Ferran Ginton has operated a very successful bakery for 30 years, and has accumulated securities that earn interest income of $40,000 per year. His other sources of income put him in the top tax bracket for personal tax purposes. He has a son, Habib who is 22 years old and currently has no income that is subject to taxation. Habib's only tax credit is the personal tax credit. Determine the amount of federal taxes that could be saved by transferring the interest earning securities to a trust with Habib as the income beneficiary, assuming that the trust will be required to distribute all of its income each year.

Question

Quizplus · Accepted Answer

Ferran Ginton is in the top tax bracket, so he is taxed at the highest marginal rate of 33%. The interest income of $40,000 is therefore subject to tax of $13,200.

If Ferran transfers the securities to a trust and designates Habib as the income beneficiary, the income earned by the trust will be taxable in Habib's hands. As Habib has no other income, he will be taxed at the lowest rate, which is 15% on the first $48,535 of taxable income. The tax on the interest income in Habib's hands will therefore be $6,000.

By transferring the securities to the trust, the tax saved is the difference between the tax that Ferran would have paid and the tax that Habib will pay, which is $7,200 ($13,200 - $6,000). Therefore, the best choice is B.

Ferran Ginton Has Operated a Very Successful Bakery for 30