Introduction
High-net-worth individuals in Texas seeking asset protection often explore self-settled trusts, but the state’s stringent requirements can complicate setup and effectiveness if not handled properly. Inexperienced advisors may fail to emphasize the need for a third-party settlor or trustee, leading to invalid trusts, lost protection, or tax pitfalls. Are you structuring your self-settled trust correctly to maximize asset protection while complying with Texas law in 2025?
At Kewal Krishan & Co, our expert tax advisors help Texas clients save an average of $50,000 annually, potentially totaling $775,000 over a decade through robust estate and tax planning. This blog examines self-settled trusts in Texas, focusing on why a third-party settlor is required under the Texas Property Code, with detailed examples and compliance steps for 2025. With Texas’s favorable trust laws and no state income tax, these structures offer strong creditor protection when properly formed. Begin fortifying your assets today with insights from Our Tax Planning Services.
Understanding Self-Settled Trusts in Texas
A self-settled trust, also known as a domestic asset protection trust (DAPT), allows the settlor (creator) to be a beneficiary while shielding assets from creditors, governed by the Texas Property Code § 112.035(d). Texas is one of the few states permitting self-settled trusts for asset protection, but strict rules apply to ensure legitimacy and avoid fraudulent transfers under the Uniform Fraudulent Transfer Act (Texas Business & Commerce Code § 24).
Why a Third-Party Settlor?
Texas law requires a third-party settlor for self-settled trusts to enhance credibility and prevent abuse. This means while the primary individual (grantor) funds the trust, a nominal third-party settlor—such as a spouse, family member, or advisor—must create it to satisfy formalities and distance the grantor from direct control, reducing risks of piercing the trust veil in court.
The trust must be irrevocable, not intended to defraud creditors, and managed by a qualified trustee (often a third-party with expertise, as per recent legislative proposals like HB 4058 in 2025). This structure aligns with federal tax rules, where the trust may be treated as grantor (IRC §§ 671-679) or non-grantor (IRC § 641), impacting income taxation.
Tax Treatment
- Federal Income Tax: Grantor trusts report income on the grantor’s Form 1040 at individual rates (up to 37% in 2025). Non-grantor trusts file Form 1041, with compressed brackets (37% over $15,650) but potential income shifting to lower-bracket beneficiaries.
- Texas Franchise Tax: If the LLC is trust-owned, it pays 0.75% on taxable margin (Texas Tax Code § 171.002), reported on Form 05-163 or Form 05-169. Single-member LLCs may be disregarded for federal purposes but still subject to franchise tax if conducting business in Texas.
The One Big Beautiful Bill Act (OBBBA) allows non-grantor trusts a $40,000 SALT deduction (IRC § 164, 2025-2029), though Texas has no state income tax, this applies to local property taxes. For details, see IRS Publication 541 and Texas Comptroller’s Franchise Tax Guide.
Detailed Example: Setting Up a Self-Settled Trust with Third-Party Settlor
Consider Mr. Johnson, a Texas entrepreneur with $3 million in real estate assets vulnerable to business creditors. He uses a third-party settlor (his spouse) to create an irrevocable self-settled trust owning a Texas LLC holding the real estate, generating $120,000 rental income in 2025.
- Setup: Spouse as settlor establishes the trust (Texas Property Code § 112.035), Mr. Johnson funds it as grantor. Qualified third-party trustee manages (per HB 4058 requirements for expertise).
- Asset Protection: Creditors limited to charging order against LLC distributions (TBOC § 101.112); trust protects from personal claims if not fraudulent (Texas Business & Commerce Code § 24.005).
- Federal Tax (Non-Grantor): Trust files Form 1041, taxing $120,000 at ~$39,600 (37% over $15,650) + 3.8% NIIT ($4,560) = $44,160. Distributed to Mr. Johnson (32% bracket): ~$38,400 + NIIT.
- SALT Deduction: Trust claims $40,000 for property taxes, saving ~$14,800 at 37%.
- Texas Franchise Tax: LLC revenue $120,000, margin = 70% ($84,000). If 100% Texas-sourced, tax = 0.75% × $84,000 = $630.
If grantor trust: Mr. Johnson reports $120,000 on Form 1040 at 37% + 3.8% NIIT ($48,960), with personal $40,000 SALT cap. Non-grantor saves ~$4,800, plus stronger protection.
Alternative Scenario
For $1 million assets generating $50,000 income: Non-grantor tax ~$16,500 (or $12,000 if distributed at 24%); franchise tax $262.50. Grantor tax ~$19,000. Non-grantor preferred for protection and shifting.
Step-by-Step Guide for Taxpayer Compliance
To establish a trust-owned Texas LLC in 2025, follow these steps:
- Engage Professionals: Consult attorney for trust drafting and CPA for tax implications; ensure qualified trustee (HB 4058).
- Select Third-Party Settlor: Choose a trusted individual (e.g., family member) to create the trust (Texas Property Code § 112.035).
- Form LLC: File Certificate of Formation with Texas Secretary of State (TBOC § 3.010), naming trust as owner.
- Draft Trust: Make irrevocable, specify beneficiaries, and avoid fraudulent intent (Texas Business & Commerce Code § 24).
- Transfer Assets: Convey to LLC, then assign LLC interest to trust; obtain appraisals for basis (IRC § 1014).
- Determine Tax Status: Confirm grantor/non-grantor (IRC §§ 671-679); file Form 1041 if non-grantor.
- Report Taxes: Federal: Form 1040 (grantor) or Form 1041 (non-grantor) by April 15, 2026. Texas: Franchise tax on Form 05-163/05-169 by May 15, 2026.
- Retain Records: Keep trust/LLC documents, appraisals, and financials for four years (Texas Tax Code § 171.211, IRC § 6001).
For multi-asset trusts, explore Our Estate Planning Services.
Common Pitfalls to Avoid
- Fraudulent Intent: Transfers within two years of claims may be voided (Texas Business & Commerce Code § 24.005).
- Unqualified Trustee: Failing to appoint an experienced trustee risks invalidation (HB 4058).
- Tax Misclassification: Retaining powers makes grantor trust, including assets in estate (IRC § 2036).
- Franchise Tax Errors: Disregarded LLCs still owe if active in Texas (Texas Tax Code § 171.101).
Why Work with a Tax Expert?
Structuring trust-owned LLCs in Texas demands expertise in Texas Property Code, TBOC, and IRC to balance protection and taxes, where pitfalls like fraudulent transfer claims can jeopardize assets. Generic advisors may neglect third-party settlor requirements or federal implications, leading to costly errors. Kewal Krishan & Co specializes in Texas-specific asset protection strategies, ensuring compliant setups and optimal tax outcomes. Our proficiency resolves complexities, as demonstrated in Our Tax Litigation Services.
Conclusion
Self-settled trusts in Texas require a third-party settlor to enhance legitimacy and asset protection under the Texas Property Code, with trust-owned LLCs providing layered safeguards against creditors while offering federal tax flexibility. Texas’s no-income-tax environment amplifies benefits, but accurate compliance is vital to avoid voids or penalties. Strategic planning in 2025 can secure your wealth—consult professionals now to implement this powerful structure.
Call to Action
Schedule a consultation with Anshul Goyal, CPA EA FCA, a licensed U.S. CPA and Enrolled Agent, admitted to practice before the IRS, specializing in tax litigation and cross-border tax for U.S. businesses and Indians in the U.S. Contact us at Kewal Krishan & Co to set up your trust-owned LLC.
About Our CPA
Anshul Goyal, CPA EA FCA, is a licensed U.S. CPA and Enrolled Agent, representing clients in IRS tax litigation and assisting with cross-border tax compliance for U.S. businesses and Indians in the U.S. His expertise ensures tailored strategies that maximize savings and ensure compliance.
Disclaimer
This blog provides general information for educational purposes only and does not constitute tax, legal, or financial advice. Tax laws change frequently, and individual circumstances vary. Consult a qualified tax professional before making decisions. The author and firm disclaim liability for actions taken based on this content.
FAQs
1. What is a self-settled trust in Texas?
A trust where the settlor is a beneficiary, protected from creditors if irrevocable and non-fraudulent (Texas Property Code § 112.035).
2.Why a third-party settlor?
Enhances credibility and avoids direct control by the grantor, reducing risk of invalidation (Texas Property Code § 112.035).
3. How are trust-owned LLCs taxed federally?
Grantor: On personal Form 1040; non-grantor: On Form 1041 (IRC §§ 671-679, § 641).
4. What’s Texas franchise tax for LLCs?
0.75% on taxable margin, even if trust-owned (Texas Tax Code § 171.002).
5. Can creditors access trust assets?
Limited to charging orders against LLC distributions (TBOC § 101.112).