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Estate
Planning Trusts
Note: In all cases, when implementing a will
or a trust, legal advice is a must!
Life’s Defensive Moves!
It's Called a What?
Interpreting Estate
Planning Trusts
Special thanks to Jefferson Pilot Financial.
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Trusts bring
life to estate planning, but understanding how one trust differs
from another is not easy. And those names! They are amalgams of
words and initials that only raise questions.
Making trusts
fulfill estate planning goals and dreams can be science and art. By
understanding the practical science of trusts, a planner can
understand why a trust may be appropriate, how a trust functions,
and how to offer the best trust solution.
Following is
a review of the fundamental elements of trusts and characterizations
of popular estate planning trusts. Using these fundamental elements
can be a great help in deciphering the purpose, strategy, and tax
treatment of different trust arrangements.
Trust Fundamentals
Parties
Trusts have
three parties known as the grantor, the trustee, and the
beneficiary.
The
grantor,
also known as the creator
or settler, is the person that creates the trust, names the other
parties, selects the trust's provisions and initially funds the
trust. A grantor may be an adult individual or an organization.
The
trustee
is the person
empowered to administer
the trust, manage trust assets, and act for the benefit of the trust
beneficiaries. The trustee's powers are listed in the trust
document and in state law. A trustee may be an adult individual or
an
organization, such as a bank or trust company.
The
beneficiary is the person that receives
the benefits from the trust. Often, the trust will name multiple
beneficiaries. Sometimes these beneficiaries are divided between
income beneficiaries and
remainder beneficiaries. Income beneficiaries typically
receive the income and possibly small amounts of principal, for a
stated period of time or for life. Remainder beneficiaries
typically receive the principal, any accumulated income, and all
remaining assets of the trust at the end of
the
term.
Creation
Trusts can be created at two times: during the grantor's life,
known as an
"inter vivos"
trust or a living trust, and at the grantor's death, known as a
testamentary
trust. Grantors typically draft trust documents
(known as trust agreements, Deeds of Trust, or Declarations of
trust) with an attorney and sign them at the end with any required
seal or witness. Testamentary trusts are
created in a
will.
Funding
The trust becomes a separate legal entity when the terms are
established in the trust document and the trust is funded with
assets that are delivered to the trustee. Often, trusts are
nominally funded with $10 or $100, and then are subsequently funded
with larger amounts of assets, life insurance proceeds, or by will.
Tax Treatment
What makes trusts complicated are the tax laws associated with
them. Trusts can be classified differently for income tax and
transfer tax purposes, so we'll look at each of these separately.
Federal Income Tax:
The income tax on trust income must be reported and paid by one of
the three trust parties: the grantor, the beneficiary or the
trustee. To determine who pays the tax, income tax law classifies
trusts as a grantor trust, a simple trust, or a complex
trust.
A grantor-type trust is treated for
income tax purposes as if the grantor owns the trust property. The
grantor is subject to tax on the income of the trust. A simple trust
is a trust that distributes all of its income every year to a trust
beneficiary. The income tax on the income also goes to the trust
beneficiary. The trust is treated as a pass-through entity,
receiving income and passing it through to the beneficiary. The
trust will report the distribution, the taxable portion, and the
type of income (such as capital gains, dividends, and ordinary
income), to the IRS and to the beneficiary.
A complex trust may accumulate income.
If it receives income and distributes it in the same year, then the
beneficiary pays the tax as described above for a simple trust (as
a pass-through). However, if the trust accumulates income, it must
pay the tax on the income that accumulates. The trust is generally
subject to the same rules as individual taxpayers, except that it
has a very small exemption amount and is almost immediately in the
top tax bracket of 35%. A trust's income tax rates on dividends and
long-term capital gains are currently 15%
Federal Gift
and Estate Tax:
Although a trust is a
separate legal entity, it may or may not be treated as a separate
entity for transfer tax purposes. The distinction is often based on
whether the trust is revocable or
irrevocable.
A revocable trust is treated as owned by the grantor for transfer
tax purposes and is included in the grantor's taxable estate when he
dies. Transfers from the grantor to a revocable trust will not be
considered a gift or bequest. However, any transfer from the trust
to another person will be treated as a gift or bequest from the
grantor at the time of distribution. If a revocable trust becomes
irrevocable, then a gift or estate transfer occurs at the time it
becomes irrevocable.
An irrevocable trust is a separate legal
entity and, unless the grantor has retained certain powers over
those assets, the assets in the trust are not included in the
grantor's estate. Transfers to the trust are treated as gifts
(transfers during life) or bequests (transfers made upon death).
Gifts to an irrevocable trust are treated as gifts to the trust
beneficiaries.
Combining Advantageous Tax Treatment:
Because
the
income tax and transfer tax are two separate tax regimes, it is
often possible to combine the preferred income tax treatment into a
well-drafted irrevocable trust. For example, an irrevocable trust
may be drafted so that income tax is paid by the grantor, the
trustee, or the beneficiary. Examples may be found in the trust
descriptions below. However, revocable trusts are, by definition,
grantor-type trusts for income tax purposes; no other income tax
treatment is available until the trust becomes irrevocable.
The tax identification number used by the trust
usually depends on whether it is a grantor-type trust for income tax
purposes. A grantor-type trust may use the grantor's Social
Security number or may obtain its own Employer Identification
Number from the IRS. Any other type of trust must obtain and use an
EIN. Trustees may obtain EINs from the IRS immediately by phone or
website.
Author’s note: The intent of this article by termlifeamerica.com is to
inform and motivate the general public into action.
One should consider only a qualified practicing legal individual or
entity, in the state in which you reside, to establish properly
drawn documents of this type.
SEE
►
Estate Planning Brochure
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