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Real Taxpayer Relief through Judicious Use of Trusts

Attorney Mark DoddsWith the recent enactment of the so-called “American Taxpayer Relief Act” (the only true relief being that we are at least relieved of having to listen to the talking heads every day discussing the “fiscal cliff”) tax rates have been increased on those with the highest incomes. (Note, I did not write that taxes were increased on the “wealthy” because the proponents of higher taxes, such as the magnificent duo of Warren Buffet and Bill Gates, will hardly be affected by the increases because i) they have very little income in relation to their wealth, so their income taxes are paltry, and ii) their wealth will ultimately avoid income and estate taxes as their assets pass tax-free to charities of their choosing, Buffet’s favorite charity being Bill Gates foundation!) High-income Californians are especially concerned due to not only their top federal tax rate rising from 35% to 39.6%, but also due to the 13.3% California income tax rate.

A generation ago, a catchphrase of income tax planners was “A tax dollar not paid today is a tax dollar not paid today,” meaning that deferral of payment of income taxes had obvious rewards. This was clearly the case in days of high inflation rates, high interest rates and high income tax rates. If a person could defer paying $50,000 in income taxes until a later year and then invest the extra $50,000 at 12%, the $6,000 of interest earned at Uncle Sam’s expense was certainly worth the efforts made through various tax deferral techniques available at the time. However, in the 1980’s various income tax laws were implemented which severely curtailed the taxpayer’s ability to defer recognition of income and thereby defer payment of taxes to later years. Furthermore, as interest rates have plunged to near zero, the ability to earn risk-free income on deferral of payment of income taxes has dramatically declined as well. As a result, during the last twenty years, much of the focus on tax planning has shifted from income tax planning to estate and gift tax planning.

Although the federal estate tax was not raised to the previous 55% level, the rate did increase from 35% to a top bracket of 40% for estates exceeding the $5.25 million estate tax exemption amount. Thus, for wealthier individuals, income tax and estate tax planning will be coming back into vogue.

So how can taxpayers get some actual relief from these very high income, gift and estate tax rates? It is time for taxpayers to become more aggressive in utilization of trusts to reduce the high tax rates their income and their estates will be subjected to and to implement a full-bore, broadside attack on the government’s ramped-up efforts to confiscate as much of the taxpayers’ wealth and income as possible.

The following matrix demonstrates the basic four classes of trusts as those trusts are affected by two variables, i.e. i) the estate tax and ii) state and federal income taxes.



Taxable  to the creator’s estate

Not taxable to the creator’s estate


Creator subject to tax (state & federal) for trust income

(a) Basic revocable living trusts; and (b) Standard Nevada domestic asset protection trust(DAPT)

(a) Completed gift trust where creator retains certain powers/benefits; and (b) Completed gift DAPT with limited benefit to creator

Creator not subject to tax (state & federal) on trust income

Trust where creator is  beneficiary, but distributions are controlled by an “adverse party”

Completed gift trust where  creator retains no prohibited powers/benefits


Thus, based upon the two variables of whether the trust grantor (generally the trust creator) is subject to income tax on the trust and whether the trust estate is subject to estate taxes upon the grantor’s death, there are four permutations of trusts:

  1.  The trust income is taxed to the grantor/creator AND the value of the trust assets is subject to estate tax as part of the grantor’s estate on his death.
  2.  The trust income is taxed to the grantor/creator BUT the value of the trust assets are NOT subject to estate taxes as part of the grantor’s estate on death.
  3.  The trust income is not taxable along with the grantor’s non-trust income, and is either taxed at trust tax rates or is taxed at the non-grantor trust beneficiaries’ income tax rates BUT the value of the trust assets is subject to estate tax as part of the grantor’s estate on his death.
  4.  The trust income is not taxable along with the grantor’s non-trust income, and is either taxed at trust tax rates or is taxed at the non-grantor trust beneficiaries’ income tax rates AND the value of the trust assets is not subject to estate tax as part of the grantor’s estate on his death.

The goal of trust planning, therefore, is to create a trust which will, naturally, result in the lowest overall combination of income tax and estate tax. In most cases (though not all) the grantor (usually a parent or parents) is in a higher income tax bracket than the grantor’s children, so shifting of the income tax burden to children in lower brackets will reduce the family’s overall income tax bill. Furthermore, if the grantor/parent is living in a high income tax state, and if the trust beneficiaries are living in lower income tax states (e.g. the parent lives in California and the children live in states without income taxes such as Nevada, Wyoming, and Washington) then if the income can be attributed to a person other than the grantor living in the high income tax state, then the overall income tax burden can be reduced.

Once the income tax rate problem is solved, the trust can then be crafted to deal with the estate taxes which may be due on the trust estate on the grantor’s death. If the trust assets are expected to appreciate in value, then the lifetime transfer of assets to the trust by the grantor/parent can help to reduce the effect of the estate taxes upon the grantor’s death by making a completed gift, thereby avoiding the estate tax which would otherwise have been imposed on the increased value of the trust estate where the gifted assets increase in value from the date of the grantor’s gift to the trust to the grantor’s death. For example, if assets are gifted out of the grantor/parent’s estate when valued at $2 million, and where those assets are worth $6 million at the parent’s death, the early transfer of those assets exempts the $4 million increased value of those assets from taxation in the grantor’s estate upon his death.

Nevada is an ideal state for implementation of these tax strategies. Not only is there no state income tax in Nevada, but Nevada also has one of the most seasoned and flexible asset protection trust statutes in the country. This one-two punch is the reason higher income and net worth individuals should call us at Grant Morris Dodds to determine whether the strategic implementation of a trust in Nevada may help you fight back the federal and state encroachments upon your freedom to control the fruits of your labors. Call Dave or Mark today at 702-938-2244.