rates that apply to individuals (i.e., a maximum rate of 15% as long as assets have been held for more than 12 months).

As for the trust beneficiaries, distributions received from a trust may be taxable.  Fortunately, this does not mean the income is subject to double taxation.  The trust will actually receive a deduction for any income distributed to beneficiaries.

To help meet a wide range of tax and estate planning needs, there are many types of trusts available.  One trust or a combination of several types may be right to help you reach your financial objectives, so talk with your financial consultant and tax planning professionals today to find out how trusts can be incorporated into your investment mix.

This article was written by a third party and provided courtesy of Kennedy Financial Services in Eastland, TX, at 254.629.3863. Securities & Advisory Services offered through VSR Financial Services, Inc., a Registered Investment Adviser and Member FINRA/SIPC. Kennedy Financial Services is independent of VSR Financial Services, Inc. VSR does not provide tax or legal advice.

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Our firm does not render legal, accounting or tax-preparation advice. You should consult your tax and legal advisors for questions regarding your specific situation.