Answers to 20 Questions on the Use of Trusts
Karl, Peter A., III, The CPA Journal
1. How are trusts formed? An inter vivos or living trust is established upon the execution of a trust document. In essence, it is a contract among the following three parties: The creator(s) of the trust, known as the settlor(s) or grantor(s),
An artificial entity, the trust, which is represented by a trustee (most often a natural person, though a corporation such as a bank or even a closely held corporation may also serve in this fiduciary role), and
The beneficiary(ies), who, while not receiving legal title to the trust property, obtains an equitable interest to the assets (i.e., the right to enforce the trust in court if the trustee is in violation of the agreement). The beneficiaries can either be the present or future recipients of benefits under the contract. In many living trusts, one spouse (or both) can be the grantor(s), trustee(s), and present beneficiary(ies).
The benefits of the trust will be underutilized if a concurrent or subsequent retitling of assets in the name of the living trust is not made. As a result, a pour-over will in conjunction with the living trust is recommended. This will directs that the decedent's assets that remain in individual name at death be transferred to the trust, which then acts as the controlling document of the testamentary plan. In addition, the will can address such areas as the designation of a guardian for minor children and the disposition of personal effects (the latter as a means of formally allocating the decedent's heirlooms not otherwise covered by a revocable trust since any anticipated dispute among beneficiaries can be resolved through probate, if necessary).
With respect to such nonprobate assets as life insurance, IRAs, and qualified plan death benefits, consideration should be given to naming the living trust as the contingent beneficiary (in conjunction with a total or partial benefit disclaimer by the surviving spouse) in order to achieve additional flexibility in post mortem trust funding (though life insurance can best be addressed through the use of an irrevocable trust-see question 14).
In comparison, a testamentary trust, using the language in a decedent's will, is initiated at death. By law, the assets vest in the trust as of the date of death. The executor of the estate is responsible for accomplishing the formality of the retitling of assets to the name of the trustee.
2. What are the benefits of living trusts?
There are as many advantages in creating trusts as there are different types of trusts. As indicated in Exhibit 1, the primary distinguishing feature among living trusts (and corresponding benefits) is whether the document provides for the trust's revocation by the settlor/grantor.
3. What are the tax considerations in the formation of living trusts?
As illustrated in Exhibit 2, the tax consequences are also determined by whether the living trust is revocable or irrevocable. This exhibit highlights the importance of treating any transfers to an irrevocable trust as an event that has tax implications (as contrasted with transfers to a revocable trust).
4. What tax traps exist when re-titling property to the name of an irrevocable trust?
From a transfer tax perspective, the contribution of property to an irrevocable trust is considered to be a gift of a future interest ineligible for the gift tax annual exclusion (resulting in the use of the unified credit or gift tax liability) unless
the trust beneficiary's income interest is paid at least annually (i.e., no accumulation of income is permitted). The annual exclusion is allowed for the present actuarial value of the beneficiary's right to receive income.
the trust is a Crummey trust, creating a present noncumulative right of withdrawal by the beneficiary for a limited period of time after the assets are contributed. This feature should be incorporated into the trust documentation along with a separate Crummey notice and waiver signed by the beneficiaries or their guardians upon each contribution to the trust. …