Estate planning: how trusts differ from residual trusts

Dear Liz: My husband and I are in our 60s and have two adult children. There are no grandchildren, and it doesn’t look like there will be. Unfortunately, our children do not share our values. We don’t want to leave our heritage to them because it will end up being donated or bequeathed to charities of their choice. They are doing well and do not “need” the money. However, we don’t want to “cut” them either. I was thinking of a charitable remainder trust so that they can have an income during their lifetime and the assets will go to our charities when they die. Can it be funded with what’s left when we die or do we have to put some or all of our assets into it now? Is our heritage large enough for such a trust? Our assets total approximately $3 million. A less complicated solution would be to leave them the house and leave the money to charity. What are your thoughts?

To respond: Consider going for the less complicated solution.

Charitable residual trusts are generally created during your lifetime. You contribute assets to an irrevocable trust and get a tax deduction for the contribution as well as a lifetime income stream. When you die, the charity keeps the remaining assets – the rest. Because trusts are irrevocable, you should have sound advice from an accountant, financial planner, the charity and a lawyer before disposing of your assets, said estate planning attorney Jennifer Sawday in Long Beach.

You could set up a trust that, when you die, pays income to your children and then pays the rest to charity when they die. Such a trust would likely need to be administered for decades, so you would need a corporate or other institution trustee – and those don’t come cheap.

Also remember that a lot could change between now and your death. Children who don’t “need” the money could suffer setbacks, or you could. Opinions can also change; they might come closer to your point of view, or you might decide that the issues that divide you are less important than the bond you share. Unchanging trust may not be the best option in an ever-changing world.

Friend’s delisting could be fraud

Dear Liz: I have a friend who drives me crazy because she keeps telling me I need to start a business. She claims she is writing off “everything” from her two businesses and a nonprofit. She says her accountant encourages her and she doesn’t pay taxes. However, when my friend had to claim unemployment benefits during the pandemic, her weekly amount was very low. She kept complaining that she had “contributed to the system”, but thought she should receive a higher amount. Maybe she hasn’t paid into the system or isn’t paying enough?

To respond: People who write off “everything” often commit tax evasion. Although businesses can deduct a number of different expenses, these expenses must be both “ordinary” – common and accepted in the specific business sector – and “necessary”, or useful and appropriate for that business or particular trade. Nonprofits, as defined by the IRS, are meant to be organized and operated exclusively for religious, educational, or charitable purposes — not for the benefit of any single individual.

Your friend could face a substantial tax bill and heavy penalties if she is audited. She may be counting on the IRS not noticing, but all it takes to trigger an audit is a tip from a disgruntled employee or someone who hears her bragging about do not pay taxes. If his accountant has a history of filing dubious returns, the IRS might figure out the pattern and start taking a closer look at all of that accountant’s clients.

Your friend’s strategy of minimizing her taxable income has already bitten her once when she filed for unemployment and may bite her again when she files for Social Security. If she pays no social security contributions, or only pays a small amount, her retirement benefits will reflect this. By the time many people realize the enormity of this particular error, it’s too late to fix it.

Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions can be sent to him at 3940 Laurel Canyon, #238, Studio City, CA 91604, or by using the “Contact” form on asklizweston.com.

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