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MICHAEL LYNN GABRIEL
ATTORNEY AT LAW
B.S., J.D., M.S.M., DIP. (TAX), LL.M. (TAX)
INTRODUCTION .........................................................................4
1. COMMON PROBATE QUESTIONS ..................................... 8
2. COMMON ESTATE PLANNING QUESTIONS ................. 49
3. DURABLE POWERS OF ATTORNEY AND ...................... 89
LIVING WILL DECLARATIONS
4. PROBATE AVOIDANCE VEHICLES ................................152
5. JOINT TENANCY ................................................................ 183
6. WILLS ................................................................................... 201
7. ESTATE PLANNING QUESTIONNAIRE ..........................308
8. ESTATE AND INHERITANCE TAXES ............................. 323
9. CONSIDERATIONS IN DECIDING WHETHER TO ........350
USE A WILL OR REVOCABLE TRUST FOR
ESTATE PLANNING
10. ASSET PRESERVATION THROUGH THE USE OF .....369
SELF-SETTLED SPENDTHRIFT TRUSTS
Index .......................................................................................... 394
TABLE OF CONTENTS
INTRODUCTION .............................................................................................. 1
1. COMMON ESTATE PLANNING QUESTIONS ......................................... 4
2. ESTATE PLANNING QUESTIONNAIRE ................................................. 44
3. ESTATE AND INHERITANCE TAXES .................................................... 58
4. CONSIDERATIONS IN DECIDING WHETHER TO USE A WILL OR
REVOCABLE TRUST FOR ESTATE PLANNING .................................. 90
5. TRUST PROVISIONS ............................................................................... 104
6. REVOCABLE TRUST TERMINATING ON TRUSTOR'S DEATH ......115
7. REVOCABLE TRUST CONTINUING AFTER TRUSTOR'S DEATH ..267
8. A-B BYPASS TRUST .................................................................................309
9. QTIP TRUST ..............................................................................................361
10. JOINT TRUST UP TO THE UNIFIED CREDIT ...................................419
11. POUR OVER WILLS ...............................................................................470
12. SUPPORTING TRUST DOCUMENTATION ........................................520
13. ASSET PRESERVATION THROUGH THE USE OF SELF SETTLED SPENDTHRIFT TRUSTS ..............................................................................544
INDEX ............................................................................................................565
INTRODUCTION
Estate planning should be viewed as a comprehensive project. Towards that end, a series of the books have been written to assist a person in planning an estate. The first two volumes of ESTATE PLANNING deal with monetary issues of estate planning for passing an estate after death. The Powers of Attorney book deals with protecting a person's estate along with providing for health care during the time that a person is incompetent. In addition, there are two books on FINANCIAL PLANNING for reserving and protecting an estate while the person is alive. Taken together these book serve as today's society's Book of the Dead.
The ancient Egyptians had their Book of the Dead to prepare themselves and their property for the afterlife. Unfortunately the Egyptian version did not work so well. Those persons who relied upon it ended with their tombs robbed and themselves (as mummies) sold as museum pieces throughout the world. This series is not as ambitious as its Egyptian precursor nor will it prepare the reader for a netherworld life. This series can, however, in a small way ease the reader's journey in this life.
Because of the depth of the subject covered, two books were necessary to cover estate planning. Several chapters are the same in both books to assure that the information is provided to the reader who may decide not to use both books.
Volume One will suffice for those with estates of less than $60,000. Those with estates worth more than $60,000 would be wise to read Volumes One and Two. Volume One deals with Estate Planning through the use of wills, gifts, joint tenancies and summary probates. In addition durable powers of attorney and living will declarations are covered in detail.
A good estate plan seeks to protect a person's life and estate during life as well as his estate after death. Towards that end this book discusses durable powers of attorney and living will declarations. These are important documents. They reflect a person's intentions concerning health care and business decisions in the event he becomes incompetent. Without such documents state law will control how the incompetent person's estate will be managed and the type and measure of health care that he will receive. It is only common sense for a competent person to draft those documents necessary to state his intentions regarding management of his life and estate. In like manner what medical treatment is wanted or should be refused during a period of incompetency should be established.
Volume Two has been dedicated to the more sophisticated revocable trusts and pour-over wills that are used as estate planning tools. Revocable trusts have been quietly used for decades. They have become prominent within the last ten years.
Generally, most persons with estates worth over $60,000 should use a revocable trust as their preferred vehicle for estate planning.
Volume Two contains several different types of revocable trusts which are designed to give the trust creator maximum freedom and authority in managing the trust. The prime advantages behind the use of revocable trusts is that they avoid probate, save thousands of dollars in probate fees and pass the property to the beneficiaries immediately upon the death of the trust creator.
CHAPTER 1
Death is the great equalizer. The only other thing that cannot be avoided is taxes. Even the Ancient Egyptians were unable to conquer the "hereafter." Since we cannot avoid taxation, we must live with it and hopefully die in a manner that will minimize the taxation following our deaths.
There are few people who believe that the government should take all of a decedent's property upon death. Unfortunately, the government does not quite feel that way. Not so many years ago, a Democrat representative stated on the floor of the House of Representatives that the people were only entitled to keep that money and property that the government says that they can keep. In that vein, the Democrats have proposed in 1992 House Resolution 4848 which called for taxing all estates over $200,000 in value. If HR 4848 passed, a $600,000 estate would have had to pay nearly $60,000 in additional taxes. One of the first acts of the new Republican Congress was to defeat the attempt to enact HR 4848 into law.
Estate planning is a legal term of art. It covers anything that a person deliberately does to manage his estate while living and which oversees its distribution after death. Wills, trusts, joint tenancies, gifts and summary probates are the main instruments used in estate planning. The questions in this chapter serve to educate and guide the reader to the form of estate planning that is most useful to his given circumstance.
In order to present as full a discussion as possible, questions regarding revocable trusts as estate planning tools are discussed even though this volume does not address revocable trusts. The second volume on estate planning specifically deals with the use of revocable trusts for estate planning. In the second volume are the following full, complete and easy-to-use revocable trusts along with all of their necessary supporting documents:
(a) Individual trusts.
(b) Joint trusts for married couples.
(c) A-B By-pass trusts.
(d) QTIP trusts.
The ESTATE PLANNING II is designed to be the most complete and user-friendly self-help revocable trust book on the market. Any person with an estate of $60,000 or more should consider the use of a revocable trust for estate planning purposes.
This chapter deals with the most common questions asked by people when contemplating
whether they need to implement an estate plan. The questions, herein, cover the general
field of estate planning and help inform the reader of the various options available.
1. WHAT IS AN ESTATE PLAN?
An estate plan is a general term for the procedure by which a person intends to preserve the assets of his estate during life and distribute them after death.
The main considerations in estate planning are the avoidance of probate, reduction of estate and inheritance taxes and the quick distribution of the estate to the designated heirs.
A complete estate plan considers the various methods for the preservation of the estate
during life by maximizing income while reducing to the extent possible, given the
circumstances of the individual, the amount of income taxes that must be paid.
2. WHAT ARE THE COSTS OF PROBATING A WILL?
The costs incurred in probating a will are large. A probate is usually one of the most expensive expenditures made by a person. An old joke which is wryly true is that if the person weren't already dead, the cost to probate his estate would kill him. Probate costs include court fees, appraisal fees, attorney fees and executor fees. Court costs and appraisal fees are modest: usually a couple of hundred dollars for an average estate. The real cost is for the attorney and executor fees.
The maximum amount of attorney and executor fees are set by statute and approved by the court. They are based upon the size of the estate (value of the property to be probated) and increase as the estate increases.
In California, for example, attorney and executor fees are calculated as follows:
(1) Four per cent (4%) of the first $15,000; maximum $600.00,
(2) Three per cent (3%) of the next $85,000; maximum $2,550.00,
(3) Two per cent (2%) of the next $900,000; maximum $18,000.00, and
(4) One per cent (1%) of the next $15,000,000, and one-half per cent (.5%) thereafter.
An estate of $100,000 probated in California would pay maximum attorney and executor fees of $6,300.00: $3,150 each to the executor and attorney. This is a maximum fee. The attorney and executor can agree to take less or no fee at all.
The avoidance of probate fees is a major inducement for implementing an estate plan. With a revocable trust there are no probate fees because the estate passes immediately to the designated beneficiaries in the trust. No court proceeding is needed to transfer the property of a trust so as such no attorney is needed.
3. HOW CAN PROBATE BE AVOIDED?
There are several means available for a person to utilize in order to avoid having to probate an estate. These probate avoidance vehicles are:
(1) Summary probate proceedings, if available in the decedent's state. A summary probate is an abbreviated procedure for clearing and transferring small estates or entire estates to a surviving spouse. Many states have adopted special procedures to by-pass the expense and long delay in probating such estates.
(2) Giving the estate away while alive.
(3) Placing the property in joint tenancy with the proposed heirs. Upon death, title for the property passes immediately without probate to the surviving joint tenants. Real property held in joint tenancy passes to the survivors without a probate by the recordation of a notice of the death of a joint tenant.
(4) Placing the estate into a revocable trust that passes the estate to the designated beneficiaries immediately upon the decedent's death. This is the most popular form of estate planning because it is fast and bestows the maximum amount of control over the estate in the hands of the present owner.
In order to determine the best type of estate plan best suited to an individual's
circumstances, the person must understand the size of the estate, how he wishes to
distribute it and the amount of control he wishes to relinquish in order to effectuate the
estate plan.
4. WHAT ARE THE DISADVANTAGES OF USING JOINT TENANCIES FOR AVOIDING PROBATE? There are three main disadvantages in forming a joint tenancy:
(1) Putting the property into joint tenancy is an immediate gift of half or more of the property. This means that property placed into joint tenancy becomes attachable to satisfy the debts of the other joint tenants upon the creation of the joint tenancy. For example, assume a house was placed in joint tenancy with a child. A creditor of the child gets a judgment. The creditor can seize and sell the child's half interest in the house.
(2) There may be gift taxes due on the gift if the value of the gift exceeds $10,000 and the unified credit has been used by previous gifts. By the way, there is no federal
gift tax on gifts to a spouse if the spouse is an American citizen.
(3) There is no stepped-up basis for property placed in joint tenancy. The basis of the property for the donee is the same as for the person who made the gift. On the other hand, property obtained through a probate or a revocable trust has its basis raised to fair market value and can be immediately sold with no income gain and thus no capital gain tax.
The main disadvantage in creating a joint tenancy is that half or more of the property is
relinquished immediately. Example: A parent puts a house in joint tenancy with a married
son. The son gets a divorce. The wife might, in some states, be awarded the son's interest
in the house which was something the parent never intended to do.
5. WHAT IS A DURABLE POWER OF ATTORNEY?
A general power of attorney is a written document that gives a person (called the attorney in fact) the authority to act on the principal's behalf. A general power of attorney lapses (becomes invalid) when the principal becomes incompetent or dies. At the time it is needed most, when the principal is no longer able to act for himself, a general power of attorney lapses, and the right of the attorney in fact to act for the principal ceases.
To address this situation, most states have adopted the Uniform Durable Power of Attorney Act. Under the Act, a durable power of attorney will continue in full force and effect even though the principal subsequently becomes incompetent. A durable power of attorney must contain specific language stating the intent of the principal for the power of attorney to continue during the period of incompetency and incapacity.
A durable power of attorney has the effect of eliminating and replacing the necessity of a voluntary conservatorship. A durable power of attorney can also give the attorney in fact the power to make all decisions or just specific health care decisions for the principal in the event the principal becomes unable to do so.
Because of their importance to estate planning, durable powers of attorney have been given
their own chapter in Volume One.
6. WHAT IS A LIVING WILL?
A living will is not a Will for probate purposes. Rather, it is a document that serves as a directive to a treating physician and the world at large that the person executing it does or does not want to be kept alive using extraordinary means. A living will is used to ascertain the intent of the person when he is unable to make the health care decisions at the time it is necessary to do so. Living Wills, including samples, are discussed in the durable power of attorney chapter.
Without the existence of a living will stating a contrary intent, a court will presume a person wanted extraordinary means used to be kept alive. The court will order extraordinary means to be used to keep the person alive, even over family objections.
Living Wills should be used in addition to durable powers of attorney for health care in
order to assure that a person's wishes are most likely fulfilled in this most dire of situations.
7. WHAT IS A POUR-OVER WILL?
A pour-over will is a special will used in conjunction with a revocable trust. After the trustor dies, the pour-over will places all property into the trust that the decedent forgot or failed to place while alive. Unfortunately, property not placed into the trust prior to the trustor's death may require a probate if the size of the assets is large enough that summary procedures cannot be used.
In a real case, the trustor forgot to place a piece of property which he owned in Hawaii into a California trust which the trustor had created. The executor of the Pour-Over Will was required to open a Hawaiian probate in order to get permission to put the property into the trust. Having to probate the non-trust property needlessly cost the estate $11,000. The trustor could have done it during his life for the cost of recording a deed into the trust usually about $10.
A simple example of the need of a Pour-Over Will would be if a person hits a lottery for
$50,000,000 and drops dead in the excitement. The Pour-Over Will operates to place the
money into the trust after it has been probated. Once placed in the trust, the money will be
managed in accordance with the trust terms.
8. WHAT IS A MARITAL DEDUCTION?
Under federal law, there is no federal gift or estate taxes on property transferred between spouses. This is an unlimited credit that has only two exceptions:
(1) It must be an actual gift. If the gift is in trust, then all of the income must go to the spouse.
(2) The spouse receiving the gift must be an American citizen.
Gifts to a non-citizen spouse are not eligible for the unlimited deduction but are eligible for a $110,000 annual exclusion under Section 2523 of the Internal Revenue Code. Property passing from an American spouse to an alien spouse, after death, does not qualify for an unlimited marital deduction either. Special tax rules apply for such transfers, and a tax consultant should be consulted if the estate of the American spouse exceeds $600,000.
Therefore, a person can generally pass his entire estate to a surviving spouse without
incurring any federal estate taxes. This may not ultimately be the best estate planning. If
the property given to the surviving spouse boosts the surviving spouse's estate over unified
credit amount, the surviving spouse's estate will have to pay estate taxes. No gift to a
surviving spouse that boosts the estate over the unified credit amount should be made until
the decedent's unified credit is depleted as discussed below.
9. WHAT IS THE UNIFIED CREDIT?
Every person is permitted to transfer assets totaling $1,000,000, which gradually rises to an unlimited amount in 2010 and back to $1,000,000 in 2011 under the Tax Relief and Reconcilation Act of 2001 by death without incurring an estate tax under federal law. There is imposed a gift tax through 2010 equal to the estate tax for gifts made during that period.
Under the Tax Act of 2001, Congress imposes a gift tax to restrict the transfer of income producing property from high income to low income taxpayers after the estate tax is eliminated. The gift tax exemption beginning in 2001 is $1,000,000. So even though transfers of property after death can be made tax free in 2010 for at least one year, unless made the estate tax elimination is made permanent by Congress, a gift tax on the transfer of property while alive will remain. The gift tax rate imposed in 2010 under the 2001 Tax Act is equal to the top individual tax rate at the time of the gift.
About half of the states impose their own estate and inheritance taxes. These taxes should also be considered in estate planning. The Internal Revenue Code permits a small credit for state death taxes to be applied against the federal estate.
The significance of the unified credit is that it permits a husband and wife to give to their
children a total combined estate of $2,000,000 trhough 2003 before incurring any estate
taxes. A person giving his entire estate to a surviving spouse is not taking advantage of the
unified credit. Not using the unified credit is ill-advised when making the gift to the
surviving spouse pushes the value of that estate over the unified credit amount and subjects
it to the payment of federal estate taxes on the surviving spouse's death.
10. WHAT IS THE ANNUAL EXCLUSION?
Under federal tax law, every individual may make an annual gift of $11,000 per year per person without incurring a gift tax or having the gift applied towards the available unified credit. A parent having four children could give each of them $11,000 for a total of $44,000 free of gift taxes. The advantage of making these gifts is that they provide a means to reduce the size of the estate to below the unified credit thereby reducing or eliminating federal estate taxes.
An alien spouse does not qualify for the unlimited marital deduction. In place of the
unlimited marital deduction, an alien spouse is permitted to receive, as a gift from the other
spouse, $100,000 per year tax free.
11. WHAT IS THE ESTATE TAX RATE?
The federal estate tax is graduated and increases as the size of the estate increases over the unified credit. The Tax Act of 2001 is a bizarre creation which gradually phases out the federal estate tax by 2009 but only for one year 2010. In 2011, the federal estate tax is reinstated at a maximum rate of 55% with a unified credit amount of only $1,000,000. The estate tax is discussed in detail in the Estate and Inheritance Taxes chapter.
For example, a taxable estate of $100,000 has a tax of $23,800. A taxable estate of $250,000
has a tax of $70,000. A taxable estate of $500,000 has a tax of $155,800. A taxable gift of
$2,500,000 has a tax of $1,025,800.
12. WHAT ARE GIFT TAXES?
The federal gift tax is graduated and increases as the size of the gift increases over the unified credit. The federal gift tax rate is the same as the federal estate tax rate up through 2009 then they change. In terms of saving taxes, the same tax rate applies whether the property is given away during life or passes to the heirs after death.
For example, a taxable gift of $100,000 has a tax of $23,800. A taxable gift of $250,000 is taxed $70,800. A taxable gift of $500,000 has a tax of $155,800. A taxable gift of $2,500,000 has a tax of $1,025,800.
Under the Tax Act of 2001, Congress imposes a gift tax to restrict the transfer of income producing property from high income to low income taxpayers after the estate tax is eliminated in the year 2010. The gift tax exemption beginning in 2010 is $1,000,000. So even though transfers of property after death can be made tax free in 2010 for at least one year, unless made the estate tax elimination is made permanent by Congress, a gift tax on the transfer of property while alive will remain. The gift tax rate iposed in 2010 under the 2001 Tax Act is equal to the top individual tax rate at the time of the gift.
13. DOES A TAX RETURN HAVE TO BE FILED FOR A GIFT?
A gift tax return is required to inform the IRS of any gifts in excess of the annual per
person exclusion ($11,000). In other words, if a gift of $12,000 is made to a son, a gift tax
return must be filed to show that a taxable gift of $1,000 was made. The gift tax on the
taxable gift of $1,000 (the amount over the $11,000 annual exclusion) will either be
deducted from the unified credit amount or the tax will be paid by the donor. Sometimes
the donor will pay the gift tax rather than deplete the unified credit. The reason is that the
donor may wish later to give appreciating property in order to keep the appreciation out of
his estate for federal estate tax purposes.
14. WHAT IS THE INCOME TAX EFFECT TO THE DONOR FOR MAKING
A CHARITABLE GIFT?
Under the federal tax code, a person, while living, can make gifts to a qualified charity and receive an income tax deduction for the gift. Gifts made by a decedent's estate do not qualify for a charitable income tax deduction, but they can qualify for an estate gift deduction.
The maximum deduction is 50% of the taxpayer's adjusted income for the year with the balance of the gift being carried forward for the next five years.
Where the gift is appreciated property instead of cash, the amount of the deductible is
reduced to 30% rather than the 50% unless special elections are made. Because of the
complexity of the tax law in this area, any large gifts to a charity should only be made after
consulting a tax professional.
15. HOW MUCH IS THE CHARITABLE DEDUCTION FOR GIFTS
MADE AFTER DEATH?
Charitable gifts made by a decedent after death, regardless of whether they were made through a will or trust, are allowed full deductions of fair market value from the decedent's estate for federal estate tax purposes. As a result, federal estate taxes are reduced when charitable gifts are made (as opposed to gifts to ordinary persons or entities).
For example, if a decedent had an estate worth $1,000,000 and gave $400,000 to a charity,
the decedent's estate would deduct that $400,000 gift leaving an estate of $600,000. If the
$600,000 was equal or less than the decedent's available unified credit, there would be no
federal estate tax owed.
16. HOW MUST A FEDERAL ESTATE TAX RETURN BE FILED?
The federal estate tax return Form 706 is required to be filed whenever the decedent has an estate greater than $600,000. The federal tax rate schedule is covered in detail in the Estate and Inheritance Taxes chapter.
The requirement to file the estate tax return does not depend on whether there will be any taxes due or if a probate is necessary. As long as the estate is greater than $600,000, the tax return has to be filed.
For example, a tax return would still have to be filed even if the entire estate was going to
the surviving spouse under a trust and was entirely exempt from estate tax as a result of the
unlimited marital credit. Likewise, a federal estate tax return would have to be filed even if
the entire estate was being given to charities exempt from tax under the Internal Revenue
Code.
17. WHAT ARE TAX-FREE MUNICIPAL BONDS?
One of the most popular investments is that of tax-free municipal bonds. Most states and many of their counties and agencies issue bonds at relatively low rates (around 6%) to help pay for their government services; hence the name municipal bonds.
Most such state and local bonds are both federally and state tax exempt. Because they are tax exempt, they can be an excellent investment for a person that is paying taxes. For example, a tax-free bond at 6% bought by a person in a 33% total tax bracket would be equivalent to a 9% taxable bond. Given the fact that most municipal bonds are backed by the full force and credit of a government entity and have low risk, they may be safer than private bonds. The buyer, however, should consult with a broker before buying such bonds.
Municipal bonds may be bought directly from the government through a bond fund
operated by a brokerage house. Tax-free bonds are assets of the estate of their owner.
Therefore, upon the owner's death, the value of the bonds is added to the owner's estate for
the calculation of federal estate tax and state inheritance tax.
18. WHAT IS A ZERO COUPON BOND?
A popular investment is zero coupon bonds. A zero coupon bond is a "Strip Bond" issued by the Treasury or by a corporation, state or municipality at a deep discount. This bond can only be redeemed at a specified date in the future for a specified amount. For example, a $60,000 corporate zero coupon bond might mature in 15 years. It would be sold for $17,000.
The purchaser of the bond pays tax each year on the accrued but unpaid appreciation in
the bond unless the bond is a tax-free zero coupon municipal bond. Zero coupon bonds are
assets of a decedent's estate. Their value is added to the owner's estate for the calculation
of both federal estate and state inheritance taxes.
19. WHAT IS THE EXCLUSION FOR SALE OF A HOUSE
FOR INCOME TAX PURPOSES?
An excellent asset for estate planning is a home that has appreciated greatly over the years.
At one time, the Internal Revenue Code only permited a one-time exclusion of gain of
$125,000 or less from the sale of a home in which the owner has lived for three years if the
owner was over 55 years of age. That changed with the Budget Act of 1997. Now, the first
$500,000 in a couple's profit from the sale of a principal residence and $250,000 for an
individual will be excluded from taxation. This credit can be used very three years. The
home must be lived in two of the previous five years. This gain can help provide for the
retirement of the owner or help start a new business. This is one of the few tax benefits in
the IRC that permits a sizeable amount of capital gain to be realized without incurring
capital gain taxes.
20. CAN COMMUNITY PROPERTY BE CHANGED INTO SEPARATE PROPERTY
FOR ESTATE PLANNING PURPOSES?
Community property is property acquired by a husband and wife during a marriage in a manner other than by gift, devise or bequest. Community property is considered to be owned jointly and equally by each spouse. Each spouse can pass their interest in the community property by deed or will.
In a community property state, the spouses may enter property settlement agreements whereby the community property is divided among them as separate property. There may be reasons for doing this other than a divorce, such as one spouse wishing to borrow against his share of the property while the other spouse does not wish to do so.
California allows spouses to change separate property into community property and vice versa. This is called transmutation of the property. The ability to change the status of property is beneficial for acquiring the stepped-up basis in the surviving spouse's share of community property upon the death of the first spouse. It permits the changing of joint tenancy property to community property and thus gives the surviving spouse the tax advantage of a stepped-up basis in the property.
Community property, in the absence of a will, usually, as in California, will pass to the
surviving spouse without a probate. Unfortunately, title companies will not insure
community property passing to a surviving spouse unless it has gone through a probate or
a trust. To address this matter, California created a spousal property petition procedure
wherein a spouse petitions the probate court for confirmation of the property being
distributed under a will or under its intestacy laws. This is a simpler, faster and cheaper
summary probate proceeding, adopted by California, to pass property easily to a surviving
spouse.
21. WHAT IS A REVOCABLE TRUST?
Estate Planning II, the second volume of the estate planning series, deals with the use of revocable trusts as estate planning tools. That volume contains several complete, user-friendly, understandable revocable trusts. No estate planning decision should be made without at least considering the possibility of using a revocable trust. In order to present the advantages of the revocable trust in estate planning, questions hereafter are intended to cover the most common concerns that normally arise when considering the use of revocable trusts.
A revocable trust is usually the best means of estate planning. The creator of the trust, called the trustor or the grantor, places his entire estate into the revocable trust. The trustor usually is also the trustee: the person who manages the estate and the prime beneficiary of the trust.
Upon the trustor's death, the person named in the trust document as the successor trustee takes over immediately without court approval being needed. Then depending on the terms of the trust, the new trustee either dissolves the trust and distributes the assets immediately in the manner designated in the trust document or continues to operate the trust in the manner directed by the trust document.
Since there is no probate, there are no probate costs incurred. The savings for the estate when a revocable trust is used will usually be several times the cost of the creation of the trust.
Because the trust is revocable, the trustor can at any time alter, amend or revoke it. If the trust is revoked, the trust assets immediately return to the trustor.
There are several types of revocable trusts. As such, there is a trust to fit the specific needs
of any person. Generally a person who wishes to give everything to a surviving spouse (or a
person without a spouse) would use the traditional grantor trust. A grantor trust provides
for the passage of the trust assets to the designated beneficiary (usually the grantor's
children, parents or siblings) upon the grantor's death. Should a grantor wish to provide
for both a spouse and children, there are two other types of revocable trust which give the
income of the trust to the spouse upon the grantor's death. After the death of the spouse,
the trust assets are distributed to grantor's children. These are known as the A-B Bypass
Trust and the QTIP Trust. Specific questions regarding how each of these trusts operate
follows. The second estate planning volume deals specially with revocable trusts and
contains several easy-to-use forms for each of these revocable trusts.
22. HOW IS A TRUST CREATED?
A trust is created very easily. The trust document is drafted, usually by an attorney, and directs how the trust estate will be administered and distributed. The trustee acts in accordance with the terms of the trust.
The trustor and trustee must both sign the trust document. If the trustor is also the trustee, he signs the trust agreement twice, in both capacities.
The final requirement is that the trust be funded. Funding the trust requires that the trustor place into the trust all of the property the trustor wishes to be in the trust.
Personal property that does not have a title, such as a television or furniture, is transferred
automatically by a statement in the trust document that the trustor's intent is to put into
the trust all personal property wherever located. Property that has a title, such as a house,
must have the title specifically changed to make the trust the owner. Merely stating an
intent to place the house or other property that has a title into the trust is insufficient. The
only way to put property that has a title into a trust is to change the title on the property so
that the trust is listed on the title documents as the owner.
23. CAN BOTH SPOUSES CREATE A REVOCABLE TRUST TOGETHER
FOR ESTATE PLANNING PURPOSES?
A common estate plan is for both spouses to create one joint revocable trust. Both spouses place all of their property into the joint trust. The spouses' property is listed on schedules marked "his," "hers," and "theirs." On the death of the first spouse, the trust is divided into separate trusts for the surviving spouse and his children or heirs, if any.
This joint trust is usually the most economical estate plan because it plans for both estates. The cost for doing the joint estate plan is almost always less than what it would cost to do a separate estate plan for each spouse.
The trust is revocable totally during the joint lifetimes of the spouses. Either spouse may
terminate it at any time. Upon the death of the first spouse, the trust usually becomes
irrevocable as to the property of the deceased spouse, but the surviving spouse usually
retains full power to revoke the trust as to the property that he contributed into it. This
type of trust gives the spouse maximum control over his assets and is accommodating to
future changes in the survivor's life following the death of the first spouse.
24. WHAT IS AN A-B TRUST?
The A-B Trust is the common name given to the general type of revocable trust used by a married person with children when the trustor's estate exceeds $600,000. It is also called a marital trust or a by-pass trust.
The trust exists for the benefit of the trustor during his life. At the trustor's death, the trust is divided into two parts. The unused unified credit, whichever is placed into the B Trust, and the rest is placed in the A Trust.
The sole beneficiary of the A Trust is the surviving spouse. The surviving spouse has ownership of the A Trust and usually has the power to terminate it and receive the assets. Since assets in the A Trust go to the surviving spouse, there is an unlimited marital deduction if the spouse is a U.S. citizen. Therefore, the A Trust is not subject to federal estate taxes. Upon the surviving spouse's death all of the property in Trust A will be included in the surviving spouse's estate for calculation of estate taxes. For example, assume that upon the trustor's death, his $2,000,000 estate was divided $600,000 to Trust B and $1,400,000 to Trust A. Upon the surviving spouse's death, Trust A had grown to $1,700,000. The A Trust beneficiary also had an additional estate of $500,000. Therefore the A Trust beneficiary's taxable estate is $2,200,000.
The beneficiaries of the B Trust are the children. Income may be applied for the surviving spouse, but the trust does not qualify for a marital deduction. It will qualify for a deduction to the extent of any unused portion of the trustor's unified credit. Thus there is no federal estate tax for this trust either. In the above example, if the assets in Trust B increase to $1,000,000 at the time of the surviving spouse's death, no estate taxes are due because the property placed into the trust was originally tax free. If $800,000 was originally placed into Trust B, the excess $200,000 would be taxable. After the taxes are paid, no additional estate taxes will be charged against it upon the death of the surviving spouse.
25. WHAT IS A QTIP TRUST?
A QTIP Trust is a special trust whereby the trustor's spouse is given all of the income from the trust with the principal being distributed to others, usually the children or grandchildren, upon the surviving spouse's death. QTIP stands for Qualified Terminal Interest Property and is a fancy name for property given to a spouse in a certain type of trust.
A QTIP Trust gives the option to the surviving spouse to have the trust property treated as a gift to the surviving spouse for estate tax purposes. If the election is made, the value of the trust will be treated as a spousal gift and be exempt from tax under the unlimited marital deduction. On the surviving spouse's death, the value of the trust assets will be included in the surviving spouse's estate for determination of the surviving spouse's estate tax.
Depending on the size of the surviving spouse's estate, it may or may not be good financial
planning to make the QTIP election and have the value of the trust included in the
surviving spouse's estate. For example, if the surviving spouse's estate was $100,000 and
the QTIP Trust was $1,000,000 and the unified credit of the deceased spouse had
previously been used, making the election would save the trust from paying federal estate
taxes until the surviving spouse dies. Meanwhile, the surviving spouse could draw a higher
interest from the investment of the pre-taxed $1,000,000. Disadvantage: If the surviving
spouse's estate grows after making the election, more tax may ultimately be paid, on the
death of the surviving spouse, than would have been paid if no election had been made.
26. WHAT IS A GENERATION-SKIPPING TRUST?
A generation-skipping trust is a trust that, as the name implies, skips one or more generations. A trust by a grandparent for grandchildren that by-passes the parents is a generation-skipping trust. The main exception is when there are no parents surviving the grandchildren: then it is treated as a direct trust.
A generation-skipping trust is complicated tax-wise. It is easy to create, but because of the
inherent tax consequences, a generation-skipping trust should not be created without first
consulting a tax advisor. Generally, $1,000,000 can be placed in a generation-skipping
trust without incurring an estate or gift tax provided the uniform credit has not been used
previously.
27. HOW IS A GENERATION-SKIPPING TRUST TREATED?
One million dollars may be transferred in a generation-skipping trust tax free. Any amount placed in the trust over $1,000,000 is taxed at a rate of 50% whenever a distribution is made. A taxable distribution is deemed to have been made when the parents of the grandchildren die or the grandchildren receive money from the trust. The purpose of this law is to avoid amassing huge estates by not paying taxes. These trusts affect only very wealthy people.
The tax consequences of a generation skipping trust are so great that no one should
consider funding one with over the unified credit amount without speaking with a tax
advisor.
28. CAN A TRUST BE IRREVOCABLE?
A trust can be made irrevocable, and sometimes it is wise estate planning to do so. In order for assets in a trust not to be included in trustor's estate, the trustor must not have control over the trust nor the reasonable expectation that the trust will revert back to him. The two main types of irrevocable trusts are life insurance trusts and charitable trusts, both of which are discussed below.
If the trust is revocable, the trustor has a great deal of control over the trust. For that reason, the fair market value of the assets of the trusts will be included in the trustor's estate upon death for estate tax calculations.
If the trust is made irrevocable, the trustor has no control over the trust. Therefore upon his death the assets in the trust, including appreciation in value, will not be included in his estate. This could pass a great deal of appreciation to the trustor's heirs without having it taxed. It is because a life insurance trust is irrevocable that the proceeds of the insurance on the deceased are not included in his estate.
Gifts made within three years of a person's death will normally not be included in the
donor's estate for tax purposes except for life insurance and the value of retained interests
by the donor in the gift. If gift taxes have been paid on the gift, credit will be given for the
gift taxes if the gift must be included in the donor's estate.
29. WHAT IS A LIFE INSURANCE TRUST?
A typical vehicle used in estate planning is the creation of an insurance trust. The trustor creates an irrevocable trust with someone else as the trustee and takes insurance policies out on his life. The ownership of insurance policies on the trustor's life is given to the trust, and the trust is made the beneficiary of the insurance policies.
When the trustor dies, the insurance proceeds will be paid into the trust, but the value of the insurance proceeds will not be included in the trustor's estate for estate tax purposes if the trustor lived more than three years after placing the policies into the trust.
Creating an insurance trust could save many thousands of dollars in estate taxes by keeping
the insurance proceeds out of the decedent's estate for tax purposes. Example: If the
decedent had a $200,000 estate and a $1,000,000 insurance policy, the estate would be
worth $1,200,000 upon the decedent's death. Since the federal government taxes any estate
with a value over the available unified credit amount, the remaining $600,000 in the estate
will be taxable. If an insurance trust had been used, the $1,000,000 in insurance proceeds
would not be included in the decedent's estate and thus not be taxable. The $200,000
would not be taxable. Since it is less than the available unified credit amount it can be
passed tax-free.
30. WHAT IS A CHARITABLE REMAINDER TRUST?
A charitable remainder trust is an inter vivos (living) trust made during the lifetime of the trustor. Property is placed into an irrevocable trust with a charity as a beneficiary. The trustee, who is usually the charity, is instructed to pay a fixed percentage of the trust assets to the trustor for the life of the trustor.
The trustor is given a tax deduction for the value of the gift to the charity. The trustor pays ordinary income tax on the payments received from the trust.
The gift to the charity is tax free. Since the charity is tax exempt, it can sell the appreciated property without having to pay capital gains. The charity can reinvest the proceeds of the sale and pay the trustor from the interest on the investment. The charity can generate more interest income from the sale than the person who transferred it to the trust: the charity can invest the whole amount without paying capital gains. For this reason, it is better to place highly appreciated property that is not earning a great deal of income, such as idle land, into the trust. The return that the trustor gets from the trust is higher than if the assets had been sold and reinvested by the trustor: capital gains taxes would have had to be paid on the trustor's sale of the highly appreciated property.
This is an excellent vehicle for estate planning for well-to-do people. Life insurance policies
can be bought with the trust payments that will replace the value of the property
transferred to the trust.
31. ARE REVOCABLE TRUSTS VALID ELSEWHERE?
All 50 states and the federal government accept as valid a revocable trust. If the trust was validly created in the original state, then all the other states will honor and enforce it.
Provisions can also be placed into a trust document stating that the terms of the trust are to
be administered by the laws of a certain designated state. All states will apply the laws of
the designated state in administrating the trust. Even if the trustor moves to another state,
the trust will still remain valid and in effect.
32. WHAT PROPERTY CAN BE PLACED INTO A REVOCABLE TRUST?
All of the property of the trustor can and should be placed into the trust. Anything left out of the trust will have to be probated unless it is joint tenancy property, insurance policies with designated beneficiaries other than the decedent's estate, or property that otherwise qualifies for summary probate proceedings.
Any property that has a title must have the title specifically changed over into the name of the trust. Merely stating in the trust agreement that such titled property is to be placed into the trust is insufficient to legally put the property into the trust.
A common example is when the trustor owns a home. Since a home has a title document,
the title must be changed to make the trust the owner. A quitclaim deed by the trustor to
himself as trustee of the trust must be executed and recorded. This is simple to do and
usually is done when the trust is created.
33. WHAT ARE THE INCOME TAX EFFECTS ON THE TRUST?
A revocable trust is considered a grantor trust for tax purposes. A grantor trust under the Internal Revenue Code is a type of trust created for the benefit of the person creating it. All of the income from the trust is attributed to the grantor for tax purposes.
Since all of the income is attributed to the grantor, the grantor remains liable for the income taxes as long as he lives. A revocable trust does not save the grantor any money on income taxes because it is not designed to do that.
A revocable trust exists to avoid probate and save estate taxes, not income taxes.
34. CAN A CONSERVATOR CREATE A REVOCABLE TRUST FOR THE CONSERVATEE?
Some states, like California, have statutes that permit a conservator to make a revocable trust for the conservatee. Such states usually require that the distribution of the trust be the same as the terms of the last will and testament previously drafted by the conservatee.
The purpose behind the revocable trust must be to avoid probate and not to change the
distribution of assets that the conservatee had decided upon when he was competent. The
situation may be different if the conservatee did not have a will: the trust must be in
accordance with the state's laws of intestacy. The estate must be distributed in the same
manner that it would have been distributed if a probate had occurred.
35. WILL PUTTING REAL PROPERTY INTO A REVOCABLE TRUST TRIGGER A REASSESSMENT OF PROPERTY TAXES?
Placing a piece of real property into a trust should not trigger a reassessment of property taxes because the transfer is not really a sale or conveyance of the property.
The property is put into a revocable trust that the owner can terminate at any time and receive back. California law specifically states that merely placing real property into a revocable trust for estate planning purposes does not trigger reassessment as long as the grantor is alive.
This is just common sense. Reassessment occurs when there is a change of ownership.
Placing the real property into a revocable trust is not really a change in ownership because
the trustor still controls it and can have the property returned to him at any time.
36. CAN CREDITORS ATTACH A TRUST FOR PAYMENT OF THE TRUSTOR'S DEBTS?
Most states will allow creditors to attach any revocable trust for the payment of debts or
other obligations owed by the trustor. The rationale for allowing the attachment is that the
trustor has effective ownership of the trust assets by the fact that he can revoke the trust
and receive the property in his own name. A court has the power to order the trustor to
terminate the trust and receive the assets back so that the trustor's creditors can be paid.
37. CAN CREDITORS OF A BENEFICIARY ATTACH ASSETS OF THE TRUST
FOR PAYMENT OF THEIR CLAIMS AGAINST THE BENEFICIARY?
Most trusts have clauses stating that the interest of the trust beneficiaries cannot be attached to pay the debts or obligations of any beneficiary. This provision is called a spendthrift clause.
Courts will enforce spendthrift provisions and deny any attachments, except in a revocable trust where the trustor is also the beneficiary whose trust interest is being attached. If there is no spendthrift clause, the trust can be attached to pay a beneficiary's debts. Moreover, most states permit a beneficiary's share of a trust to be attached to pay spousal or child support obligations even if there is a spendthrift clause in the trust.
California has recently passed legislation stating that a spendthrift clause will not shield a
trust from attachment for payment of a tort judgment against a beneficiary.
38. CAN A TRUST REPLACE OR AVOID THE EFFECT A STATE'S
DOWER OR CURTESY LAWS?
If the provisions of a trust are in conflict with a state's law regarding how much of a decedent's estate goes to the surviving spouse, the surviving spouse has an election of whether to take the share of the trust or to insist on receiving a statutory share of the estate.
If the spouse elects to take the statutory share, the trust will pay assets as necessary and distribute the remainder of the trust in accordance with the terms of the trust. To avoid this problem in such states that have statutory provisions for providing for a surviving spouse, the spouse should disclaim statutory rights and agree to take only the disposition given under the trust on the date executed.
If the trust does not give the surviving spouse a statutory share, the beneficiary should
consult with an attorney for advice on the legal consequences before proceeding.
39. IS THERE A GIFT TAX FOR FORMING A TRUST?
If the trust is revocable, there is no gift tax because the trustor can always revoke it. All income is still taxed to the trustor.
If the trust is irrevocable but the trustor is the beneficiary, there is no gift tax because the trust is still for the trustor's benefit. Such a trust is called a grantor's trust, and all trust income is taxed to the trustor.
If the trust is for the benefit of the grantor's spouse, there is no gift tax because of the unlimited marital deduction.
If the trust is for the benefit of someone other than the trustor or the trustor's spouse, the
general rule is that a gift tax is owed. The gift tax must either be paid or deducted from the
unified credit or annual exclusion.
40. IS IT DIFFICULT TO SELL OR TRANSFER PROPERTY IN A TRUST?
Property in a trust is sold like any other property that is not in the trust. All that is needed
to sell, transfer or convey real property from a trust is a deed executed by the trustee. The
trustee merely signs the deed as the representative for the trust and title is passed upon
recordation. For example, the deed from the trustee will read: "John Doe, Trustee of the
John Doe Revocable Trust, hereby deeds, conveys, sells, and transfers to John Smith all
right, title and interest in the following property."
41. WHEN DOES A REVOCABLE TRUST HAVE TO FILE A FEDERAL INCOME TAX RETURN?
As long as the grantor of the revocable trust is the trustee and treated as the owner of the trust, no tax return for the trust should be filed. The income and deductions for the trust should be listed on the grantor personal tax return.
A Form 1041 should be filed by the trust when the grantor is not considered the owner. This return should list to whom any distributions of income were made and pay the trust income tax on any income not distributed.
When the grantor is no longer the trustee, a trust tax return on Form 1041 should be filed.
42. CAN A TRUST'S ADMINISTRATION BE REVIEWED BY A COURT?
A common fear that many people have is that the trust will be mismanaged, and no one will be able to stop it. There is little to worry about on that score. All states permit concerned persons to petition the court for review of the administration of a trust.
A trustee is a fiduciary and owes both the trust and the beneficiaries a fiduciary duty to act reasonably and responsibly. If the court finds that a trustee has breached his duty of care, it will remove the trustee and surcharge (find the trustee liable) for all of the damages caused by the trustee's misconduct.
Even if the trust document states otherwise, probate courts will always have the power to
review the actions of a trustee. The court will never permit a trustee to misuse the faith
and power of his position and hide behind the trust document to avoid judicial scrutiny.
Anyone, not just the beneficiaries, can take their suspicions of abuse to the court, and the
court will investigate. In Bakersfield, California, an attorney conspired with a trustee to
raid an elderly woman's trust. Concerned neighbors expressed their concern to the court,
which ordered an investigation. Ultimately the attorney was charged, convicted and
sentenced to seven years in prison. The attorney's defense that everything was done in
accordance with the terms of the trust was not persuasive.
43. CAN ACCOUNTINGS BE ORDERED BY A COURT FOR THE TRUST
EVEN IF THE TRUST DOCUMENT WAIVES THEM?
Most trust documents contain clauses which require annual accountings to be made by the trustee unless the grantor is the trustee or all the trust beneficiaries waive them.
In addition, any concerned person, not just a beneficiary, who feels that the trust is being mismanaged, can seek a court order directing the trustee to perform an accounting. The court can order an accounting even if the trust agreement waives them.
A major concern that many people have about a trust is that the trustee may take and
otherwise mismanage the trust assets after their death, and the beneficiaries will be
helpless. Such is never the case. The probate court always has jurisdiction to oversee every
trust, whether or not such jurisdiction is spelled out in the trust document. No court will
ever let a trustee intentionally mismanage or steal trust assets. Anyone, not just
beneficiaries, can raise their concerns to the court, which will order a hearing to investigate
the matter.
44. CAN A TRUSTEE RESIGN?
A trustee can always resign. In such a case, the trustee is replaced just as though the trustee had died. Most trust agreements contain a list of proposed successor trustees to replace dying or resigning trustees. If the trust does not provide for a successor trustee and the trustor is dead or did not retain the right to amend or revoke the trust, the probate court will appoint a trustee. No trust will ever fail just because the trustee died or resigned.
Before a trustee can resign, the trustee, unless the trustor is the trustee, will be required to
provide a full accounting of the trust business during the time he managed it. All of the
beneficiaries may together waive the accounting.
45. HOW IS THE TRUSTEE REPLACED IF THE TRUSTOR BECOMES INCOMPETENT?
Most trusts have language for a successor trustee to take responsibility when the trustee becomes unable to perform the duties of the trustee. This may cause problems when the trustee is the trustor and does not believe himself to be incompetent.
To alleviate the problem, many agreements permit a trustee to be replaced when two competent doctors determine the trustee to be incompetent. Moreover, a court can adjudge a person incompetent and appoint a successor trustee to take over.
46. IS THERE A REQUIRED BOND FOR A TRUSTEE?
Normally, the trustor waives the bond for any trustee or successor trustee named in the trust document. After all, such a bond would be paid by the trust and thus diminish the trust estate. If the trustor did not have faith in the named trustees, he should not have named them.
In the case of a court appointed trustee, the court will require a bond unless all of the
beneficiaries agree to waive it.
47. WHEN DOES THE TRUST TERMINATE?
A trust must terminate within 21 years after the death of someone alive and mentioned in the trust when it was created. In other words, the trust must be totally distributed within 21 years of the death of the last person alive when the trust was created. This is known as the Rule Against Perpetuities and is the law in all 50 states.
If it appears that the trust would continue after the death of the beneficiary mentioned in the trust document, then the trust will be declared invalid. Clauses are usually inserted in the trust document to guarantee that the trust will not violate the Rule Against Perpetuities.
Except for the Rule Against Perpetuities, a trust terminates at the time the trustor specified
in the terms of the trust agreement. Usually it terminates on the death of the surviving
spouse or the death of the trustor's last child.
48. HOW IS A TRUST REVOKED?
If a trust is revocable, all that is needed for an effective revocation is for the trustor to notify the trustee in writing that the trust is terminated as of a certain date and to demand the trust assets be paid over to the trustor.
When the trustor is also the trustee, he simply affixes a letter to the trust document revoking the trust and then executes new deeds from the trust back to himself as an individual.
Revocation is simple and quick which is one of the prime advantages of the trust over any other form of estate planning, Ease of revocation means that the trustor's control over the assets of the trust is never truly lost. Until the trustor actually dies, he retains the ability to revoke and terminate the trust merely by stating that the trust is revoked.
49. MUST A TRUST BE RECORDED?
A revocable trust does not ever need to be recorded. Unlike a Will, it is a private document. The only documents that need recordation are the deeds transferring real property into the trust.
In some states, a revocable trust is required to be registered with the probate court. To register, a short statement is filed listing the trustee and giving some basic information. Registration gives the court jurisdiction to oversee the trust. There are no penalties, however, for failure to register.
The states requiring registration are Alaska, Colorado (after the death of the grantor but
no registration is required if there is an immediate distribution to the beneficiaries),
Hawaii, Idaho, Maine, Michigan, New Mexico and North Dakota. Florida and Nebraska
do not require registration with the probate court, but both states allow it and suggest it.
50. SHOULD BANK ACCOUNTS BE IN A TRUST OR IN JOINT TENANCY FOR A HEIR OR BENEFICIARY?
A person may have his bank accounts placed in joint tenancy with the spouse or children or all. The problem is the same as with all joint tenancy property (as stated before). The opening of joint bank accounts is a legal gift of a large portion of all money placed into the account: the account may be attached to pay the other joint tenant's debts.
If a revocable trust is used, all that is needed to avoid probate is just to retitle the bank
account so that the trust is the new holder. The trustor controls the trust which controls
the account. The bank will want to see the trust document to ensure that the trust exists
and to identify the successor trustee. The use of a trust as the owner of the bank account
assures that it will not be attached to pay any one's debts but the trustor's.
51. HOW MUCH IS THE STANDARD ESTATE PLAN?
The standard estate which includes the revocable trust, durable power of attorney, living will, and pour-over will is usually between $500 and $1,100, depending on the type of trust used. There are different types of trusts depending on the type of trust needed to accomplish the trustor's intent.
Different trusts are used depending on whether or not the grantor is single or married with or without children and whether the trust is a joint trust between the spouses. Special trusts such as life insurance trusts, generation-skipping trusts or charitable trusts can also be part of an estate plan and obviously will increase its cost.
CHAPTER 2
ESTATE PLANNING QUESTIONNAIRE
Before anyone starts on the creation of an estate plan it is important, indeed it is critical, that the person be aware of the size of the estate and how it ultimately is to be distributed. There are a variety of available ways to accomplish the desired result, but the person must first know what that result is to be. The purpose of this questionnaire is to assist the reader in marshalling (assembling) the assets for evaluating the size of the estate and to avoid missing or overlooking assets. Assets not included in an estate plan will have to be probated unless they fall into a state's exemption from probate.
The use of such a schedule cannot be over-stressed. Many times a person forgets a piece of property inherited years ago from Uncle Bill in Tulsa or Aunt Emily in Maine. Then after death, the heirs discover the existence of the property and are forced to spend thousands of dollars needlessly to probate the property to place the title in their names.
Unless a person knows the size of his estate, it is difficult to make an accurate estate plan. If gifts figure in the estate plan, he must know how much to give to reduce the estate's value below the unified credit amount.
This questionnaire is structured to help recall any forgotten assets and serves as a guide to the executor, trustee or heirs as to where property is located. This questionnaire is not needed if the person knows the extent of his property, and where it is going. This form, however, does make decisions easier for the heirs when they use it. Use of the questionnaire also tends to prove the competency of the person to make an estate plan. In any will or trust contest, use of this schedule would be evidence demonstrating that the person used deliberate care in drafting the estate plan. Such evidence, in any competency challenge, would be beneficial.
ESTATE PLANNING QUESTIONNAIREA. BACKGROUND INFORMATION
1. Name (include all other names once used, i.e. maiden) _______________________________________________________
_______________________________________________________
2. Address and phone number (home and business) __________
_______________________________________________________
_______________________________________________________
3. Employer's name, address and phone number: ____________
_______________________________________________________
4. Spouse's employer's name, address and phone number: _______________________________________________________
_______________________________________________________
5. Occupation:____________________________________________
6. Spouse's occupation:___________________________________
7. Social security number:________________________________
8. Spouse's social security number:_______________________
9. Former military service (branch and dates of service): _______________________________________________________
_______________________________________________________
_______________________________________________________
10. Date and place of birth:_______________________________
11. Name of spouse:________________________________________
12. Date and place of spouse's birth: _____________________
_______________________________________________________
13. Date and place of marriage: ___________________________
_______________________________________________________
14. Length of residency in the state: _____________________
_______________________________________________________
15. Previous marriages for each spouse: ___________________
_______________________________________________________
_______________________________________________________
_______________________________________________________
16. Children:______________________________________________
_______________________________________________________
_______________________________________________________
17. Children of spouse (step-children):____________________
_______________________________________________________
_______________________________________________________
18. Deceased children: ____________________________________
_______________________________________________________
19. Grandchildren: ________________________________________
_______________________________________________________
_______________________________________________________
20. Grandchildren of spouse: ______________________________
_______________________________________________________
21. Parents and address: __________________________________
_______________________________________________________
_______________________________________________________
_______________________________________________________
22. Parents of spouse and address: ________________________
_______________________________________________________
_______________________________________________________
_______________________________________________________
23. Last Will:
a. Date executed:____________________________________
b . Location of original: ____________________________
__________________________________________________
c. Attorney who prepared will, address, phone: ______
__________________________________________________
__________________________________________________
B. PROPERTY
1. Real property (for each piece of real property state):
a. (1) Type of property: ________________________________
__________________________________________________
(2) Location of property: ____________________________
__________________________________________________
(3) Holder and amount of liens on the property:_______
__________________________________________________
(4) Fair market value of the property not deducting for the liens: _______________________________________
END OF CHAPTER PREVIEW
CHAPTER 3
One of the main reasons for doing estate planning is to eliminate or minimize estate and inheritance taxes, both on the state and federal side. To effectively plan an estate, a person must know how the Internal Revenue Code and his own state's tax laws affect the property in the estate.
The purpose of this chapter is to appraise the reader of the federal and state inheritance and estate taxes to which estates are subject. Given that each state's taxing provisions are different, the most that can be done here is to give the taxing schedule for the state. Hopefully, the reader will be able to employ it in calculating taxes under whatever estate planning scheme is adopted.
I. ANNUAL EXCLUSION
Under federal law every person can give $11,000 per year to an unlimited number of individuals without incurring a federal gift tax or having his unified credit reduced for the gifts. For example, assume a man has two children and five grandchildren. As such, he can give each child and grandchild $11,000 each every year. This means that the man can give $77,000 or less per year tax-free: without having to pay any gift taxes.
By making such gifts it is possible to reduce an estate substantially over a period of years. Such gifts are not included in the estate of the donor after his death. For this reason, gifts are an excellent means of reducing the size of the estate for federal estate tax purposes provided the donor lives long enough to give away enough property.
II. UNLIMITED MARITAL CREDIT
The Internal Revenue Code authorizes an unlimited marital credit for all transfers of property between spouses if they are American citizens. If the recipient of the transfer is not an American citizen (Internal Revenue Code Section 2523), there is no unlimited marital credit for gifts. Instead, the marital credit for gifts from an American citizen to an alien spouse is only $110,000 per year. This means that an American citizen can only give $110,000 per year or less to an alien spouse without having to pay federal gift taxes. If the spouse were an American citizen, any amount of property could be given away each year tax-free.
The unlimited marital deduction is also not available for a trust established by an American citizen for an alien spouse. Section 2056 of the Internal Revenue Code requires that such gifts are immediately taxable to the estate of the American spouse, unless it was placed in a qualified domestic trust. In such case the tax is delayed until distribution to the alien spouse. The tax is delayed: it is not forgiven as it would be if the receiving spouse was an American citizen. Therefore, if a couple wishes to use a joint trust, they should both be American citizens or consult a tax attorney or other tax professional to determine how the reduced marital credit will affect them. This problem can be cured by the non-citizen spouse becoming a citizen.
If a husband gives $1,000,000 to his wife, an American citizen, the unlimited marital credit ensures there will be no federal estate gift taxes on the transfer.
III. UNIFIED CREDIT
Under federal law, everyone can pass upon death a total of $1,000,000 of property, which gradually rises to an unlimited amount in 2009 and then reduces again to $1,000,000 under the Tax Relief Act Reconciliation Act of 2001. As bizarre as it may seem, Congress did not make the elimination of the estate tax permanent. It is eliminated for only one year and is reinstated at the top rate of 55% with a $1,000,000 unified credit unless Congress by another tax act makes the elimination of the estate tax permanent.
Under the Tax Act of 2001, Congress imposes a gift tax to restrict the transfer of income producing property from high income to low income taxpayers. The gift tax exemption beginning in 2010 is $1,000,000. So even though transfers of property after death can be made tax free in 2010 for at least one year, unless made the estate tax elimination is made permanent by Congress, a gift tax on the transfer of property while alive will remain. The gift tax under the 2001 Tax Act is equal to the top individual tax rate at the time of the gift.
The Tax Act of 2001 did not change the annual exclusion of $11,000 per year per person for gifts made during life. So taxpayers can still give $11,000 per year per person away without having it reduction the unified credit amount of the donor.
V. STATE ESTATE AND INHERITANCE TAXES
A. PICKUP TAXES
Most states do not impose a direct estate or inheritance tax on an estate. Instead, many states employ what is called a "pickup tax." Under federal law, a decedent is permitted to take a statutory credit for a fixed amount of state death taxes. These states having pickup taxes require the estate of the decedent, that must file and pay federal estate taxes, to deduct the maximum allowable state credit for death taxes and pay it to the state. Prior to the Tax Act of 2001, the ultimate tax was still the same of the decedent's estate for tax purposes. The total tax owed and paid remained the same it was just split between the IRS and the state taxing agency. If the estate did not pay the pickup tax, it would remain liable for the taxes along with interest. A claim for a refund on the overpayment of any estate tax could be sought from the IRS, along with interest, if it is filed within three years of the overpayment of the estate tax.
The 2001 Tax Act made the area much murkier. The Act instituted of the State death tax
credit. Under the Act the credit will be phased out by 2005 and replaced by a deduction for
death taxes actually paid.
| Year | REDUCTION IN TAX CREDIT |
| 2002 | 25% |
| 2003 | 50% |
| 2004 | 75% |
| 2005 | Credit eliminated replaced with deduction for taxes actually paid |
For example, if a decedent in one of the following states died with an estate of less than $1,000,000, there would be no federal or state estate taxes. Assume however that the decedent died in one of those states and he had a large estate which generated a federal estate tax of $23,000. If the state death credit in effect then is $5,000, the state gets $5,000 and the IRS gets the remaining $18,800.
The states with the pickup tax are:
ALABAMA ALASKA ARIZONA ARKANSAS CALIFORNIA
COLORADO DIST. OF COLUMBIA FLORIDA GEORGIA
HAWAII ILLINOIS MAINE MINNESOTA NEVADA
NEW MEXICO NORTH DAKOTA OREGON PUERTO RICO
RHODE ISLAND SOUTH CAROLINA TEXAS UTAH
VERMONT VIRGINIA WASHINGTON W. VIRGINIA WISCONSIN WYOMING
B. STATE TAX SCHEDULES
Below are the state estate and inheritance tax rate schedules. These rates are applied to estates in probate in that state. In these states the inheritance taxes usually apply to the recipient of decedent's property. In most states property distributed to spouses and children is taxed at lower rates than property distributed to others. For this reason each state's tax rate is different. The reader must calculate his taxes using the particular state schedule where probate and any ancillary probate is conducted.
The reader should also be aware that tax laws frequently change. In the last few years several states have repealed their inheritance and estate taxes. In the future such taxes may again be reimposed or raised.
CONNECTICUT
CLASS AA Surviving spouse
CLASS A Parent, grandparent, adoptive parent or natural or
adopted descendant
CLASS B Son or daughter-in-law of child (both natural or adopted) who has not remarried. Step-child, brother or sister(full, half or adopted). Brother's or sister's children or descendants (both natural and adopted)
CLASS C All other heirs
TAXABLE AMOUNT TAX RATE
CLASS AA -0- -0-
CLASS A 50,000 to 150,000 3%
150,000 to 250,000 4%
250,000 to 400,000 5%
400,000 to 600,000 6%
600,000 to 1,000,000 7%
1,000,000 and over 8%
CLASS B 6,000 to 25,000 4%
25,000 to 150,000 5%
150,000 to 250,000 6%
250,000 to 400,000 7%
400,000 to 600,000 8%
600,000 to 1,000,000 9%
1,000,000 and over 10%
CLASS C 1,000 to 25,000 8%
25,000 to 150,000 9%
150,000 to 250,000 10%
250,000 to 400,000 11%
400,000 to 600,000 12%
600,000 to 1,000,000 13%
1,000,000 and over 14%
EXEMPTIONS:
1. Class AA All property is exempt
2. Class A First $50,000 is exempt
3. Class B First $6,000 is exempt
4. Class C First $1,000 is exempt
The state has an estate tax equal to the federal state death tax credit.
DELAWARE
CLASS A Spouse
CLASS B Parent, grandchild (both natural and adoptive), son-in-law and daughter-in-law, lineal descendant or step-child
CLASS C Brother, sister, their descendants, aunts and uncles and their descendants
CLASS D All others
TAXABLE AMOUNT TAX RATE
CLASS A 70,000 to 100,000 2%
100,000 to 200,000 3%
200,000 and over 4%
CLASS B 25,000 to 50,000 2%
50,000 to 75,000 3%
75,000 to 100,000 4%
100,000 to 200,000 5%
200,000 and over 6%
END OF CHAPTER PREVIEW
Deciding upon a type of estate plan that a person or a couple will employ is one of the most important personal decisions will ever be made. Use of a trust or Will in an estate plan should only be done after careful deliberation. In most instances, a revocable trust will be superior to probate of a will.
Probate actions are the only legal proceedings in which fewer number each year are being instituted. Revocable trusts were designed to replace probates and they do it very well. A probate action exists solely to determine who gets a person's estate when no provision had been made by the decedent to provide for its immediate passing upon death. More people are turning to revocable trusts to avoid probate and time-consuming hassles, hearings and delays which it entails. Some of the prime advocates for revocable trusts are judges themselves. Most judges, handling probate matters, view the basic exercise of probate jurisdiction as unnecessary in view of the fact that revocable trusts can do the job faster and cheaper.
Although revocable trusts are, however, generally superior to probate, there are estate situations where probate may be advantageous. A general rule is good but with every rule there is an exception. Before deciding on a trust, each person should review his personal situation to determine if it is an exception to the rule and that therefore a probate should be used.
This chapter deals with the major disadvantages commonly cited by estate planners as grounds for not using a revocable trust. They are presented here for the reader to apply them to his own fact pattern to determine if a trust is warranted.
This book is written for the average person with an average estate of about $1,00,000 individually or $2,000,000 per couple which gradually rises to an unlimited amount in 2010 and then reduces back to $1,000,000 each in 2011 under the Tax Act of 2001. People with estates significantly over these amounts should go to a tax advisor and spend a few dollars for the expert estate planning needed by virtue of having a larger estate. Someone with assets significantly above these limits should consider charitable contributions, charitable trusts, life insurance trusts and a myriad of other estate devices that are far beyond the scope of this book. The trusts contained in Estate Planning II are for people who have already made up their minds to use a revocable trust or are considering it and have assets close to the limits stated above. According to IRS estimates, those trusts apply to 90% of the American people.
It is impossible to address every tax consideration that could arise from the use of a trust. Bearing that in mind, here presented are the most important ones. Nonetheless, the reader should be able to make a knowledgeable and informed decision as to whether to execute a will or use a revocable trust as his main estate planning tool after reading this book and the second volume, Estate Planning II.
I. EFFECTS OF DIVORCE ON PROBATE AND REVOCABLE TRUSTS
In many states a divorce automatically revokes all gifts made to a former spouse in a will. In some states the validity of the gifts still remains in effect until the will is changed.
A revocable trust is a nonprobate transfer, and the property contained therein passes by contract. Therefore, a divorce will not affect a divorcee's right to receive a distribution from the ex-spouse's revocable trust unless the divorce decree specifically terminates that right. Thus, unless a revocable trust is amended after a divorce to remove the former spouse as a beneficiary, that former spouse will still receive the original share of the trust even though now divorced from the deceased ex-spouse.
A difficult situation exists when an incompetent trustor (creator of the trust) is divorced. An incompetent trustor cannot revoke or amend a trust that was validly created during a time when the trustor was competent. The conservator or guardian of the incompetent trustor must seek court permission to revoke the trust in the divorce proceeding or in a separate petition.
While divorce is always a consideration in any relationship, amending a revocable trust is extremely easy. All the trustor must do is deliver a written statement to the trustee, who is usually himself, stating that the former spouse is not to receive anything under the trust. The trustor notifies the trustee that the trust is either terminated or that the former spouse's share goes to someone else. It is that simple. Although the revocation does not need to be witnessed, it should be to avoid having its execution challenged by the former spouse.
II. CREDITOR CLAIMS AGAINST THE ESTATE
Under probate law, the decedent's creditors are given a statutory period of time, usually four months, after the probate is opened to present their claims against the estate (debts owed by the decedent) for payment. Claims filed after that period normally are disallowed and cannot be paid no matter how meritorious. This can be quite an advantage to an estate. Should large creditors happen to be late in presenting their claims, they won't be paid. As such, the heirs will receive the estate free of any potential creditor claims not presented during the statutory period.
In addition, a probate also permits a certain amount of property to pass to the family as a family allowance. This property is exempt from all creditor claims. The amount of the family allowance varies from state to state, but it can exceed $40,000.
On the other hand, a revocable trust does not cut off any creditor claims. A creditor can sue the trust or the beneficiary receiving the trust property for a period of four years (depending on the state's statute of limitations) for debts owed by the decedent. The beneficiaries of the estate are responsible to pay any judgment awarded that is within the value of the trust property they received.
A decedent cannot avoid his debts by transferring property into a trust for the trustor's benefit. All states have laws which prevent transfers designed strictly to avoid or defraud creditors. So a revocable trust established by a trustor would be liable for the trustor's debts.
Generally, if use of a trust will pass more to the beneficiaries after all the creditors have been paid than if a Will had been used, then the trust should be the estate planning vehicle employed. Usually this is the case because once an estate exceeds the state limits for a summary probate, it will cost more to probate the estate than it would to create the trust and thereby avoid the probate.
III. STATUTORY SHARE OF SURVIVING SPOUSE
A revocable trust cannot deprive a surviving spouse of a statutory share of the deceased spouse's estate. If state law gives a spouse a mandatory one-third share of the other spouse's estate, the surviving spouse can insist on that one-third share regardless of the amount the trust document purports to give the surviving spouse.
In community property states there usually are no statutory shares in a spouse's estate because the community property interest replaces the need for a statutory share. Most states, however, do have mandatory statutory shares. Therefore, in order for the trust to work the surviving spouse must elect to take the share given under the trust and waive the statutory share.
As a practical matter, this is usually not a problem. A husband and wife usually create a joint trust which establishes how they want the property distributed upon both of their deaths. The most common joint trust gives everything to the surviving spouse with the remainder, if any, going to their children. In the usual joint trust, the surviving spouse is receiving far more property than the statutory share. The bottom line is that if one spouse feels that the other spouse will challenge the trust, don't bother with it.
IV. WILL OR TRUST CONTESTS
Both wills and trusts can be challenged by heirs, beneficiaries or disinherited family members. The challenges are the same for each: lack of capacity, mistake, fraud, duress, insane delusion, pretermitted heirs, etc.
There is no difference as to how a court will treat a will contest or a trust contest. The probate court has the same jurisdiction to determine trust contests as it does will contests.
All wills and trusts should have a protective clause to limit challenges. The no-contest clause states that should any heir or beneficiary challenge a trust and lose, the challenger also loses all right to receive property under the will or trust. For example, a beneficiary due to inherit $1,000,000 seeks to inherit $2,000,000 by overturning the will or trust. If he loses the challenge, the beneficiary also loses the $1,000,000 that was to pass under the Will or trust. It is amazing to contemplate the amount of litigation avoided by the No-Contest Clause in Wills and Trusts.
V. TIME IT TAKES TO PROBATE A WILL OR TRANSFER PROPERTY IN TRUST
Assets in probate can be held for quite a while before final distribution to the heirs. Partial distributions based on need can be made under court approval prior to the close of the estate. Generally, a normal probate (assets over $60,000 that are not going to a surviving spouse) takes a minimum of six months.
Under the Uniform Probate Code, adopted by many states including Colorado, the personal representative may take possession of the decedent's assets within five days of death. In addition, there are special provisions for summary probates when the estate is small or going primarily to the surviving spouse. Such summary proceedings are fast, usually no more than two months.
Revocable trusts are the fastest way to transfer assets following the trustor's death. Upon the trustor's death, the trustee or successor-trustee immediately transfers the property in accordance with the terms of the trust, subject only to whatever delays exist in paying required federal and inheritance taxes. Since the same delay for payment of taxes exists for probates, trusts clearly have the advantage of speed.
VI. EFFECT OF REVOCABLE TRUST ON MEDICAID ELIGIBILITY
A revocable trust has an unfair effect on the beneficiary spouse's ability to claim Medicaid benefits if institutionalized. For this reason elderly couples with small estates should give particular attention to this matter if they feel that they might one day have to seek institutionalized Medicaid assistance.
Under 42 U.S.C. Section 1396(a)(k), assets and income from a revocable trust for a surviving spouse institutionalized as a Medicaid recipient will be counted as available for the surviving spouse's use in determining eligibility for Medicaid assistance. The assets and income will be attributed to the surviving spouse even though the trust has placed an independent trustee in control. This is not the case when the trust was created for the surviving spouse in the deceased spouse's will. The assets and income of a testamentary trust (trust created by a will) will not be counted toward the institutionalized spouse in determining Medicaid eligibility.
This is an important consideration and should be reviewed with the Social Security Administration if Medicare is an important consideration for a person. Democrats in Congress have proposed changing the law to include assets from a testamentary trust into a surviving spouse's estate as well as those of a revocable trust created by a deceased spouse.
VII. GIFTS WITHIN THREE YEARS OF DEATH
Nowadays gifts made by an individual within three years of death are no longer brought back into the estate for tax purposes. There are exceptions: those transfers involving life insurance or those transfers in which the decedent retained control over the property. Therefore, a parent, for example, could give $10,000 to a child within three years of death without having the money return to the parent's estate for estate tax purposes.
A different situation exists when the parent makes the gift directly from a revocable trust. The IRS holds that gifts made directly from a revocable trust within three years of the trustor's death are included in the trustor's estate for tax purposes. In other words, if the parent's revocable trust makes a $10,000 gift to the child, the gift will be brought back into the estate for tax purposes (Revenue Ruling 75-553, 1975-2 C.B. 477).
This is a result of incompetent tax writing by Congress. The problem, however, is easily avoided if the trustor first takes the $10,000 out of the trust in the parent's own name before making the gift. In other words, the transaction goes through two steps rather than one to avoid having the money brought back into the estate.
VIII. TAX I.D. NUMBERS
Everyone fears the IRS. No one wants to have anything to do with the IRS any more than the average person looks forward to going to a dentist for a root canal. The thought of having to get a Federal Identification Number scares most people. Getting an I.D. number means that the person has become a cipher in the IRS machine, and secrecy and privacy have been lost to the taxing behemoth.
Once a probate is opened and a tax return due, the personal representative is required to file for a Federal Identification Number. This I.D. number must be placed on all income tax and estate tax returns for the estate.
In a revocable trust, no federal tax identification number is required and no separate tax return for the trust need be filed as long as the grantor is the trustee. The trust, however, will need a federal identification number and must start filing annual federal fiduciary tax returns (Form 1041) if the grantor is replaced as trustee.
IX. EFFECT OF TRUST ON HOMESTEADS
A potential drawback in a trust is that homestead exemptions are not available in some states for homes placed into a revocable trust. A homestead exemption is an exemption from attachment on the equity of a person's home by a creditor's judgment. For example, if a state's homestead exemption is $45,000 and the equity in a debtor's home is $46,000, a judgment creditor can only keep $1,000 if the home is taken and sold to pay off a judgment. The remaining $45,000 in equity is returned to the debtor to start over.
If the home is placed into a trust, the homestead exemption will not apply, and the creditor can take the entire $46,000 of equity to reduce the trustor's debts.
The loss of the homestead exemption can be a significant concern in deciding to create a trust. If a person is in a business with a potential for a great deal of liability or lawsuits, it might be advisable not to form a trust. The average person will, however, have enough insurance to guard against judgments for normal negligence, and thus the loss of the homestead is not that important. Hopefully all states will eventually extend homestead protection to homes placed into a trust.
X. TRANSFER TAXES
Some states or territories, such as the District of Columbia, impose transfer taxes for property placed in a revocable trust. Most states do not impose a transfer tax as long as the grantor is a beneficiary in the trust. The rationale for not applying the tax is obvious: there really is no change of ownership until the grantor dies. Until the death of the grantor, the grantor has the power and ability to terminate the trust and receive the property back. As such, the transfer is at best tentative. Neither Colorado or California charge a transfer tax for property placed into a revocable trust if the grantor is a beneficiary.
In any event the transfer taxes are a small amount compared to the savings in probate fees.
XI. REAPPRAISAL OF REAL PROPERTY PLACED INTO TRUST
Some states reappraise real property to determine tax value when the property is placed in a revocable trust. Most states will not reappraise real property placed into a revocable trust as long as the grantor is a beneficiary in the trust. The rationale for not reappraising the real property is obvious: there really is no change of ownership until the grantor dies. Until the death of the grantor, the grantor has the power and ability to terminate the trust and receive the property back. The transfer is at best tentative. Neither Colorado nor California will reappraise real property placed into a revocable trust where the grantor is a beneficiary.
In any event, the additional taxes in those states where reappraisal occurs usually is a small amount when compared to the savings in probate fees. If not, then the transfer of the property into the trust might be delayed, or the trust may not be formed at all with the result that the property would have to be probated upon its owner's death.
XII. TAX EXEMPTIONS
There is a slight difference in the tax exemptions available for trusts and those tax exemptions available for estates. A revocable trust has a personal exemption of $300 while an estate has a personal exemption of $600. This means that an income tax return need not be filed for a probate until its income exceeds $600 while a trust must file the return when its income exceeds $300.
There are expensive probate fees involved a the probate of a Will transfers large income-producing property as opposed to the use of a trust. Although a trust only has an exemption of $300, as compared to a probate, use of the trust avoids having to probate a large estate and thereby offers significant savings by avoiding having to pay the large probate fees.
XIII. S CORPORATION STOCK
One area where a probate has a distinct advantage over a revocable trust is where the decedent owned stock in an S Corporation (a corporation treated as a partnership). A trust may hold the stock for two years following the grantor's death. At the end of the two-year period the stock loses its S Corporation status, and the corporation is then taxed as a normal corporation. In contrast, the probate estate may hold the stock until completion of the probate, and the stock will always remain S Corporation stock. This means that the estate can hold the S Corporation stock for years and receive the tax benefits of the S status for the corporation.
An estate may be kept open for as long as 15 years if an installment payment election under Code 6166 was made. It might prove worthwhile to keep the estate open for that long just to keep the S Corporation status.
XIV. DEPRECIATION DEDUCTIONS
There is a tax difference as to how losses for the distribution of depreciated property made to satisfy bequests in a probate and those made by a trust are handled. A probate may deduct such losses whereas a trust may not deduct the losses.
XV. STOCK OPTIONS
A stock option exercised by a revocable trust is taxable. If a stock option exercised by probate estate, it is not taxable. The difference in the taxability of the exercise of valuable stock options is important. Generally, most people do not die with large amounts of unexecuted stock options. Those, however, who have such options should discuss this matter with tax professionals to determine the effect on their estate plan.
XVI. PASSIVE ACTIVITIES
Internal Revenue Code Section 469 limits trust deductions for losses from passive activities to the amount of passive income received. An exception under Section 469(i)(4) permits an estate which closes within two years of the decedent's death to be treated as an active participant in rental real estate. An estate, but not a trust, may offset its losses with non-passive income up to $25,000 if the decedent was an active participant in real estate at the time of death.
XVII. DISTRIBUTION OF INCOME
An advantage available to a trust, but not an estate, is the sixty-five (65) day distribution rule under Internal Revenue Code Section 663(i). A trust is permitted to distribute income within 65 days of the close of its tax year and treat the distribution as made at the close of the previous tax year.
Thus under this tax rule there is an opportunity not available to a probate estate to
reallocate income to a lower income tax bracket of a beneficiary by treating the distribution
as made the prior year.
CHAPTER 5
TRUST PROVISIONS
All revocable trusts share certain common clauses. Often these clauses are referred to as "boilerplate." The purpose of these provisions is to cover those important issues that will not be disputed or challenged if they are stated in the document.
The intent of this chapter is to cover those trust provisions that usually appear in all revocable trusts in some form or another. This chapter will explain why such clauses are used and what they hope to accomplish. Armed with this knowledge, when reviewing the following trusts, the reader will be able to appreciate the legal significance and reason for the use of the clauses. As such, the reader will become, not just a blind user of the trusts, but an active participant in the construction and creation of his own revocable trust.
I. TRUSTOR AND TRUSTEE
All trusts, revocable and irrevocable, need a trustor, a creator of the trust, and a trustee, a person to manage the trust. The respective positions must be specifically delineated in the trust document. A trustor can be and, in a revocable trust usually is, the trustee. There is no legal prohibition against a trustor serving as a trustee.
The document purporting to create a trust must state that the property in the trust is being
held by the trustee for and on behalf of the trust. If there is no such statement, then a
serious question arises as to whether a trust was created. A valid trust document has three
requirements: (1) the designation of the trustor, (2) the designation of the trustee and (3)
the designation of property transferred into the trust (called "funding the trust estate"). If
any of the above requirements are not met, then a valid is not created.
II. INCOME TO GRANTOR
Revocable trusts, used for estate planning, generally require that the trustee, who is usually the trustor, pay to the grantor or apply for the benefit of the grantor all of the income and as much of the trust estate as the grantor may demand.
The main purpose behind the use of revocable trusts is to avoid probate. Since the value of the trust will be included in the estate of the trustor, there is no reason not to allow the trustor, at all times, to have full access to the trust income or principal.
When an revocable trust is used, the real estate planning takes place after the trustor dies. It is at that point that a probate is actually avoided and the trust estate truly passes to the designated beneficiaries.
III. DISTRIBUTION AFTER THE TRUSTOR'S DEATH
The reason for estate planning is to avoid probate. In order to do that, the trust document must state who succeeds to the trust estate after the death of the trustor. In other words, the trust must state what happens to the trust assets after the trustor dies.
The trustor can designate many different dispositions of the trust estate after his death. The trusts in this book highlight the most common dispositions. Usually, a married decedent with children leaves the entire estate to the surviving spouse, in trust, to be distributed to the children upon the surviving spouse's death. A person without a spouse but with adult children simply has the trust estate divided among the children.
The trust document must state what is to happen to the trust estate after the death of the trustor, or the trust will be terminated by operation of law and the assets probated.
IV. PAYMENT OF THE TRUSTOR'S FUNERAL EXPENSES
Because the trust is revocable, it remains, under the law, an asset of the trustor. A person cannot avoid his debts by transferring all property into a revocable trust. Such transfers are viewed as being intended to defraud creditors and will be set aside by the courts. As such, the trust is always liable for payment of the trustor's debts, including the funeral expenses, if the debts are not paid by other sources. Therefore, most trusts have provisions stating that the trustee has the power to pay the funeral expenses and any bequests made by the trustor's last Will. The purpose behind such an express clause is to ensure the trustee does not have to get court approval to make the payments.
V. TRUSTEE POWERS
All states give the trustee certain limited statutory powers to operate a trust. Since, however, the trustor is usually also the trustee with full power to alter, amend or revoke the trust, there is no reason to restrict the trustor, when acting as the trustee. For that reason, the trustee in the trusts in this book has the power to do virtually anything necessary to manage the affairs of the trust without having to get court approval.
The trustor can limit the powers of the successor trustees by executing an amendment to the paragraph dealing with trustee's powers. Usually there is no reason for a trustor to limit the powers of the successor trustee. Often the succeeding trustee is a surviving spouse or child who is a beneficiary and is trusted to make intelligent decisions. If the succeeding trustee is not expected to have reasonable intelligence or business guile, he should not be appointed trustee.
When the trust document calls for the trust to terminate and its assets be distributed upon the trustor's death, the only power the trustee then has, by implication, is to pay the trust debts and transfer the property to the beneficiaries. The termination usually takes between one day and two weeks.
VI. REVOCABILITY
Many states, such as California, hold that a trust is presumed to be revocable at any time unless a trust document expressly states otherwise. In order to avoid problems in construction and conflicts with other state laws, all revocable trusts should have clauses specifically stating that the trust is revocable.
The trustor in a revocable trust reserves the right to alter, amend and revoke the trust at any time. As such, the trustor never loses control over the assets placed into the trust regardless of whether the trustor serves as the trustee.
The purpose of using a revocable trust is to probate. As such, there usually is no sense in making the trust irrevocable (except for life insurance trusts discussed later) and lose control over the trust assets. The assets of a revocable trust will be included in the trustor's estate for estate tax purposes.
VII. GOVERNING LAW
All trusts should have a clause stating under what state's law its terms and conditions will be construed. This serves as a basis upon which to determine any conflicts. Among the states there are very different trust laws. If a trustor were to move the trust estate to another state without such a clause, it is unclear how the trust will be thereafter construed.
A trust document is a contract between the trustor and trustee. If the trust is valid in the state where written, all other states must give it full force and credit under the U.S. Constitution. Therefore, if a trust states the terms must be construed under the laws of California, in a suit over the trust terms brought in another state, the courts of that state will apply California law. For example, a Texas Court will apply California law to decide any ambiguity in the trust's terms.
VIII. PAYMENT TO MINORS
Where it is possible that trust assets may be distributed to minors there should be a clause to cover it. The trusts in this book give the trustee the discretion to keep the property in trust for any minor, to distribute the property to a court appointed guardian of the minor or give it to the parent as a guardian in trust for the child. Some provision for this possibility should be provided when it is possible that minor children may be or become trust beneficiaries.
The trust will not fail because a minor might be a beneficiary. At most, a court petition might have to be filed appointing a guardian to receive the property on the beneficiary's behalf. The trust would still be valid and still accomplish its intended results of avoiding probate and passing property to the designated beneficiaries. Still, providing for this alternative simplifies and reduces the possibility of needing court assistance.
IX. SUCCESSOR TRUSTEE
Since the original trustee of a revocable trust is usually the trustor, a successor trustee must be appointed when the original trustee dies or becomes unable to perform the duties of the trustee. No established trust will ever fail because it lacks a trustee. If the trust document does not name a successor trustee or the named successor trustee refuses to act or resigns, the court having jurisdiction over the trusts will appoint a successor trustee.
The trusts in this book contain a successor trustee provision wherein the trustor names several alternate successor trustees. In the off-chance that all of the designated successor trustees are unable to act, the trust gives the authority to the court to appoint the successor trustee.
In addition, the trusts also contain a clause wherein an incompetent trustee can be removed by a court or by a finding of incompetence by two medical doctors.
X. BOND
Unless a trust document states otherwise, a trustee is usually required by law to post a bond. It does not make sense for a trustor to post a bond when the trustor is the trustee. Moreover, when the trustor names a family member as successor trustee in the document, the trustor normally does not feel the need to spend trust funds to pay for a bond.
The trusts in this book contain a clause wherein no bond is required for a trustee named in the trust.
XI. ACCOUNTINGS
State laws require a trustee to make annual accountings on the state of the trust unless waived in the trust document. Such annual accountings make no sense when the trustor is the trustee.
The trusts in this book require that annual accountings be performed except when the trustor is the trustee. This clause gives the maximum flexibility to the trustor and provides a mechanism whereby the performance of successor trustees can be gauged. Under most states' laws all of the beneficiaries may waive accountings.
XII. SPENDTHRIFT CLAUSE
Almost all trusts have spendthrift clauses which prohibit the beneficiary's share of the trust being attached by creditors. All states will enforce such clauses to some extent.
Since the trust is revocable, it can always be attached to pay the trustor's debts regardless of a spendthrift clause. Most states do not permit an attachment until a distribution has been made to the beneficiary. However, when the trustor is the beneficiary, the trust assets are usually attachable directly without a distribution having first to have been made.
An important exception to the spendthrift clause is for court-ordered child or spousal support. All states will permit a beneficiary's share of a trust to be attached to pay such court-ordered child or spousal support. California recently enacted a law whereby a beneficiary's share of a trust can also be attached to pay a tort judgement regardless of a spendthrift clause.
XIII. NO-CONTEST CLAUSE
All revocable trusts should have a no-contest clause. This clause is similar to the no-contest clause of a will. If a beneficiary of the trust challenges the trust and loses, that beneficiary and his family lose the right to receive anything under the trust.
A no-contest clause prevents a greedy beneficiary from attacking the trust in an attempt to get more. The risk of losing everything usually prevents the beneficiary from risking the guaranteed distribution (the bird in hand).
A no-contest clause sometimes prevents the estate from being in costly litigation. Nothing is to be lost by having such a clause and a great deal of certainty can be gained.
XIV. PERPETUITIES CLAUSE
All states require that a trust be terminated within twenty-one (21) years of the life of someone living at the time of execution. States do not want a trust running for centuries, as they once did in Great Britain.
All trusts should have such a clause as a safety brake. If not for this clause, the entire trust could fail in complex estate plans. The trusts in this book contain the perpetuities clause. In addition, all of these trusts are designed to be distributed within 21 years of the death of the trustor or the trustor's beneficiaries living on the date of trustor's death.
XV. SEVERABILITY CLAUSE
The trusts contained herein have a provision stating that if any clause is unenforceable, the remaining trust clauses still remain in effect. If not for this clause, any error in any clause would render the trust null and void.
XVI. ACCEPTANCE OF TRUSTEE
Since a trust requires a trustee, the trust document should be signed by the designated trustee. By accepting the trust property and agreeing to hold it in accordance with the terms of the trust document, the designated trustee forms the trust.
When the trustor is also going to serve as trustee, the trustor must sign the trust document in both capacities: trustor and trustee.
XVII. WITNESSES FOR A TRUST
Only Florida has a statute which requires that a revocable trust created in the state be witnessed by two persons. There is case law in Florida which holds that a trust does not have to be witnessed if it is notarized. In addition to Florida, there are other states which also require that a revocable trust be notarized in order to be valid.
The purpose behind having a revocable trust witnessed or notarized is to prove or help to prove:
1. That the grantor or grantors actually signed the trust.
2. That the grantor or grantors were competent and not acting under any duress or fraud when they signed the trust.
3. That the grantor or grantors actually knew they were signing a trust.
The issue of validity of a trust comes into play only after a grantor dies. Before the grantor dies, the grantor can always alter, amend or revoke a revocable trust. Therefore, during the grantor's life the validity of the trust is unquestioned. After the grantor's death, heirs or taxing agencies may seek to set aside a trust for their own purposes. To do so, they have to prove that either the grantor did not sign the trust or the grantor did not know what he was doing when the trust was executed.
To avoid this problem, the trusts contained in