Revocable Living Trust
A revocable living trust (sometimes simply called a living trust) is a legal entity that you create using a formal trust instrument, declaring that you are holding certain property in trust. You retain the right to revoke the trust at any time, or to remove the property from the trust. Because the trust is revocable, it is treated as a fictional entity during your lifetime. You pay taxes on any trust income during your lifetime, and your creditors could access trust assets to pay your debts.
Upon your death, the trust becomes irrevocable and takes on a new life as a truly separate legal entity. Any property owned by the trust is not subject to probate, because it is not owned by you or your estate at the time of your death. However, the probate court has authority to resolve disputes about the trust, and the trust usually remains liable for your debts, including any estate taxes.
A revocable living trust does not save or defer any estate taxes by itself, but there are provisions that can be added to serve that purpose. If a husband and wife jointly create a revocable trust, then when one spouse dies, the trust is usually split into two parts: one part contains the surviving spouse's property and remains revocable, while the other part becomes irrevocable and is usually earmarked for the use of the surviving spouse. Any balance remaining at the survivor's death passes to the couple's children. Many different trust arrangements are possible, each with differing legal and tax consequences. Qualified terminable interest property trusts (QTIP trusts) and A-B trusts are examples.
The grantor can act as the trustee, but he or she needs to be careful to act in accordance with substantial requirements, called fiduciary duties. These duties include: a duty to administer the trust, a duty of loyalty to administer the trust solely for the beneficiaries’ benefit, a duty to be impartial if there is more than one beneficiary, a duty to use special skills, a duty to delegate responsibly, a duty to be a responsible investor, a duty to control and protect trust property, a duty to keep records, a duty to collect trust property, and a duty to inform and report to the beneficiaries.
If you die owning a life insurance policy on your life, the proceeds are not taxed as the beneficiary’s income for income tax purposes but are counted as part of assessing your estate tax. An irrevocable life insurance trust (ILIT) is specifically designed to hold life insurance. It is structured to prevent the policy proceeds from being subject to estate tax at your death or subject to creditor claims during your lifetime. An ILIT can be implemented to pass benefits to your children or business partners without subjecting the insurance proceeds to estate tax. It can also be used to provide liquidity to pay estate taxes or to pay off debts upon your death. If you establish a life insurance trust with insurance on your life, the trust can be maintained after your death, and provide income in a manner that you specify.
A qualified personal residence trust (QPRT) is a special irrevocable trust designed to provide estate and gift tax benefits for a personal residence or a vacation home. Our homes are frequently a large component of our taxable estate. A QPRT allows you to transfer your home to your children, resulting in a current taxable gift that is a fraction of today's value. You retain the right to live in the home for a chosen term of years and can typically act as the trustee. At the end of the term of years, the house goes to the children, free from any additional estate and gift tax. Another tax benefit is that you freeze the value of your home in today’s value, which may be greatly reduced due to today’s marketplace.
Don’t worry about outliving the term; the home will still belong to you because we can include a mandatory lease-back clause. If you are looking for a way to transfer additional tax-free assets to your beneficiaries, the lease-back can require you to pay rent at a fair market value.
A QPRT is a great vehicle to protect your home from creditors because the home is no longer titled in your name. If you still have a mortgage on the home, deciding to use a QPRT is a major decision because: (1) you will likely need to file a gift tax return each time you make a mortgage payment, as each mortgage payment is considered a current gift to the QPRT, and (2) you cannot refinance the mortgage once it is in trust.
A grantor retained annuity trust (GRAT) is a tax-favored trust designed to allow you to transfer property to your heirs without gift or estate taxes. To establish a GRAT, you transfer chosen assets to a fixed-term irrevocable trust. The trust is required to pay you an annuity for a specified term of years in exchange for the assets. At the expiration of the term of years, the GRAT terminates and the assets in the GRAT are distributed to your beneficiaries free from estate or gift tax. Under current tax laws, the annuity is much less than the value of the assets transferred to your beneficiaries. Therefore, you are able to effectively increase the amount you can give your heirs tax-free because the GRAT transfers all of the appreciation in an asset over the current interest rate to one’s children (or other selected beneficiary). Similar to the QPRT, all appreciation in value of the assets from the date the trust is established escapes gift or estate tax. Also, as with the QPRT, the GRAT results in tax benefits only if you outlive the chosen term of the GRAT. You can act as the Trustee of the GRAT you establish.
An intentionally defective grantor trust (IDGT) is an alternative to a GRAT that allows the trust assets to be excluded from an estate and allows for making tax-free or discounted gifts of appreciation of assets. In effect, it is an estate-freezing device that works well in down markets. The trust is irrevocable and set up to be defective for income tax purposes. The grantor sells an asset that is expected to appreciate to the trust and receives a promissory note in exchange. Because the trust is defective, no gain is recognized upon the sale.
If a loved ones currently receives SSI, Medicaid, or other public benefits, you must be very careful in leaving any assets to them that would jeopardize the continuation of their benefits. If you want to help and make life more comfortable for them, a special needs trust (SNT) can allow you to pass assets and allow them to collect benefits at the same time. Public benefits only provide for basic necessities, and an SNT will allow you to supplement those benefits with quality-of-life items such as: education and tutoring, dental expenses, transportation, hobby and recreation activities and supplies, vacations, entertainment, pleasure items (televisions, video games, computers, etc.), and special diet or personal care needs.
Estate planning can also include transfers for the benefit of a charity. You can make transfers to a charity either during your life or at death. The gifts can be outright or can be given in a manner which allows you to retain the right to future income or principal. Lifetime transfers to charities provide you with an immediate income tax deduction which is generally equal to the present value of the interest to be received by the charity.
A charitable lead trust (CLT) provides for income or annuity payments to be made to one or more qualifying charities for a specified term, with the remainder assets passing to the grantor or other non-charitable beneficiaries.
A charitable remainder trust (CRT) holds property for a period of time, measured either by a term of years or for the lifetime of specified beneficiaries, and generates income for you or your chosen beneficiaries. At the expiration of the chosen period of time, the property goes to a charity. The CRT is generally not subject to income tax on its earnings, thereby making it an attractive tax-savings device for highly appreciated assets that you want to sell. By transferring highly appreciated assets to a CRT, the subsequent sale of the assets by the CRT results in no income tax on the gain. The use of a CRT can actually result in greater earnings to you and your heirs than if you sell the assets outright. Particularly when coupled with insurance policies, you can pass greater amounts to your heirs than possible without the use of a CRT.
The following types of trusts can be used to smoothly transition your business from your hands to the next generation. By putting your business interests in trust, you can provide liquidity to allow continued operation and avoid disputes over control and ownership. Discussed below are a few of the methods we have available to help your plan for the continuation of a successful business.
An electing small business trust (ESBT) is useful because the trust is allowed to be a shareholder of an S corporation. The ESBT can have multiple beneficiaries and is not required to distribute all income; some can stay with the business. The drawback is that income is taxed at the highest ordinary income rate and is hit by a 20% long-term capital gains rate.
Like the ESBT, a qualified subchapter S trust (QSST) is permitted to be a shareholder of an S corporation. This shareholder trust must distribute all of the income and can only have one beneficiary.
While not a trust, a family limited partnership offers asset-protection benefits similar to a trust. It permits only general partners, not limited partners, to operate the company and perform day-to-day duties.
At Stahancyk, Kent & Hook, P.C., we will counsel you in how to protect your assets to ensure that your beneficiaries receive distributions as you intended and give you peace of mind that your wishes will be carried out during your lifetime and beyond. Click here for new client information.
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