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Bob
Parrish C PA. P.C.
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Living
Trust ~ What It Is NOT |
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July
11, 1997
A trust is a general tool for use in financial affairs. Just as a drill is a tool to use in shop work. However not only must the drill be used in the correct manner, it must be used with the correct attachments to accomplish the job. We can use a wood drill bit, we can use a bit for using the tool as a screwdriver, we can use a wire brush we can use an orbital sanding attachment. The trust instrument can be drafted to include many different clauses to meet many different objectives. The trust’s “attachments”, or clauses allow this tool to perform the task(s) you desire. A trust is a written document just as a will is a written document. However — the trust is different in that the trust can be used during the lifetime of the grantor and the trust in many states will have a very long life — if not perpetual. The will is active only upon the demise of the person making the will and it as an entity will last only a short while (while it is in probate court). The trust document also different from a will in that one may draft many trusts, while one may have one will. The trust's "attachments" or clauses allow this tool to perform the task(s) you desire. Before one can define objectives and/or clauses, one should consider a few different types of taxes: 1. Income tax 2. Gift tax 3. Estate tax Estate
taxes: It's a fairly common misconception that living trusts
save estate taxes, but that's not the case. The trust assets
will be subject to estate tax just as if you continued to own
them outright. In fact, a living trust generally decreases
estate tax planning possibilities. For estates not subject to
estate tax, of course, this is not a negative factor. 1. Federal government for estate tax 2. Federal government for gift tax 3. Federal government for income tax of the trust or estate 4. State government for estate (death) tax 5. State government for income tax 6. State government for intangible tax 7. Probate Court for the final affairs of an individual[i] In general, let us focus on the use of what is popularly known as a LIVING TRUST. First some very general remarks about the LIVING TRUST: ·
It
is also known as a revocable trust, a grantor trust · The grantor retains very broad powers over all the trust assets during the lifetime of the grantor · The income is included in the grantor’s income — in other words this LIVING TRUST will NOT accomplish anything for the income tax planning of the grantor · The living trust bypasses probate reporting when the estate comes into existence. There will be no need for probate reports, filing with the probate court and those records that would be public with the probate reporting bypass the disclosure to the public.[ii] · The gross estate will usually include all property, assets, investments, etc. the deceased had title to, owned, and controlled, whether as sole owner or jointly. First
Focus Living Trust: This
is a trust written to bypass probate court red tape and to assist the
survivors with continuation of business affairs without the necessity of
court oversight, transferring assets, etc. There are many, many types
of trust. The LIVING trust is only one of these many trusts.
Even the living trust can be drafted to accomplish more than the
one mission of probate planning. The living trust is only a
very minute speck in the world of trusts. One must decide now what
one wants to accomplish. What do you want to
accomplish?
Reduce current federal income taxes for the grantor Reduce future income taxes for the grantor Reduce income taxes for the beneficiaries Reduce the estate taxes on the estate of the grantor Reduce gift taxes Assist with current asset transfers Assist with future asset transfers Assist with charitable bequests Make it more simple for the surviving spouse or other beneficiaries for the final affairs after the grantor's demise Protect the grantor's assets from possible litigation or collections against the grantor's estate Protect the grantor's assets from a spendthrift heir There are certain persons the grantor wants to list as beneficiaries, however those are "troublemakers" and will contest anything the grantor may do through a will
The grantor desires to direct the use of the money
The grantor desires to help reduce all expenses — current income taxes, future income taxes, reduce probate costs, reduce gift taxes, reduce estate taxes, reduce federal, state and local taxes, reduce the legal and
accounting fees for probate, reduce estate administration costs, reduce my potential for losses due to litigation or creditors.
Estate taxes If you expect no estate tax, then you may find the
alternatives to the Living Trust are more beneficial than the
Living Trust. In other words if one believes the estate is
a simple one, then perhaps you should not use the Living
Trust. Call Bob Parrish CPA or see your adviser. ”Revocable living trusts” have become
popular estate planning tools. Whether a living trust is right for you,
however, depends on a number of factors. A living trust may benefit you
greatly, or you may be worse off with one. A living trust is a trust that you set up
during your lifetime, to which you transfer most or all of your assets.
You get the income from the trust, and also have the right to withdraw
principal. You can revoke--or cancel--the trust at any time during your
life. At death, the trust becomes irrevocable and its income and assets
are disposed of under terms specified by you in the trust papers. Why would you do this? The main advantage
of the living trust is that its assets are distributed without going
through the court probate process. That avoids a filing fee in the
probate court. Also, trustee fees generally are lower than non-family
executors' or personal representatives' fees would be. However, even if
probate is avoided there will be the expense of preparing an estate tax
return, valuing and transferring assets, and making a formal accounting
and settlement. In addition, to avoid probate, all probate assets must
be included in the living trust. If some were left out, a probate
proceeding still would be necessary. As a result, those with living
trusts usually also have a will to direct any extra property into the
trust. The Living Trust Does Not Change The Estate
Tax or the Estate Tax Return This Trust only defines who will pay income
tax on the income producing assets
The living trust will not eliminate or reduce the federal estate tax or the state death taxes. One must also consider the income taxes of the assets producing income. The income tax will be due
— "period", "end of subject". Any consultant stating otherwise (or failing to warn about the income tax) is either not telling the entire story, not seeing the whole picture, or selling
The living trust will only accomplish defining who or what entity will pay the income
tax from the income producing assets. If the assets are left in the trust and the trust becomes irrevocable" at the date of the demise, then the trust pays the income taxes and files its own income tax return. If the trust distributes its corpus, then those receiving the income producing assets will pay income tax on each one's individual income tax return. If income producing assets are in the estate, then the estate will be required to file an income tax return and pay taxes on the income in addition to the estate tax and state inheritance tax returns. Since each taxpaying entity has its own tax return - it will have its own tax bracket. These tax brackets are defined by legislation, are subject to, and will change from time to time. Whether more taxes or less taxes are owing because of the implementation of the living trust (more likely than not with a clause converting it to an irrevocable trust at date of demise) will depend upon the marginal tax rates of each of the entities involved.
Some of the other benefits and pitfalls to
consider are: ·Quicker
distributions: Probating a will and gathering assets into the estate for
distribution can take quite a bit of time. With a living trust, by
contrast, all assets already are gathered together, so the trustee can
make immediate distributions and continue paying bills as usual. ·Protecting
minors: Living trusts can help avoid the need to appoint a guardian to
represent children's interests, which can cause delay and add to
administration costs. ·Privacy
protection: Since probate records are public, the size of your estate,
and the names of beneficiaries and the amounts each received, can come
into anyone's possession. The size and terms of a living trust, by
contrast, are not necessarily public matters. ·Multiple
residences: Those with real estate in more than one state can avoid the
problems and expense of multiple probate proceedings by putting the
out-of-state real estate in a living trust. ·Income
taxes: If you create a living trust, you will be taxed on its income in
much the same way as if you continued to own the property outright. Estate
taxes: It's a fairly common misconception that living trusts save estate
taxes, but that's not the case. The trust assets will be subject to
estate tax just as if you continued to own them outright. In fact, a
living trust generally decreases estate tax planning possibilities. For
estates not subject to estate tax, of course, this is not a negative
factor.
Summary of tax
rules.--Before the specifics of each type of trust are considered,
various rules relating to trusts generally should be taken into account;
more specifically, how and when trust income is taxable to the trust,
the beneficiary, and the settlor, and how the trust property can be kept
out of the settlor's estate. The gift tax aspects involved in the
creation of trusts and the transfer of trust interests will also be
examined. This brief
summary provides a general idea of the tax rules: (1) Trusts are
generally treated as separate taxable entities, and they have their own
limited personal exemptions from income tax. (2) If all the
trust income is required to be distributed currently to the
beneficiaries, the beneficiaries are generally taxable on that income. (3) If the
beneficiary is a minor under the age of 14 and either parent is alive at
the end of the tax year, unearned income of the child in excess of
$1,300 (1996) will be taxed at the parent's top rate. (4) If trust
income is accumulated, the trust is taxed on the income received and the
beneficiaries are taxed on it when it is distributed to them under a
special “throwback” rule. This rule provides for the imposition of
the tax under a “short-cut” method “as if” the income, instead
of having been accumulated, had been distributed to the beneficiaries
when it became taxable to the trust. The beneficiaries are allowed a
credit against the tax they owe for the taxes paid by the trust on the
same income. (5) The settlor
of a living trust may be taxable on the income of his trust if at any
time it can be used for his personal or economic benefit. (6) Under Code
Sec. 644, a trust is taxable at the settlor's
tax rates on “built-in” gain from the sale of property transferred
to the trust and sold within two years of the transfer and before the
death of the settlor. (7) Trust
property is not includible in the settlor's gross estate if: (a) the
trust is irrevocable; (b) the settlor does not possess any substantial
rights and powers over it; and (c) any substantial rights or powers
retained by the settlor on the transfer were not released within three
years of the settlor's death. (8) Transfers
to living trusts are treated as gifts to the beneficiaries and are
taxable as such in accordance with the general gift tax rules Below
are a few examples where the trust was drafted such that the grantor
held authority over the trust assets, and where the grantor enjoyed the
benefits of the assets: Because of retained rights to govern enjoyment of trust property and power
to amend, alter, revoke or terminate the trust, property transferred
to the trust was included in decedent's estate. In addition, a
certificate of beneficial interest in the trust held by the decedent
also was included in his estate, to the extent that its value was not
reflected in other property included in decedent's estate. Rev. Rul. 75-259, 1975-2 CB 361. Where the language of a trust failed to give the trustee discretionary
power over payment of trust income for support of settlor's wife,
trust assets were included in decedent's gross estate. The decedent
retained the right to have trust income applied to discharge his legal
obligation of supporting his wife. Est. of S. L. Richards,
(CA-10) 67-1 USTC ¶12,463,
375 F. 2d 997. Aff'g, Dec. 27,577, 24 TCM 1436, T. C. Memo. 1966-263. CCH-EXP, FINH ¶6535.05, Determination of decedent's interest in property
at time of death.-- Determination of decedent's interest in property at time of death.-- Interpretation of Code Sec. 2033 involves the following three questions: (1) What types of property are includible in a decedent's estate? (2) Did the decedent have an interest in such property sufficient to
warrant inclusion in his estate of the value of the interest involved?
and (3) The decedent having had an interest, did he still have it at the time
of his death, and what was its extent at that time? Bob
Parrish [i] Let you and I, for a
moment, focus on the mission of the probate court.
Whenever an individual passes on, and that person owns or
controls property, then there is a need for oversight.
The oversight is the court.
The court’s responsibility is to guide the process and
assure the intentions of the decedent, as stated in the will, are accomplished. The
creditors first must be paid, including taxes.
Second the remainder of the estate assets must be distributed
in an orderly manner to the parties as directed in the will. [ii] If the LIVING
TRUST is not funded, then its purpose is lost.
If there are assets outside the living trust, then those
assets must pass through probate. Keep in this picture that merely because
probate is bypassed is not in itself the bypassing of federal estate
tax reporting. The
assets in the control of the deceased at date of demise are usually includible
in the gross estate
for federal estate tax reporting.
These two reporting procedures are very similar for the
listing of the “inventory”.
However — they may not be the same.
The fact that probate reporting is not required does not in
itself eliminate the estate tax reporting. |
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