Clifford Trust

Clifford Trusts allowed someone to grant income-producing assets to another for no less than 10 years. The grantor could then take the assets back after the trust expired, thus avoiding paying taxes on the income produced by the assets.

Key Takeaways

  • Clifford Trusts were used by the wealthy to avoid paying taxes on income produced by assets.
  • The Tax Reform Act of 1986 discourage this practice by placing trust tax responsibilities on the grantor.
  • Clifford Trusts are rarely used today because there is no more tax advantage when using one.

What Is a Clifford Trust?

Clifford Trusts allowed grantors to transfer assets that produced income into the trust and reclaim them when the trust expired. They are little used today owing to changes in the tax code.

How Clifford Trusts Worked

Clifford Trusts often were used to shift income-producing assets from parents to children prior to the Tax Reform Act of 1986 to avoid paying taxes on the income. However, this legislation rendered this strategy impractical, as the Act mandated that Clifford Trust income must be taxed to the grantor. Therefore, few of these trusts have been created since then. Clifford Trusts once were commonly used as an effective and legal means of avoiding large tax expenses.

Wealthy parents generally named their children in these trusts because they didn't pay income taxes.

The grantor would shift their assets to a trust which would then later be claimed by a recipient who ideally would be subject to a lower marginal tax rate. These trusts were mandated to be for a term of not less than 10 years plus one day. Grantor trust rules are guidelines within the Internal Revenue Code, which outline certain tax implications of a grantor trust. Under these rules, the individual who creates a grantor trust is recognized as the owner of assets and property held within the trust for income and estate tax purposes.

Grantor Trust Rules

Grantor trust rules allow grantors to control the assets and investments in a trust. The income the trust generates is taxed to the grantor rather than to the trust itself. Grantor trust rules offer individuals some degree of tax protection because tax rates are generally more favorable to individuals than to trusts.

The Internal Revenue Service views all revocable trusts as grantor trusts by definition. As such, the trust is not a taxable entity.

Grantors can change the beneficiaries of a trust along with the investments and assets within it. They can direct a trustee to make alterations as well. Grantors can undo the trust as long as they are deemed mentally competent at the time the decision is made. This distinction makes a grantor trust a type of revocable living trust. However, the grantor is also free to relinquish control of the trust making it an irrevocable trust.

In this case, the trust itself will pay taxes on the income it generates, and it would require its own tax identification number (TIN). A grantor trust agreement dictates how assets are managed and/or transferred after the grantor's death. Ultimately, state law determines if a trust is revocable or irrevocable as well as the implications of each. Grantor trust rules also outline certain conditions when an irrevocable trust can receive some of the same treatments as a revocable trust by the Internal Revenue Service.

What Happens to Irrevocable Trusts When the Grantor Dies?

The trust continues until the trustee distributes all of the assets within the trust.

What Is a 2503(c) Trust?

A 2503(c) trust is designed to hold gifts for a minor until they reach the age of 21. The gifts in this type of trust qualify for the annual tax exclusion.

Who Owns the Assets in an Irrevocable Trust?

Assets in an irrevocable trust have had their ownership transferred to the trust, which is a legal entity. The trust owns the assets.

Article Sources
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  1. U.S. Congress. "H.R.3838 - Tax Reform Act of 1986."

  2. Internal Revenue Service. "Abusive Trust Tax Evasion Schemes - Questions and Answers."

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