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Tax consequences of dissolving a trust

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mrcontext

Junior Member
My mother is the beneficiary of a trust that was set up for her by her sister. Her sister has been contributing funds to the trust as gifts. The trust was initially set up in New York, and my mother lives in Maryland.

Her sister, who is the trustee, would like to dissolve the trust and give the contents to my mother, who needs to know the tax consequences of this. Will this cause a lump-sum distribution that would be taxable? If so, would it all be taxed in one year?

My mother is over the age of retirement.
 


tranquility

Senior Member
No one can tell. The mere fact that sister has made "gifts" to the trust and still feels she has the power to dissolve the trust is problematical. See an attorney who will review the trust itself (including the trust's purpose) and prior tax treatment of amounts deposited (Were Crummy letters involved?) and income from those amounts.
 

Kiawah

Senior Member
Was the trust document written as a 'revocable' trust, or an 'irrevocable' trust? That's the first piece of info required to determine how it's handled from a tax perspective.
 
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mrcontext

Junior Member
Clarification

My main question here is whether it makes more sense to transfer trustee to a different party or to dissolve the trust and give the contents to my mother. Her sister wants to relieve herself of trustee responsibilities - she is not trying to take back the money.

The gifts her sister made into the trust were all post-tax money, and the investments were all in tax-free bonds.

Do we need additional information to determine whether a distribution would be taxable?
 
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tranquility

Senior Member
My main question here is whether it makes more sense to transfer trustee to a different party or to dissolve the trust and give the contents to my mother. Her sister wants to relieve herself of trustee responsibilities
Most trusts have a method of changing trustees. Also, they have a method of distribution of the assets. Why do you think there is only a decision to be made as to if the trustee wants to distribute the assets to dissolve the trust? Usually, there is some standard on what is a valid distribution from the trust. If the grantor is the trustee and has the power to simply dissolve the trust without regard to certain standards accepted by law, there has almost assuredly been an error in the tax treatment of the gifts and income from the trust. (There are certain, very advanced, estate planning techniques where this could not be in error such as an intentionally defective grantor trust. But, there would have been an attorney who was paid a lot of money to set that up and he would be the best one to ask the questions of.)

So, again, I am doubtful the proper question is if it makes "sense", but if it is allowed under law.
 

curb1

Senior Member
What was the reason for the initial decision to put these tax free bonds into a trust? Why weren't these bonds just gifted to your mother? Who authored this trust, an attorney?

There seems to be more to this story than has been presented. What is the value of the assets?
 

mrcontext

Junior Member
What was the reason for the initial decision to put these tax free bonds into a trust? Why weren't these bonds just gifted to your mother? Who authored this trust, an attorney?

There seems to be more to this story than has been presented. What is the value of the assets?
I believe that there were two reasons for the trust - 1) to allow her (my mother's sister) to contribute (to add more gifts) without my mother knowing, and 2) to not burden my mother with concerns of managing the investments

I'm sure the trust was authored by an attorney. The trust is probably valued at between $500k and $1M.

Another piece of information is that the alternate trustee pre-deceded my aunt, and my aunt is trying to simplify her life - hence the question of dissolving the trust.
 

tranquility

Senior Member
See an attorney. Any reasonably-prepared trust will have some way to transfer trustees when the main contingent trustees are dead or don't want to do the act. For a trust of this size, there may be an institutional trustee at the end of the succession line.

I agree with curb1, there is more to this story. An attorney is appropriate. I very much doubt the trust can be completely distributed at the whim of the trustee/grantor without profound complications.
 

curb1

Senior Member
If this trust were prepared by a competent attorney, there should be very direct information concerning the distribution of the assets. I suspect that the situation is not that difficult. There are almost always words that direct specifically the termination of the trust. The net worth of "the sister" could come into play concerning the taxation aspect of this transaction. Was a purpose of this trust to avoid some taxation by "sister" and her estate?
 

curb1

Senior Member
I still don't understand the reason for this trust. If all "the investments were all in tax-free bonds" there was no apparent need for setting up a trust to produce the desired results as stated. A simple brokerage account could have accomplished what has been presented. There has to have been other motives, or this trust setup was a waste of time and money.
 

Kiawah

Senior Member
You have not provided enough facts to answer your original question. Depending upon whether it is a revocable trust or an irrevocable trust... the tax consequences to both the sister grantor and the beneficiary mother will be different.

Additionally as indicated prior, the trust document should have language about:
- who is to trustee, and successive trustee's
- who are the beneficiaries, and when or under what circumstances 'can' (or possibly 'should') distributions be made (or not made)
- how long the trust will remain in effect, whether it is irrevocable or revocable, and when it can/should be dissolved/end.
What you are asking about, should be already specified and controlled by the trust document.

You indicate that the sister is the trustee, which can't typically happen in irrevocable trusts (grantor can't be trustee). That leads me to think the trust is either a revocable trust (grantor can be and often is trustee), or there is someone else (or some company) who is actually the trustee of an irrevocable trust. Yet you also indicate that gifts have been made to the trust, which would tend to suggest that it is an irrevocable trust, unless the sister is using the word gift to just separate monies that she wants in an account to live on, versus money that she is trying to set aside to pass on to the mother in a revocable trust. She technically hasn't really gifted it if she still controls it as trustee, if this is the case.

The sister needs to have a lawyer review the details of the trust document, to get the actual facts of this situation and to provide accurate trust and estate planning guidance. At this point, you don't have enough facts. You have to understand and establish the facts of the trust, before any questions about possible tax consequences can really be answered. Making the wrong decision could ultimately cost the grantor some gift tax (yielding less $$ to pass on to others), and/or your mother the step up basis of assets (which might mean an unnecessary hit in taxes on the value of the assets, and less after tax $$'s in mothers pocket).
 
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