It may be advantageous for a husband and wife to establish a living trust while both spouses are still living. This action can reduce or eliminate the estate taxes in both parties’ combined estates, skip the need for expensive and cumbersome probate action and eliminate any possible need for a conservatorship in the event of either parties’ incapacity.
The federal government has a death tax referred to as the "United States Estate Tax." This tax is based on the assets owned by a person at the time of death. Any assets passing to the spouse are exempt, regardless of value, provided the surviving spouse is a United States citizen, and any assets passing to a qualified charity at death are exempt from tax. In addition, each individual has an exemption of $1,500,000 to $3,500,000 depending upon the year of death. Any amounts above that are taxed at a rate of between 41- 47%.
Furthermore, advantage may be gained with regard to Federal Estate Tax.
If a husband and wife leave everything to each other, there is no tax at the first death, regardless of the value of their assets, if the survivor is a United States citizen. However, at the second death, if there is more than the current estate tax exemption passing to the children or other relatives, it is taxed. By using a trust, the first spouse to die may set aside up to $1,500,000 to $3,500,000 in an irrevocable trust. When the survivor dies, the surviving spouse also has a $1,500,000 to $3,500,000 exemption. Thus, with a trust, a couple can pass up to $3,000,000 to $7,000,000 to children or other parties tax free of the Federal Estate Tax, as opposed to only $1,500,000 to $3,500,000 without a trust.
Most people want to avoid the process called "probate." This is a legal proceeding designed to validate the person's will and designate the person or persons who would receive the assets. Such a procedure takes approximately 6-12 months. The court appoints a person designated as an "executor" to handle the assets and to administer the estate. The fees that the executor and attorney receive are set by law and are a percentage of the value of the assets which go through this process.
One method of avoiding probate is to hold assets in joint tenancy, or, in the case of married persons in Tennessee, as tenants in the entirety. At death, the assets pass to the survivor without any legal procedure. This works very well for husband and wife. However, there are sometimes problems with putting assets into joint tenancy with other people, such as children. A gift is sometimes made when some assets are put into joint tenancy. In addition, if an asset is put into joint tenancy with a child, the child's creditors can reach that asset if the child becomes bankrupt or defaults on his debts.
A living trust avoids the probate problem because the assets are turned over to a trustee to manage in accordance with a written trust agreement. Until the trust terminates, the assets are controlled by this written agreement. If the person dies, the trust continues. If the trustee dies, a new trustee is named. With a living trust the assets avoid probate on the death of both spouses.
If a person becomes incapacitated, and all of the assets are in the name of that person, a legal proceeding called a "conservatorship" is frequently required. This is a legal process not unlike probate. An attorney and a court become involved, with significant costs.
A living trust avoids the need for a conservatorship. The trust assets are managed by a trustee. If the trustee becomes incapacitated, a new trustee, who is named in the trust agreement, takes over. The court does not become involved.
A living trust is nothing more than a written agreement between the person or persons who establish the trust, called the "settlors" or "trustors" and the person, persons or bank who manage the trust, called the "trustee" or "trustees."
This trust agreement contains the entire framework of the trust. It provides how the trust operates while both husband and wife are alive, how the assets are divided at the first death, how the trust functions upon the death of either husband or wife, and what happens upon the death of both spouses. Payments from the trust, who receives the assets when the trust terminates, and who serves as trustee and successor trustee must be spelled out in great detail. Because part of the trust becomes irrevocable upon the death of the first spouse, a couple must carefully determine what they want done, since the surviving spouse cannot change this part of the trust later.
While husband and wife are both alive, the trust continues as a revocable trust. The couple may cancel the trust completely, amend it in any way they wish, and buy and sell assets for the trust.
While husband and wife are alive and the trust is revocable, it is not legally necessary to keep any records. Although the trust normally has attached to it a list of assets showing what was originally placed in the trust, it is important to keep this list updated periodically. If both husband and wife die, the successor trustee, such as one of the children, needs to know what assets are in the trust.
While the trust is revocable and either husband or wife is the trustee or a co-trustee, a separate tax return is not required for the trust. The husband's or wife's social security number is used, and the couple continues to report all interest, dividends, capital gains, and other taxable income and deductions on the couple's personal tax return, without reference to the trust.
One major concern is to be sure assets are placed in the trust. To get assets into the trust they must be reregistered in the names of the trustees. The registration would be "John Q. Doe and Mary S. Doe, trustees of the John Q. Doe and Mary S. Doe Trust, dated March 3, 1999."
Deeds are recorded to change title to real property (this does not trigger a reassessment for real estate taxes). Assignments of deed of trust are recorded to change title to any deeds of trust. Stock and bond certificates are mailed to transfer agents and are reregistered. Limited partnerships are contacted and title changed for those interests. Bank and savings and loan associations must be contacted and accounts changed. Stock brokerage accounts must be transferred and placed in the trustees' names.
Life insurance companies are contacted and beneficiary changes are put through to name the trust as beneficiary of life insurance policies so that at death the proceeds are payable to the trust. Because of income tax considerations, 401k plans, IRA accounts, profit sharing plans, and other similar plans are usually not payable to the trust but to the spouse or others.
Husband and wife can take as much as they wish out of the trust. They can take the dividends, interest, or other money, or withdraw funds from their bank or savings and loan accounts without the necessity of keeping records.
DEATH OF FIRST SPOUSE
Upon the death of the first spouse, the trust is subdivided into two parts, designated as "Trust A" and "Trust B." Frequently other terms are used for the trust such as "survivors trust" or "bypass trust."
Trust B consists of the decedent's portion of the trust assets. It consists of one-half of the couple's community property and all of the decedent's separate property. If the couple has $1,500,000 of community property and the husband dies, Trust B would consist of $750,000. Since the estate tax exemption is $1,500,000 to $3,500,000 depending upon the year of death, not more than the current estate tax exemption may go into Trust B. While Trust B is subject to estate tax, not more than $1,500,000 to $3,500,000 is placed in Trust B at the first death, so there is no tax due.
The remainder of the assets go to Trust A. Trust A qualifies as a marital deduction trust for the surviving spouse's benefit, so that any assets going into Trust A are exempt from taxation. Trust A is a revocable trust and the survivor can draw all of the assets out of Trust A, withdraw any amount of income or control Trust A in any way he or she wishes. The survivor can change the trust investments in any way he or she wishes.
Division of Trust
The first concern is to divide the trust assets into the two sub-trusts. To do this, all assets must be valued with their fair market value as of the date of death of the first trustor. After determining the value of all of the assets, the trustee is then able to determine the value of the assets which go into Trust A and Trust B.
If the couple has $1,500,000 in community property, $750,000 would go into Trust A and $750,000 into Trust B. If the couple has $3,500,000 of assets, $1,500,000 (2004) would go into Trust B and $2,000,000 into Trust A.
The trustee is generally free to determine the division of assets, based on their value as of the date of death. If the home is valued at $500,000, the home can be allocated all to Trust A, all to Trust B, or partially to Trust A and partially to Trust B.
All of the division of assets is done without court supervision, since there are no probate or legal proceedings.
Reregistration of Assets
The trust agreement provides who is the trustee upon the death of either husband or wife. Normally, husband and wife are the initial trustees, and upon the death of one, the surviving spouse is the sole trustee. It is necessary to reregister the assets in the name of the surviving spouse as the new trustee. Assets would be registered in the name of "Mary S. Doe, Trustee of the John Q. Doe and Mary S. Doe Trust, dated March 3, 1999-Trust A" and "Mary S. Doe, Trustee of the John Q. Doe and Mary S. Doe Trust, dated March 3, 1999-Trust B."
Trust A continues as a revocable trust for the surviving spouse's lifetime. The survivor receives as much of the income and principal of the trust as desired, can change the provisions of Trust A or cancel the trust, and take out the assets if he or she wishes. No trust income tax returns are required, since the survivor reports all income, deductions, and capital gains and losses on his or her personal return.
Trust B, representing the decedent's assets, continues as an irrevocable trust. The survivor can be the sole trustee of Trust B, manage the assets and receive the income, and in some cases, the principal. However, the survivor cannot cancel Trust B or change any of its provisions. The survivor cannot change the disposition set up to distribute Trust B on the survivor's death.
An annual fiduciary income tax return is required for Trust B and the survivor must get a tax identification number for the trust. Normally, all earnings such as interest, dividends, and net rents are paid to the survivor, and these are taxed to the survivor and not to the trust. Capital gains are generally kept in the trust and are taxed to the trust.
The survivor can use the principal if needed for the survivor's health, support and maintenance, and can dip into principal if there is a need or emergency. The survivor does not have to justify this need, but the individuals who get the assets in Trust B when it terminates can object if funds are not used for health, support or maintenance.
With the surviving spouse as the sole trustee, the two trusts continue after the death of the first spouse. The surviving spouse can sell or purchase assets for either trust, take as much as desired from Trust A, and all of the income from Trust B. In the event of need, the survivor can use the principal of Trust B. The survivor must keep some records for Trust B, but not necessarily for Trust A. An annual income tax return must be filed for Trust B.
No accounting is required for Trust A, but the people who receive the assets in trust B when it terminates, such as the children, can demand an annual accounting of all receipts and disbursements for Trust B.
DEATH OF THE SURVIVING SPOUSE
Upon the death of the surviving spouse, the trust frequently terminates and goes to the couple's children or others. If the surviving spouse has been the trustee, a new trustee must take over the operation of the trust in order to carry out the distribution of the trust assets.
All assets will have to be transferred and placed in the name of the successor trustee who is named in the trust agreement. Upon the death of Mary S. Doe, the couple's son, Frank H. Doe is named as the successor trustee. He must reregister assets in his name as the successor trustee. No probate is necessary for the assets in Trust A or Trust B.
Federal Estate Tax
Upon the death of the surviving spouse, the assets in Trust B are not subject to estate tax since they were subject to estate tax at the first spouse's death (although there was no tax due). However, the assets in Trust A are subject to the federal estate tax. If the fair market value as of the date of death of the surviving spouse of the assets in Trust A and any assets owned by the surviving spouse outside of the trust are more than $1,500,000 to $3,500,000, depending upon the year of death, there will be a tax due.
The successor trustee must determine if any tax is due and file an estate tax return within nine months of the survivor's death if a tax is due.
Distribution of Assets
The assets in Trust B are distributed to the people who are directed to receive them. If the trust agreement states that the assets go to the couple's three children, the successor trustee must reregister these assets in the children's names and deliver them to the children.
The surviving spouse has the option of changing the disposition of the assets in Trust A. Since Trust A continues as a revocable trust for the survivor's lifetime, the survivor has the right to determine who receives the assets in Trust A at the survivor's death. If the survivor elects to do nothing, then the assets in Trust A follow the disposition of the assets in Trust B -- to the couple's children.
Even though a couple has a living trust and places all of their assets in the trust, they should still have wills. The wills cover assets which are not in the trust, such as furniture, jewelry, cars and some bank accounts out of the trust. There are certain legal exemptions.
Normally, the will leaves furniture, furnishings, and personal effects as well as automobiles to the surviving spouse and then to children. Any other assets are added to the trust to follow the provisions of the trust for children, grandchildren, etc. This type of will is referred to as a "pour-over" will.
Upon the death of the surviving spouse the trust frequently terminates and goes to the couple's children. It is possible to have the trust continue for the children's lifetime, going to their children, the trustor's grandchildren, upon the child's death. Or, when the survivor dies, a portion of the assets may be carved out as an educational trust for grandchildren. Numerous variations are possible depending upon the couple's wishes.
When the trust is signed, contingencies must be considered and written into the trust, since if one trustor dies, the survivor cannot change Trust B. Thus, if the assets go to the couple's three children upon the death of both trustors, who gets the assets if one child dies ahead of the surviving parent must be provided for and listed in the trust agreement.
The question of trustees also must be fully considered. Generally, husband and wife are the co-trustees when the trust is set up. Upon the death of either the surviving spouse is usually the sole trustee. When the surviving spouse dies or becomes incapacitated, a successor trustee must be named. Frequently, this is one or more of the children. If the child is deceased, another successor trustee must be named.
As the trust lasts longer, there needs to be more concern for who will be the trustee. If a trust continues for a child's lifetime, possibly some 40-50 years, careful consideration must be given to naming successor trustees. If no one is named as trustee, the court is petitioned to name a new trustee.
Living trusts are not for every couple. Although they save death taxes, avoid probate, and avoid the need for a conservatorship, they do require work on the couple's part. A trust agreement with new wills must be prepared. The couple must change title to many of their assets and put through change of beneficiary forms for life insurance.
After death of one spouse, the survivor must divide the trust, keep records, and file an income tax return for Trust B. The survivor cannot change the provisions of Trust B after one spouse dies. If a couple feels that the benefits outweigh the disadvantages, then they should explore the possibility of establishing such a trust.