Which trust is more appropriate for selling shares while minimising taxes? Option 1: a revocable trust where the cost basis of investments increases to the market value on the date of settlor’s death. Option 2: an irrevocable trust where the cost basis of investments does not change, and the assets are not subject to estate taxes.
Answer says: assets in the revocable trust are subject to estate taxes upon settlor’s death, at which time the cost basis will be increased to market value. Thus total taxes are minimised by selling from revocable trust.
I understand that for the irrevocable trust, current taxes are 0, but taxes later are based on the full capital gain. For revocable trust, there are current taxes at settlor’s death, but why are total taxes lower for revocable?
I can only assume that this question is referring to minimization of capital gain tax. Under option 1, there would be no capital gain assuming assets are sold at the stepped up market value at death. If assets were sold in the irrevocable trust, there would be capital gains tax. Of course, had the assets declined in value, tax would be minimized through the irrevocable trust (because the irrrevocable trust could take the capital loss whereas the revocable trust would lose the capital loss since the basis would equal the lower market value at death). Nothing in this example states that the decedent’s estate is subject to estate tax.
If this is the question from CFA Mock 2011, I think the rationale is the following:
Shares in the revocable trust have already been stepped up, so shares in both trusts have the same cost basis. However, shares in the revocable trust currently are subject to estate taxes, whereas those in the recovable trust are not.
Since this question is asking you for tax minimization, that would be selling shares in revocable trust, that are being taxed.
I am speaking from memory cause I’ve recently done this mock, and I think that was the answer, correct me if I’m worng please.