Tax considerations are an important aspect of estate planning. This is why many people in Maryland and other states utilize trust planning strategies in order to minimize tax liabilities. However, there are times when the tax laws regulating trusts may not be exactly straightforward. This was the case in a recent court dispute involving the Internal Revenue Service (IRS) over the real estate activities of a particular trust.
The legal dispute centered around three trustees of a family trust who had participated in managing and making decisions regarding real estate properties. Three of the five beneficiaries had worked for an LLC that was owned wholly by the trust. The LLC managed most of the rental properties owned by the trust. The LLC employed the three beneficiaries who were also trustees of the trust.
However, during 2005 and 2006, the trust reported losses incurred from the rental properties on the trust income tax returns. On the return, the trust listed its rental property activities as non-passive rather than passive activities, which allows for a larger tax deduction for the trust. The IRS disagreed with this classification and determined in a deficiency notice that the rental activities should be considered passive activities, which would mean less deductions allowed for the trust. After a court battle between the trust and the IRS, the U.S. Tax Court ruled that, in this particular case, the IRS was in the wrong, and that the real estate activities of the trustees should be considered non-passive.
On the other hand, not all cases are the same when it comes to trust planning and tax strategies. Each situation in Maryland or any other state is unique and requires a close examination of the facts of the case in order to decide on the best trust planning strategies. Therefore, knowledge of the laws pertaining to trusts and taxation, as well as how the courts have interpreted these laws in the past, are essential in making trust planning decisions.
Source: Forbes, “Material Participation Of Trusts And Estates: The Frank Aragona Trust Case“, Lewis Saret, Aug. 26, 2014