Estate Planning | VIII. Trusts

Trusts are used in estate planning to provide for the management of assets and flexibility in the operation of the plan.

Why Use A Trust?


To provide for the management of the trust property.

Creditor Protection

If property is placed in a trust with appropriate spendthrift protection provisions instead of being transferred outright, the creditors of the beneficiary will not be able to access the funds in the trust to satisfy outstanding creditor claims.

A spendthrift clause states that the beneficiary may not anticipate distributions from the trust, and may not assign, pledge, hypothecate, or otherwise promise to give distributions from the trust to anyone and, if such a promise is made, that promise is considered to be void and may not be enforced against the trust.

Split Interests in Property

This may be particularly important for clients who have most of their estate tied up in very valuable assets that they do not want to sell and do not want to divide amongst their children.

Avoiding Probate (Living Trust)

When setup in a trust, the trust will pass assets directly, avoiding probate.

Minimizing Taxes

Trusts can generate transfer and income tax savings from:
1. The transfer of future appreciation to the grantor's heir
2. The minimization of transfer taxes on subsequent generations
3. The reduction in the size of the grantor's gross estate
4. The reduction of income taxes for the donor of income produced on the transferred asset.

Trust Duration - The Rule Against Perpetuities

The rule against perpetuities states that all interests in trust must vest, if at all, within lives in being, plus 21 years.

Accounting and Income Taxation of Trusts

Income Taxation of Trusts

Trusts are treated for income tax purposes as hybrid entities. Since trustees of a trust (or the executors/administrators of an estate) are often given the discretionary right to distribute income to the beneficiaries, the trustee or executor can avoid taxation at the trust level by passing all income through to the beneficiaries.

Special Rule: If an appreciated property is sold within two years of the date of transfer to a trust, an income tax is imposed on the trust equal to what the grantor would have paid if the gain had been included in his or her income for the year of the sale occurred.

Once a trust or estate has $11,350 in 2011 taxable income it is subject to income tax at the highest marginal income tax rate for trusts and estates.

Taxable Income Tax
Income < $2,300 15% of Taxable Income
$2,300 > Income < $5,450 $345 + 25% of amount over $2,300
$5,450 > Income < $8,300 $1,132.50 + 28% of amount over $5,450
$8,300 > Income < $11,350 $1,930.50 + 33% of amount over $8,300
$11,350 > Income $2,937 + 35% of amount over $11,350

A complex trust is a trust that is permitted to accumulate income, benefit a charity, or distribute principal.

Distributable Net Income

The concept of distributable net income ensures that income earned by a trust is subject to only one level of tax. DNI equals the total income of a trust or estate for the taxable year, after making the following adjustments.

Gift Tax As Applied to Trusts

If the trust is a revocable trust, a transfer to the trust will not be considered a completed gift for gift tax purposes, and therefore will not be subject to the gift tax.

Inclusion/Exclusion From Gross Estate of Trust Assets

For estate tax purposes, the assets held by an irrevocable trust funded during a grantor's lifetime are generally excluded from the gross estate of the grantor.

If a grantor makes a transfer to an irrevocable trust, the assets of an irrevocable trust are included in the grantor's gross estate when the assets retain:
1. The right to receive income from the trust
2. The right to use the trust assets
3. The ability to exercise voting rights on stock transferred to the trust
4. A reversionary interest with a value greater than five percent of the trust
5. The right to terminate, alter, amend, or revoke the trust
6. The right to control beneficial enjoyment of the trust

Classification of Trust Arrangements

Revocable Trusts

Retains the right to revoke the trust at any time prior to his incapacity or death. A revocable trust must be inter vivos.

Irrevocable Trusts

The grantor cannot take back the property that was transferred to the trust

Inter Vivos Trust

A trust that is created during the lifetime of the grantor

Testamentary Trusts

A trust created after the death of the grantor

Standby Trust

A contingent trust that is created during the grantor's lifetime that is either unfunded or minimally funded. The trust may be used during life, times of incapacity, or at death to assist with estate administration.

Pourover Trust

A trust that receives assets from another source, generally the grantor's estate at the grantor's death.

Grantor Trust

A trust where the grantor is responsible for paying the income tax from the trust's income not the trust itself or the trust beneficiaries.

Funded or Unfunded

Technically, a trust is not considered to be in existence until it is funded. An unfunded trust is a trust that has been drafted, but not funded.

Simple or Complex

Simple trusts are trusts that mandate the annual distribution of all trust income. The beneficiaries of a simple trust pay all of the income tax on the income of the trust. To be classified as a simple trust, there cannot be any principal distributions or charitable gifts made during the year. If any occur, the trust will be treated as a complex trust for that year.

A simple trust is entitled to a personal exemption of $300.
A complex trust is entitled to a personal exemption of $100.
An estate is entitled to a $600 exemption.

Totten Trust

A Totten trust is a bank account set up in the name of the depositor, which is in trust for the named beneficiary.

Bypass Trust

A Bypass Trust can also be called a Credit-Shelter Trust, Nonmarital Trust, Family Trust, or "B" Trust. This trust is set up by a will to receive assets that will take advantage of the applicable credit amount under the estate tax laws (which is the equivalent of $5,430,000 in 2015). The trust must be written in a way so that the assets will not qualify for the marital deduction.

QTIP Trust

A QTIP Trust can also be called a "C" Trust. An election by the executor is required for QTIP treatment. The assets escape estate tax in the decedent's estate by qualifying for the marital deduction, but are taxable in the surviving spouse's estate.

Dynasty Trust

A dynasty trust is an irrevocable trust that postpones vesting and continues as long as is permitted under state law.

Specific Trusts Used in Estate Planning

Inter Vivos Revocable Trusts

All revocable trusts are grantor trusts for federal income tax purposes, requiring the grantor of the trust to pay income tax on all of the trust income.

Probate Avoidance - Revocable trusts are effective probate avoidance devices. The use of revocable trusts is important in states that have high probate costs.
Privacy - The use of a revocable trust can provide privacy for the decedent and his family.
Discourages Will Contests
Estate Taxes - Revocable trusts provide significant probate avoidance and privacy benefits, but are not effective for reducing taxes for estate planning purposes. Gift tax is due upon creation of the trust, and the entire value of the trust is included in the grantor's gross estate for estate tax purposes.

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