What Is a Clifford Trust and How Does It Work? (UPDATED) – A Clifford trust is a type of trust that allows a person to transfer an income-producing asset to a beneficiary for a fixed period of time, usually between 10 and 20 years. The beneficiary is typically a minor child or grandchild of the person who creates the trust, also known as the grantor. At the end of the trust term, the asset reverts back to the grantor or their estate.
The main purpose of a Clifford trust is to reduce the income tax liability of the grantor by shifting the income from the asset to the beneficiary, who is usually in a lower tax bracket. For example, if a grantor owns a rental property that generates $10,000 of income per year, they can transfer it to a Clifford trust for their child and avoid paying taxes on that income. The child, who may have little or no other income, will pay taxes on the rental income at a lower rate.
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Clifford trusts are not as popular or effective as they used to be, due to changes in the tax laws that occurred in 1986. The Tax Reform Act of 1986 introduced the grantor trust rules, which require the grantor of a trust to pay taxes on any income that they can control or benefit from. Since a Clifford trust gives the grantor the right to reclaim the asset after the trust term, it is considered a grantor trust and subject to these rules.
Therefore, if a grantor creates a Clifford trust today, they will still have to pay taxes on the income from the asset during the trust term, regardless of who receives it. The only tax benefit of a Clifford trust today is that it can avoid estate taxes by removing the asset from the grantor’s taxable estate. This benefit only applies if the grantor dies during the trust term and does not reclaim the asset.
How to Set Up a Clifford Trust
To set up a Clifford trust, you will need to follow these steps:
- Choose an income-producing asset that you want to transfer to the trust. This can be any type of property that generates income, such as stocks, bonds, real estate, royalties, or business interests.
- Choose a beneficiary who will receive the income from the asset during the trust term. This should be someone who is in a lower tax bracket than you and who you want to benefit from your asset. The beneficiary can be anyone, but it is usually your child or grandchild.
- Choose a trustee who will manage the trust and distribute the income to the beneficiary. The trustee can be anyone you trust, such as a friend, relative, lawyer, or bank. You cannot be your own trustee or have any control over the trust assets.
- Choose a trust term that is between 10 and 20 years. The longer the term, the more income you can shift to your beneficiary and avoid estate taxes. However, you also have to consider your life expectancy and your need for the asset in the future.
- Draft a trust document that specifies the terms and conditions of the trust. You will need to include information such as:
- The name and address of the grantor, trustee, and beneficiary
- The description and value of the asset transferred to the trust
- The duration and expiration date of the trust
- The powers and duties of the trustee
- The rights and obligations of the beneficiary
- The provisions for terminating or modifying the trust
- Sign and date the trust document in front of a notary public and witnesses. You may also need to file it with your local court or registry office.
- Transfer the legal title of the asset to the trustee. You will need to complete any necessary paperwork and formalities depending on the type of asset. For example, if you are transferring real estate, you will need to record a deed in the county where the property is located.[ez-toc]
Pros and Cons of a Clifford Trust
A Clifford trust has some advantages and disadvantages that you should consider before setting one up. Some of the pros are:
- It can reduce your estate tax liability by removing an asset from your taxable estate.
- It can provide financial support and education for your beneficiary during the trust term.
- It can protect your asset from creditors and lawsuits during the trust term.
- It can allow you to reclaim your asset after the trust term if you need it.
Some of the cons are:
- It does not reduce your income tax liability during the trust term due to the grantor trust rules.
- It can expose your beneficiary to income tax liability during the trust term.
- It can limit your access and control over your asset during the trust term.
- It can trigger gift tax liability when you transfer the asset to the trust.
In conclusion, Clifford trust is a type of trust that allows you to transfer an income-producing asset to a beneficiary for a fixed period of time, usually between 10 and 20 years. At the end of the trust term, the asset reverts back to you or your estate. A Clifford trust can help you reduce your estate tax liability and benefit your beneficiary, but it does not save you any income tax due to the grantor trust rules. If you are interested in setting up a Clifford trust, you should consult a qualified estate planning attorney who can advise you on the legal and tax implications of this strategy.
Frequently Asked Questions (F&Qs)
Why would someone create a Clifford trust?
There are a few reasons why someone might create a Clifford trust. One reason is to reduce estate taxes. Another reason is to provide income to a beneficiary for a specific period of time, such as until the beneficiary reaches a certain age.
How does a Clifford trust work?
When a Clifford trust is created, the grantor transfers assets to the trust. The trustee then invests the trust assets and distributes the income to the beneficiary. The trust assets revert back to the grantor after the specified period of time.
What are the advantages of a Clifford trust?
There are a few advantages to using a Clifford trust. One advantage is that it can help to reduce estate taxes. Another advantage is that it can provide income to a beneficiary for a specific period of time.
What are the disadvantages of a Clifford trust?
There are a few disadvantages to using a Clifford trust. One disadvantage is that the grantor loses control of the trust assets during the trust period. Another disadvantage is that the trust assets may be subject to income taxes.
Who can use a Clifford trust?
Clifford trusts can be used by anyone who wants to reduce estate taxes or provide income to a beneficiary for a specific period of time. However, there are some restrictions on who can use a Clifford trust. For example, the grantor cannot be a minor or a person who is mentally incapacitated.
How much does it cost to create a Clifford trust?
The cost of creating a Clifford trust will vary depending on the complexity of the trust and the fees charged by the attorney who creates the trust. However, in general, the cost of creating a Clifford trust is relatively affordable.