A trust is an arrangement in which a trustee holds property for the benefit of the beneficiary.
There are three entities involved in a trust: the Grantor, the Beneficiary, and the Trustee. The Grantor is the person (or persons) who provides the assets for the trust. The Grantor may also be called the Settlor or Trustor. The beneficiary is the person(s) or organization(s) which are named to receive a distribution from the trust. The Trustee is the entity named to manage the trust. The trustee may be a person(s) or an organization such as a bank.
Trustee
The trust document gives the authority to the trustee to do what is directed in the trust. The trustee's duty is to the beneficiaries of the trust and is called a fiduciary duty. This means the trustee must always act with the highest degree of good faith. The trustee has a duty of undivided loyalty to the beneficiaries. The trustee must not act for his own benefit. Usually the trustee must provide an annual accounting to the beneficiaries of the trust. The trust document should state the amount of trustee compensation.
Trust document
The trust language in the document directs how the assets are to be managed and how and when the assets are to be distributed. In other words, the trust document contains the "rules" for the trust. A trust should be written specifically to the person's needs and goals because the language of the document governs the trust and assets contained within the trust.
Trust assets
The assets which are to be managed by the trust are titled to the trust. There is a split title of an asset once it is titled to the trust. The legal title is held by the trust. The equitable title or beneficial interest is held by the beneficiary.
The assets in the trust may include, but are not limited to, the following: bank accounts, real estate, bonds, stocks, CDs, businesses, cars, assets such as very valuable works of art or antiques, and personal property.
Trusts are governed by federal and state law.
Trusts are either inter vivos or testamentary. The inter vivos trust is created and exists during the person's life. The testamentary trust is created by a person's will and exists after a person's passing.
Trusts are also considered revocable or irrevocable. A revocable trust may be amended, restated, and revoked by the grantor. The grantor also has the right to regain possession of the assets placed into the trust. An irrevocable trust is one that cannot be amended or revoked. In other words, after it is created and executed, it cannot be changed.
There are many different types of trusts. The following provides information about some of the more common types of trusts.
Revocable living trust
This trust is created during the life of the grantor. It generally may be amended, restated, or revoked during the grantor's life. Upon the grantor's death or incapacity, the trust becomes irrevocable. It has many different uses. Usually, the Grantor is the only person that is allowed to amend, restate, and revoke the trust.
The revocable living trust can be used to provide a plan to take care of the grantor's needs during his life, particularly if he later becomes incapacitated and is unable to manage his own affairs. The trust can state his wishes upon incapacity including where he prefers to live, who is to make decisions for him, and how his assets are to be used. The trustee can be authorized by the trust to run a business for the grantor. The trustee can be authorized to provide for the needs of others while the grantor is alive or to continue charitable giving. The trust can also specify who is to receive the grantor's estate upon his passing. The trust is still operative upon the passing of the grantor which gives the trustee authority to continue to take care of the needs of the grantor after his passing and even thereafter if the trust does not make final distributions of all of the grantor's assets. The trust could provide for a trust to be set up to manage the assets of a minor which is to be created upon the grantor's passing. The trust may not call for direct distribution of assets but rather continue the trust to provide income to the beneficiaries for periods of time.
The trust must be properly funded in order to carry out the grantor's wishes. In other words, there is more to having a trust than just signing the documents. The assets to be managed by the trust must be properly titled to the trust.
The reasons for a revocable trust include the following:
1. To avoid probate of assets.
2. In Summit County, to allow someone other than an Ohio resident to
manage the affairs of a person upon his passing.3. To provide ease in post-mortem administration of out-of-state real
estate of the grantor.4. To provide for management and distribution of assets for
beneficiaries who are not able to manage the assets themselves.5. To prevent or lessen the need for guardianship of the grantor.
6. To provide privacy to the estate of the grantor.
7. To prevent a spouse from electing against the estate of the other
spouse. (In Ohio, upon the passing of a spouse, the surviving
spouse has the right to elect to take against the probate estate of the
deceased spouse. This prevents a spouse from cutting his or her
spouse totally out of his will. However, this only applies to the
assets that pass through the will. This does not currently apply to
the assets contained within a trust because these assets do not go
through probate. This will likely be eliminated in the future in
Ohio.)8. To allow a spouse to be certain his assets will pass to his children
after the death of this spouse. This is important with couples who
have children from a previous marriage.
There are other ways to achieve some of the above advantages. This is one of several reasons why it is best to consult an attorney versed in estate planning before purchasing a trust. Trusts are expensive so if there is an easier way to achieve the same goal, an Elder Law Attorney can tell you this.
The disadvantages of a revocable living trust include the following:
1. Cost to set up and administer.
2. Medicaid has a five-year look-back for trust transfers.
The following are tax implications of a revocable living trust:
1. All income is taxed to the grantor since he is considered the owner
of the trust corpus.2. No gift tax is generated by placing assets into the trust since the
grantor has the right to remove the assets at any time before the
trust becomes irrevocable.3. Because the grantor has not irrevocably disposed of any assets, all
of the assets are contained within his estate for estate tax purposes.
A common myth is the revocable living trust saves estate taxes. This is not true unless tax-saving measures are included in the trust. In fact, you can obtain the same tax saving measures in a Will which is properly drafted.
The reason for needing tax-saving measures is based on the estate, gift, and generation-skipping transfer tax laws.
Estate tax
Estate tax is the tax on the transfer of property when a person passes away. It is measured by the value of the property rights that are shifted from the decedent to others. The estate tax is paid by the estate. Estate taxes are assessed by both the federal and state government.
The federal government provides a credit which reduces the amount of estate tax that must be paid. Currently in 2005, the amount of this credit is $1.5 million. So if a person's estate is valued at $1.5 million or less at death and he passes away in 2005, he would owe no federal estate tax. In 2006, the credit will be $2 million. This tax credit increases over the next few years. In 2010, there will be no federal estate tax on anyone's estate if he passes away in 2010. There is uncertainty about what the amount of estate tax credit will be after 2010. It is up to President Bush and Congress to decide this issue. There is a lot of speculation about what will happen about the federal estate tax, but the fact of the matter is that no one knows. But, tax planning can be done despite the uncertainty of the estate tax law at this time.
Currently the top federal estate tax rate is 47%. Proper tax planning may eliminate or reduce the amount of estate tax owed.
Just like the federal government, Ohio has an estate tax credit. Currently this credit is $338,000.00. Ohio estate taxes are owed on any amount of an estate over $338,000.00. Taxes are calculated on a sliding scale, beginning with 7% and going down to 4%.
Gift tax
Gift tax is a tax that is assessed for all transfers or gifts made during the person's lifetime. Upon a person's passing, gifts that were made over the person's life are brought back into the estate to determine if a gift tax is owed to the federal government. However, a person is currently permitted to give $11,000 each year to as many persons as he wishes. As long as the person limits the yearly amount to $11,000 per person per year, no gift tax will be assessed for these gifts. Additionally, the federal government provides a credit for gift tax. The Gift Tax Credit is $1 million.
Ohio has no tax on lifetime gifts. However, any annual gifts greater than $10,000 per person within the three years before death are included in the estate for Ohio estate taxes.
Generation skipping transfer tax
A generation skipping transfer (GST) is defined as any transfer of property by gift or at death to any person who under federal tax law is considered a generation that is two or more generations below that of the transferor. The transferor's grandchildren and great nieces and nephews are considered two generations below the transferor. The generation-skipping transfer tax is a flat tax equal to the highest gift and estate tax and is assessed on every generation-skipping transfer. The federal government provides for an exemption from this tax as well which varies over the next few years. The amount of the GST tax exemption in 2005 is $1.5 million. There is no GST tax in 2010.
Marital/Non-marital trust
This type of trust is also called the A-B trust and has other names as well. This trust may be created for married couples. This is an arrangement designed to allow the surviving spouse to have the total benefit of the family wealth, but minimize the total amount of estate tax for both spousal estates. The trust can also minimize generation skipping transfer tax if this is needed for the couple's situation.
One spouse can give his entire estate to the other spouse without any estate taxes being assessed because the federal government and Ohio allows for an unlimited marital deduction for estate tax purposes. However upon the passing of the surviving spouse, if the combined estates of the two spouses exceed the credit for estate tax of the surviving spouse, the estate of the surviving spouse will owe estate tax. Estate tax is about 50%. To avoid this hefty estate tax, married couples may choose to execute a marital/non-marital trust.
The same principles of the revocable living trust apply. However, the marital/non-marital trust contains provisions to lessen estate tax. Generally how this trust works is that the assets of the couple are divided between the couple. Husband's assets are placed into his trust and Wife's assets are placed into her trust. If the Husband passes away first, his assets are divided into two trusts: the marital trust and non-marital trust. The amount of assets placed into the non-marital trust is the amount equal to the unified credit because the tax on these assets will be eliminated by the unified credit. The remaining amount is placed into the marital trust which is not taxed at the death of the first spouse because of the unlimited marital deduction. The non-marital trust will not be assessed estate taxes upon the passing of the surviving spouse. The assets contained within the marital trust will be taxed in the estate of the surviving spouse. The surviving spouse is entitled to the income from both trusts throughout her life as well as the income from her own trust. Other provisions are written in the trust about distribution of principal to the surviving spouse.
The advantages of a Marital/Non-marital trust include the following:
1. To prevent needless federal and state estate taxation upon the passing of the second spouse.
2. To provide management of trust assets for the surviving spouse and/or other beneficiaries.
3. To avoid probate.4. To allow a spouse to be certain that his assets will pass to his children after the death of his spouse. This is important with couples who have children from a previous marriage.
The disadvantages of a Marital/Non-marital trust include the following:
1. The cost of creation and administration of the trust.
2. The surviving spouse cannot have unlimited control or unlimited access to the assets in the non-marital trust. However, there are ways to minimize the impact of this.
Example of tax benefits of Marital/Non-marital trust
The value of Husband and Wife's combined estates is $3 million. Husband passes away in 2005 and leaves all of his estate to Wife. Wife's estate contains all of the assets of Wife and Husband and is now valued at $3 million. Wife does not pay estate taxes upon what she receives from her husband at the time of his passing because of the unlimited marital deduction (the amount which one spouse can give to the other at death is unlimited for estate tax purposes).
However, Wife passes away in 2006 and the amount of the unified credit for an estate of a person passing away in 2006 is $2 million dollars. This means that Wife's estate must pay estate tax on $1 million. The highest tax rate in 2006 is 46%.
However if Husband and Wife had had a Marital/Non-marital trust and had divided their assets between them, Husband's trust would contain $1.5 million and Wife's trust would contain $1.5 million. If Husband passes away in 2005, Husband's trust would put an amount equal to the unified credit in his non-marital trust. The amount of the unified credit is $1.5 million in 2005. Wife would still have her $1.5 million in her trust. If Wife passes away in 2006, Wife uses her Unified Credit of $2 million against her estate of $1.5 million. The net result is no federal estate tax paid on either Husband's or Wife's estates.
However, they would be subject to Ohio estate tax which taxes estates over $338,000. The Ohio estate tax rate is calculated on a sliding scale, beginning with 7% and going down to 4%.
Special Needs Trusts
This type of trust is used to plan for the needs of a disabled person. This trust must be carefully worded so that the assets titled to the trust do not disqualify the person for governmental benefits such as Medicaid and SSI.
The goal of a Special Needs Trust is to provide funds to the disabled person to supplement the income, services, and resources provided by governmental programs so that the quality of the disabled person's life is improved. The funds in the Special Needs Trust can be used for educational programs, companions, purchase of or modification to a house, transportational needs, and non-covered medical needs. The trust funds should not provide for basic necessities such as food, clothing, and shelter.
Both federal and state laws apply to these trusts.
This type of trust may be funded by the disabled person. The disabled person may receive assets to fund this type of trust from a settlement awarded to him, an unexpected inheritance, or other unanticipated funds.
One type of this trust is called a Medicaid Payback trust. This trust is established by a parent, grandparent, legal guardian, or a court. At the passing of the disabled person, the state receives the amount remaining in the trust up to the total value of medical assistance paid on behalf of the disabled person.
Another type of trust is called a Pooled Income Trust. A nonprofit organization establishes and manages the trust. However, at the passing of the disabled person, any remaining funds go to a nonprofit organization.
Charitable Trusts
There are different types of trusts that are used to make charitable gifts to reduce an estate for estate and gift tax purposes. A trust can be set up in which only a qualified charitable organization is the beneficiary. In that case, no gift tax will be assessed. The person's estate will be reduced by the amount of the gift so this gift will reduce the amount of the taxable estate for estate tax purposes.
There are other charitable trusts which provide for charitable and non-charitable beneficiaries. This type of trust can be set in one of two ways. The non-charitable beneficiary receives a fixed amount or fixed percentage annually of the trust principal with the charity receiving the remainder of the assets after a fixed period of years. The other method is to provide a fixed amount or fixed percentage annually of the trust principal to the charity and the non-charitable beneficiary receives the remainder of the assets after a fixed period of years. These trusts provide both gift and estate tax savings. These trusts must be irrevocable.
Trusts with retained interests
There are a couple types of these trusts. The trust contains a specified amount of asset which is given to beneficiaries after a specified term. While the assets are in the trust, the grantor receives a fixed amount of income at least annually. At the end of the specified term of years, the asset plus any income from the assets in the trust goes to the beneficiaries. The advantage of this type of trust is that the value of the assets placed into the trust (considered a gift for gift tax purposes) is reduced from the actual amount placed into the trust for gift tax purposes. Another advantage is that it reduces the amount of the estate by the amount of the asset. Two disadvantages include that the trust must be irrevocable and the donor must live until after the term of the trust is over. If the donor dies before the term is up, the tax advantages are lost.
Crummey Trust
Rather than gifting money to family members or friends outright as permitted by gift tax laws, an option to consider is a Crummey trust. The amount of the annual gift exemption (currently $11,000) is placed into the Crummey trust for as many individuals as one likes. An advantage of this trust is that it allows a person to put this money aside for these persons and obtain estate and gift tax savings for his estate.
The disadvantages of this are the grantor cannot be a beneficiary nor have any control over how the assets are invested. The trust is irrevocable, meaning you cannot terminate it or change it once it is executed. You could however stop making the yearly contributions. If the beneficiary has potential gifts tax concerns, the amount of money put into the trust can be reduced to ensure he does not use up gift tax exemptions for the money placed into the trust for him.
This brochure provides brief information on just a few types of trusts. The topic of trusts is a very complex subject. The information contained in this brochure should not be used as legal advice. Please feel free to contact Attorney Barbara J. Weinschenk or Attorney Margaret H. Kreiner with questions about the information contained here or if you have other questions about trusts.
