Some families create a separate legal entity in the form of a trust to provide benefit to future generations down the line with little or no estate taxes. They do so through the use of dynasty trust.
Every time an asset changes hands from one generation to the next, estate duty or gift tax is levied in the absence of dynasty trust. These dynasty trusts avoided these taxes by putting in place a second estate that outlived most of the family members including those unborn at the creation of the trust and continue to look after future generations.
These are long term trusts for future generations. Dynasty trusts can survive 21 years beyond the death of the last beneficiary alive when the trust is instituted.
There is no tax savings when a dynasty trust is created. Tax savings materialize later at the death of any descendant. Even as the assets of the trust grows and accumulates for years it is free from federal estate or gift tax throughout the life time of the trust.
There are no federal taxes on distributions from the trust to the founder or his descendants either during the continuity of the trust or on its liquidation. Given the current estate tax rate at 46% every time asset changes hands from generation to generation, the savings are significantly large.
In this background in 1986 the congress passed the Generation Skipping Transfer Tax (GSTT) Act based on the deeming legal fiction that the beneficiaries get the assets in the dynasty trust outright. However, transfer from an individual up to one million to a dynasty trust is exempt from GSTT tax.
As such, dynasty trusts of one million or less offer the same estate or gift tax advantages as a similar trust set up in 1986 before coming into force of the GSTT Act.
Provisions may be inserted in the dynasty trust deed limiting the access of the beneficiaries to the income or principal of the trust.
Since the IRS taxes income from dynasty trust at a rate which may go as high as 40%, it is advisable to fund the corpus of such trust with tax free assets such as tax free municipal bonds, fixed income bearing securities, non- dividend growth stock, cash rich life insurance etc.
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