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Trusts

OVERVIEW

A trust is a legal instrument used to hold and manage property for the benefit of a beneficiary. Putting property in a trust transfers it from the person who creates the trust (grantor, settlor or donor) to a separate legal entity called the trust.  Upon transfer, the law considers the property that has been transferred as if it was owned by the trust. Any kind of real or personal property can be transferred to the trust.

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Trusts can be simple and intended for limited purposes or they can be complex and continue to exist for many years.

TRUSTEES

Role of the Trustee

In a trust relationship, the trustee (an individual or qualified trust company) holds property for the benefit of the beneficiary or ultimate recipient of the property.  In its simplest form, the grantor transfers property to the trustee for certain purposes and the trustee agrees to manage and distribute the property in the way specified. The trustee can be the grantor of the trust or a third party.

Choosing a Trustee

Deciding who the trustee will be is often a difficult decision and is dependent upon multiple factors. If the trust is established to provide for a child during his/her minority, and particularly where the trust estate is not large or complicated, it may be advisable to have the guardian of the child(ren) also serve as trustee. Where the trust estate will contain extensive assets or complex business interests, a more sophisticated or institutional trustee may be a better choice. Needless to say, the trustee must be an individual or entity in whom the grantor has a high degree of trust and is bondable.

Obligations of Trustee

The trustee has a fiduciary duty to act with the utmost of good faith and in the best interests of trust estate and beneficiaries. Many trust instruments require the trustee to obtain a bond so that a bonding company will be responsible to pay for any losses sustained due to improper actions taken by the trustee.

CREATING A TRUST

Testamentary Trusts

Many trusts are set up in wills and take effect upon death; others can be set up to take effect during the grantor’s lifetime.  A trust set up in a will is called a testamentary trust.  In a testamentary trust, the grantor retains ownership of the property during his lifetime and upon the grantor’s death it passes to the trustee to be administered and distributed to the beneficiaries in accordance with the trust document. While the grantor is alive, a testamentary trust exists only on paper. Testamentary trusts can be altered, amended or revoked each time a new will is executed.

Intervivos (Living) Trusts

A trust that comes into existence during the grantor’s lifetime is referred to as an ‘intervivos’ or ‘living’ trust. To set up a living trust, a writing called a ‘trust agreement’ or ‘trust declaration’ must be prepared.

Revocable Trusts

Living trusts can be either revocable or irrevocable. The grantor can terminate a revocable trust at any time. A revocable trust gives the grantor flexibility to change his mind about the beneficiaries, trust property, or even the advisability of making a trust at all, but no tax advantages. The trust property is still considered to be part of the grantor’s estate since he/she can dispose of or use the trust assets as he/she desires.

Irrevocable Trusts

An irrevocable trust is a completed transfer and gift and may have tax consequences. In an irrevocable trust, the property is permanently transferred to the trust and is no longer controlled by the grantor.  Accordingly, an irrevocable trust generally is not considered to be part of the grantor’s estate for estate tax purposes.  A trustee must file a separate tax return for an irrevocable trust.  Such trusts are often used as an estate-planning tool since property transferred by way of an irrevocable trust is excluded from the grantor’s taxable estate if the grantor properly gives up all ownership rights (incidents of ownership) to the trust property.

Trust Document- Requirements

Since a trust is a separate legal entity which holds assets for the trust beneficiaries, a trust document must be created to indicate the purpose of the trust, the names of the beneficiaries, the name of the trustee, the trustee’s rights and responsibilities, any limitations and/or directions concerning investment of trust assets, when and under what conditions disbursements can be made to trust beneficiaries, when the trust ends and to whom trust assets are distributed. Generally, trusts are executed with the same formalities as a will, i.e., they are signed by the grantor and require two witnesses.

Funding a Trust

A testamentary trust is funded with assets passing under the grantor’s will and with the proceeds of policies of insurance in which the estate or the trust has been designated as beneficiary. Living trusts can be funded through transfers of property or gifts to the trust at any time during the grantor’s lifetime. Transfers should be made through appropriate instruments of transfer, such as a deed.

Pourover Will

A grantor may fund a living trust with minimal assets and direct in his/her will that certain assets be added (poured over) to the trust upon the grantor’s death.

USES OF TRUSTS

Minors

Parents may use a trust to manage their assets for the benefit of their minor children in the event the parents die before the children reach the age of majority.  Through the use of a trust, the grantor will control the disposition of assets after his/her death by specifying the use to which the trust property is to be put, e.g., for education, health care, food, rent and other basic support.  The grantor can also choose the age at which the trust assets are to be distributed and may provide that distributions are to be made over a number of years.  Trusts can be flexible; the trustee can vary payments in accordance with the cost of living and the current needs of the trust beneficiary.

Incompetents or Beneficiaries Unable to Manage Property

Trusts are also useful to hold and manage property for a beneficiary who due to mental or physical incapacity is unable to manage the property themselves.  Through the trust, the grantor can specify what expenses the trust property can be used for and provide a source of funding for the needs of a beneficiary for many years or over the beneficiary’s lifetime.

Avoiding Probate

Property transferred to an intervivos, or living trust, prior to the grantor’s death is not subject to probate as it is not considered to be part of the decedent’s estate. The property may, however, be part of the decedent’s taxable estate if the decedent retained control over the trust property during his/her lifetime.

Estate Planning

Trusts can be used to avoid or reduce estate taxes through the use of tax-free gifts and marital deductions. Various types of trusts are used in estate planning, including the exemption trust, spousal trust, power of appointment trust and QTIP trusts.

NOTE: State laws change frequently and the following information may not reflect recent changes in the laws. For current tax or legal advice, please consult with an accountant or an attorney since the information contained in this article is not tax or legal advice and is not a substitute for tax or legal advice.

Florida Estate Taxes

Prior to January 1, 2005, Florida’s estate tax system was commonly referred to as a “pick up” tax. This was because Florida picked up all, or a portion of, the credit for state death taxes allowed on the federal estate tax return (federal Form 706 or 706NA). Under this system, when the estate’s gross value was below the minimum federal estate tax filing threshold, estate tax was not due to Florida. Federal changes eliminated Florida’s estate tax after December 31, 2004. This happened because the federal credit for state death taxes on the federal estate tax return became a deduction for state estate taxes. Since Florida estate tax was based solely on the federal credit, after December 31, 2004 estate tax was no longer due. However, the personal representative of an estate may still need to complete certain forms to remove the automatic Florida estate tax lien. Federal inheritance issues are discussed below:

Federal estate tax filing threshold

These federal filing thresholds are for informational purposes only. Please confirm with federal Form 706 instructions. Also see §2010 and 6018(a), Internal Revenue Code.
Date of Death Minimum Filing Requirements
2000 and 2001 $675,000
2002 and 2003 $1,000,000
2004 and 2005 $1,500,000
2006, 2007, 2008 $2,000,000
2009 $3,500,000
2010 $0
2011 and 2012 $5,000,000

Gift Tax

Creating a trust often involves transferring assets by way of gift. Giving gifts during one’s lifetime can be an effective way of reducing a large estate, avoiding probate and reducing inheritance taxes.  Currently federal law also exempts the first $13,000 of gifts made to anyone other than a spouse from the federal gift tax, which is an increase from the $12,000 exemption that was available in 2008. This dollar amount is referred to as the annual exclusion from gift tax. In 2010 the lifetime exemption from gift taxes was only $1,000,000 with a top tax rate of 35%, but under current law the lifetime exemption from gift taxes has increased to $5,000,000 and the top tax rate remains at 35%. These numbers, however, will only be in effect for the 2011 and 2012 tax years. In 2013, the lifetime gift tax exemption is scheduled to decrease back down to $1,000,000 and the top gift tax rate will jump to 55%.

OTHER TYPES OF TRUSTS

Charitable Trusts

Charitable trusts are created to support some charitable purpose.  Since charitable requests and gifts can operate to reduce estate taxes, they are often used as an estate-planning device.

Discretionary Trusts

Discretionary Trusts permits the trustee to distribute income and principle among various beneficiaries as the trustee deems fit.

Spendthrift Trusts

A spendthrift trust can be established for beneficiaries who the grantor believes are unable to manage their own affairs and are likely to squander or waste property that is given to them directly. A spendthrift trust does not allow the beneficiary access to the trust principal; likewise, it is exempt from the claims of creditors to whom the beneficiary may owe money.  It is therefore useful for beneficiaries who need protection from creditors or from their own excesses.

Totten Trusts

A bank account that is held in trust for a beneficiary is sometimes referred to as a ‘totten trust”.  The bank account will generally be titled “A, in trust for B”. The assets in a totten trust pass to the beneficiary immediately upon the grantor’s death.

TRUST RELATED EXPENSES

Trusts can be complex documents and it may cost several hundred to several thousands of dollars in legal fees to create a living trust or incorporate a trust into a will as part of an estate plan.  There are also additional expenses that may be incurred in transferring ownership of trusts assets to the trustee, including taxes.  Additionally, the trustee may be entitled to fees for services rendered and administering the trust estate.