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Don't Be Afraid of the Dark--Navigating Trusts Through NIIT

Continuing with our reports from the 2016 Heckerling Institute on Estate Planning

Robert Romanoff of Levenfeld Pearlstein, LLC discussed the implications of the net investment income tax (“NIIT”) on the design, creation and administration of trusts and suggested that trusts should be designed and administered with a focus on minimizing the NIIT to the extent consistent with the grantor’s intent.

In the case of trusts primarily consisting of investment assets, this tax can impede the growth of the trust assets. Most strategies to reduce a trust’s exposure to NIIT involve the current distribution of income to beneficiaries who won’t be subject to the NIIT, something that may be contrary to the grantor’s objective of creating a long-term generation-skipping trust to minimize the exposure of the assets to estate tax.  

Mr. Romanoff suggested that a single trust for the collective benefit of a group of beneficiaries (a “one-pot trust”) is better from a NIIT perspective than separate trusts for each beneficiary. This is because with a one-pot trust, the trustee can time distributions and allocate income among beneficiaries who may not be subject to NIIT, whereas with a separate trust for each beneficiary that opportunity would be limited. In addition, he suggested that distributions to younger family members, rather than their parents, can be attractive from a tax perspective because even though the kiddie tax would apply to the distribution, it would not be subject to the NIIT unless the minor had a significant amount of net investment income which in most cases would be unlikely.

Mr. Romanoff also suggested that practitioners should consider changing how they draft distribution standards. The use of an ascertainable standard, even though attractive for other reasons, may not allow for planning to minimize the NIIT. With such a standard, the trustee may not have discretion to make distributions to beneficiaries in an effort to reduce the trust’s NIIT. To give a trustee greater flexibility with respect to distributions, Mr. Romanoff suggested a non-ascertainable “best interests” standard for distributions.   

Finally, Mr. Romanoff addressed the importance of the selection of trustees, especially if the trust holds a business interest. The choice of trustee in the case of a non-grantor trust will control whether the income/loss from a business interest is passive or not. This is because whether the trust materially participates in an activity depends upon the trustee’s level of participation.  

For more content stemming from the 2016 Heckerling Institute on Estate Planning, please click here

Karen L. Goldberg in the Private Wealth Advisory Group leads the trust and estate practice in the New York office. Karen specializes in estate planning for closely held business owners, senior corporate executives and other high net worth individuals.

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