The New Tax Law's Effect on Trusts and Home Sales

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This week, Gail answers questions about the new $350 billion tax package's impact on trusts and on the sale of a primary residence.

Dear Gail,

My brothers and I are beneficiaries of a trust my grandfather set up years before he died. It's got a lot of stocks in it that pay dividends. We're wondering if the new low tax on dividends applies to trusts?



Dear Shawn --

As you point out, the Jobs and Growth Tax Relief Reconciliation Act (JEGTRRA) which became law at the end of May, provides that dividends paid on qualifying stock (as I described in a previous column) will be taxed at a maximum rate of 15% instead of the taxpayer's ordinary income tax rate. The higher your income, the bigger the savings. Example: for people in the (new) 35% bracket, this cuts their tax on dividend income by more than 50%

The reduced tax rate on dividends also applies to trusts, according to Bill Wagner, author of The Ultimate Trust Resource. Although they're not human beings, trusts are nevertheless considered taxable "entities" under the law. The difference is, trusts reach the highest tax brackets at much lower levels of income. For instance, both single and married taxpayers hit the 35% bracket once their taxable income exceeds $311,950.* A trust reaches this point when its income goes above $9,350!

But the trust might not owe any tax on the dividends if it passes them through to you and your brothers. "In general," says Wagner, "income that is passed through to beneficiaries is taxed to the beneficiary." In other words, you would owe the tax on the dividend income you receive from the trust.

On the other hand, if the trust retains the dividends it receives (for instance, because the beneficiaries are minors), then the trust would pay the tax on this income and the maximum rate would be 15%. Essentially, it comes down to this: the person/entity which receives the dividends, pays the taxes due.

Important exception! There's a particular type of trust called a "grantor" trust. In this case, the person who creates the trust (the "grantor") retains some controls over the trust and the assets in it. For instance, the grantor might be able to change the beneficiaries or decide when and if income is paid by the trust. In this case, the grantor pays the tax on the income the trust receives -- regardless whether it is kept in the trust or paid out to the beneficiaries. If dividends are paid out, the beneficiaries do not owe any additional income tax when they receive them.

Wagner cautions that there are complex rules which govern trust accounting. You probably receive an annual statement from the attorney or trust accountant on your grandfather's trust each year detailing how much income you were paid and the sources of it. The important thing is to understand that through 2008, the maximum tax on dividends is 15% -- period. No matter who pays it.

Hope this helps!


*Now you know what's meant by "marriage penalty". Two single individuals could each earn $311,950 -- for a total income in excess of $622,000 -- before reaching the highest tax bracket. For married couples, the 35% bracket kicks in at half that!

Dear Gail-

Re: this new, lower rate on capital gains. My wife and I are wondering if it applies to your home? We'll be selling our current house in about 5 years when we retire (if the market gods co-operate) and will be buying a new place.


Doug & Jan

Dear Doug and Jan,


As you probably know, the rules about avoiding tax on the gains from the sale of your home by rolling all of the profit into a new residence were eliminated several years ago. Now you don't have to worry about always "trading up."

Instead, you'll only owe tax when you sell your primary residence if your profit exceeds certain limits. For a single taxpayer, you can avoid tax on up to $250,000 of profit; double that amount for couples.

One caveat: you must have owned the home for two out of the past 5 years and it must have been your primary residence for 2 out of the past 5 years. But these periods don't necessarily have to overlap. For instance, five years ago you rent a house and live in it. Three years later, you buy it. In year four you turn around and rent it to someone else. No worry, mate: you qualify.

So long as you meet these requirement, as a couple, you can actually make up to a $500,000 profit on your home without owing any capital gains tax!

Any amount over this would be subject to long-term capital gains tax at a maximum of 15% -- as opposed to 20% -- through 2008. After that, the rate reverts to 20%.

I don't advocate selling your home just to take advantage of this slightly lower tax rate. If you are planning to move anyway, however, it makes sense to do so while this lower rate is in effect.

Happy house-hunting!


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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.