Posts Tagged ‘bypass trusts’

Weighing Estate Tax “Portability” Against the Bypass Trust

NOVEMBER 9, 2015 VOLUME 22 NUMBER 41

Here’s a challenging problem for lawyers who focus on estate planning: how can we explain federal estate tax “portability” to clients in a way that helps them figure out how the concept applies to them? After five years of experience with the idea, you might expect us (collectively) to be better at this.

When Congress introduced the idea of estate tax portability in 2010, it was partly to simplify estate tax planning. In the decades before that development estate planners regularly found themselves explaining the idea of a “bypass” trust — although some favored “credit shelter” or “exemption equivalent” or “A/B” or “decedent’s” rather than “bypass.”

The bypass trust idea was not all that complicated, but it was not intuitive. First, it was only important for married couples. Second, it was much more important for couples with a taxable estate — though that included a lot more people twenty years ago than it does today. For married couples worth more than the estate tax exemption amount, though, the bypass trust was almost universal.

Here’s the basic idea: when one spouse dies, his or her share of assets subject to the estate tax — up to the amount of the estate tax exemption in place at the time of death — could be put into a trust that was treated as taxable. Since the amount going into the trust would be less than the tax limit, the amount of tax would be $0. That money would then not be taxed in the surviving spouse’s estate when she or he later died. It was fairly easy to double the estate tax exemption amount, in most cases, using the bypass trust.

Now “portability” makes that planning moot — or it seems like it might, anyway. When a spouse dies under the new rules, any unused estate tax exemption equivalent figure is passed on to his or her surviving spouse. It’s brilliantly simple in concept, but a little harder to apply in the real world (as it turns out).

Let’s consider an imaginary couple under the new portability rules. We’ll call them Dick and Jane, and they are worth a total of $8 million. Their estate plans simply leave everything to each other. When Dick dies in 2016, his $4 million (we’re going to keep Dick and Jane simple — they own every single asset jointly, with a 50/50 interest) simply passes to Jane outright. It won’t matter, for our purposes, whether that happens by his will, by the operation of joint tenancy, or by the terms of their trust or trusts.

Dick has used none of his $5.45 million estate tax exemption equivalent (that’s the new number for next year, if you didn’t already know it). Jane inherits his $4 million AND his $5.45 million in unused exemption amount. If her estate grows before her death, she still won’t owe any estate tax — even though she will be worth more than the $5 million adjusted-for-inflation figure in the year of her death.

Under the old rules, Dick and Jane would have needed to pay someone to prepare their bypass trust plan, Jane would need to actually divide the trust assets on Dick’s death, and Jane would need to give accounting information to Dick and Jane’s children for the rest of her life, while also filing separate income tax returns for the bypass trust. What a nuisance — and good riddance.

But wait. There are still times when the bypass trust is important to consider. Why? Because there are some limitations in the use of portability. Those limitations include:

  • The need to file an estate tax return. Jane can’t elect the portability option after Dick’s death unless she files a federal estate tax return — it’s a nuisance and an expense. She’ll need to get at least some valuation information for all their assets, even though no tax will be due.
  • State estate taxes. Arizona doesn’t apply an estate tax, and if Dick and Jane lived here, Jane decides to stay, and they own no assets in other states, then Jane won’t much care about state estate taxes. But what if she plans on moving, or they own a summer cottage in a state with an estate tax, or there is some other reason to worry about state taxes? Sometimes the bypass trust might be a better option.
  • Future changes in the law. It seems unlikely that estate tax levels will drop below the current $5 million plus. But then it seemed unlikely that they would go up to $5 million, too — and yet they did. Future tax rates might change, or portability might even be done away with. The bypass trust option locks in Dick’s estate tax status as against those possible changes.
  • Generation-skipping tax. If Dick and Jane intend to leave the bulk of their estate to grandchildren rather than children, or in trust for children and ultimately to grandchildren, they might want to rethink relying on portability. Why? Because the $5.45 million (in 2016) generation-skipping tax exemption does not have a portability feature. It’s unlikely to affect Dick and Jane, but it might — if they really plan on leaving much of their estates to the grandkids (and that could change over time, as the children age and gain wealth during the rest of Jane’s life).
  • Assurance of inheritance. Are both Dick and Jane completely comfortable with the surviving spouse’s ability to decide to leave most or all of their combined wealth to someone outside the family? If Dick simply leaves everything to Jane, he’s trusting that she won’t have a second family, or a big interest in a charity that Dick doesn’t actually care for, or a good friend who ends up receiving some or all of their wealth. Maybe Dick and Jane aren’t worried about this problem, but maybe they are — at least a little bit.
  • Growing wealth. Jane likely won’t add another $2 million or more to her wealth after Dick’s death — but she might. If she does, that could subject assets to the estate tax, and creating a bypass trust could have possibly avoided that eventuality.

Portability is a great boon to couples with straightforward estate plans and estates well under twice the taxable level. But it’s not a panacea, and it just makes the explanation process more complicated for us when we talk with couples about their estate planning. We hope this outline of the issues helps speed up that process.

What Survivor Must Do When Trust Mandates Split on First Death

SEPTEMBER 14, 2015 VOLUME 22 NUMBER 33

Once in a while we read an appellate court decision that nicely addresses a subject which isn’t the issue before the court. A recent Arizona Court of Appeals case illustrates this phenomenon nicely.

The legal issue was technical and would appeal only to lawyers — and probably only to appellate lawyers, at that. After the probate court ruled against them, some of the beneficiaries to a trust filed a motion to have the court reconsider its decision. When that also failed they appealed, but alleged that the probate court should have considered an argument similar to but different from the one they actually made. That approach was, unsurprisingly, unsuccessful.

What’s more interesting about the decision, though, is the background of the dispute. It involved a joint revocable trust that mandated division of a married couple’s assets into two equal shares on the death of the first spouse.

A little background might be appropriate here. Joint revocable trusts are fairly common in Arizona, and provisions like those involved in this case are far from unusual. Until recent years, the mandatory division was often a tax-driven decision, in order to minimize estate taxes on a married couple’s assets. Today that is less likely to be the reason for a mandatory trust split, since only very large estates face any tax liability at all and surviving spouses inherit their deceased spouse’s estate tax exemption amount, to the extent that it is unused.

The combined estate in the recent appellate case was apparently modest, and so estate taxes seem unlikely to have been the reason for the mandatory split. What other reason, then, might a married couple have for ordering a split of assets on the first death? Second marriages.

Dale and Mary were married for some years. They each had children from a prior marriage, and they owned their home in Green Valley, Arizona. In order to make sure that their home’s value was split equally between the two families, they created a trust to hold just their residence. That trust included a mandatory split into two shares on the first death, and directed that each half-interest in the trust would pass to one spouse’s children. That way they could assure the division even if the survivor lived for years after the death of the first spouse.

As it happens, Dale died first — in 2005. Mary died four years later. Though she was trustee of the trust holding the residence, she never actually divided the trust in half. She did, however, use the home as security for a loan she took out after her husband’s death.

Four years after Mary died, one of Dale’s children filed an action to compel Mary’s children to account for the administration of the trust, and to perfect the claim to half the house. The probate judge hearing the matter did not order an accounting, but did order half of the home’s value to be distributed to Dale’s children — along with $33,429.33 from Mary’s half, to make up for the fact that her children had used the residence after Mary died. The judge also ordered an offset for the loan Mary took out against the house after Dale’s death.

Mary’s children asked the probate judge to reconsider his decision, which he declined. That set up the actual legal argument in the appellate case, which (as we’ve already noted) as actually less interesting than the mandatory trust split issue. Suffice it to say that the Court of Appeals chose not to upset the probate court’s judgment directing distribution of the trust according to its terms, plus damages for Mary’s (and her children’s) misuse of the trust’s sole asset. In Re Newman-Pauley Residential Trust, August 31, 2015 (an unpublished decision).

Why is the uncompleted split so much more interesting than the actual legal issue in Dale and Mary’s trust case? Precisely because it is so commonplace.

We regularly meet with surviving spouses who have not gotten around to the division of assets mandated by a joint trust document. Sometimes the trust might include provisions that allow the surviving spouse to skip the requirement, or to undo it. But if the trust unequivocally directs such a division and the surviving spouse does not follow that direction, the courts will ultimately order a split to reconstruct what should have happened months, years or sometimes decades before.

Of course these disputes are most common in second-marriage situations, where each spouse has children — often children who were grown when the marriage took place. They also occur in family situations where each spouse is closer to one child or one group of children. Sometimes we see them when the couple operated a family business, and less than all of the children are involved in managing the business after one spouse’s death.

What is the lesson to be taken away from the dispute between Mary’s and Dale’s children? Get legal advice early, and follow it. If Mary had talked with her lawyer shortly after Dale’s death, she might have gotten direction about how to actually make the trust split. Her expectations — and those of her children — might have been set more reasonably, too. That might have saved the later dispute and attendant legal expenses.

How Increased Estate Tax Exemptions Affect Existing Trusts

SEPTEMBER 29, 2014 VOLUME 21 NUMBER 35

A lot has changed in American estate planning in the last decade (as you may have already heard). Estate tax thresholds have increased to (as of 2014) $5.34 million. On top of that figure, there is a relatively new concept of “portability” of the estate tax exemption, so that married couples can (more or less) double that exemption amount in most cases. Meanwhile, Arizona has eliminated its estate and gift tax regimens altogether.

It goes without saying, but we can’t avoid saying it: if you haven’t updated your estate plan in the past decade, you should contact your attorney right away about getting that process started. You probably can get by with a simpler estate plan than you needed before, and you can probably make most or all of your decisions on the basis of what you’d like to do with your money, rather than the tax consequences.

Meanwhile, we see a lot of estate plans that have not been updated. Some of those belong to people who have died with their aging wills and trusts in place. We also see a fair number of trusts for people who died years ago, and for whom estate tax liabilities turned out to be unimportant. Is there anything that can be shed to fix tax-driven complications that are no longer needed?

Yes, as it turns out. We do have a couple caveats that need to be mentioned as we open this discussion, though:

  1. We are writing about Arizona tax and estate law, not other states’. If you live in another state, or if your trust is set up in another state, you probably ought to speak with someone familiar with that state’s laws. Keep in mind, though, that the governing law might not be obvious; if your mother wrote a trust in, say, Florida, and died in Tennessee naming a California daughter as trustee, do you know which state’s law applies? Neither do we — the answer is going to be very fact-driven, and so the first question you might want to address with a lawyer is whether you’re even talking to a lawyer in the right state.
  2. Even if Arizona law applies, or the principles we describe here are the same for the state governing the trust, be very careful about generalizing the points we raise here. Discuss them with an attorney, and be alert for the possibility that seemingly small changes in facts can yield entirely different answers.

Disclaimers in mind, we can proceed to discuss what has to be done, and what can be done, with tax-driven estate plans that have not been updated to modern tax concerns. Here are a few examples of what we see:

  • Mr. and Mrs. Johnson created a joint revocable trust in 1995. It provided that on the first spouse’s death, the trust would be divided into two separate trusts. One is called the “decedent’s” trust, and it consists of the separate property of the first spouse to die, plus that spouse’s one-half interest in community property. Since Mr. and Mrs. Johnson are only worth about $1 million, they probably didn’t need such a two-trust arrangement at all — but Mr. Johnson has now died. Mrs. Johnson doesn’t want to go through the bother of dividing assets and, knowing that the estate tax exemption is now several times their combined net worth, she wonders if she can just skip the two-trust part.
  • Mr. and Mrs. Gonzales had a very similar trust. Mrs. Gonzales died in 1999, and Mr. Gonzales actually made the division into two trusts. The “decedent’s” trust is now worth about $1 million, and Mr. Gonzales is tired of paying the annual cost of preparing income tax reports for the trust and providing accounting information to his children (they say they don’t want him to have to do that, anyway). Can he just terminate the decedent’s trust?
  • Mr. and Mrs. Lee have a very similar trust. Mr. Lee is very ill, and Mrs. Lee has been handling their trust for the past several years. The Lees are worth about $6 million. Is there anything Mrs. Lee should be doing with their trust? Assuming Mr. Lee dies before Mrs. Lee, is there anything she should watch out for?
  • Mr. and Mrs. Jorgensen also created their two-trust arrangement in the late 1990s. A very large part of their estate is in Mr. Jorgensen’s 401(k), which names the trust as beneficiary. Is there anything they ought to be thinking about?

Of course the Johnsons, Gonzales’, and Lees could have made changes to their estate plans if both spouses were alive and able to understand and sign changes in each case. But since that didn’t happen, they may be stuck with their estate plans — unless either there is language in the trust or something in Arizona law allowing changes. The Jorgensens are in a little bit different situation, as the decision to name the trust as beneficiary of Mr. Jorgensen’s 401(k) was probably driven by tax considerations that no longer apply.

Let’s deal with the authority to make changes first. We have a couple suggestions for Mrs. Lee, Mr. Gonzales and Mrs. Johnson:

  1. Read the trust. Read it again. It may be hard to parse all the rules, but it will be a productive session. Look for things like the discretion to make distributions of principal, the authority to amend the trust, and any authority the trustee (or the surviving spouse) might have to modify the trust’s terms. Nothing there? Don’t panic. But you can’t just choose to ignore the parts you don’t like.
  2. Talk to a lawyer about Arizona’s law on modification of trusts. Ask specifically about three words: modification, reformation and decanting. Arizona law now makes it easy to change trust provisions in some circumstances — but note that you may well have an obligation not to hurt the interests of the remainder beneficiaries (children, step-children or whoever receives property on the death of the surviving spouse). Know that Arizona’s trust law has changed dramatically in the past few years, and so even if you got advice that nothing could be changed a decade ago, the answer today might be different.
  3. Check with the remainder beneficiaries. They might even agree with you that modification or termination of the trust might be a good idea. Just to be safe, though, talk with your lawyer first; she (or he) might give you a specific idea to discuss with them, or might want to initiate the discussion herself.

Mr. Jorgensen: get in to your lawyer’s office and discuss beneficiary designations. While naming a trust as beneficiary of a retirement account is not necessarily bad, it is usually dangerous and should only be done when you understand exactly what you are trying to accomplish.

Our takeaway: get good legal advice before you just decide to make changes. But don’t despair, as it might be possible to modify old estate plans, even after death.

Bypass Trusts, Disclaimer Trusts and Portability in Estate Planning

MAY 6, 2013 VOLUME 20 NUMBER 18
Last week we wrote about questions we often hear from our clients in the wake of big changes to the federal estate tax structure. Almost immediately we heard from a reader asking about portability and disclaimer trusts; our reader suggested we try to explain the two concepts and how they are related. It’s a good idea.

First, a caveat: if you are not married OR if you are married but you and your spouse are “worth” less than about $5 million, then your interest in this topic is probably academic. That doesn’t mean you shouldn’t read on, but only that the explanation won’t affect you much — except perhaps to alert you if you have a more-complicated estate plan than you need.

Let’s start, as we often do, with a brief explanation of the classic A/B trust setup that prevailed in estate planning for married couples for nearly three decades. In an environment where estate taxes kicked in at the relatively low level of $600,000 of net worth, many couples had estate plans that created an irrevocable trust (sometimes called the “bypass” or “decedent’s” trust) on the first death. That typically allowed the surviving spouse to get the benefit of the money left to the trust, but not include it in her (or his) estate — thereby effectively doubling the $600,000 exemption amount to a total of as much as $1.2 million.

Of course, over the last decade the exemption amount rose from $600,000 to $3.5 million and then settled at $5 million (plus an annual increase for inflation). That meant that only couples with estates  of $5 million would need to create the two-trust setup, and that their estates would be covered up to a total of over $10 million with fairly simple estate planning.

But the other change made by the 2010 tax law (and made permanent effective this year) makes it harder to explain the planning options. That change is usually called “portability.” Here’s how it works:

Each spouse in a married couple has an exemption amount of $5 million (plus the inflation adjustment effective the year of that spouse’s death). If, say, the husband dies in 2013, with a $5.25 million exemption amount, but leaves his entire estate outright to his wife — she inherits his estate PLUS his exemption amount. She immediately has a $10.5 million exemption amount, and it goes up (or at least “her” half does) next year for inflation. No irrevocable trust needed. No fancy estate planning required. No legal fees, no accounting or tax preparation until the surviving spouse dies.

That’s a great outcome. It should save money for most married couples, and it is much easier to understand (and execute) than the two-trust solution. The hardest thing to understand about portability might just be its formal name: DSUEA (“Deceased Spousal Unused Exclusion Amount”).

There are, though, a number of wrinkles that well-informed planners need to appreciate. Note that these wrinkles do not mean that you should not rely on the portability arrangement. Most people will not be affected by them.

Generation-skipping tax. The generation-skipping tax exemption is a flat $5.25 million this year (it is also indexed for inflation). if you and your spouse are worth more than about $5 million AND you plan on leaving your assets to grandchildren, or in trusts for your children lasting past their deaths, then you might not want to rely on the portability arrangement.

Filing an estate tax return. The portability of the exemption amount is not automatic. The surviving spouse can only keep the deceased spouse’s exemption amount IF a federal estate tax return is filed. Say what? In order to get this benefit you have to file a return that almost no one else has to file, and to incur the expense of valuing assets (which would not have to be done otherwise)? Yes.

State estate taxes may not work the same way. Arizona, as we keep reminding clients, does not have a state estate tax. But a number of other states still do, and they will apply even to Arizona residents if they own real estate in one of those states. So portability may not be enough in cases where there are significant out-of-state assets.

Remarriage can cause loss of the portability exemption. Let’s sketch out a story. Martha’s husband David died in 2011, leaving his $2 million estate to Martha. She filed a federal estate tax return and claimed David’s $5 million unused estate tax exemption. In 2013, she has $10.25 million in exemption equivalent amount (David’s $5 million plus her $5.25 million). Note that she inherited more exemption amount from David than she inherited of actual estate value.

This year Martha’s wealthy parents died, leaving her their estate; she is now worth $8 million. She remarries. Her new husband, Hal, is a wealthy and very generous man; he has previously given his children a total of $5 million in gifts.

Does this story seem absurdly fanciful? Do you wish you had these problems? Do you want to tell Martha she shouldn’t have married Hal? Because if Hal dies, Martha “loses” David’s unused estate tax exemption, and gets Hal’s instead — and that could mean estate tax on a couple million of her estate. On the other hand, if Martha dies Hal inherits her unused exemption (the exact amount depends on who she leaves her estate to), making it possible for him to give several millions of dollars more to his children with no gift or estate tax consequences.

Can you just imagine the prenuptial agreement? And aren’t you glad that the estate tax system has been simplified?

The truth is, of course, that it has been simplified — vastly simplified, in fact, for individuals and couples worth less than about $5 million. That means most of us — about a quarter of one percent of American households are worth more than $5 million, according to some calculations.

What does all this say about disclaimer trusts? As we reported last week, having a back-up trust for your spouse might make sense in at least some circumstances, and one way to do that would be to give the surviving spouse the power to fund the trust by disclaiming the ability to inherit outright. But we predict that disclaimer trusts will be implemented infrequently.

Some Questions We’re Being Asked a Lot Lately

APRIL 29, 2013 VOLUME 20 NUMBER 17
You probably have read that Congress has made big changes to the estate tax system. More accurately, Congress has made “permanent” the big (but piecemeal and temporary) changes introduced over the past decade. We hear a lot of questions from our clients about what those changes mean. Here are some of the more common questions we get asked:

Should I revoke the living trust I signed a few years ago? The answer is almost certainly no, but it might require some explanation.

Trusts (and here we generally mean revocable living trusts) have been useful for the past few decades, and help address a number of concerns. They can make it easier for you to avoid the necessity of probate of your estate. They can provide more efficient and clear-cut management of your assets if you become incapacitated. They can spell out any limitations on your heirs’ access to your estate after your death. And (especially for married couples) they can help minimize estate taxes — or at least they have traditionally been useful for that purpose.

The federal government’s change in estate tax limits means that very, very, few estates of decedents will pay any estate tax whatsoever. But does that mean that your trust will no longer be helpful?

Even though your estate will likely not be subject to any estate taxes, the other benefits provided by your living trust will continue to be available. Probate avoidance is still easier with a trust. So is protection of your assets in the event you become incapacitated. So is control over your children’s inheritance.

If you had not already created a living trust, the recent changes in tax law might make it less compelling for you to sign a trust today. But if you have already created your trust, there is little likelihood that you will be better off by revoking it. The only real downside to creating a trust (in most, nearly all cases) is the cost (our fees) and the difficulty of transferring assets into the trust (the “funding” process). You’ve already incurred both of those, so it probably makes little sense to undo your trust now.

Do my spouse and I still need a two-trust arrangement? It has been common in Arizona (and other community property states) for a husband and wife to create a single, joint trust that divides into two trusts upon the first death. Those trusts are sometimes called “survivors” and “decedents” trusts, or “family” and “marital”, or more simply A and B trusts. Many practitioners think they are outmoded now — and they might be right.

The recent tax law changes make permanent the concept of “portability” of the estate tax exemption. That means that when one spouse dies, the surviving spouse gets to keep the deceased spouse’s $5 million estate tax exemption (it’s actually even better than that, since the $5 million figure is indexed for inflation and has already risen to $5.25 million). No fancy trusts are necessary to allow a combined estate of up to $10.5 million (or more) to completely escape federal estate tax.

For a number of reasons, though, some lawyers favor keeping the two-trust split in place. There might be a state estate tax to consider (there isn’t in Arizona, but perhaps you have property in another state where there is an estate tax). There is still the generation-skipping tax issue, if you are putting money in trust for your children (which we favor) or leaving money directly to grandchildren.

This issue takes a lot of individualized consideration. The answer may depend not only on the size of your estate, but also who you intend to leave your money to and whether you will be leaving it in trust. Suffice it to say that married couples with combined estates of well under the $5 million threshold probably don’t need the two-trust arrangement, while couples worth more than twice the $5 million figure likely do. But even those generalizations are uncertain — your mileage definitely might vary. Talk to your lawyer.

What if my spouse died several years ago, and an irrevocable trust was set up — do I still need to keep it going? It might well turn out that you don’t, but you may not have control over the question.

For couples worth more than a few hundred thousand dollars a decade ago, the division into two trusts was commonplace. If one spouse has already died the division might well have already taken place. If so, the irrevocable trust files separate tax returns, has its own EIN (Employer Identification Number — the trust’s equivalent of a Social Security Number) and has requirements that some form of accounting information is provided to the ultimate beneficiaries. Would it be advisable (or even possible) to terminate that trust?

It might, particularly if the total value of the irrevocable trust and the living spouse’s own estate does not exceed $5 million. Recent changes in Arizona law might make it easier to terminate the trust and save the cost and hassle of administering it. But it is not always easy to terminate the irrevocable trust, and there may be some costs associated with doing so. Talk to your lawyer. You might find yourself discussing merger, termination or “decanting” of the irrevocable trust.

Are these changes really permanent, or will we be revisiting everything again in two years? This really looks permanent — or at least permanent for the next decade or two. Can Congress revisit the estate tax? Yes, of course. Have they done so over the past fifteen years? Yes, repeatedly. Is there any move afoot to make further changes? Yes, some politicians talk about eliminating the estate tax altogether. But even with all that said, there is little indication that any serious changes are going to be discussed in the next few years. And even if Congress significantly lowered the estate tax limit, the result would be that the tax could affect a handful more than the half-percent (or so) of people who now need to worry about estate taxes.

Tax Identification Numbers for Trusts After Death of Spouse

MARCH 26, 2012 VOLUME 19 NUMBER 12
Here at Fleming & Curti, PLC, we keep tabs on what brings people to our website. We look at referring pages, at search terms and at a variety of other items. We are intrigued by what persistently tops the search-engine list. The most common search? It’s some variation of: “do I need a new tax ID number for my living trust?” (For those keeping score, the second-most-common question seems to be “can I leave my IRA to a living trust?“)

Why the enduring interest? Because the question is so much less complicated than people think it is. There is a surprising paucity of clear information about when you need to have a new tax ID number (an EIN, if you want to use the correct acronym). And much of the information out there is contradictory.

We have written about the question several times before. In 2009 we asked and answered the question: “Do you need a new tax ID number for your living trust?” Just last year we reviewed the question, along with some other reader questions, and provided a little more detail on when your trust needs an EIN. Since those two explanations the rules haven’t really changed — but your questions have gotten a little bit more sophisticated.

Several of those questions deal with the same basic scenario: what happens when a husband and wife have a joint trust, using one spouse’s Social Security number, and then that spouse dies? The answer will depend on what the trust provides.

First, a word about joint trusts for spouses: they are common in community property states (like Arizona), not as common in those states where community property principles do not apply. Remember, please, that we are Arizona lawyers, and so we write here about Arizona rules. Attorneys from other states are more than free to add their comments; we will post them as we receive them — but we are not vouching for the accuracy of their advice in states other than Arizona.

Let’s set up a scenario, drawn from our common experience: Husband and wife created a joint revocable trust, and their bank accounts, brokerage accounts, insurance — all of their assets, in fact — listed the husband’s Social Security number. They could do that because, as with a joint account outside of a trust, tax rules allow one owner’s identifying number to be used rather than having to use all owners’ numbers. But now the husband has died. What should the (surviving) wife do about the TIN (Taxpayer Identification Number)?

Before we answer, we need to know what happens to the trust on the death of the first spouse. Let’s assume, for a moment, that it remains in one trust, that the wife now has the power to amend or revoke it in its entirety, and that she is the sole trustee. In that case, the direction is easy: tell the bank, the brokerage house and the insurance company to change the name of the trustee from the couple to the wife, and to change the TIN to the wife’s Social Security number. How do you do that? Send them a death certificate and a letter instructing them to make the changes. Assume, incidentally, that they won’t — it will often take you two or three tries, several phone calls, and some wheedling to get the task done. But that’s what should happen.

What if the wife is not the sole trustee? Let’s say, for a moment, that the oldest daughter now becomes co-trustee with her mother, but that the trust remains revocable and amendable by the wife. In that situation, we have the same answer: switch to the wife’s Social Security number.

What if the wife has the power to revoke or amend the trust, but she is now incapacitated? The oldest daughter is the sole trustee, and isn’t sure what to tell the financial institutions. The answer is still the same: the trust is still revocable (even though there may be no practical way to revoke it if the only person with power to do so is incapacitated), and the wife’s Social Security number is the trust’s TIN (expect to have an argument with the financial institutions over this one). Is a bank trust department the successor trustee instead? Same answer — but with the ironic twist that the argument between trustee and financial institution will now occur between two branches of the same organization.

Sometimes a joint revocable trust becomes irrevocable on the death of one spouse. More commonly it splits into two (or sometimes three) portions, one (or two) of which are irrevocable. What happens then? The answer, as you might expect, is a little bit more complicated — and may not be the same in every case.

Generally speaking, an irrevocable trust that does not contain the assets originally belonging to the beneficiary is likely to need its own EIN. That may mean that one (sometimes two) of the trusts resulting from the death of one spouse needs a new EIN, and one just uses the surviving spouse’s Social Security number.

Let’s use a specific example: in our earlier scenario, after the death of the husband the joint revocable trust splits into a “Decedent’s” (sometimes “bypass”) share and a “Survivor’s” share. The Decedent’s Trust is irrevocable. Wife is the trustee, and she is entitled to all the income from the trust. She may even have the ability to distribute trust principal to herself, or to decide how the Trust is divided among the couple’s children at her death. But this trust is not  “grantor” trust — it gets taxed as a separate entity. Hence, it needs its own EIN, and it files its own tax returns.

Mechanically, the process of dividing the trust is a little more complicated than in our earlier scenario. An estate tax return may be required (although it may not). A division of trust assets needs to be completed (the assistance of a competent lawyer and a good accountant is essential here). The share to be assigned to the Decedent’s Trust needs to be identified, and then physically transferred into a new account — often titled something like “The Jones Family Trust — Decedent’s Trust” (yeah, we know — your name isn’t Jones. Stick with us anyway). And that new account needs to use the Decedent’s Trust’s new EIN.

Note that we said that the assets need to be transferred into the new account. Most financial institutions will insist on opening a new account, with a new account number, rather than simply changing the name on an existing account. But when the process is completed — however you and the financial institution get there — the Decedent’s Trust should be physically separated from the Survivor’s Trust, it will have its own EIN, and it will need to file tax returns. Note: it probably will not pay any tax as a separate entity — all its income will  probably be imputed to the surviving spouse.

Meanwhile, the remaining trust assets in our example will continue to use the wife’s Social Security number. It may not be crucial to change the name on that account to “The Jones Family Trust — Survivor’s Trust” (those Joneses — they end up will all the money anyway). If you long for clarity, we would certainly support a transfer of the Surivor’s Trust share into a new account, titled as part of that sub-trust, and bearing the wife’s Social Security number — even if it is not required.

Recall, please, that there are lots of variations on this basic scenario. Be careful about generalizing from this information to your precise circumstances. Our goal here is to give you some general notions about what needs to be done — we do not think of ourselves as a substitute for good, personalized legal advice. We think, in fact, that you should get some of that, because your situation might well be more complicated than you think it is. But we hope we’ve given you some idea of what your attorney will be asking you, and what he or she is likely to tell you.

Different Types of Trusts for Different Purposes

JANUARY 17, 2011 VOLUME 18 NUMBER 2
We frequently are asked to explain the differences between different types of trusts, or to analyze a trust with no more information than its type. Confusion about the differences is widespread, and we hope to provide a little clarity to consideration of trust types.

Before we embark, we have three caveats:

  1. We are not trying to list every possible type of trust here, but just those our clients most often encounter. We may expand this list over time.
  2. Just because you believe your trust is, for example, a “spendthrift” trust does not necessarily make it so. Even if the name of the trust includes one of these categories, it might be inaccurate. The type of trust is determined by the language of the trust itself, and it may take some close reading to identify a trust’s correct categorization.
  3. Most of these categories are neither magical nor exclusive. Just because we can categorize a given trust as a “spendthrift” trust, for example, it does not necessarily mean that it will be protected against all of the beneficiary’s creditors. And just because a trust is a “spendthrift” trust does not mean it could not also be a “special needs” trust, a “bypass” trust or some other category.

With that out of the way, let’s get started on a partial list of common types of trusts you might encounter (or create):

Spendthrift trust. This trust is protected against the creditors of a beneficiary. The trustee can not be compelled to make distributions to a beneficiary, or to the beneficiary’s creditors. This does not necessarily mean that the trustee is not permitted to make such distributions (after all, it might be in the beneficiary’s best interests to pay his or her debts). Even very strong spendthrift language might not be effective against some types of creditors in some states. Common exceptions adopted by state law include child support and alimony obligations or governmental debts. State laws vary widely on these lists.

“Third-Party” Special Needs trust. These trusts are usually specialized spendthrift trusts created for a beneficiary who suffers from a disability. The language of the trust will usually include a clear expression of the intent that the trust’s monies should not interfere (or not interfere too much) with the beneficiary’s public benefits, like Supplemental Security Income or Medicaid. The variation here from state to state, and from beneficiary to beneficiary, can be tremendous, so be very careful about generalizing when discussing third-party special needs trusts.

“Self-Settled” Special Needs trusts. Just to keep the confusion level high, there are also special needs trusts created by the beneficiary himself or herself. Of course, a beneficiary with a disability may have to act through a court proceeding, a guardianship or conservatorship, or a parent or grandparent. But whoever signs the actual documents, if the money in a special needs trust comes from the beneficiary’s own resources (like a personal injury settlement, or an unrestricted inheritance) then the special needs trust will be treated as a self-settled trust. That means the rules will be more difficult, both as to creation and administration of the trust. Can a self-settled special needs trust also be a spendthrift trust? What an interesting question you ask.

Bypass trust. Sometimes these trusts are called “credit shelter,” “exemption,” “decedent’s,” or just “B” trusts, but all of those names are pretty much interchangeable. The basic premise of a bypass trust is that a married couple arranges to take full advantage of the federal estate tax exemption amount, so that they can pass up to twice that amount to their heirs on the second death. That means that on the first spouse’s death a portion of the couple’s assets transfers to the bypass trust irrevocably, with some limitations on the use of the money during the surviving spouse’s life.

Bypass trusts are a special breed just now. Because the new federal estate tax law allows a married couple to retain both estate tax exemption amounts without having to create a bypass trust, there are a lot of trusts out there that may not still be needed. If both spouses are still alive it may be time to change the documents. If one spouse has already died the problems are more complicated. About the time we all figure this out (in two years) the estate tax provisions are scheduled to end automatically. We will have to wait most of those two years to find out if bypass trusts will fade out of existence.

Revocable trusts. Any trust that can be revoked — by anyone, but usually by the person who established the trust — is “revocable.” You may sometimes see the phrase “revocable living trust,” which means the same thing. If the only person who can revoke the trust has died (or become permanently incapacitated) then the trust has become irrevocable. Even if the name of the trust includes the word “revocable” (as, for instance, “The Smith Family Revocable Trust”) it may now be irrevocable.

Irrevocable trusts. The flip side of a revocable trust is, obviously, an irrevocable trust. The category just means that no one has the power to revoke the trust. That does not mean it will go on forever — if the assets held by the trust are spent or distributed, it ceases to exist even though it was irrevocable.

Grantor trusts. This term is most important in considering federal income tax liabilities, but it is often used more broadly. In a nutshell, a grantor trust is one in which the person who established the trust has retained one or more of the elements of control listed in the federal income tax code. Most important (but not the only ones) are: the power to revoke the trust, the right to receive the trust’s income and/or principal, and the role of trustee. Grantor trust rules are actually quite complicated, and are sometimes subject to some interpretation — fortunately, the shades of meaning don’t show up very often. Most trusts are either quite obviously grantor trusts or quite clearly not.

Those are some of the most common terms you might see to describe trusts. In a future Elder Law Issues we will tackle some of the less common ones, like “Crummey” trusts and ILITs, QTIP and QDoT trusts, and — well, feel free to ask us to try to describe/define your favorite trust category.

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