Bryant - Course 6. Estate Planning. 9. Trusts Flashcards
Module Introduction
An essential technique to be considered in the structure of an estate plan is a “trust.” Because of the flexibility and convenience resulting from properly implementing a trust, trusts have become extremely popular as estate planning techniques.
A trust arrangement is one in which one party (the trustee) holds legal title to property for the benefit of one or more beneficiaries. The beneficiaries are the equitable owners of the trust because they are entitled to the trust property.
The party serving as trustee has a fiduciary obligation to the beneficiaries. As the legal titleholder of the trust property (commonly called the corpus, the principal, or the res), the trustee has certain administrative responsibilities and management authority over the trust assets.
The Trusts module, which should take approximately four and a half hours to complete, will explain the different kinds of trusts, their utility, and their tax implications.
Upon completion of this module, you should be able to:
* Name the different kinds of trusts and explain how they work,
* Describe the different kinds of charitable trusts,
* Explain the tax implications of trusts, and
* Describe the conditions under which a trust terminates.
Module Overview
A trust is an essential component in the structure of an estate plan. Trusts are popular because of the flexibility and convenience with which they can be used as estate planning techniques.
A trust can be as complex or as informal as the individual establishing it. The individual establishing the trust is commonly referred to as the grantor, settlor, or creator.
Responsibility for the tax liability depends on the type of trust created.
* For example, the grantor is taxed on all appreciation of assets within a revocable trust.
* If an irrevocable trust is a grantor trust for income tax purposes, then the grantor, and not the trust entity, is considered the taxpayer.
Tax savings can occur if a trust is implemented properly, and tax can be saved in one’s lifetime in the form of income and gift tax savings as well as at death in the form of estate tax savings.
Lastly, it is important to remember that even trusts have a certain duration. Please note, however, that some states have enacted statutes that modify or nullify this rule. The rule against perpetuities will not allow a trust to go on forever. Once the purpose for which the trust was initially created is served, it terminates. But this is not the only reason or cause for termination. There are a host of factors and conditions under which a trust can terminate even before its purpose is served.
To ensure that you have an understanding of trusts, the following lessons will be covered in this module:
* Defective Trust
* Powers of a Trustee
* Types of Trusts
* Income Tax of Trusts
Section 1 - Fundamentals of Trusts
A trust may be defined as an arrangement in which a trustee holds legal title to property for the benefit of the beneficiaries named by the grantor.
A trustee is entrusted with the entire responsibility of the property as articulated by the grantor. The trustee must distribute and/or accumulate income based upon the trust’s provisions.
Ideally, any trust’s terms and conditions should be written. This reduces the chances of ambiguity and eliminates the possibility of error.
Trusts are used for purposes other than saving estate taxes - even when the estate is not large enough to be subject to tax, trusts are used to ensure that the beneficiaries have assistance in managing and investing funds.
A trust is a financial management tool that allows the grantor to coordinate the investment, use, and distribution of property during one’s lifetime and after death.
To ensure that you have an understanding of trust, the following topics will be covered in this lesson:
* Defining a Trust
* Trust Elements
Upon completion of this lesson, you should be able to:
* Define a trust,
* Explain the role of a trustee,
* List the requirements of a trust,
* Explain the conditions of a trust, and
* Explain the advantages of a trust.
What are the five elements of a trust?
Defining a Trust
A trust arrangement is one in which one party, the trustee, holds legal title to property for the benefit of one or more beneficiaries.
There are five elements of a trust:
* grantor,
* trustee,
* corpus (or res),
* terms of the trust, and
* beneficiaries.
Match the descriptions on the right to the correct corresponding elements on the left.
Beneficiary
Grantor
Trust Terms
Corpus
Trustee
* The written instrument of a trust’s provisions.
* Any person who transfers property to and dictates the terms of a trust.
* A party to whom property is transferred by the grantor and who receives legal title to the property placed in the trust.
* A party that will benefit from creation of the trust and will receive direct or indirect benefit of the use of the trust property and/or income.
* The amount of principal in a trust.
- Trust Terms - The written instrument of a trust’s provisions.
- Grantor - Any person who transfers property to and dictates the terms of a trust.
- Trustee - A party to whom property is transferred by the grantor and who receives legal title to the property placed in the trust.
- Beneficiary - A party that will benefit from creation of the trust and will receive direct or indirect benefit of the use of the trust property and/or income.
- Corpus - The amount of principal in a trust.
Describe the role of Trustee
A trustee is a party to whom property is transferred by the grantor, who receives legal title to the property placed in the trust, and who generally manages, distributes, and accumulates income and principal as per the terms of a formal written agreement (called a trust instrument) for the benefit of the beneficiaries.
As a fiduciary, the trustee must hold the property, invest it, distribute its income, accumulate income if necessary, and render any services required by law. This is to ensure that the beneficiaries receive the enjoyment and use of the property equitably.
* Someone other than the trustee may be required to pay tax.
* The trustee may be required to file a tax return.
Define and describe Beneficiary
A beneficiary is a party for whose benefit the trust is created and who will receive the direct or indirect benefit of the use of income from and/or principal of the trust property, as follows:
* Income beneficiary: The beneficiary who receives income, generally for life or a fixed period of years or until the occurrence or nonoccurrence of a particular event.
* Remainder person: The ultimate beneficiary of trust property (can be the income beneficiary).
However, depending upon the trust’s provisions, as articulated by the grantor, even a lifetime beneficiary may not automatically receive all income. The grantor may leave this to the discretion of the trustee.
Define Inter Vivos Trust
An inter vivos trust is a trust which takes effect and is funded with assets during the lifetime of the grantor.
* An inter vivos trust may be either revocable or irrevocable.
* On the other hand, a testamentary trust is revocable until the creator dies, at which point it becomes irrevocable.
What elements are required for the creation of a valid trust?
In most states, the following elements are required for the creation of a valid trust:
* There must be specific property. The property must be specifically identified as the property constituting the corpus of the trust.
* There must be one or more ascertainable beneficiaries who will receive equitable ownership of the income through their use and enjoyment of it. In the case of property that is non-income producing, the beneficiary must receive at least the use and enjoyment of the corpus. Though the beneficiaries must be ascertainable, there is no requirement that they are named individually in the trust agreement. Every trust has current and remainder beneficiaries. A common example of trust beneficiaries whose identities are ascertainable but who are not named in the trust itself would be a class of beneficiaries, for example, “the grantor’s grandchildren.”
* There must be a trustee who holds legal title to the property and who administers the property for the benefit of the beneficiaries. Though usually identified in the terms of the trust agreement, many states do not require the trustee’s identity to be established. If the trustee is not identified in the terms of the trust agreement, or if the designated trustee predeceases the grantor, most states permit a trustee to be appointed by the court. Most courts take the position that if it was the intent of the grantor to create a trust, the trust will not fail for having failed to designate a trustee. To avoid having the court appoint a successor trustee, the grantor should name a successor in the trust document.
* There must be an intention to create a trust that is clear from the grantor’s language or actions. Though the use of the words trust, trustee, or trust arrangement may not be required, the language must indicate the clear intention of the grantor to separate legal and equitable titles in the property while having one party serve as fiduciary for the others. It is not enough that a grantor in his wills leaves the property to another with the hope or desire that the recipient creates a trust. Usually, this language evidences no trust arrangement.
* If the trust is of a type that is required to be in writing, then the written requirements must be complied with.
* Finally, most trusts are required to have terms or conditions under which the trust will terminate or fail. If the trust does not have conditions or terms under which it will terminate, so that the trust could conceivably be of infinite duration, then the trust will violate the rule against perpetuities and will fail unless the trust beneficiary is a charity. The rule against perpetuities requires that a trust cannot last longer than the life of a beneficiary who was alive when the trust was created and an additional 21 years and 9 months after the beneficiary has died.
Describe Professional Management of Assets in a Trust
The grantor chooses trustees, and they can be individuals or institutional trustees such as banks or trust companies. Individual and institutional trustees can be named to the same trust since trusts can have multiple trustees.
* An institutional trustee is useful for a client who wants professional management of assets upon death, as well as during lifetime, particularly in the event of mental incapacity.
* Clients desire such an arrangement when they know that the surviving spouse and/or other family members have little professional investment or business experience.
* Using a trust can assure the client that a trustee with professional asset management experience is available to serve in that capacity.
Trustees, whether individual or institutional, have a fiduciary duty to the beneficiaries always to put their interests first.
* Trustees can be sued for a breach of fiduciary duty by the trust beneficiaries if any self-dealing, mismanagement, or wrongdoing occurs.
Structure of Income
Since the income needs of the beneficiary are subject to change, the trustee may be in a better position to determine the actual needs of the beneficiaries than the grantor, who may be deceased.
Income may be accumulated at the trustee’s discretion, depending on the trust provision. Suppose the grantor wants the trustee to have the authority to ascertain the needs of the beneficiaries. In that case, the grantor should allow the trustee to make income distributions “at the discretion of the trustee.”
* Also, remember that from an income tax standpoint, particularly with an irrevocable trust, which is not a grantor trust for income tax purposes, the trust may be in a higher tax bracket than the beneficiaries.
* Therefore, the trustee can manage income tax liability in the other direction by applying the income away from the trust - the higher tax bracket payer - to the beneficiaries who are in lower tax brackets.
Practitioner Advice:
* In a grantor trust, which attributes the income tax liability of the trust assets to the grantor, there is no opportunity to switch the taxpayer for income tax purposes.
* However, suppose the trust is a non-grantor trust for income tax purposes, meaning someone else is responsible for paying the tax. In that case, we need to know whether the trust is a simple trust - all income to beneficiaries, subject to income tax at their rates,
* or a complex trust - income may be accumulated, for which we need to use the DNI calculation to determine the tax liabilities. DNI stands for Distributable Net Income and will be defined under the Tax Treatment of Trusts.
Practitioner Advice:
Practitioner Advice:
* In a grantor trust, which attributes the income tax liability of the trust assets to the grantor, there is no opportunity to switch the taxpayer for income tax purposes.
* However, suppose the trust is a non-grantor trust for income tax purposes, meaning someone else is responsible for paying the tax. In that case, we need to know whether the trust is a simple trust - all income to beneficiaries, subject to income tax at their rates,
* or a complex trust - income may be accumulated, for which we need to use the DNI calculation to determine the tax liabilities. DNI stands for Distributable Net Income and will be defined under the Tax Treatment of Trusts.
Describe Special Needs Trust
If a client wishes to assist a family member who has suffered a disability through an accident or who has been disabled since birth or childhood, a trust arrangement can be used. These trusts are known as supplemental needs trusts, special needs trusts, or craven trusts.
A trust arrangement can provide extra amenities to a disabled person in a way that would not disqualify the disabled beneficiary from receiving public assistance benefits, such as Medicaid/Medicare, Social Security disability benefits, or other forms of supplemental assistance. If a trust is structured correctly, it can achieve all of these objectives.
Section 1 - Fundamentals of a Trust Summary
Trusts are a popular and effective tool for estate planning.
With the help of a trust, a grantor can leave his or her estate to any beneficiary he or she chooses.
There are different types of trusts, but they can be broadly classified into living and testamentary trusts.
The grantor names or appoints a trustee within the trust document. A trustee is the legal titleholder of the property. There are certain requirements that the trust must meet to be considered valid. A trust makes arrangements for a grantor, keeping his or her specific requirements in mind.
In this lesson, we have covered the following:
* A trust is an arrangement in which one party, the trustee, holds legal title to property for the benefit of one or more beneficiaries. In order for a trust to exist, there must be trust property (also known as trust principal, res, or corpus).
* Trust Arrangements can be used for a variety of purposes. These include:
* Professional management of trust assets
* Distribution of income and/or principal to the beneficiary
* Assist family members of the grantor with special needs
Beneficiaries are equitable owners of the trust in the sense that they are: (Select all that apply)
* Entitled to the enjoyment of the trust property
* Entitled to the income produced by the trust property
* Entitled to hold legal title to the property.
* Expected to pay the trust’s income tax liability
Entitled to the enjoyment of the trust property
Entitled to the income produced by the trust property
- Beneficiaries can be considered to be equitable owners of the trust in the sense that they are to enjoy the property or its income.
- A trust arrangement is one in which one party (the trustee) holds legal title to property for the benefit of one or more beneficiaries. As a fiduciary, the trustee must hold the property, invest it, distribute its income, pay the trust’s income tax liability, accumulate income, if necessary, and render any services required by law to ensure that the beneficiaries receive the enjoyment and use of the property in an equitable manner
The advantages of a revocable trust include: (Select all that apply)
* Flexibility
* Easily amendable
* Does not incur estate tax liability
* Does not incur income tax liability
Flexibility
Easily amendable
- The main advantage of a revocable trust is that it provides the grantor with flexibility if the corpus needs to be consumed by the grantor or the grantor’s family.
- It also provides the grantor with greater ease in amending the trust if the grantor is unhappy with the way in which the trust is operating.
- The primary disadvantage of a revocable trust is that the assets placed into the corpus of such a trust are included in the gross estate of the grantor and incur both estate tax and income tax liability.
Trust property better known as which of the following?
* Corpus
* Assets
* Possessions
* Belongings
Corpus
- Trust property is often referred to as corpus or principal.
Section 2 - Powers of a Trustee
The trust agreement’s terms determine a trustee’s duties and powers. The powers of a trustee can vary from state to state.
A trustee holds legal title to the property and administers the property for the benefit of the beneficiaries. If the trustee is not identified in terms of the trust agreement or if the designated trustee has predeceased the grantor, most states provide for a trustee to be appointed by the court. However, the grantor can name successor trustees. A Grantor can also be a trustee and a beneficiary, which is common in revocable trusts.
To ensure that you have an understanding of the powers of a trustee, the following topics will be covered in this lesson:
* General Powers of a Trustee
Upon completion of this lesson, you should be able to:
* List the powers of a trustee
What are the General Powers of a Trustee?
Trustees enjoy certain general powers. These include:
* Power to collect trust property, settle claims, sue, or be sued.
* Power to sell, acquire or manage trust property in a manner that is in the best interests of the trust.
* Power to vote corporate shares.
* Power to borrow money and use the trust corpus as collateral.
* Power to enter into contracts and leases that do not exceed the trust’s duration.
* Power to make payments to a beneficiary of the trust.
* Power to make required divisions and distributions of the trust property.
* Power to receive additional assets into the corpus of the trust.
What if there are Two or More Trustees?
If there are two or more trustees, all trustees must act unanimously.
* Suppose the trustees cannot agree upon a unanimous course of action. In that case, a special hearing will have to be held to determine the effectiveness of the trust and the conditions under which one or more trustees may have to step down or resign.
* On the other hand, if the grantor has designated more than two trustees, the grantor may stipulate that agreement by a majority of the trustees is sufficient for any action under the provisions of the trust.
Section 2 - Powers of a Trustee Summary
The powers of a trustee differ according to state law.
However, trustees enjoy certain general powers in the state in which they operate. If a trust has more than one trustee, and if the trustees are not in agreement regarding some issues, then a special hearing is called to resolve the issue.
In this lesson, we have covered the following:
* Powers of the trustee include the power to collect and sell trust property. They also include the power to borrow money and, while doing so, use the trust corpus as collateral. Trustees also enjoy the power to make payments to a beneficiary of the trust and the power to divide and distribute trust property or receive additional assets into the same.
Section 3 - Trusts
The kind of trust documents a grantor can use for estate planning varies according to the needs, estate size, the amount of estate tax the grantor is to pay, and the specific identifiable objectives of the client. Just as the tax laws change, so do the types of trusts that are available to meet a specific client objective.
To ensure that you have an understanding of types of trusts, the following topic will be covered in this lesson:
* Types of Trusts
Upon completion of this lesson, you should be able to:
* Classify the different types of trusts,
* Explain the special characteristics of different types of trusts,
* Identify the differences between revocable and irrevocable trusts, and
* Identify the differences between living and testamentary trusts.
Describe Revocable and Irrevocable Trusts
Trusts may be characterized as revocable or irrevocable. The grantor can terminate a revocable trust at any point in time.
A revocable trust is considered flexible because the terms of the trust can be amended, altered or revoked by the grantor if the grantor feels that they are not suitable. Revocable trusts also provide the grantor with the flexibility needed if the grantor or the grantor’s family needs to consume the corpus. A revocable trust provides the grantor with comparatively greater ease in amending the trust should the grantor become dissatisfied with how the trust is operating.
An irrevocable trust can be used to hold life insurance policies.
* The primary goal of such a trust is to shift the ownership of the policies from the insured’s generation to a succeeding generation in order to remove the policy proceeds from taxation at the death of the insured and/or spouse.
Describe a Living Trust
A trust that takes effect during the grantor’s lifetime is called a living trust.
* This is also known as an inter vivos trust.
* All revocable trusts are inter vivos trusts.
It can be established for a limited period, last until the occurrence or nonoccurrence of a specific event, or continue after the grantor’s death.
A revocable living trust is one created by the grantor during their lifetime in which the grantor retains the right to revoke the trust, change its terms, or regain possession of the property in the trust.
A revocable trust becomes irrevocable when the grantor dies.
Describe Revocable Trusts
Trusts must be legally funded to exist. The grantor transfers the legal title of property to a trustee, and the grantor and trustee must be legally competent parties. Trusts can control who benefits from the property placed in trust, when property is distributed, and who manages the property. Trusts permit the accumulation of income and provide a choice of situs for the management of multi-state assets.
Revocable trusts can be funded, which avoid probate and ancillary probate for real property held out of state.
* Assets in a funded revocable trust are included in the grantor’s gross estate.
Revocable trusts can also be unfunded, therefore assets not placed within a trust are subject to probate.
* An example of an unfunded trust is a Standby trust.
* This trust is created by a grantor to manage trust assets if the grantor becomes incapacitated, or leaves the country for an extended period of time.
* The grantor as trustee and beneficiary names a successor trustee to manage assets for the grantor in these situations.
* Trusts may be intentionally unfunded to fund the trust in the future. Examples are revocable By-pass trusts and Disclaimer trusts.
Revocable trusts have the advantage of being flexible.
Revocable trusts become irrevocable when the grantor dies, however, this should not be confused with a testamentary trust, which is created by the will at the testator’s death.
* The revocable trust can also become irrevocable if the grantor becomes incapacitated according to the definition of incapacity included in the trust document.
* The grantor can decide to make a revocable trust irrevocable at any time, but gift taxes may result when this change occurs.
A disadvantage of revocable trusts is the costs associated with establishing the trust. Some examples of costs are attorney fees, costs for changing the title of property transferred into the trust, and trustee fees for managing trust assets if desired.
Another disadvantage is that revocable trusts offer no creditor protection since the grantor retains too many rights and powers.
Describe an irrevocable trust
An irrevocable trust can reduce the grantor’s estate tax liability, as long as the grantor retains no incidents of ownership over the property. Also, if the grantor retains no powers over the corpus of the trust that could be construed as ownership, the assets placed into such a trust will escape inclusion in the gross estate of the grantor and will avoid probate.
There are certain exceptions to this rule. These occur when certain types of property are transferred to the irrevocable trust, and the grantor dies within three years of the date of the transfer.
Examples are:
* If the grantor retains a right to income for life, or a right to use or enjoy trust property.
* If the grantor retains a reversionary interest greater than 5%. Only the value of the reversionary interest will be included in the grantor’s estate.
* If the grantor retains a general power of appointment or a testamentary general power of appointment over trust assets.
* If the grantor dies within 3 years of transferring a life insurance policy or retains any incidents of ownership in the policy transferred into the trust.
Other situations that would cause the FMV of irrevocable trust assets to be included in the grantor’s estate are:
* If the decedent as sole trustee could distribute or accumulate trust income, or distribute trust corpus to income beneficiaries.
* If the decedent could change or add new trust beneficiaries.
* If the decedent could change the trustee unless the new trustee is an institutional trustee.
* If the trustee could use trust income or corpus to discharge the grantor’s legal obligations such as child support.
What is a Pour-Over Trust?
Pour-over trusts are funded or unfunded revocable trusts established by a grantor while alive, which hold their assets at death.
* Assets from the decedent’s estate, pensions, life insurance death benefits, and out-of-state property can be “poured over” into this trust at death for asset management purposes.
* This way diverse property interests can be managed in one trust for the benefit of the decedent’s beneficiaries.
What is a Discretionary Trust?
- In a discretionary trust, the beneficiaries do not have a fixed entitlement or interest in the trust funds.
- The trustee has the discretion to determine which of the beneficiaries will receive the capital and income of the trust and how much each beneficiary will receive.
- Generally, such trusts are taxed at the maximum marginal rate (MMR). This rule is, however, subject to certain exceptions.
What is a Spendthrift Trust?
Spendthrift trusts or spendthrift provisions in irrevocable trusts may provide beneficiaries a degree of creditor protection.
* Creditors can reach an individual’s personal funds to satisfy their claims.
* With a revocable or an irrevocable trust, any distributions made to beneficiaries can be accessed by creditors as well.
* Therefore, spendthrift trusts are designed to prevent beneficiaries from receiving distributions from the trust, so creditors cannot access their funds.
* This is accomplished by giving the trustee the power to accumulate income and discretionary authority to distribute to a beneficiary.
* A spendthrift clause in the trust may state that the beneficiary cannot assign, pledge, or promise to give away distributions from the trust to others, or the beneficiary may forfeit their interest in the trust.
* A beneficiary must not be given a general power of appointment or permitted to have access to trust corpus through an ascertainable standard, which would provide funds for his health, education, maintenance, and/or support.
Spendthrift trusts also provide creditor protection if they are established solely for a beneficiary’s supplemental support, not for their general support. This prevents the beneficiary from compelling distributions for support in favor of creditors.
States are responsible for enforcing spendthrift provisions in trusts, which vary from state to state. Most states will uphold spendthrift provisions because the beneficiary is not the owner of the trust assets, and they can only receive discretionary distributions.
* However, if the grantor created a spendthrift trust and named himself beneficiary, this is considered a self-settled trust, which would not receive creditor protection in most states.
What is a Sprinkling or Spray Trust?
A trust that permits the trustee to distribute income or corpus among various beneficiaries according to the needs of the beneficiaries is sometimes referred to as a trust with sprinkling provisions or a sprinkling or spray trust.
* A sprinkling trust can distribute income to beneficiaries, and
* a spray trust can distribute both income and corpus.
Under the terms of such a trust, the trustee has the discretion to determine whether a particular beneficiary needs any income. If such a need is determined, the amount that the beneficiary will receive is also the sole discretion of the trustee.
* Since the beneficiary has no right to receive income annually, the beneficiary does not have a present interest.
* Therefore the grantor will not be able to take an annual exclusion for transfers into the irrevocable trust.
The primary advantage of a sprinkling trust is __ ____??____ __.
* flexibility
* annual income distributions
* annual exclusion eligibility
* preservation of trust corpus
flexibility
- The primary advantage of a sprinkling trust is the flexibility it provides to the trustee in making income distributions to beneficiaries who may not have a need for income in one year but could have needs in subsequent years.
Describe the Generation-Skipping Trust
The generation-skipping trust can provide income to the grantor’s spouse for the spouse’s lifetime. Upon the death of the spouse, or simultaneous with the income distribution to the spouse, the grantor’s children can receive income for their lives. Upon the deaths of all of the children, the income and principal may pass to the grantor’s grandchild, great-grandchild, etc.
Generation-Skipping Trust
* After Grantor’s Death - The trust provides income for the rest of the grantor’s spouse’s lifetime.
* After Death of the Spouse - The children of the grantor receive income for the rest of their lives.
* After Death of All Children - The grantor’s grandchildren receive the outright title to the property in the corpus.
Describe Characteristics of Generation-Skipping Trust
To be an effective means of saving estate and gift taxes for the grantor, the trust must possess the following characteristics:
* The trust must be irrevocable.
* The trust income may be distributed to the grantor’s spouse and children, but the absolute title to the property must “skip” at least one generation. The ultimate beneficiary of the assets is a skip person.
* The outright title to the trust property must pass to someone separated from the grantor’s generation by at least two generations.
* The generation-skipping transfer tax is only imposed on those transfers deemed direct skips, taxable terminations, or taxable distributions. Thus, the generation-skipping transfer tax is imposed only when the property transfers to the skip person.
Before 1976, this type of trust arrangement was structured primarily to avoid estate or gift tax liability in the child’s estate had the property been transferred directly from the grantor to the grantor’s children. Thus, a direct transfer to the next succeeding generation was avoided, and estate and gift taxes were minimized. However, since 1976, when Congress imposed a generation-skipping tax on transfers of this sort, the attraction of such an arrangement for the extremely wealthy has diminished greatly.
Describe the Uniform Gifts/Transfers to Minors Act
There are a variety of trusts that can be used to benefit minors. The most informal of these are not really trusts but custodial accounts established for the benefit of a minor beneficiary under the Uniform Gifts to Minors Act (UGMA), or the Uniform Transfers to Minors Act (UTMA). UTMA is a modification of UGMA and most states have replaced their Uniform Gifts to Minors Act with the Uniform Transfers to Minors Act.
In this type of fiduciary relationship, the property is placed in an account that bears the name of the minor as the legal titleholder.
* The property is then held by an adult who has “custody” of the property until the minor reaches the age of majority. This person is known as the “custodian.”
* UGMA or UTMA accounts are convenient and relatively inexpensive to administer. They do not have significant administration costs or accounting expenses like more formal trust arrangements.
UGMA provides that an adult, while alive, may make a gift of certain types of property to a minor by having the gift registered in the name of or delivered to the donor or another adult person as custodian for the minor.
* These gifts qualify for the annual exclusion amount.
UTMAs are very similar to UGMAs except that UTMAs are more flexible.
* UGMAs authorize bank accounts and purchase stocks, bonds, and mutual funds.
* UTMAs allow greater use of various investments, including real estate transfers, partnership interests, and oil and gas interests.
* UTMAs also allow for testamentary transfers into the minor’s account.
Not all states recognize both forms of gift-to-minor options.
* The correct format will depend upon the state of residency of the minor.
* UGMAs typically terminate at the age of 18 while UTMA terminates at age 21 or 25, depending on the state.
* Custodians and/or donors may find a UTMA a better alternative than a UGMA because control of the assets is not turned over to an 18-year-old younger adult.
Exam Tip: If the donor to the UGMA/UTMA also is named as custodian, and the donor/custodian dies before the child reaches the age of majority, the value of the custodial account will be included in the donor/custodian’s estate.
Exam Tip:
Exam Tip:
* If the donor to the UGMA/UTMA also is named as custodian, and the donor/custodian dies before the child reaches the age of majority, the value of the custodial account will be included in the donor/custodian’s estate.
What are 2503(b) Trusts?
Special trusts that are structured for the benefit of minors include both 2503(b) and 2503(c) trusts.
* These are trusts that meet the requirements of these Internal Revenue Code sections, respectively, in order to qualify contributions for the gift tax annual exclusion.
A 2503(b) trust can provide a beneficiary with a stream of income when the beneficiary is a minor.
- The trust must distribute the income to the minor annually or more frequently.
- All or portions of gifts to such trusts will qualify as gifts of present interest for the income beneficiaries, and thus are eligible for the annual gift tax exclusion.
- The annual exclusion cannot be used to offset the donor’s gift tax for the present value of the remainder interest passing to any remainder beneficiaries.
- The corpus of a 2503(b) trust need not be distributed to the beneficiary when the beneficiary reaches the age of majority.
- The corpus will be excluded from the gross estate of the donor who is not a trustee.
- The corpus will also be excluded from the gross estate of the income beneficiary if the income interest terminates at the beneficiary’s death.
Example (2503(b) Trust: Present Interest)
Arbitrarily assuming a 7.0% interest rate, if the trust provides income for life to the donee to be distributed at least annually, and if the donee is age eleven, then based on government valuation tables, the amount of the gift which will be considered as a present interest if $10,000 was put into a Section 2503(b) trust would be $9,724 (the actuarial value of an 11-year-old’s right to income on $10,000 paid annually for life).
In some respects, a Section 2503(b) trust is more flexible than either a Section 2503(c) trust or a custodial account because a Section 2503(b) trust does not require distribution of principal and unexpended income at age 21 or sooner.
* Furthermore, a Section 2503(b) trust can last for the beneficiary’s lifetime or for any lesser period of time.
* Also, unlike the case with a Section 2503(c) trust or a custodianship, under a Section 2503(b) trust, the principal does not ever have to be paid over to the income beneficiary.
* Trust principal can go to a different donee specified by the trust’s grantor or a person specified by the income beneficiary.
What are 2503(c) Trusts?
An IRC Section 2503(c) trust is a gift tax tool that enables a grantor to make a gift to a minor in trust and still obtain the annual gift tax exclusion.
* The use of this irrevocable funded trust for gifts to minors eliminates many of the following practical objections to outright gifts:
* Brokers are reluctant to deal in securities owned by minors since minors may disaffirm either a purchase of stock that subsequently falls in value or a sale of stock that later rises in value.
* Property titled in a minor’s name is, to a large extent, “frozen.” It is difficult to sell or exchange that property since a minor’s signature on a real estate deed gives the buyer no assurance of permanent title.
* Guardianship must be used to avoid many of the objections of an outright transfer to a minor, but a guardian must generally post bond and account periodically to a local Orphans’ (sometimes called Surrogate’s or Probate) Court.
A gift to a minor through a Section 2503(c) trust will be considered a gift of a present interest (so the gift will qualify for the annual gift tax exclusion) if the income and principal is available for distribution to or on behalf of the beneficiary at any time prior to the time the beneficiary reaches age 21.
* ** Income that is accumulated in the trust is taxed to the trust and not to the beneficiary**. (Regardless of when a person becomes an adult under state law, the “magic” age is still 21 for Section 2503(c) purposes.)
Unexpended income and principal must be distributable to the beneficiary when that individual reaches age 21. If the beneficiary dies before age 21, accumulated trust income and corpus must go to the minor’s estate or appointee according to a general power of appointment.
Even if the minor is legally unable to exercise a power or to execute a will because the minor is under the legal age, this fact will not cause the transfer to fail to satisfy the above conditions. Furthermore, it is permissible to provide that the trust will continue beyond the donee’s 21st birthday, as long as anytime after reaching age 21, the donee can obtain the property in the trust if he wishes. Thus, the trust property does not have to be forced on a trust beneficiary upon reaching age 21.
Example (2503(c) Trust Transfers and Taxation)
Larry Smith transfers stock in his closely held corporation to three trusts for his three minor boys. Larry is not the trustee for any of the three trusts. Assuming the trusts qualify under Section 2503(c), the irrevocable stock transfer annually to the trusts will be considered gifts of a present interest. This will allow Larry to obtain the gift tax annual exclusion and therefore minimize or eliminate any gift taxes.
Gifts, to the extent they qualify for the annual exclusion (without taking gift splitting into account), reduce the value of Larry’s estate, and the income from any dividends paid on the stock is taxed currently either to the trust, if accumulated, or to the children, if distributed.
* Such trusts are often used to start children on a life insurance program by providing the trusts with sufficient cash each year to pay premiums for the insurance on the boys’ lives.
* Alternatively, trust income could be used to purchase non-necessities or be accumulated and used to help provide non-necessities when the children reach college age.
Describe Section 2702
When a donor makes a gift to a donee that is less than the entire property, the donor retains a partial interest in the property and gifts a partial interest away.
* A “retained interest” is one held by the donor both before and after the transfer to the trust.
* The donor in this case has a retained interest that is greater than zero. That’s because the value of a gift is generally determined by subtracting the value of the donor’s retained interest from the fair market value of the property gifted.
Chapter 14 of the IRC affects the value of partial interest gifts to “applicable family members” that are transferred into new or existing trusts, or the assignment of an interest in an existing trust.
Applicable family members under Section 2702(a) include:
* The spouse of an individual.
* The ancestor or lineal descendant of an individual or that individual’s spouse.
* The brother or sister of an individual and the spouse of any such person.
Section 2702 affects the value of a remainder interest gift to family members in trust when the grantor retains an income interest (a partial interest) in the same trust for a period of time.
* The remainder interest is subject to gift tax when the grantor transfers the assets into the trust, therefore the gift tax value of the remainder interest needs to be determined.
Section 2702(a) provides that all retained interests in trusts that are not “qualified interests” are valued at zero.
* Grantors who make remainder interest gifts to family members in trusts must retain a “qualified payment” or the grantor’s retained interest is valued at zero!
A “qualified payment” is a payment fixed in time and amount.
* Annuity and unitrust payments are qualified payments under Section 2702.
* If a grantor retains an annuity or a unitrust payment, then the gift of the remainder interest is valued as the PV of the remainder interest on the date the property is transferred into the trust.
* However, if the grantor can receive all income from the trust the payment is not a “qualified payment” and the value of the remainder interest gift to family members is based on the entire amount transferred into the trust.
When does Chapter 14 not apply?
Chapter 14 does not apply to:
* Sales to family members
* Gifts to non-related persons
* Incomplete gifts
* A transfer of the entire property to family members
* Partial interests bequeathed to family members
* Remainder interests in trusts if income can only be distributed at the sole discretion of an independent trustee
* Certain property settlement agreements
* Charitable lead trusts
* Personal residence trusts
Describe Grantor Retained Trust - GRAT, GRUT
A grantor retained trust, as its name implies, is an irrevocable trust into which the grantor places assets and retains an income interest for a fixed period of years.
* Principal and any trust appreciation at the end of the specified term will pass to a non-charitable beneficiary, usually a family member, such as a grantor’s child.
The purpose of the GRAT and GRUT is to:
* Transfer property to family in trust at a reduced (or zero) gift tax value.
* Pass appreciation in the GRAT to beneficiaries without incurring additional gift tax.
* Reduce the value of the grantor’s gross estate.
In a grantor retained annuity trust (GRAT), the grantor retains a right to payment of income for a fixed period of years. Annuity payments can be level payments or may increase up to 20% per year.
In a grantor retained unitrust (GRUT), the grantor retains a right to payment of a fixed percentage of the value of the trust property (determined annually) for a fixed period of years. As an example, take a $1 million transfer that retains a 5% income stream. With a GRAT, the income will be a fixed $50,000; with a GRUT, the initial payout is $50,000, with the next year’s distribution to the grantor equal to 5% of the value of the assets within the trust. This payout amount could be more or less than $50,000 depending on how well the invested assets perform. The grantor, not the trust, must pay taxes on the income distributed from a GRAT or a GRUT, but tax payments will further reduce the grantor’s gross estate.
With a GRAT and GRUT, the grantor is essentially making a current gift of the right to trust assets to the remainder beneficiary at a future date. This gives the grantor significant gift tax savings since only the present value of the remainder interest in the trust is taxed, not the current fair market value of the assets transferred into the trust.
GRATs are preferable when using assets that are difficult to value, such as closely-held stock or real estate that is expected to appreciate.
* GRATs should be funded with assets that are likely to outperform the federal Section 7520 rate used to value the grantor’s annuity.
* The lower the Sec. 7520 rate, the easier it is for trust investments to beat that rate.
* Any appreciation that exceeds the annuity payouts will be transferred tax-free to the beneficiaries when the grantor’s income interest ends.
* GRUTs are unaffected by lower interest rates since income distributions are based on variable payments.
* Because the GRUT does not “freeze” the grantor’s interest, as a GRAT does with its fixed annuity payments, it is less effective in passing appreciation to the beneficiaries.
GRATs should be funded when asset values are low, which lowers the gift tax and gives beneficiaries greater upside potential for future appreciation.
* A longer payout term for the grantor or a higher annuity payout for a shorter term results in a lower taxable gift of the remainder interest.
The grantor’s annuity interest can be structured to equal up to 100% of the trust’s value to avoid taxable gifts.
* This is known as “zeroing-out” the GRAT.
* The annuity, typically structured for two or three years, pays the grantor the amount initially transferred to the trust plus a return equal to the Sec. 7520 rate.
* The GRAT must state that the annuity is payable to the grantor’s estate if the grantor dies during the trust term for this gift tax strategy to work.
For example, assume a transfer of $1 million into a 10-year GRAT with a Sec. 7520 rate of 3%. An annuity payment of $117,231 per year will zero out the GRAT. However, if the trust earns an average return of 7%, its value at the end of the 10-year term will be more than $347,000, which will transfer to the beneficiary tax-free.
If the grantor survives the term selected, the beneficiaries would receive the trust property and any appreciation in its value without additional gift taxes imposed on the transfer.
* Furthermore, the trust corpus is removed from the grantor’s estate.
* If the grantor does not survive the specified period selected to receive trust income, then a portion of the trust necessary to yield the annuity or unitrust interest would be included in the grantor’s estate.
* The amount includible is determined by dividing the annual annuity by the Sec. 7520 rate in effect at the grantor’s death. If the result is greater than the trust’s value, then the amount in the trust is included in the estate. If the result is less than the trust’s value, then only the smaller calculated amount is included in the grantor’s estate.
A disadvantage of a GRAT or GRUT is that beneficiaries will receive the grantor’s carryover basis in the trust assets rather than a stepped-up basis, had they inherited the property at the grantor’s death.
* Also, with a GRAT, the fixed annuity must be paid to the grantor even if the trustee has to dip into the trust corpus or has to borrow funds to pay it.
* Grandchildren should not be beneficiaries of this trust since the grantor’s GST exemption cannot be allocated to the trust until after the grantor’s income period ends.
* By that time, the grandchildren’s interest could be much greater than when the trust was established.
Practitioner Advice:
* When these split-interest trusts are created, the value of the remainder interest passes to the non-charitable income beneficiaries.
* This is a** gift that does not qualify for the annual exclusion but does qualify for the $12.92 million gift tax exclusion (2023)**.
* A GRAT may be beneficial in an environment where the federal 7520 rate is low.
Practitioner Advice:
Practitioner Advice:
* When these split-interest trusts are created, the value of the remainder interest passes to the non-charitable income beneficiaries.
* This is a** gift that does not qualify for the annual exclusion but does qualify for the $12.92 million gift tax exclusion (2023)**.
* A GRAT may be beneficial in an environment where the federal 7520 rate is low.
