A. ALL TRUSTS
Q. WHAT IS A TRUST?
A. A trust is a legal relationship in which one person (the trustee) holds legal title to property for the benefit
of another (the beneficiary). Many kinds of trusts exist, and each state has different rules outlining the specific requirements for trusts.
Trusts are used to accomplish a variety of estate planning goals. A trust may supplement a will, or replace a will. A trust may allow your estate to avoid probate. A trust may be created to manage a person's property or protect it from creditors. Some trusts provide tax benefits or reduce tax liabilities.
To create a trust, the trust maker (usually called the settlor or grantor in the trust document) transfers legal ownership of his or her property to a person or institution, the trustee. The trustee can then manage the property for the benefit of another, the beneficiary. Often the trustee receives compensation for serving as trustee. A trustee has a fiduciary duty to act in the best interests of the beneficiary.
Depending on the type of trust, a trust maker may name himself or herself a trustee or a beneficiary. Regardless of what kind of trust a person establishes, the trust will only become effective after the trust maker has funded it, i.e., transferred assets to it.
Q. WHAT IS THE DIFFERENCE BETWEEN A REVOCABLE TRUST AND AN IRREVOCABLE TRUST?
A. A revocable trust is a trust that the trust maker can change, amend, or revoke during his or her lifetime.
The trust maker still has complete control over the assets that he or she has transferred into the trust. Revocable trusts may include a provision that makes that trust irrevocable on the trust maker's death. On the other hand, an irrevocable trust is one that the trust maker cannot modify or revoke. The maker of an irrevocable trust permanently relinquishes any right to make changes to the trust.
Q. WHAT IS THE DIFFERENCE BETWEEN AN INTER VIVOS TRUST AND A TESTAMENTARY TRUST?
A. A testamentary trust is a trust that is funded and comes into existence only after the maker has died. Testamentary trusts may be created by a will or living trust. A testamentary becomes irrevocable on the maker's death.
A testamentary trust, as opposed to an outright gift, allows the maker to have more control over the management and distribution of his or her property after death. For example, parents often establish a testamentary trust for the benefit of their minor children through which the trustee manages the assets and disbursement of money to the children until the children reach a certain age or attain certain milestones.
An inter vivos trust is a trust that is established and funded during the maker's lifetime. It may terminate after a specified period or on the trust maker's death, or it may continue after the trust maker's death. An inter vivos trust may be revocable or irrevocable. One type of inter vivos trust, the revocable living trust, may allow a person's estate to avoid probate IF his or her assets were transferred into the trust before his or her death.
Irrevocable inter vivos trusts are often used for protecting property from creditors or for certain tax benefits.
B. REVOCABLE LIVING TRUSTS
Q. WHAT IS A REVOCABLE LIVING TRUST?
A. A revocable living trust is an estate planning tool. A revocable living trust is created between the trust maker (called the settler or the grantor) and the trustee for the benefit of the trust beneficiaries.
The trust maker is you (or you and your spouse). The trustee is the person or persons whom you designate to manage your trust, typically you (or you and your spouse) during your lifetime and a successor on your death. Your trust beneficiaries are the individuals and/or organizations whom you designate to receive your assets on your death.
Once your revocable living trust is created, you transfer your assets into the trust. The trust assets, however, are still considered yours to be used for your benefit throughout your lifetime. The trust maker of a revocable living trust can change, modify or terminate the living trust during his or her lifetime.
Living trusts are usually drafted to include a back-up (or successor) trustee who will manage your trust in the event you die or become incapacitated. The trust will most likely include special provisions that allow for the management and distribution of the trust assets upon your death. On your death, your trustee distributes your property to your beneficiaries under the terms of your trust without the need to go through probate.
Q. WHAT ARE THE BENEFITS OF A REVOCABLE LIVING TRUST?
A. A revocable living trust provides several benefits that are not available with a will.
When you die, the assets in your living trust do not need to go through probate. Probate can be time-consuming and costly. With a revocable living trust, your trustee can manage your estate and transfer your assets to your designated beneficiaries immediately on your death without delay or payment of probate fees.
Because your trust does not need to be probated, it does not become a public document, so the details of your estate plan remain private.
If you own real estate in more than one state, a living trust can eliminate the need for multiple probate proceedings in each state in which the property is located.
A living trust permits you to name a successor trustee to take over management of the trust assets if you are incapacitated, which may avoid the need for a court-appointed guardian.
Q. WHAT ARE THE DISADVANTAGES OF A REVOCABLE LIVING TRUST?
A. A living trust is not the best option for everyone. The main disadvantage to having a living trust is the upfront costs associated with it. Attorney fees will be higher for a living trust estate plan than a will-based estate plan because the attorney needs to spend more time preparing the documents and discussing the options and possibilities that are available under a trust-based plan.
In addition, maintaining the trust requires time, effort, and expense. The living trust is not effective unless the trust is funded. Therefore, once the trust is created it is necessary for you to transfer your assets into it. Whenever you acquire new assets, you will also have to transfer them to the trust. If assets are left outside the trust, your estate may need to be probated.
Sometimes holding assets through a trust can complicate dealings with third parties. They may be hesitant to accept checks drawn on the trust's account. You may have to first purchase real estate in your own name and then in a second transaction, transfer it to the trust. Or you may have to transfer an asset you want to sell from the trust to your own name before selling it. Insurers may not want to insure a vehicle that is held in trust and lenders may require loans to be paid off before a vehicle can be put in the trust.
Another downside of a living trust is that because a trust does not go through probate, the court does not have the ability to monitor the estate for fraud or abuse. Finally, minor differences exist between tax obligations for a trust-based estate versus a will-based estate. You should discuss these differences with a tax professional or your attorney before deciding which option is best for you.
Q. HOW DO I CREATE A REVOCABLE LIVING TRUST?
A. It is best to contact an attorney who specializes in estate planning to help you create your living trust.
While many forms and programs are available online that would allow you to create your own living trust, a trust can be lengthy and complicated. To ensure that your estate planning goals are met, you should meet with an attorney who handles these matters on a regular basis so that he or she can draft your trust to accomplish your goals. A “form” may not cover your individual needs. Also, even if a trust is created and signed by you, it will not be effective unless it is properly funded and you have transferred your assets into it.
Q. WILL A REVOCABLE LIVING TRUST AVOID OR REDUCE ESTATE, GIFT, AND INCOME TAXES?
A. With proper planning and under certain circumstances a married couple may reduce their estate taxes
with a revocable living trust. However, the couple can obtain the same reduction by using wills that include one or more tax-saving testamentary trusts. Transfers of assets to a revocable living trust are not subject to gift taxes.
As the maker of a revocable living trust, you are responsible for the income taxes on any trust assets just as though the assets were still in your name, regardless of whether you or someone else is named trustee.
Q. WILL A REVOCABLE LIVING TRUST PROTECT MY ASSETS FROM CREDITORS?
A. A traditional revocable living trust that is established for estate planning for the purposes of avoiding probate will not protect your assets from creditors. Although your assets are transferred to the trust, you, as the trust maker, are still are taxed on the assets and have control of the assets. In addition, you have the authority to revoke or terminate the trust at any time and then the assets revert to your name. If your goal is to shield your assets, you should discuss with your estate planning attorney whether other more complex trusts are appropriate for your estate plan.
Q. WILL A REVOCABLE LIVING TRUST PREVENT A WILL CONTEST?
A. The short answer to this question is no. Technically, a trust is not a will, so the trust itself cannot be part of a will contest action. Under a traditional trust-based estate plan, a document called a pour-over will usually accompanies the trust. The pour-over will serves as a safety net for anything not covered by your trust. The pour-over-will, however, could be contested.
A living trust may reduce the likelihood of a contest because it is not a public record, but it does not guarantee the distribution of your estate will be uncontested. If your family members are unaware that another person is receiving more than they are, the likelihood of a contest is reduced. However, a living trust, like any other contract, can be challenged in court based on fraud, undue influence, or lack of capacity. These are also the same grounds on which a will is often challenged.
Q. WILL A REVOCABLE LIVING TRUST HELP ME QUALIFY FOR
MEDICAID OR OTHER GOVERNMENT BENEFITS?
A. A revocable living trust will NOT help anyone qualify for Medicaid or government benefits. The reason is that, under a revocable living trust, the trust maker (you) still has the ability to control your assets, either by managing their distribution or by revoking the trust and having the assets revert to you. With careful drafting and planning, several types of irrevocable living trusts, such as a special purpose trust or Medicaid asset protection trust, may help you to qualify for Medicaid or other government benefits. The laws regarding transferring property into these types of trusts are complex; therefore it is in your best interest to seek the advice of an attorney who specializes in this area to assess whether you do qualify for these benefits and to properly draft a trust that would achieve these goals.
Q. DO I STILL NEED A WILL IF I HAVE A REVOCABLE LIVING TRUST?
A. Yes. You should still have a will to accompany your living trust. This type of will is called a pour-over will. Because your living trust deals strictly with your assets, a pour-over will acts as a safety net for everything else pertaining to your estate plan that your trust does not cover. If you have minor children, for example, a pour-over will contains provisions addressing the appointment of a guardian for them. Also, if you pass away before you transfer all your assets into your trust, the pour-over will transfers any assets in your sole name into your trust to be distributed to your beneficiaries.
Q. WHAT PROPERTY SHOULD I TRANSFER INTO MY REVOCABLE LIVING TRUST?
A. In order for your trust-based estate plan to be effective, you need to fund the trust. Specifically, you should transfer your most valuable assets into your trust. This may include the following: real estate, business interests, brokerage accounts, money market accounts, stocks, bonds, mutual funds, royalty contracts, patents or copyrights, antiques, jewelry, and artwork. Even if you jointly own real estate with another person or entity, you may want to still consider transferring your share into your trust so that it can be distributed with the rest of your trust estate.
Life Insurance proceeds do not need to be transferred into your living trust, because you can name your beneficiaries in your policy and the proceeds can be distributed directly according to the terms of your policy. Also, retirement accounts such as 401k's or IRA's by law are not allowed to be owned by a trust entity Because you can still designate beneficiaries on those accounts, the proceeds can be distributed directly to your named beneficiaries rather than having to go through probate. Also, property of little value and personal checking accounts are types of property that should not be transferred into your living trust.
Q. CAN I SELL PROPERTY THAT IS IN MY REVOCABLE LIVING TRUST?
A. Yes. If you are the trustee of your revocable living trust, you can sell the property just as if the title was still held in your name. Similarly, if your successor trustee is managing trust assets because you are no longer able to do so, he or she can sell or transfer the property out of the trust.
Q. CAN I MOVE PROPERTY IN AND OUT OF MY REVOCABLE LIVING TRUST?
A. Yes. So long as you have your own, individual living trust, you may transfer property in and out of your trust as often as you wish. If you own a joint trust with another person, such as a spouse, you may need his or her written consent when moving the assets.
Q. CAN I MAKE A LOAN FROM MY REVOCABLE LIVING TRUST TO A BENEFICIARY?
A. Yes. You should have your revocable living trust drafted in a manner specifically tailored to your estate planning goals. If allowing for your beneficiaries to receive a loan from your trust is one or your wishes, you should ensure that your trust is drafted accordingly. Therefore, you can have certain provisions included in your trust that outline the terms and conditions of how a trustee can administer a loan to a beneficiary.
Q. CAN I REVOKE OR AMEND MY LIVING TRUST?
A. Yes, so long as you have a revocable living trust, you can revoke or amend it at any time. If you wish to
make a minor change to your trust, you can create an amendment to the trust, which is a simple document outlining the changes. The document needs to be signed, dated, and kept with your original trust document. If you need to make substantial changes to your trust, you will need to create something called an amendment and restatement. An amendment and restatement avoids your having to transfer all your property into a new trust. Rather, the document serves to “restate” the terms of the original trust combined with any new provisions.
Q. WHAT ARE THE RESPONSIBILITIES AND DUTIES OF MY TRUSTEE?
A. The trustee's job is to manage the affairs of a trust and distribute its assets. In carrying out this role, a trustee must follow the wishes of the trust maker pursuant to the instructions outlined or specified in the terms of the trust.
The duties of a trustee differ, however, when a trustee is serving as a successor trustee for a trust maker who is incapacitated, as opposed to when the successor trustee steps in when the trust maker has died. A successor trustee for an incapacitated trust maker is responsible for managing the trust assets as well as managing the care of the trust maker. When the trust maker dies, the successor trustee's responsibilities focus on executing the terms of the trust, which may include inventorying the assets, taking an accounting of the assets, and settling the trust estate.
Often the trust continues after the estate has been settled, (for example in situations where a sub-trust is created for the benefit of a minor child). In these circumstances, the trustee is still responsible for managing the trust on a longer basis. In doing so, the trustee must make sure that he or she keeps the assets of the trust separate from his or her own assets. In addition, a trustee must be communicative with the beneficiaries and treat them equally (unless the trust provides otherwise).
When managing the trust assets, the trustee must make conservative investments for the trust, or invest trust funds in a manner to earn interest with minimal risk to the trust assets. Finally, a trustee is responsible for maintaining accurate records, filing appropriate tax returns and reporting to the designated beneficiaries as outlined in the terms of the trust.
Q. WHOM SHOULD I CHOOSE AS MY TRUSTEE?
A. With a revocable living trust, most people choose themselves as the initial trustee. This enables them to
manage their assets for as long as they are able to do so. Married couples may choose to serve as co-trustees, which would allow for the other to step in as sole trustee in the event that one person dies or becomes incapacitated.
When naming an individual as a successor trustee, you should consider naming multiple individuals to serve if the first person you name is unable to act. Because the role of the trustee is to manage and distribute the assets of the trust, it is important to choose someone whom you trust and who is responsible. Often this could be a spouse, adult child, relative, or close friend. Sometimes people choose a corporate trustee, rather than a family member or close friend. Corporate trustees may include bank trust departments, attorneys, or CPAs.
Q. WILL I STILL NEED A DURABLE POWER OF ATTORNEY IF I HAVE A REVOCABLE LIVING TRUST?
A. Yes. When you have your estate plan prepared, you will need a durable power of attorney in addition to your living trust. A durable power of attorney, sometimes referred to as a financial power of attorney, allows you to name someone as your agent who can immediately handle your financial affairs if you become incapacitated and are unable to do so yourself. A trustee only has the power to manage your assets that are in your trust. A durable power of attorney, however, gives the agent whom you appoint the power to manage assets that are not included in your trusts, such as personal bank accounts and retirement accounts. The agent listed in your durable power of attorney also can pay bills on your behalf and even address insurance issues.
Q. WHAT HAPPENS TO MY REVOCABLE LIVING TRUST WHEN I DIE?
A. A revocable living trust becomes an irrevocable trust upon your death, and changes can no longer be
made to it. Your successor trustee becomes your trustee and then takes on the role of managing the trust funds and distributing the trust assets to your beneficiaries. Your trust will remain in existence for as long as it takes the trustee to complete this process. If a sub-trust was created for property to be held in trust for your spouse or minor children, the trustee will continue to manage the sub-trust until the beneficiary has satisfied all the conditions outlined in the trust in order to receive the full distribution of the trust property.
C. OTHER TYPES OF TRUSTS USED FOR ESTATE PLANNING
Q. WHAT IS A MINOR'S TRUST?
A. A minor's trust is a type of testamentary trust used to leave money or other property to a minor, but in
the care of a trustee (person who manages the property) until the minor attains a certain age. Often minor's trusts are in effect until the minor attains 18, 21, or 25 years of age. The minor's trust is created through either a living trust or a will, and it comes into existence on the trust maker's death.
Q. WHAT IS A POT TRUST?
A. A pot trust, which is sometimes referred to as a “family pot trust” is a trust in which the makers (usually
parents in this type of situation) leave their money for their children or designated beneficiaries in a combined “pot” in one trust, as opposed to separate trusts for each child. The trustee has the discretion to take money from the “pot” for the needs of each child as they arise. Once all of the children have reached a specified age (e.g., 18 or 21), the trust pot is usually divided into separate shares for each of the children. An advantage to a pot trust is that it allows the trustee to make unequal distributions to the beneficiaries as their needs may require. For example, one child may have greater medical needs than the others.
Q. WHAT IS A SPENDTHRIFT TRUST?
A. A spendthrift trust is a type of irrevocable trust that is created for the benefit of a beneficiary who may have a difficult time managing money and property. The maker of a spendthrift trust names an independent trustee to manage the trust funds. The independent trustee's powers to protect the beneficiary from frivolous spending can vary and are described in the trust agreement. For example, the trustee may be allowed or required to make cash payments to the beneficiary or to purchase goods and services for the beneficiary. The spendthrift trust protects the trust estate because creditors of the beneficiary cannot attach a claim to trust funds, although they can reach distributions from the trust in the beneficiary's hands. To create a spendthrift trust, a provision must be included in the trust agreement specifically stating that the maker intends for the trust to be a spendthrift trust.
Q. WHAT IS A MARITAL DEDUCTION TRUST?
A. The estate and gift tax provides for an “unlimited marital deduction.” A spouse can transfer all of his or her assets to the surviving spouse, free of all federal estate and gift tax regardless of the size of the spouse's estate. Outright gifts qualify for the deduction, but gifts in trust must meet special Internal Revenue Code requirements. A marital deduction trust is a testamentary trust that meets these requirements.
Specifically, the surviving spouse must be the only named beneficiary of the trust. In other words the surviving spouse is the only person who can receive any assets from the trust for as long as he or she is living. Depending on the type of marital deduction trust, additional requirements must be met. Two common types of marital deduction trusts are the general power of appointment (GPOA) marital deduction trust and the qualified terminable interest (QTIP) trust. A marital deduction trust can be created in a will or living trust.
Q. WHAT IS A GENERAL POWER OF APPOINTMENT MARITAL DEDUCTION TRUST?
A. The general power of appointment (GPOA) marital deduction trust is created by the trust maker's will or
living trust. The maker leaves some or all of his or her estate in trust to the surviving spouse for use during the spouse's lifetime. The trust provides the surviving spouse with income and trust principal if needed. It also gives the surviving spouse a general power of appointment over the trust assets. A general power of appointment means the surviving spouse has the authority to dispose of the trust property on death as he or she sees fit without any restrictions.
On the surviving spouse's death, the trust assets are distributed to the beneficiaries named in the surviving spouse's will or living trust, usually the couple's children.
The assets in the GPOA marital deduction trust are not subject to federal estate and gift tax on the death of the first spouse. However, the general power of appointment causes the entire trust to be included in the surviving spouse's estate on his or her death. If the value of the surviving spouse's estate is high enough, estate taxes could be owed.
Q. WHAT IS A QUALIFIED TERMINABLE INTEREST TRUST?
A. A qualified terminable interest trust, often referred to as a Q-TIP, is a type of marital deduction trust that can be included in a will or living trust. A qualified terminable interest trust permits the trust maker to do all of the following:
• Give his or her spouse all the income from the trust property for life;
• Claim the estate tax marital deduction for the full value of the property transferred to the trust, not just the income;
• Name the ultimate beneficiaries of the property on the spouse's death.
The QTIP trust must give the surviving spouse the right to all income from the property for life payable at least annually and must prohibit distributions of the trust property during the surviving spouse's life to anyone other than the spouse. QTIP property, except for the family residence, must be income producing property. The trustee can invade the principal for the benefit of the surviving spouse.
The trust qualifies as a QTIP trust only if the executor elects to treat the trust property as qualified terminable interest property on the deceased spouse's estate tax return.
This type of trust is often used by those who have been married more than once and have children or grandchildren from previous marriages. The trust allows the maker to ensure that trust assets pass to his or her family, rather than to the family of the surviving spouse as could be the case with a GPOA marital deduction trust.
On the surviving spouse's death, the assets are included in his or her estate. If the estate is large enough, estate taxes may be owed.
Q. WHAT IS A QUALIFIED DOMESTIC TRUST?
A. A qualified domestic trust, often referred to as a Q-DOT, is a trust that allows for married individuals to
take advantage of the unlimited estate and gift tax marital deduction when the surviving spouse is a non-US citizen. The transfer of assets outright to a non-citizen surviving spouse is not eligible for the marital deduction.
When property passes estate tax free to a surviving spouse who is a citizen, it is subject to tax in the surviving spouse's estate (if not consumed during his or her life). The concern with a non-citizen surviving spouse is that he or she will take the property outside of the United States where it will not be subject to estate tax on the surviving spouse's death.
With a Q-DOT, the non-citizen surviving spouse is entitled to all of the income generated from the assets held in the trust for his or her entire lifetime, but he or she is not entitled to the principal absent the trustee's authorization. If principal is distributed, estate taxes may be owned. When the surviving non-citizen spouse dies, trust assets pass to beneficiaries, usually the couple's children. Estate tax is payable on the assets left in the trust after the surviving spouse's death.
In order for a Q-DOT to be valid, certain criteria must be met. The executor of the deceased citizen spouse must make an election on the deceased spouse's return to treat the trust as a Q-DOT. At least one named trustee must be either a U.S. citizen or a domestic corporation. The terms of the trust must provide that the trustee may withhold the amount of a Q-DOT estate tax prior to any distribution of the trust assets. Finally, the trustee must ensure that an adequate amount of trust assets remains within the United States so as to guarantee payment of federal taxes.
Q. WHAT IS A CREDIT SHELTER OR BYPASS TRUST?
A. A credit shelter or bypass trust allows a married couple with significant assets to minimize their combined estate tax bill. If the first spouse to die leaves his or her entire estate to the survivor, no estate tax is owed because of the unlimited marital deduction. But the full estate will be subject to estate tax on the death of the survivor, reduced by the survivor's unified credit only. The unified credit of the first spouse to die goes unused. The unified credit allows each individual to transfer a certain dollar value of property without any estate (or gift) tax liability. For deaths in 2021, the exclusion is $11.7 million per individual and $23.4 million per couple.
A credit shelter or bypass trust allows both spouses to use their unified credits against estate and gift tax.
The bypass trust is created by will or living trust and comes into existence on the first spouse's death. The will or living trust will provide that the estate of the first spouse to die is divided into two parts. One part, the marital deduction gift, goes to the surviving spouse and is protected from estate tax by the marital deduction. This gift can be outright or in a marital deduction trust.
The other part goes into the bypass trust and is sheltered from estate tax by the first spouse's unified credit. Income from the bypass trust is paid to the surviving spouse during her life. On the surviving spouse's death, assets in the bypass trust pass to the beneficiaries designated by the first spouse, typically the children. Assets in the bypass trust are not included in the surviving spouse's estate (they bypass it) because the second spouse is not considered to be the owner of the trust.
Q. WHAT IS AN IRREVOCABLE LIFE INSURANCE TRUST?
A. An irrevocable life insurance trust (ILIT) is a trust that you establish to hold your life insurance policy. An ILIT removes life insurance proceeds from your estate. Many people are surprised to learn that life insurance death benefits can be included in the estate of the person who owned the policy. For example, if you purchased a $500,000 life insurance policy on your life, and you are the owner at your death, the entire $500,000 would be included in your estate for estate tax purposes.
In addition, an irrevocable life Insurance trust avoids probate and protects the cash value of your life insurance policy from creditors. Furthermore, an irrevocable life insurance trust enables you as the trust creator to control when and how your beneficiaries will receive the proceeds.
Once you have transferred a life insurance policy into the trust, you cannot revoke the trust and take the policy back in your own name. However, you can select the beneficiaries and the trustee, the person who will manage the trust. To avoid having the policy proceeds included in your estate for estate tax purposes, your estate should not be a beneficiary.
Q. WHAT IS A CRUMMEY TRUST?
A. One technique for minimizing estate and gift taxes is to make annual or periodic gifts to your children in an amount that is less than the annual gift tax exclusion ($14,000 per person for 2017). A Crummey trust is an irrevocable trust that enables the trust maker to take advantage of the annual gift tax exclusion while retaining the gift in trust until the beneficiary is older than 21.
For the gift tax exclusion to apply, beneficiaries must have a present interest in the gift. In other words, a beneficiary must be able to immediately use the money. Thus, the beneficiary is given a right to withdraw each gift from the trust as the gift is made. The beneficiary must be notified whenever a gift is made to the trust. If the beneficiary (or his or her guardian) doesn't exercise this right within the period specified in the notice (usually 30 days), the right lapses and the beneficiary then will be able to access the money only according to the terms of the trust.
The Crummey Trust is named after Clifford Crummy, who was the first taxpayer who had set up a trust in this manner.
Q. WHAT IS AN IRC §2503(C) TRUST?
A. An IRC §2503(c) trust is an irrevocable trust established during the trust maker's lifetime for the benefit
of his or her children. Gifts to a trust created under IRC §2503(c) qualify for the annual gift tax exclusion without the need for withdrawal rights that are required for a Crummey trust. However, the trust must meet certain requirements. Both the trust assets and income must be available for the benefit of the beneficiary while the beneficiary is under 21 years old, which means that the trust must have only one beneficiary. Any property remaining when the beneficiary turns 21 must be distributed outright to the beneficiary, unlike the Crummey trust which permits assets to remain in the trust until the beneficiary is older than 21. If the beneficiary dies before age 21, the trust property must be distributed to his or her estate or as the beneficiary directs under a general power of appointment.
Q. WHAT IS AN EXTENDED IRC §2503(C) TRUST?
A. An extended IRC §2503(c) trust is a cross between a Crummey trust and a §2503(c) trust. A §2503(c) trust is simpler to create and administer than a Crummey Trust, because there's no need for annual withdrawal rights and notice to the beneficiary of such rights. However, the fact that a §2503(c) trust must terminate when the beneficiary turns 21 makes the trust undesirable to trust makers who want the assets to remain in trust until the beneficiary is older.
A one-time right to withdraw the trust assets at age 21 can be used to extend a §2503(c) trust until the beneficiary is older. The withdrawal right in an extended §2503(c) trust must allow the beneficiary to empty out the entire trust. However, the withdrawal right can be limited in time. For example, if the beneficiary does not exercise it within 30 days of turning 21, the trust instrument can provide that the right will lapse and any funds not withdrawn will remain in trust indefinitely. The annual gift tax exclusion applies to each gift without the need for a Crummey notice.
Q. WHAT IS A SPECIAL NEEDS TRUST?
A. A special needs trust is a trust that is established to provide for the “special needs” of a disabled beneficiary and still enable the disabled individual to qualify for the government benefits. The term “special needs” is a defined as the requisites for maintaining the happiness and comfort of a disabled individual when such requisites are not being met or provided by any governmental or private agency. The law provides an extensive list of “special needs,” including but not limited to, medical and dental expenses, education, transportation, rehabilitation, dietary needs, spending money, and items to enhance self-esteem.
Receipt of an inheritance, lawsuit settlement, or financial gift could affect a person's right to continued eligibility for government benefits, such as SSI and Medicaid. If the money is instead placed in a special needs trust, a beneficiary can receive payments from the trust without losing his or her benefits. The disabled beneficiary must not have the power to control the amount of or frequency of the trust distributions or to revoke the trust.
Q. WHAT IS A QUALIFIED PERSONAL RESIDENCE TRUST?
A. A qualified personal residence trust (QPRT) allows the trust maker to transfer his or her residence to his
or her children while minimizing estate and gift taxes. A QPRT is an irrevocable trust into which the trust maker transfers his or her home or vacation home (or both in two separate trusts) while retaining the right to live in it for a specific term of years that the trust maker chooses. A QPRT reduces estate taxes by allowing the home to pass to the children on the conclusion of the term without further gift or estate taxes.
Gift tax is imposed on the initial transfer of the home to the trust, but the value of the transfer for gift tax purposes is reduced because the trust maker retains the right to live in the home. This reduction in value depends on the trust maker's age, current interest rates, and the length of the retained term. All appreciation in the home after the initial transfer passes to the children gift and estate tax-free.
If the trust maker fails to survive the selected QPRT term, the value of the home is included in the trust maker's estate. However, the estate receives a credit for any gift taxes paid. If the trust maker wants to live in the home after the trust term, he or she must pay market rent.
Q. WHAT IS A GRANTOR RETAINED ANNUITY TRUST?
A. A grantor retained annuity trust (GRAT) is an irrevocable trust that is created for a specific period of time
as a tool to minimize estate and gift taxes. The trust maker transfers assets to the GRAT and receives from the GRAT an annuity for a term of years.
The transfer of assets to the trust is a taxable gift to the beneficiaries in the amount of the fair market value of the assets, minus the value of the annuity. To avoid a taxable gift, the annuity can be designed to equal the value of the assets transferred, based upon the term of the GRAT and an assumed growth rate over the term that is established by the Treasury Department. This rate is fixed at the time the GRAT is initiated and is referred to as the IRC §7520 rate.
For the GRAT to be effective, the trust assets must appreciate faster than the §7520 rate. When the GRAT's total return outperforms the §7520 rate, the excess passes to the next generation free of estate and gift taxes. If the trust maker dies before the expiration of its term, the GRAT fails and its assets, including any income and appreciation, remain subject to estate tax.
Q. WHAT IS AN INTENTIONALLY DEFECTIVE GRANTOR IRREVOCABLE TRUST?
The intentionally defective grantor irrevocable trust (IDGIT) is a sophisticated strategy for minimizing estate and gift taxes by freezing the value of assets. The IDGIT is an irrevocable trust that is treated as the trust maker's alter ego for income tax purposes but not for estate tax purposes. Typically the trust maker funds the trust initially with a small amount of seed money. Then he or she sells assets to the trust, removing them from his or her estate, in exchange for a promissory note.
The transaction has no income tax consequences. The trust maker has no gain or loss on the sale of the assets or receipt of interest payments on the note because the trust maker and the trust are not treated as separate taxpayers. Moreover, the sale is not a taxable gift so long as the note is for the fair market value of the transferred assets and it bears interest at an appropriate rate. The interest rate is determined by the Treasury and depends on the term of the note.
The trust maker pays income taxes on trust income reducing his or her estate while allowing trust assets to grow tax free for the benefit of the beneficiaries' (typically the children). Appreciation of the trust assets at a greater rate than the interest rate on the note is passed free of estate and gift taxes to the beneficiaries. If the trust maker dies before the note is paid, the fair market value of the note is included in his or her estate and could be subject to estate tax. However, post-sale appreciation in trust assets in excess of the interest rate on the note should be excluded.
Q. WHAT IS A CHARITABLE REMAINDER TRUST?
A. A charitable remainder trust is an irrevocable trust that holds assets that are contributed to charity when
the trust ends. During the trust term, the trust makes payments to one or more beneficiaries. These may be the trust maker and his or her spouse, the trust maker's children, or other parties.
The payments from the trust to the trust maker or other beneficiaries can be in the form of either a fixed percentage of the value of the assets (a charitable remainder unitrust), which will vary from year to year, or an annuity (a charitable remainder annuity trust), which will always be the same amount. The trust can last for the lifetime of the trust maker and spouse or other beneficiary, or a specified number of years up to 20. The trust may be funded either during the trust maker's lifetime (an inter vivos trust) or on the trust maker's death (a testamentary trust).
Typically individuals with highly appreciated assets use a charitable remainder trust to provide themselves with a lifetime stream of income and achieve significant income and estate tax savings while supporting a favorite charity. The trust removes assets from the trust maker's taxable estate and provides the trust maker with an immediate income tax deduction for the value of the charitable remainder interest.
The income earned by the charitable remainder trust is tax exempt. Assets that have long term appreciation are exempt from capital gains tax when sold by the charitable remainder trust. Consequently, the trust maker can contribute an appreciated asset to the trust. The trust can sell the asset free of capital gains tax and use the proceeds to buy income producing assets to fund the annuity or unitrust payments. Because of the tax savings, a charitable remainder trust can provide a trust maker with more income over his or her life than if the trust maker had sold the asset himself or herself.
Trust income received by the trust maker or other beneficiaries is taxable.
Ongoing contributions can be made to a charitable remainder unitrust. Ongoing contributions are not permitted to charitable remainder annuity trust.