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Trusts and tax avoidance on asset appreciation

The end of the year is always a good time to think about the future.

And this certainly includes estate planning and tax considerations.

In today's post, let's look at one example of how intelligent tax planning can result in significant savings when transferring assets.

The example involves a type of trust called a grantor-retained annuity trust, otherwise known as a GRAT. The GRAT format involves the rapid adding and taking out of assets from a trust in order to avoid tax liability on increases in value of those assets.

The assets could be stocks, real estate or bonds. The main thing is that the quick churning in and then out of the trust can allow the assets to be passed along tax-free to another party.

The use of grantor-retained trusts for this purpose has reportedly cost the U.S. Treasury about $100 billion since the turn of the century.

More broadly, an important estate and tax planning strategy concerns the avoidance of taxes when assets appreciate in value. Fortunately, the tax system tends to favor this approach.

To be sure, capital gains taxes are still on the books. But those taxes typically don't apply to increases in the value of securities and property holdings before the time that those assets are sold.

Of course, some critics are none too happy with this outcome. They believe that the commitment to a progressive tax system in the U.S. has wanted in recent years, leading to greater income inequality.

The critics may have a point regarding the effect of the estate-tax system on society. But each individual taxpayer must still act in his or her best interests within existing law.

Source: Bloomberg, "Look How Easy It is to Game Estate Taxes," Dec. 17, 2013

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