TOP TEN TRUST TRICKS
Part I
THE BASIC TAX TRUSTS
by
JERRY FRANK JONES
Austin, Tx
Copyright 1995
ALL RIGHTS RESERVED
Trusts are the greatest invention since sliced bread. Trust are
more flexible than a politician. Trusts accomplish a variety of
estate planning purposes.
A trust is simply one person's promise to hold property for the
benefit of another. A trust can go into effect during your life
(an intervivos trust) or at your death through your will (a
testamentary trust). An intervivos trust can be revocable (you
can change your mind and shut it down or change its terms) or it
may be irrevocable (make sure you have it right because you can't
change it).
The basic estate tax building blocks are:
1. By-Pass Trust (also known as "Credit Equivalent Trust" or
"Credit Shelter Trust".
The Federal Estate Tax allows a person to pass during
his life and upon his death, a total of $600,000 to any
person or persons without taxation. If a husband and wife
have a community estate of $1, 200,000, they can pass all
of that to their children without taxation by using a By-Pass
Trust. On the death of the first spouse, rather than
leaving $600,000 to his spouse, he leaves it to a By-Pass
Trust. The By-Pass Trustee can be the surviving spouse.
The beneficiaries during the life of the surviving spouse
can be the surviving spouse or the surviving spouse and the
children. The surviving spouse can have a special power of
appointment. Then, on the death of the surviving spouse the
property goes to the children without taxation. It is not a
part of the surviving spouse's gross estate (it by passes
her estate for purposes of taxation). Thus, each spouse has
transferred $600,000 to their children without taxation.
2. Marital Deduction Trust. Like the By-Pass Trust, these can
be created in your will or in an intervivos trust ("Living
Trust" or "Loving Trust"). The estate tax law allows you to
give as much property to your spouse as you want without any
taxation (the unlimited marital deduction). Any property
qualifying for the marital
deduction, to the extent it is around, must be included in
the gross estate of the 2nd spouse: Uncle Sam wants at
least one opportunity to collect his tax.
This can be done by an outright gift, but it can also be
done by trust. The two most common marital deduction trusts
are the "QTIP" trust (Qualified Terminal Interest Property)
and "QDOT" trust (Qualified Domestic Trust ). A QTIP Trust
typically arises there are children by a prior marriage.
The QTIP must give the surviving spouse all of the income
for life and may allow principal invasion. On her death, it
passes to the children. The QDOT Trust is required if your
spouse is a foreign national. IRS wants to make certain
that they are able to collect their tax on the trust after
the surviving spouse has died. In the past, they have had
problems with surviving spouses moving back to their
original country and never being able to find the property
for subsequent taxation. Thus, to get the marital deduction
for a foreign national surviving spouse, the property must
be in a trust that insure its ultimate taxability.
Primarily, it requires a responsible trustee that is a U.S.
corporation or citizen.
The Marital Deduction Trust and the By-Pass Trust are the
basic building blocks of any estate plan for a couple with a
taxable estate ($600,000 or more).
3. Generation Skipping Trust. Like the By-Pass Trust, this
allows avoidance of taxation of your assets again when your
children die. The typical Generation Skipping Trust also
includes the by pass provisions discussed in 1. above. The
Generation Skipping Trust says,
I put "X" dollars in trust for my wife during her life.
On her death, the trust shall continue for the benefit
of my child. During my child's life, my child can be
the trustee, can receive the income, can receive
principal under an ascertainable standard and can have
a special power of appointment. Then on my child's
death, the property passes to my grandchildren.
This trust is not a part of the child's gross estate and is
not taxable on the child's death. This property while
subject to tax on the original death, has not been subject
to tax on the spouse's death or the child's death. It is
not subject to tax again until the grandchildren die. This
is sometimes referred to as a "Dynasty Trust."
Part II
THE GIFTING TRUSTS
by
JERRY FRANK JONES
Austin, Tx
Copyright 1995
ALL RIGHTS RESERVED
Set out below are three trusts most commonly established during
a person's life ("inter vivos" trusts). Each of these will
reduce the ultimate estate tax.
1. Qualified Minor's Trusts (aka 2503c Trust). Federal gift
tax law allows a gift of $10,000 per donor per donee per
year of present interest gifts. For example, a husband and
wife can give $20,000 to each of their children during 1995;
then they can give another $20,000 to each child in 1996.
The "present interest" requirement means that the recipient
must be able to use the property immediately. You must hand
the $10,000 to Sonny immediately. You cannot give the
$10,000 to Uncle Joe to hold and turn over to Sonny next
year or when he turns 30. However, an exception is made for
minors. The law recognizes that we cannot and do not want
to give $10,000 to a child. Thus, the exclusion can be
obtained by putting the $10,000 into a Qualifying Minor's
Trust (sometimes called a 2503c trust). To qualify the
trust:
a) must have only 1 beneficiary;
b) must terminate when the beneficiary reaches age 21
and
c) if the child dies before age 21, the trust must
pass to the beneficiary's estate or he must have a
general power of
appointment.
The advantages of this transfer are great: The income may
be taxable at the child's lower rate, no charge is made
against the parent's $600,000 exemption equivalent, and the
transferred asset will not be taxed on the parent's death.
2. Irrevocable Life Insurance Trusts. Because life insurance
often is of little use to the owner during his life, it is
a great planning asset. If you have life insurance that you
do not presently need (it is not security for a loan or you
do not expect to borrow from the cash surrender value) and
you have a taxable estate, it should be transferred to a
life insurance trust.
If you transfer the policy to a properly crafted trust, it
will not be a part of your gross estate on your death.
Further, you can typically transfer it to the trust for a
fraction of its death benefit value. The transfer value is
the amount an insurance company would charge for the policy
on the date of the gift (the "interpolated terminal
reserve"). Generally, this translates into the cash
surrender value plus the unearned premium.
For example, a typical $100,000 life insurance policy might
have a cash surrender value of only $5,000 and an annual
premium of $1,000.. While slightly oversimplified,
transferring that life insurance policy to a trust
immediately after the annual premium would represent a gift
of only $6,000. However, on death, you have avoided
taxation on $100,000.
To maintain the policy the insured can transfer money to the
trust. However, extreme caution should be exercised. IRS
hates how effective these trusts are and has a long history
of challenging how they are administered. Basically gifts
should be made at a time other than the due date of the
premium and for amounts other than the premium amount.
Under no circumstances should the insured pay the premium
directly; nor should the trustee endorse the check over to
the insurance company.
The transfer of the original policy and the subsequent gifts
of money to the trust are not present interests. The
beneficiaries don't get anything until the insured dies.
But, the present interest exclusion can be obtained if
"Crummy" provisions are included. The "Crummy" provisions
(named after the IRS court case involving Dr. Crummy's
trusts) allow the beneficiaries to withdraw the gifts if
they want to. Allowing immediate withdrawal turns the gifts
into "present interests."
The beneficiaries rarely exercise this right. They know if
they do, there will be no more gifts.
3. Charitable Remainder Trusts. This is an increasingly
popular device. It allows a person to make charitable
gifts, to enjoy an income tax deduction currently and to
insure income to themselves. In its simplest form, a person
transfers $500,000 of property to a Charitable Remainder
Trust. The terms of the trust indicate how much the grantor
wants to receive each month (or each year) for the rest of
his life. Then, taking into consideration the age of the
grantor and the current interest rate, the value of the
remainder interest is calculated.
The amount of the remainder interest is currently deductible
on the income tax return. For older people without
children, this is sometimes the very best planning technique
available. Its first cousin is the charitable annuity.
There a gift is made to a charity in exchange for the
charities' promise to pay a certain amount per month for the
life of the beneficiary. With both of these devices, for
older people it is possible that they can receive more
income per month than retaining the property in a CD.
TOP TEN TRUST TRICKS
PART 3
THE NON TAX TRUSTS
by
JERRY FRANK JONES
Austin, Tx
Copyright 1995
ALL RIGHTS RESERVED
There are reasons for creating a trust that have nothing to do
with taxation. The trusts set out below illustrate how important
trusts can be for even a person of modest means.
1. Ancillary Trust. If you have real estate in another state,
an Ancillary Trust can save you the cost of a second
probate. If you live in Texas and all of your property is
in Texas, your will can be probated in Texas. However, if
you also own a condominium in Colorado, you need some means
of transferring title. Usually that is the probate process.
You can avoid the second probate by placing the Colorado
condominium in a Texas trust (the ancillary trust). This is
a trust created under Texas law; then the Colorado property
is deeded to the trust. Then, at your death, the title to
the real estate is in the trust and not in your name. As a
result, no probate is needed in Colorado: The owner (the
trust) did not die. And, in fact, all the new trustee has
to do to transfer or otherwise deal with the property is
prove his successorship and sign the necessary documents.
2. Standby Trust. It is a fact of modern life that over 50%
of us will go through a period at the end of our lives where
we cannot care for our own affairs. It is an important part
of estate planning to anticipate this vulnerable period by
making prior arrangements for the care of our assets. The
simplest of alternatives is to create a durable power of
attorney where you appoint someone to have control over your
assets.
A more sophisticated technique is to create a power of
attorney that (among other things) gives the authority to
transfer assets to a trust. And then to create a trust that
has only a nominal asset transferred to it at the present
time. The understanding is that if and when you become
disabled, that the power of attorney holder will transfer
all of the assets to the trust for management. Because
third parties are more comfortable with trusts, standby
trusts are generally more effective than powers of attorney.
Banks and other institutions will more readily deal with a
trust and trustee than persons holding powers of attorney.
Further, with trusts you can in more detail spell out the
relationships and duties between the trustees and the
beneficiary/grantor.
3. Management Trust. Sometimes a person merely wants someone
else to manage their assets for them. Quite often this is
why a trust department is hired. The trust created that
spells out the duties and relationships between the trust
department and the customer is a management trust. It makes
clear that the trustee is responsible for managing the
assets.
Sometimes people use this trust to "train" their children to
manage assets. It is an excellent vehicle to teach the
child how to manage money without losing control. If the
child is not careful or acts contrary to the parents wishes,
the trust can be revoked or the child removed.
4. Medicaid Trusts. To qualify for nursing home benefits under
the federal medicaid program, you must have very limited
resources. What is and what is not a "resource" is
established by the medicaid guidelines. In 1993 Congress
enacted a series of new laws effecting eligibility for these
benefits. Before 1993 only a testamentary trust or a
special needs trust was a non-resource for medicaid
purposes. Now there are several that are not counted
against a person in qualifying for government benefits.
a. Testamentary Trusts. As with the prior law, any
properly drawn trust created by will is not a resource.
Thus a husband can establish in his will a trust for
the benefit of his wife and not have the trust assets
count against her when qualifying for nursing home
benefits. These assets can be used for the wife,
within certain limits, to supplement her government
funded care.
Medicaid has an income test as well as a resource test.
If you receive too much income (or other benefits) in
any one month, you lose your benefits for that month.
All distributions from the trust to the spouse (or for
her benefit) is counted as income. In making
distributions the trustee has to be careful not to
exceed the guidelines in any one month.
b. Under 65 Disabled Trusts. A disabled person under age
65 can now create a trust for himself (or herself) and
not have those trust assets counted as resources. The
disabled person can have limited distributions from the
trust during his life like those allowed for
testamentary trusts. To the extent trust assets are on
hand at the death of the recipient, the government is
entitled to recover its medicaid expenditures from the
trust. Oddly enough once a disabled person reaches age
65 they cannot create this trust.
c. Miller Trusts (aka QUIT trust). As noted before, to
qualify for medicaid not only must your resources be
limited but also your income. Sometimes this results
in a person not being eligible for nursing home
benefits, but not having sufficient funds to pay for
nursing home care.
The new federal statute now allows the transfer of all
income into a trust. The trust can be used to
supplement the recipient during his life as discussed
above. However, on the recipient's death, the
government must be reimbursed.
d. Nonprofit Association Trusts. The 1993 act also
allows a recipient to transfer his or her assets into a
pooled asset trust established by a nonprofit
association for disabled persons. Again, any amounts
on hand at the recipient's death are subject to
reimbursement.
e. Disabled Child Trusts. Finally, the 1993 act allowed
a parent to transfer assets to a trust for the sole
benefit of a disabled child. The parent would then be
immediately eligible for nursing home benefits. The
child would be entitled to distributions from the trust
for the child's lifetime. On the child's death, the
govenment would again be entitled to reimbursement.
f. Special Needs Trusts. As before the 1993 act, a third
party can create a special needs trust for the medicaid
beneficiary. Typically this allows the trustee (in its
sole discretion) to make distributions for the benefit
of the recipient for needs not provided by governmental
benefits.
Mandatory Recovery. Prior to 1993 each state could
establish its own rules about recovering medicaid benefits.
Now Texas is obligated to pursue reimbursement from the
probate estate of the medicaid recipients.
To date a person's home has not been counted as a "resource"
in determining eligibility. Further, until 1993 the home
was allowed to pass to the recipient's heirs at death
without reimbursment. You may recall that several years ago
someone in the State legislature proposed recovering those
expenses from the recipient's home on their death. That
proposal met with a firestorm of objection and was quickly
withdrawn. No one has even suggested taking the home since.
But now with the mandatory recovery requirement that may
change.
This area has been complicated and has now become even more
so. However, there are a great many opportunities for
planning.
As you have seen, trusts are wonderful devices with a great
deal of flexibility. They are most useful when coupled with a
thoughtful plan about managing your estate and planning its
ultimate disposition.
Copyright 1998 by Glenn M. Karisch Last Revised May 15, 1998