Minimizing Taxes: Keeping it All in the Family
20 Pages Posted: 24 Apr 2018
Date Written: April 1, 2018
Households can reduce taxes by transferring taxable income generating assets from high income family members to those in lower tax brackets. Parents, for instance, may exploit differences in the marginal tax rates that they face and those that apply to their children. But under progressive taxation, the marginal tax rates may converge upon transferring large sums from high to low income members as the income of the recipient is pushed into higher tax brackets, thereby limiting the tax arbitrage benefits of intergenerational transfers. As an alternative, and under a more effective form of income splitting, high income family members may create trusts for the benefit of other family members, and divide the transferred assets among a large number of trusts so as to subject the income from each trust to the lowest possible tax bracket. The Tax Reform Act of 1986 modified the treatment of trusts such that the maximum individual tax rate became applicable at very low levels of trust taxable income thereby erasing much of the benefits of transferring income through this vehicle. This paper provides an overview of the tax treatment of income received by individuals and that of trusts, and provides evidence on how changes in differential tax rates introduced in 1986 altered the use of trusts as means to splitting income and sheltering it from taxation.
Keywords: Trusts, Income Tax, Intergenerational Transfers
JEL Classification: D1, H24, H31
Suggested Citation: Suggested Citation