2012 Tax Relief Act Hammers Certain Trusts

Like many of the provisions of the 2012 Tax Relief Act that flew under the media radar, one aspect is particularly troubling.

To the casual observer, they were aware that for those with incomes above$450K they would be in the top tax bracket of 39.6% and subject to an increased capital gains rate of 20%--and that those making above $250K would be subject to the Obamacare 3.8% tax on investment income. 

What most didn't realize is that these taxes hit non-grantor trusts on any income that it does not distribute over just $11,950.  In other words, trusts that retain small amounts of income will get hit much hard and at an accelerated rate, even though its beneficiaries will be in a lower bracket.

While there are ways to navigate through these issues, careful consideration should be made as to how much should be distributed and when it should be distributed from the trust as there is always a tension between the current income beneficiaries and the remainder beneficiaries who stand to inherit what is left.

The biggest complication arises when you have a trust established for a spendthrift child or special-needs child who, under the terms of the trust, really isn't supposed to gain access to 100% of the trust's income.