We all know that guy. Heck, we might be that guy.
You know who we’re talking about. He’s the guy who solves one problem by creating three even worse problems.
Well, that guy is at it again. In an attempt to get around the $10,000 cap on state and local income and property tax deductions many are turning to trusts and LLCs. Here’s how the strategy works . . . and why it’s a bad idea:
- Establish an LLC in a no-tax state such as Alaska or Delaware.
- Transfer fractions of that LLC into multiple non-grantor trusts.
- Since non-grantor trusts are treated as independent taxpayers (unlike grantor trusts where the people who create them are generally taxed on the trust income) each trust can take a deduction up to $10,000 for state and local taxes.
Seems easy enough. If the SALT deduction would have been $50,000 but the new law limits it to $10,000 then use the strategy to create five trusts. Problem solved.
Or is it?
Multiple problems abound:
- Establishing and administering multiple non-grantor trusts can be impractical and burdensome. Costs can easily exceed $20,000.
- The IRS can derail the strategy by issuing guidance preventing taxpayers from using the strategy. So far they’ve warned about schemes with no apparent purpose other than tax avoidance. What’s more an existing provision says that multiple non-grantor trusts with identical beneficiaries and identical grantors can be deemed a single entity and, therefore, just one $10,000 SALT deduction.
- People who establish trusts lose control over assets placed therein.
- In addition to the real estate for which the $10,000 deduction is sought income-proudcing assets will need to be contributed. A taxpaying entity cannot deduct $10,000 from income if there isn’t at least $10,000 of income.
- A non-grantor trust owning a primary residence that’s ultimately sold will not be able to take advantage of the $250,000 ($500,000 for married filing joint) gain exclusion.
- Mortgage lenders may not allow the transfer of a residence to an LLC.
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