Other Tax Questions
Questions and comments on other topics covered in Fairmark.com, such as UTMA accounts, and any tax questions that don't fit our other categories.
Lottery winnings and trusts (!)
Posted by: Trustnaive, November 1, 2017 07:57PM
[hypothetical situation followed by real questions]

I am the holder of a ticket that will win tomorrow's Powerball Lottery.

My state does not allow any entity other than an actual human ("natural person") to win the lottery so the prize has to be claimed FIRST, fully taxed, THEN "pocketed".

I want my 18+ kid to have $2 million of the after-tax winnings. I for sure do NOT want those winnings to be double-taxed so I cannot claim the prize, then give my kid $2 million and I for SURE do not want to give my kid $3 million to cover the tax hit, too.

My kid is only 18+ so I don't want to simply make the kid a co-claimant of the prize; I want fairly severe restrictions on the post-tax $2 million that the kid will co-claim.


Alright - silly foreword done, now questions:

I can arrange for a run-of-the-mill legal contract to be drawn up that has serious financial implications for the kid if the kid does not follow through with other terms of the contract that require the kid to immediately place the $2 million in a financial vehicle that restricts the kid's access to the funds (or interest from them).

But what type of financial vehicle should that be?

In THIS case, the kid is the one that is placing the $2 million into the vehicle AND the kid is the one who would get regular payments from the vehicle AND the kid is the one who gets total control of all funds in the vehicle on expiration of the "severe restrictions" timeframe.

I assume some sort of Trust is the answer but, again, double taxation is what is to be avoided at the SAME time as not allowing the kid to change the Trust's "rules" on what the kid gets.

Reading this site and forum it LOOKS like a "Bypass Trust" or some sort or an "Irrevocable Trust" perhaps (except the latter has a grantor who is the kid and a beneficiary who is the same kid and I wouldn't want the Trust itself to have to pay taxes on income at the SAME time as the kid having to pay taxes on whatever the Trust gives the kid...).

Or what other methods are there?


Summary: Dad tells kid "You want $2 million? Sign this contract - not negotiable". Kid signs contract. Dad and kid co-claim lottery prize with kid's post-tax bucks being $2 million. Kid turns around and puts that $2 million into an investment "vehicle" as required by the contract the kid signed with Dad. That vehicle invests the $2 million and pays the kid yearly from the ROI but the kid can't otherwise touch the vehicle nor the vehicle's funds. The vehicle expires after a certain number of years and the kid then gains full control of all funds. During ALL this the Dad never had control of the pre-tax nor post-tax funds nor anything else, just the contract he and the kid signed BEFORE co-claiming the prize.

What is the best vehicle for such a situation - I imagine the same situation has arisen many many times with, say, inherited funds rather than lottery prizes so there has to be a fairly simple answer...I think.

Re: Lottery winnings and trusts (!)
Posted by: Sven, November 1, 2017 09:11PM
Lets start with some basics. You win $10,000,000 and pay total combined tax of $4,000,000, netting you $6,000,000. Your are free to make a gift to your son of $2,000,000. It is not income to him. It is a gift, and gift amounts are not income. Neither is gift money any kind of deduction to you if it goes to someone other than a charity. In round terms you have used up $2,000,000 of your lifetime estate tax and gift tax exclusion/allowance, which as of next year is up to $5,600,000. So I do not understand all this double taxation stuff.

I share your concern about giving him $2MM outright and setting up an appropriate trust for his benefit and funding it with $2MM. These sometimes are called spendthrit trusts and are fairly standard vehicles to control when and how your son gets income, principal, etc. They should be worked out in consultation with goot trust and estate lawyers, because there are tax implications and family implications. It is not a DIY event.

I would be afraid of some king of a "contract" for all sorts of reasons not worth going into at this time here.

Hope you win.

Re: Lottery winnings and trusts (!)
Posted by: Trustnaive, November 1, 2017 10:06PM
Your reply is totally appreciated.

I am not only Trust Naive, I am tax naive, too.

As such, I was under the impression that about $14,000 was it as far as giving bucks to the kid per year with no tax ramifications for the kid (or $28,000 if wife and I do it).

If it is as simple as just forking over $N million to the kid once along with the kid's (contractual) promise to put it away in some type of Trust with the aforementioned features - great! That IS simple!

Is it really that simple?

[post-reply addendum: I looked into Spendthrift and more Trusts due to your reply - thanks very much for that]

[post-addendum addendum: Okay, looked into tax ramifications of simply giving kid a couple megabucks after claiming the WHOLE lottery prize and paying taxes on it and - how about that - it IS as simple as that w.r.t. no extra/double taxes.

Claim prize, pay taxes, create Spendthrift Trust with kid as beneficiary, put 2 megabucks into that Trust, the Trust then handles "the rest". Very cool. I have questions about what entity pays taxes on income, for example (since the Trust will be investing the original 2 megabucks somewhere to generate interest/income to send part of to the kid regularly), but that part can be handled by the suggested attorneys.

Thanks again, for your response; it plus some significant surfing answered the main questions perfectly]

Re: Lottery winnings and trusts (!)
Posted by: Sven, November 2, 2017 03:27AM
I think you were pretty much on the edge of the right track and now seem to be on it. The long and short of trust taxation is assume the trust gets funded with $2MM. It invests in CD's paying 2% a year. So it has interest income of $40,000. If the trust paperwork says all income has to be distributed to the beneficiary, and it certainly can be set up to say that, then your son gets $40,000, assuming the trust has no expenses or deductions to reduce the $40,000. Your son reports $40,000 of interest income on his tax return and pays whatever that amount does to his tax return. The trust files a trust return on Form 1041 for the same tax year and shows how much was distributed to the beneficiary. If it was everything the trust has no taxable income and pays nothing. It is not quite that simple, but that is the theory.

If the trust says the trustee has the discretion to distribute or not distribute all or part of net trust income to the beneficiary, if the trustee says I have decided this yea that the beneficiary only gets $20,000, because I sense lots of trips to Vegas going on, the beneficiary reports $20,000 of interest income on his return. But the trust now has to report the other $20,000 of interest that was not distributed on its Form 1041. The problem is the trust finds itself in higher marginal tax brackets much, much faster than does an individual. So the trust keeping half is a costly tax event, and might make sense, for example, if the trustee felt there was a good reason to pay the extra tax to keep the other $20,000 in the trust for a possible rainy day down the road and out of the hands of the beneficiary.

Control costs. You have to know what the objectives are, like keeping a high living beneficiary from living life too high on the hog.

Read around some more. Lots stuff on this board and out there. There are other tax wrinkles lurking, especially when trust income gets up to higher levels, like the Obamacare surcharge on investment income. Trusts get nailed with all the bad stuff quicker than individuals.

Closing thought. Skip the idea of some kind of contract. It is a formula for regret and disaster.

Re: Lottery winnings and trusts (!)
Posted by: Drewremedy, November 3, 2017 04:05PM
You can give your kid or even me megabucks ...YOU use up your lifetime credits ...assuming they survive tax reform.and for megagifts beyond your lifetime credit YOU pay gift taxes .....as to tax math ..gift taxes are LESS than comparable amount shifted by estate .

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