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By The Wyoming LLC Attorney Team

Oct 08, 2021

Asset Protection Trust Taxation

Asset Protection Trust


An Asset Protection Trust safeguards assets through irrevocable terms, shielding them from creditors and legal judgments. The trustee manages assets for designated beneficiaries. Tax implications vary based on asset type, generated income, and tax liability. Parties involved include grantors, trustees, and beneficiaries. Some assets, like tax-qualified retirement accounts, can't be transferred. While Asset Protection Trusts provide creditor protection, tax planning is essential.

An Asset Protection Trust is irrevocable, which means the terms and conditions of the Trust cannot be changed. The grantor who wants to protect assets designates a trustee to manage the Trust for the benefit of every beneficiary named by the grantor. Asset Protection Trusts offer several advantages, with the most significant benefit allowing the grantor to protect assets from creditors and legal judgments.

One of the issues concerning the establishment of an Asset Protection Trust is the taxation implications. The taxation implications depend on the type of assets in the Trust, the amount of income generated by the assets, and which party is legally liable to pay taxes.

Who Are the Parties Involved With an Asset Protection Trust?

As the creator of an Asset Protection Trust, the grantor determines which assets to protect and names the beneficiaries to receive the assets. In some cases, an agent designated with the Power of Attorney creates an Asset Protection Trust on behalf of the grantor.

Named by the grantor, the trustee manages the Trust. Since an Asset Protection Trust is considered irrevocable, the trustee cannot also be the grantor. Trustees typically are close, trusted friends of grantors. Lifetime beneficiaries have the right to withdraw income from the Trust during the grantor’s lifetime. Death beneficiaries receive the assets placed in the Trust upon the death of the grantor.

What Types of Assets Can I Transfer to an Asset Protection Trust?

You can transfer just about any type of asset into an Asset Protection Trust. The exception is tax-qualified retirement accounts. If any of the assets generate income during the life of the Trust, the terms of the Trust should be reviewed to determine who are the lifetime beneficiaries of the generated income and who is legally liable to pay taxes on the income.

What Is the Impact of Taxation on a Medicaid Asset Protection Trust?

If you have more assets than allowed for Medicaid enrollment, you can shield them by placing them in a Medicaid Asset Protection Trust. Referred to as a Grantor Trust, a Medicaid Asset Protection Trust requires the grantor to pay taxes on any generated income even if the grantor does not receive the income as a lifetime beneficiary.

Establishing a Medicaid Asset Protection Trust can be a highly effective financial planning tool for older Americans. Not only do you shield assets from Medicaid’s maximum limit, but you also might avoid paying a gift tax. Many Americans confuse the gift tax with the estate tax. If you transfer an asset into a Medicaid Asset Protection Trust as a completed gift, you must pay a gift tax when you transfer the asset. On the other hand, an asset that you consider an incomplete gift qualifies for the gift tax when the Trust makes distributions to lifetime beneficiaries.

To define whether you want an asset to qualify as a complete or incomplete gift, submit the long-form application for starting a Medicaid Asset Protection Trust

The Bottom Line

Estate planning often requires analyzing the tax implications of making different financial moves. When it comes to an Asset Protection Trust, you receive more protection from creditors and legal judgments than you get from the IRS. Setting up a Medicaid Asset Protection Trust does not get you off the hook for taxation purposes. However, starting one can help you qualify for Medicaid even if you exceed the maximum limit for asset valuation.