Living trusts and bankruptcy protection

In the usual case, you cannot employ a living trust as a mechanism to protect your own assets from your creditors. However, you may provide such protection for legacies for your heirs with a properly drafted trust. Trust assets may be out of reach if the heir declares bankruptcy, becomes divorced, or has some other financial calamity. A “spendthrift clause” may be used to achieve this objective. It puts full discretion over trust distributions in the hands of the trustee. In the unusual case, living trusts may yet provide another layer of protection.

Unusual facts

Faith Campbell created a living trust worth $1.8 million for the benefit of her four children, one that included a spendthrift provision. The trust was to terminate after Faith’s death “upon the settlement of her estate.” Faith died in 2011.

One of Faith’s grandchildren was the trustee of her trust. One child, Linda, was in financial difficulty resulting from the last recession. After Faith died, before her estate was settled, Linda wrote to the trustee suggesting that he exercise his discretion allowed under the trust. He took the hint and placed her share in a Merrill Lynch account, for which he continued to be the trustee. Distributions to the other children from the living trust continued as before.

A month later, Linda declared bankruptcy. She included her trust interest in her bankruptcy petition, but noted that she was simply a discretionary beneficiary subject to the spendthrift clause. The bankruptcy trustee challenged that characterization and sued Linda for her share of the trust’s assets. He also characterized the creation of the Merrill Lynch account for her as a fraudulent transfer.

The Bankruptcy Court agreed. The Court also was concerned that the trustee of the spendthrift trust was Linda’s nephew. In its decision on the case, the Court worried that the trustee simply would follow Linda’s instructions, which gave her effective control of the money. The Court ruled against Linda on every issue.

Reversed on appeal

Linda appealed the Bankruptcy Court’s decision to Federal District Court, which found in her favor. The key to the District Court’s reasoning is that by its terms the living trust had not yet terminated, because Faith’s estate had not been finally settled. Considerable work may be required to settle an estate. Until that work is finished, trust administration was required, which gave continued life to the trustee’s spendthrift powers. Linda had not yet acquired a property interest in the trust that could be included in her bankruptcy estate.

Linda received an extra layer of financial protection from her mother’s living trust by an accident of timing, the fact that her bankruptcy occurred before the trust reached its termination point. Her mother could have deliberately provided for such creditor protection for the inheritance for Linda or for all of her children by having the living trust continue for the children’s lives. Her single trust could have been divided into four continuing trusts, one for each beneficiary. If the successor trusts also included spendthrift provisions, creditor protection could have lasted a lifetime.

On the other hand, adult children may prefer unfettered access to their inheritance. They may feel uncomfortable making their case to the trustee each time that a substantial trust distribution is wanted. They may harbor the feeling that the parent did not trust them with the family fortune.

The balance needs to be struck by the trust grantor. If the long-term asset protection plan is selected, the benefits and burdens should be explained carefully to all beneficiaries, in order to avoid misunderstandings and litigation later.

IRS announces 2016 retirement plan limits

To make it possible for voluntary retirement savings to keep up with inflation, the various numerical limits embedded within qualified retirement plans are indexed for inflation. In October the IRS announced the numbers that will apply in 2016, as shown in the following table:



2016 limit

401(k) and 403(b) employee deferral limit


457 employee deferral limit (most plans)


Catch-up contribution limit


Defined contribution dollar limit


Defined benefit dollar limit


Compensation limit


Highly compensated employee income limit


Key employee in a top-heavy plan


Note that the deferral limits for 401(k) and 403(b) plans are unchanged from 2015.  Catch-up contributions are permitted by those employees who are 50 years of age or older during the calendar year.

Personal saving for retirement never has been more important.  These tax benefits make saving a bit less painful.

A new worry for executors

Business people work as team in office


For several years President Obama has proposed adding a requirement to the tax code for consistent basis reporting for estate and income tax reporting. There was a perception that basis mismatches were costing the Treasury considerable sums. The proposal never went anywhere.

Until this summer, that is, when it was attached to a temporary extension of highway funding. The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, signed by the President on July 31, 2015, includes a new requirement that taxpayers who receive property from a decedent use as their income tax basis the value of that property as finally determined for estate tax purposes. New reporting requirements have been created for executors of estates, who must advise both the IRS and the estate’s beneficiaries of the values. New regulatory projects will have to be under way shortly at the IRS.

Although relatively few taxpayers are likely to owe higher taxes because of this law, the more important burden may be the filing requirements for executors. Fortunately, the new law only applies to property that increases federal estate taxes due. That means it doesn’t affect property from estates lower than the exemption amount or property excused from taxation via the marital or charitable deduction.

According to the Joint Committee on Taxation, the new provision will raise $117 million next year, more than $1.5 billion over the next ten years. Note that although the highway funding is temporary, the “sunset” provisions don’t apply to the new basis-reporting portion of the law—those are permanent.

Contact our office today if we can help you with this or any related matter.


© 2015 M.A. Co. All rights reserved.

Last minute tax tips for 2015

With limited exceptions, a taxpayer’s opportunity for controlling income tax liabilities for 2015 expires on December 31. Here are a few ideas to consider before the year closes.

  • Accelerate deductions, defer income. You may be able to pay real estate taxes early and delay a bonus, for example.
  • Bunch deductions. Push deductions into the tax year that you expect to be able to itemize them, if you will take the standard deduction in other years. Some expenses, such as medical costs, have floors on deductibility—10% of AGI for most taxpayers, 7.5% for those 65 and older. Bunching those expenses into a single year may create a deduction that otherwise would not be large enough to exceed the floor.
  • Contribute to charityMake your final charitable gifts early, to avoid ambiguity about which tax year they belong in.
  • Maximize retirement plan contributions. For 2015, up to $18,000 may be deferred to a 401(k) or 403(b) plan. An additional catch-up contribution of $6,000 is permitted for those 50 and older.
  • Check for AMT exposure. Upper-income taxpayers have to calculate their income tax liability, in two ways. The regular way has a top marginal rate in 2015 of 39.6% and lots of allowable deductions. The Alternative Minimum Tax (AMT) has two brackets, 26% and 28%, and it provides for far fewer deductions. Taxpayers pay the higher of the two tax figures.
  • Family gifting. The annual exclusion from federal gift taxes in 2015 is $14,000 per donee. The exclusion expires at the end of the year, and it can’t be carried forward if it is unused.
  • Portfolio check. Tally your gains and losses for the year to see where you stand. Tax consequences shouldn’t drive portfolio management decisions, but they do need to be taken into account. Tax efficiency matters. Capital gains and losses for the entire tax year are netted against each other, according to these rules:
    • Short-term losses are netted against short-term gains.
    • Long-term losses are netted against long-term gains.
    • If one of these is a gain and the other is a loss, they are netted.
    • Any resulting short-term gains are taxed as ordinary income. Any resulting long-term gains from securities sales are taxed at 15%. At some income levels, the rate is boosted to 20%, and at still higher levels a 3.8% surtax applies, for a maximum capital gains tax rate of 23.8%.
    • Up to $3,000 of net capital losses may be deducted from ordinary income. Short-term losses are used up first, then long-term losses.
    • Unused capital losses may be carried to future years until death.

The conventional wisdom resulting from these rules is that long-term gains are better than short-term, because they have a lower tax rate. Short-term losses are better than long-term losses, because they shelter income at a higher tax rate.

Federal estate tax exemption


My estate is about $5 million—do I have to worry about federal estate taxes?



You are very close to the boundary for exposure to the federal estate tax. The exemption for 2016 has been increased to $5.45 million, which would seem to let you off the hook.  However, how accurate is your estimate of your estate?  Have you included the full value of your home and other real estate? Do you own interests in a closely held business that might be worth more than you realize? Do you own any fine art?  Values in some parts of the art market have boomed recently.  Getting a precise fix on the value of an estate is not an easy matter. What’s more, if your assets grow in value faster than inflation, you could easily find yourself in taxable territory.

On the other hand, are you married?  If so, to the extent that your property passes to your surviving spouse, federal estate taxation will be deferred until the survivor’s death, no matter how large your estate is when you die. What’s more, your surviving spouse may inherit any federal estate tax exemption that goes unused by your estate.  That means your spouse won’t have to worry about federal estate taxes unless the estate grows to over $10 million (plus accumulated inflation adjustments).

However, there is one more point to consider—state death taxes (estate taxes, inheritance taxes, or both).  Do you live in a state (or own property in a state) that has “uncoupled” from the federal estate tax regime?  A few states impose their death taxes on much smaller estates than does the federal government. If you live in one of these states, you should see an estate planner promptly to explore your options.

Garden State Trust Company