Trust Accounts Benefit from Tax-Exempt Income
April 23, 2019 By Sage Advisory
by Jeffrey Timlin
Unlike the graduated federal income tax brackets that max out at 37% with taxable income at $500k or more, trust accounts benefit from owning municipal bonds at a significantly lower tax bracket. As the political and economic environment becomes increasingly uncertain, many high-net-worth clients are turning to trusts to protect their assets as well as provide a tax-efficient way to transfer assets to family members. In 2012, the American Taxpayer Relief Act (ATRA) added new net investment income tax (NIIT) brackets for certain trusts as shown in the tax table below.
For clients in non-grantor trusts, the benefit of owning municipal bonds is realized almost immediately since the maximum income bracket tops out at only $12,500. As an added benefit, by utilizing tax-exempt municipal bonds to produce income, the trust’s beneficiary could also avoid paying the 3.8% investment income tax associated with the Affordable Care Act of 2010 for a maximum tax savings of 40.8%. Depending on the state of residence, an allocation to in-state municipal bonds may further enhance the tax-efficiency of the income generated within the trust.
Since the inception of municipal bonds, high-net-worth individuals have successfully utilized the benefits of tax-exempt income. Along with tax-free income, investors have benefited from a high degree of principle protection and low levels of price volatility. To ensure the proper use of municipal bonds within a trust, please review the trust agreement with your financial advisor, tax accountant, and trust attorney. Once approved, allocating to municipal bonds could significantly reduce your annual tax liability.
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