Illinois residents with significant investments often look for ways to shelter their profits. For many years, a Clifford Trust was a means to reduce federal taxes on income from high-net-worth assets. However, changes in the tax law reduced the popularity of this type of trust.
What is a Clifford Trust?
A 1940 Supreme Court Case set the stage for the creation of the Clifford Trust. Helvering v. Clifford involved the establishment of a five-year trust with immediate family members as beneficiaries. While the grantor still controlled the assets, he did not declare the income on his federal taxes.
The court ruled that, in his case, Clifford was liable for the taxes. However, the court ruling brought the status of other trusts into question. In 1945, the Treasury Department released a set of Clifford regulations to clarify the issue.
A loophole in these rules allowed parents to establish trusts with children as beneficiaries. The government taxed the income for these Clifford trusts at the lower children’s tax bracket, protecting them from higher taxes for the life of the trust.
The impact of the 1986 Tax Reform Act
In 1986, Congress passed tax reform legislation that closed this oversight. So long as the grantor retained control of the assets in the trust, the government would tax any income at the grantor’s tax rate. The new regulation reduced the popularity of Clifford Trusts as an estate planning tool.
Do investors still use Clifford Trusts?
There are situations where a Clifford Trust is still a useful asset management tool. If the grantee creates a temporary trust where the beneficiaries are non-US residents, the Clifford model still offers some tax relief.
Estate planning is a complicated process for people with a high net worth. Careful research into the current tax laws will help you develop the best strategy for protecting your assets.