Don't Get Greedy on Non-Grantor Trusts

Published on: 14:24PM Jul 23, 2018

One of the nice provisions about the new Section 199A deduction is that trusts and estates are also entitled to the 20% deduction.   Farmers who have high income and low wages paid and depreciable property can benefit from transferring part of their business to a non-grantor trust for the benefit of their children or grandchildren and receive a greater deduction as a family.

Here is an example:

Chris operates a farm that generates about $1 million of net income each year, but has very little wages or depreciable property.  The Section 199A deduction could be $200,000, however since he is over the threshold and has very limited wages and depreciable property, his net Section 199A deduction is less than $5,000 each year.  He has four children and transfers a 15% interest in trust for each of his kids.  This generates about $150,000 of income each year and results in a Section 199A deduction of about $30,000 for each trust or $120,000 total.  The tax savings each year for the family is about $44,000.

Many advisors to high net worth families have been promoting this planning as a way of maximizing the Section 199A deduction.  However, these plans include possibly setting up multiple trusts with the same grantor and beneficiary (in some cases, they are discussing over 100 trusts to be created).  In these cases, the IRS is likely to challenge the creation of these trusts as purely a device to create a Section 199A deduction and disallow the deduction.

Therefore, make sure that you are creating these non-grantor trusts for more than simply getting a Section 199A deduction.  Some of the other reasons are to ease the transfer of ownership, creditor protection, etc.

Until we get further guidance from the IRS (which may be Labor Day at the earliest), it is likely unwise to do much structural change to your farm operation.  We hate to use the words "we don't know" but for now this is the best advice we can give.