The Reciprocal Trust Doctrine is a legal principle used in the context of trusts to prevent tax avoidance strategies that involve creating two or more trusts that are essentially mirror images of each other, set up by related parties to benefit one another.
Under this doctrine, if two trusts are established by two parties (often spouses, but not limited to this) where each trust benefits the other party, the Internal Revenue Service (IRS) may disregard the separate identities of the trusts for tax purposes. This means that the assets in these trusts could be included in the taxable estate of the grantor if the trusts are deemed to have been set up primarily to avoid estate or gift taxes.
For example, if Spouse A creates a trust for Spouse B, while Spouse B simultaneously creates a similar trust for Spouse A, the IRS may view these transactions as reciprocal. If the arrangement is seen as lacking genuine independence and each trust primarily benefits the other, the assets may be treated as if they are still owned by the grantors, leading to potential estate tax implications.
The Reciprocal Trust Doctrine is particularly relevant in estate planning strategies, as it underscores the importance of ensuring that trust arrangements are structured with clear, independent purposes rather than mere tax avoidance. Those engaged in creating trusts should carefully consider this doctrine to safeguard against unintended tax consequences.
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