In the previous article, we explained how trusts work to divide ownership into two categories. The legal title is held by a trustee, while beneficial ownership belongs to the beneficiary. This division of ownership can create a very strong wall of protection around the property from lawsuits, divorces, catastrophic care expenses and estate taxes.

Such a trust can be established for someone in your estate plan who will receive the property upon your death, or you can put property in trust for them as a gift while you are living. The sort of trust I am describing is not your own revocable living trust. Rather, it would be a trust you set up for the benefit of someone else to hold property when you give it to them.

The classic trust is one responsible person holding title as trustee for the benefit of a less responsible person as beneficiary. But the same individual can serve in both roles. Last month, I shared the example of Perfect Patti, the beneficiary who is perfectly mature and capable, and who is a trustee managing the trust for her own benefit.

So, by creating a trust for your Perfect Patti, you help her protect what you have given, and still give her broad control of her inheritance. Why doesn’t everyone who is transferring anything of significant value do it this way? I see three common reasons:

1.  Hassle. The first reason is the hassle factor. If Patti received property in trust, it requires some record-keeping and a separate tax return. The assets and income of the trust must be kept distinct from Patti’s personal assets and income. Blurring the line between the two would destroy the trust protections.

This is similar to something many farm families are already accustomed to: the business entity. You might have a limited liability company, corporation or partnership. If so, you know that the books and records of the business must be kept separate and distinct from your personal records. You also know that there are appropriate channels for money to pass from the entity to you, or vice versa. You can’t simply draw money out of your corporation without recording it as a distribution, a dividend, a loan or compensation.

A trust is not much different. Trust records must be maintained, and money should flow in or out only according to the terms of the trust. Keeping separate records for the trust is the price you pay for the tax and other benefits.

2. Income tax. The second objection is income taxes. A revered legend says the income taxes will be higher if Patti received property in trust. For two good reasons, this should never be true. Reason No. 1 is a good accountant. Reason No. 2 is a good attorney.

The trust for Perfect Patti will allow her to distribute any income to herself. Each year, with the advice of her accountant, she will determine what the taxable income of the trust is and will distribute some or all of it to herself. The income distributed will be taxed to Patti at the same rate as if there was no trust. A small amount of income can even be left in the trust and taxed at a lower rate than Patti’s, which means the trust will save income taxes for most people.

If Patti really appreciates her trust, she doesn’t want to distribute income except when she truly needs it. That’s because distributing income means money leaves the protection of the trust. So, an even better solution to the income tax problem is a good attorney. A well-drafted trust will include provisions that cause most of the trust income to be taxed to Patti even if it remains in the trust, undistributed. This allows income to accumulate within the trust where it can be reinvested.

If Patti or her spouse are farmers, receiving farmland in trust means they can convert some of their income from self-employment to rental income. This will save substantial income tax dollars as compared to Patti inheriting that same land outside of any trust.

3. Ignorance. Finally, the third reason I think people do not give or leave assets to responsible heirs in protective trusts is simply the lack of knowledge. If you don’t know something is possible, you won’t ask your attorney to help you do it. But even if you are aware of the possibility, for most people it is rather mysterious. Most people avoid what they don’t fully understand.

Perhaps reading columns like this will help.

Ferguson is an attorney who own The Estate Planning Center in Salem, Ill. Learn more at thefarmersestateplanningattorneys.com. The opinions of this writer are not necessarily those of Farm Progress/Informa.