In What’s the big deal about offshore banks?, Cecil says:
Does this mean, as it appears to, that the government gets 35% off the top *and then* a percentage of the rest, too? It gets taxed twice? :confused:
I've never understood people who cheat on their taxes, but in that situation I might understand the temptation.
RR
<< Does this mean, as it appears to, that the government gets 35% off the top and then a percentage of the rest, too? It gets taxed twice? >>
Yep. If you set up a taxable trust fund, it’s a tax-paying entity. This situation tends to happen when a deceased relative’s will sets up a trust fund for the grandchildren, so to speak. The trust fund itself is a tax-paying entity, and the money the fund gives to the children may also be taxable.
Smart fund managers will help minimize taxes to the fund itself by making payouts to the beneficiaries if possible. This maneouvering can be tricky, and can be impossible (depends on how rigid the terms of the trust are.)
The trust fund is taxed like any other tax-paying entity: earnings less expenses. Payments to beneficiaries are deemed expenses (I’m grotesquely oversimplifying here), so IF you can make payments to the beneficiaries of the trust, you can often avoid most of the taxes. The children (in my example) are probably taxed at a much lower tax rate than the high (30% and up) rate of the fund, but that depends on each child’s income, of course.
Thanks, CKDH. Wow. That’s a lotta taxes. Maybe one day I’ll be rich enough to have to worry about it.
RR
The column and preceding reply aren’t absolutely accurate. Yes, many trusts (sometimes called ‘complex trusts’) are separate tax-paying entities – but if they are, there are two ways that double taxation of the same income can be avoided. First, a complex trust has what’s called “distributable net income” – if it distributes that income, IT won’t be taxable on the income, but the beneficiary/distributee will be taxable. So, one level of tax. If a trust accumulates income for some time and then distributes it, the beneficiary is generally entitled to a tax credit reflecting the amount of tax the trust paid previously.
Neither of these mechanisms works perfectly (hey, we’re talking about the Internal Revenue Code here!) – but it’s not as bad as advertised…
ATW
Um, I think that’s what I said in the prior post, taxingwoman, but welcome to the Straight Dope Message Boards anyhow.
The column was citing what would happen in general terms to a taxable trust fund, to compare to an offshore fund. The post above expanded, and did not that there are techniques to avoid the double taxation. I used the example of payment to a beneficiary of the trust, which is the most common example of distributing income. However, that depends very much on how the trust is set up – a trust that doesn’t allow distribution until the beneficiary hits age 21 (for instance) doesnt have the flexibility to make payments to reduce taxation.
Much of the stink being raised today is about American corporations setting up mail drops in the Islands. Saves HUGE bux on the tax bill. I understand Stanley Tool Works evaded 40 million in taxes this way. Enron, when it made billions did the same. A lot of corporations pay almost no tax at all this way. You know who picks up this bill, don’t you? The poor guy with the 100 bucks to deposit.
Stanley backed out of moving their virtual headquarters.
Enron’s case, and that of the investment banks, is much more serious. They have moved off-shore to avoid regulators.
I don’t think I’ve ever seen this many inaccuracies in one of Cecil’s columns. Granted, they’re what he was told by an expert – but why’d he ask a scientist about tax law?
(Coincidentally, should he ever need corporate or tax law advice, I’m out here.)
The term is “trust.” “Trust fund” just means the fund – that is, money – that’s in a trust.
If you set up a trust for your own benefit, it’ll be treated as a grantor trust, which means its income is taxed to you, not it. (In addition, if it has no economic effect and no non-tax purpose, the IRS will assert the trust is a sham to be disregarded for tax purposes. Same net result.)
Under no circumstance (well, no realistic one, anyway) is a trust double-taxed. A trust that distributes income will not owe any tax on that income (though its beneficiaries will); the beneficiaries of a trust that accumulates income will owe no tax on that income (though the trust will).
Creating a foreign trust is a very, very bad idea, if you’re law-abiding. Yes, a foreign trust does not have to pay taxes currently. But, an American who receives a distribution from a foreign trust with an American grantor, like our hypothetical tax-avoider, is not only taxed on the income he receives, but at the highest individual rate – and has to pay the government interest as if he’d been receiving it all along. At a high interest rate, too (the rate applicable to underpayments of tax). This is much, much worse than the situation with direct investment or holding through a (not-disregarded) domestic trust. (If you replace the trust with a corporation, it’ll be subject to much the same rules under the Passive Foreign Investment Company regime, except that the holder may have the option to treat it as a pass-thru under the Qualified Electing Fund election. If you have a chance to make such election, you really, really want to make it.) There are (arguably) legitimate ways to save money by investing through an offshore entity, but they’re all much, much more complicated than setting up a bank account. (Think: setting up your very own insurance company, and then somehow avoiding being in “control” of it.)
Even if foreign trusts did what Sam said, contributions wouldn’t be deductible, so they’d be quite inferior to almost all real IRAs and 401(k)s.
<< The term is “trust.” “Trust fund” just means the fund – that is, money – that’s in a trust. >>
Pick, pick, pick. A trust without money in it doesn’t incur tax.
<< 2. If you set up a trust for your own benefit, it’ll be treated as a grantor trust, which means its income is taxed to you, not it. (In addition, if it has no economic effect and no non-tax purpose, the IRS will assert the trust is a sham to be disregarded for tax purposes. Same net result.) >>
Yes, fair enough. SDStaff Sam deals with offshore trusts set up as non-qualified retirement plans, hence the assumption that the beneficiary is not yourself. And he did say, “Broadly speaking…”, because otherwise the report would have been sixteen pages long and had footnotes every other line.
<< 3. Under no circumstance (well, no realistic one, anyway) is a trust double-taxed. A trust that distributes income will not owe any tax on that income (though its beneficiaries will); the beneficiaries of a trust that accumulates income will owe no tax on that income (though the trust will). >>
Depends on the timing of the distributions and the purposes of the trust.
<< 4. Creating a foreign trust is a very, very bad idea, if you’re law-abiding. >>
The column did make that point, at least in a sort of left-handed way.
<<5. Even if foreign trusts did what Sam said, contributions wouldn’t be deductible, so they’d be quite inferior to almost all real IRAs and 401(k)s. >>
The comparison to IRAs and 401(k)'s was an analogy, relating to the accumulation of tax-free income, which is the only advantage that an offshore trust offers.
A while ago, I was cajoled into setting up a system of so-called “pure trusts” by some rather questionable salespeople who claimed that I could manage my daily affairs with such entities, and in the process eliminate nearly all my income tax and make my assets immune to lawsuits.
Don’t believe anything these snake-oil “pure trust” salesmen tell you. It’s a scam to get you to pay them to prepare worthless documents for you. I’ve detailed my experiences, along with the reasons why the particular trust system I used was bogus, at http://www.netcom.com/~rogermw/nts.html.
We now return to our regularly scheduled dissection of IRS form 1041.
I mention “pure trusts” because the organization that sold them to me (NTS, later renamed TES) called them “irrevocable complex trusts” to make them sound all mainstream and legitimate.
Lionel Hutts said:
I was confused by this statement, so I checked the column. I have identified the source of your confusion. The column refers to “Sam, pillar of the Straight Dope Science Advisory Board”. You must have missed the part “and international business consultant”.
SDSAB is the title of the group of people who are technical experts in various fields. They are often called upon for the Staff Reports, and to provide specific technical knowledge and references for Cecil. Being on the SDSAB does not require one to be a scientist, though there are some scientists on the board (like George Angehr and Jillgat).