Trust Distribution and Support

[Kram BergGold]

My client's son is the sole benificiary of a trust. In 2008 the trust disbursed close to $50,000 to pay for the child's high school education and other items of support. As the trust made very little income in 2008 only $400 shows up on the kid's K-1 Form. Clearly the money from the trust provided over 50% of the kid's support. So can we say that the kid did not provide over 50% of his support allowing he parent's to claim him as a qualifying child or is the trust corpus considered to be funds the child provided for his own support?

[Koss]

Support

Where did the corpus of the trust come from?

In other words, who funded the trust?

Is it a revocable trust?

BMK

[Kram BergGold]

Answers

The trust is irrevocable and the funding came from the grandparents.

[Koss]

Trust

Hmmm...

You may be in a gray area of the law.

A few more questions:

Is the trustee one or both of the child's parents?

Are the distributions discretionary? Can the trustee choose not to make any distributions at all?

How does this thing terminate? When the kid turns 18? or 24? Or...

Who is the contingent beneficiary, e.g., if the kid died?

BMK

[Koss]

Trust Issues

I am utterly fascinated by trusts. I think the trust is among the most interesting and most versatile entity structures available. But it is also underused, widely misunderstood, and often abused.

Here are my random thoughts on this...

If a grandparent simply makes an outright transfer of funds, without establishing a trust, then there's basically no issues. The grandparent could simply write a check to the child's parents. The parents then use the funds for the benefit of the child. Yes, you might have to do a gift tax return, but you won't necessarily avoid that by setting up a trust. An outright transfer would be treated as a gift from the grandparent to the parents. The funds then become the property of the parents. Thus, the child is not using his own money for his own support.

Alternatively, the grandparents could write a check directly to the school. Now the parents are not involved, and it appears that a substantial amount of support for the child is coming from the grandparents. But the kid still isn't providing more than half of his own support.

The trust agreement you have described creates a formal mechanism by which the grandparents can provide support for their grandchild. The economic substance of the transaction is the same as if they had given the money directly to the parents, or directly to the school.

Looked at this way, one could begin to fashion a form-over-substance argument, i.e., that the trust is merely a conduit of some sort. In other words, looking at the substance of the transactions, it is clear that the kid is not providing more than half of his own support.

The problem with this argument is that sometimes form really does make a difference.

The formal structure of the trust is meant to facilitate the transfer of a relatively large sum of money over time, and to protect the child's interests in the event that the grandparents or the parents fall out of the picture (by dying or becoming incompetent, for example). And you can't get this type of sophisticated protection without the formal structure of a trust.

The trust effectively declares that the money really belongs to the child, but then appoints someone else to manage the money. That's very different from an outright transfer from the grandparents to the parents. With an outright transfer, the parents could, if they wanted, use the money for something else.

The trust is an entity that separates ownership from control. Ownership of the assets vests in the beneficiary, while control of the assets lies with the trustee.

Thus, for your client, it could be argued that the corpus of the trust actually belongs to the child. On this view, the child might be providing more than half of his own support.

An imperfect analogy may be drawn from the treatment of social security benefits.

Publication 17 (2008) says:

If a child receives social security benefits and uses them toward his or her own support, the benefits are considered as provided by the child.

Young children receive social security benefits that flow from the work record of a deceased parent. For example, when Tommy is only five years old, his father dies in a tragic accident at the age of 30. Tommy will get survivor benefits until he reaches age 18.

But the social security administration is not going to issue checks directly to a five-year old. The checks will be issued to Tommy's mother.

But this does not mean that Tommy's mother is now the owner of those funds. The funds still belong to Tommy...

BMK

[Burke]

Good post. Making a long story short, disbursement of funds from a trust to the extent you mention here means that child is providing his own support. Parents cannot meet support test.

[Lion]

How much did the parents spend?

Did the parents spend $50,001? If so, the child did not provide over half his own support.