Bryant - Course 6. Estate Planning. 9. Trusts Flashcards

Question

Describe Revocable Trusts

Answer 1

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.

Answer 2

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**.

Answer 3

**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**.

Answer 4

* 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.

Answer 5

**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**.

Answer 6

**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**.

Answer 7

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.

Answer 8

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.

Answer 9

**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**.

Answer 10

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.

Answer 11

**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**.

Answer 12

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**.

Answer 13

**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**.

Answer 14

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.

Answer 15

**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**.

Answer 16

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

Answer 17

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**.

Answer 18

A grantor retained income trust (GRIT) is another type of **split-interest trust**. * A GRIT **distributes all of the trust's income to a grantor for a specified number of years and then distributes the trust's remainder interest to beneficiaries**. A GRIT was **commonly used for income property before the adoption of IRC Section 2702**. Previously, a grantor could receive all income from a GRIT and receive favorable gift tax treatment for the remainder interest passing to family beneficiaries. **Since 1990 this is no longer the case. Now, under Chapter 14 of the IRC, assets transferred into GRITs are taxed at FMV for gift tax purposes**, not at the discounted value of the trust's remainder interest, when family members are trust beneficiaries. **In contrast, GRATs and GRUTs receive favorable gift tax treatment for remainder interests transferred to family beneficiaries**. * The difference in gift tax treatment can be explained by the type of payments the grantor receives. * **An annuity or unitrust payment in a split-interest trust (GRAT or GRUT) is considered a "qualified payment" under Chapter 14 of the IRC**. * All income distributed annually from a GRIT is not. * **Trusts with "qualified payments" and family member beneficiaries can receive favorable gift tax treatment, while GRITs, which do not have qualified income payments, are taxed on the full value of the assets initially transferred into the trust**. **GRITs are now limited to transfers of a personal residence or certain tangible property, such as a painting, in situations where the grantor retains the use of the property during the trust term**. * It is also used for split-interest trusts with non-family members such as friends, life partners, nieces, and nephews, which retains its favorable gift tax treatment. A grantor who establishes a GRIT and **dies before the term of years** has ended will **have the full FMV of the trust corpus included in the gross estate**. If the grantor is only entitled to a portion of the trust income (30%) then only 30% of the value of the trust is included in the grantor's estate.

Answer 19

**A qualified personal residence trust (QPRT) is an irrevocable trust that holds a person's residence, allowing couples or individuals to live in the house rent-free for a specified period of time**. At the end of the term, **the home will pass gift-tax free to the trust beneficiaries**. * An advantage of this technique is that the **transfer of the home into the trust is taxed at the present value of the home's remainder interest, rather than at its fair market value**. * The **gift tax can be reduced** because a QPRT is not subject to the unfavorable gift tax provisions found in Chapter 14 of the IRC. * The **gift tax is further reduced for the grantor's right to have the residence revert to his estate if he does not survive the selected term**. * However, **if the grantor dies before the term is completed, then the fair market value of the home is included in the grantor's estate**. **A QPRT allows the grantor to "freeze" the value of the home when it is placed in the trust, and pass any future appreciation on to trust beneficiaries**. * But **if the beneficiaries intend to sell the home in the future, it would be better to keep the residence in the grantor's estate to receive a stepped-up basis at death**. * **Otherwise, a beneficiary's basis is the grantor's original basis increased by a portion of any gift taxes paid**. **A person can transfer a personal residence into a QPRT and establish another QPRT to hold an additional home**. * It is possible to **transfer a rental vacation residence to a QPRT if the owner occupies the home for the greater of 14 days or 10% of the number of days it is rented out during the taxable year**. * QPRTs can be structured as grantor trusts with income tax deductions taken for mortgage interest payments and property taxes paid. * If the grantor wishes to continue living in the home beyond the term of years selected, the grantor could lease the home back at fair rental value. * Payment of rent to the trust further reduces the grantor's gross estate and makes additional tax-free gifts to the trust beneficiaries. * Moreover, rental payments do not generate taxable income for the trust or the trust beneficiaries. * The grantor can decide to sell the home before the term ends, but the trust would immediately terminate. * Instead, the grantor could transfer the property into a GRAT which can hold real estate, to preserve some tax advantages. One such advantage is using the original value assigned to the children's remainder interest in the QPRT when initially funding the GRAT.

Answer 20

* **A GRAT, GRUT, or QPRT** is particularly useful when the client is **single** and has a **substantial estate upon which federal estate taxes are certain to be paid**. Wealthy widows or widowers, divorced individuals, or other unmarried persons can **use such a trust as a "marital deduction substitute."** * **A married couple with an estate above the couple's combined unified credit equivalent can use a GRAT, GRUT, or QPRT to eliminate or reduce taxes on the death of the second spouse to die**. The larger and more rapidly appreciating these estates are, the more effective such a trust would be. * A GRAT, GRUT, or QPRT is **effective where the income-producing property is located in more than one state and unification and probate savings are desired**. The GRAT, GRUT, or QPRT would serve to transfer ownership in a manner that would **avoid ancillary administration**. * A **GRIT** is a useful technique when a client wants to **purchase certain tangible assets such as a work of art, retain the right to display it in his or her own home, and have it pass to a specified person immediately and without probate at death**. (However, if the grantor is unable to establish the value of the retained interest through comparable rentals, the gift of the transferred remainder will equal 100% of the value of the transferred property). * A **GRAT, GRUT, or QPRT** can be an alternative to (or be used in conjunction with) a recapitalization or other freezing technique with the **added advantages of gift tax leverage and possible estate tax savings**. * When there is a **high probability that the client will outlive the trust term that is needed to obtain a low present value gift to the remainder person**. When the client has assets so substantial that a significant portion can be committed to a remainder person without compromising his financial security, and when the client has a high-risk tolerance and a strong incentive to achieve gift and estate tax savings (rather than taking the safer but more costly approach of making an immediate gift).

Answer 21

* **Discretionary Trust** -vests the distribution of income or corpus to beneficiaries according to the trustee's discretion. * **Spendthrift Trust**: a discretionary trust that affords some creditor protection to beneficiaries. * **Sprinkling or Spray Trust** allows the trustee to distribute income or corpus among various beneficiaries, based upon the needs of the beneficiaries. * **Generation-skipping Trust** is designed to ultimately transfer assets to skip people and provide for interim generations prior to the distribution. **Properly structured, no or minimal GST tax will be required when the assets pass to the skip person**. * **UGMA** is a custodial account, which is used for the benefit of minor children. * **UTMA** is similar to a UGMA, but also allows transfers of cash and other property to be placed into the minor's custodial account. * **2503(b) Trust** provides a beneficiary with a stream of income during the trust term and also **qualifies for the annual gift tax exemption**. * **2503(c) Trust** allows an annual gift tax exclusion for transfers to the trust with the minor having a right to withdraw accumulated income and principal at age 21. **Exam Tip:** Keep the unique planning opportunities offered by each of the testable trusts on the CFP® Exam top of mind. Think to yourself, **“How can this specific trust maximize the client’s potential to achieve their stated goals?”**

Answer 22

Capable of being flexible and terms of the trust can be altered, amended or revoked. The grantor can revoke the trust entirely if he realizes that it does not fulfill his larger estate planning objectives. * 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 do not escape estate tax liability or income tax liability.

Answer 23

Crummey trust * If a trust is properly structured a minor beneficiary can demand the lesser of the amount transferred annually to the trust or the maximum amount allowed under a five and five power which works out to be the **greater of $5,000 or 5% of the value of the corpus**. * In such a case the minor beneficiary has a right, better known as a Crummey right. * Such a trust is termed a Crummey trust.

Answer 24

* Generation-Skipping Trust - A trust that benefits several generations within the same family. It is established primarily to take advantage of estate and gift tax savings for the grantor. * Sprinkling or Spray Trust - A trust that permits the trustee to distribute income or corpus among various beneficiaries. * Discretionary Trust - A trust that vests the distribution of income or corpus to beneficiaries. * Support Trust - A trust that is established solely for the purpose of providing income to a beneficiary in discharge of the grantor's obligation of support to the beneficiary.

Answer 25

Moreover, if the client needs some of that money to continue his or her current lifestyle, he or she can set up the trust in such a way that it pays a monthly or yearly income, even if the tax has already been written off. Trust arrangements can be used for a variety of purposes. To ensure that you have an understanding of other kinds of trusts, the following topics will be covered in this lesson: * Trusts that benefit charities * Trusts that benefit income and families * Trusts that avoid probate * Trusts that benefit taxes and deductions Upon completion of this lesson, you should be able to: * Outline the different kinds of charitable trusts, * Describe the characteristics of charitable trusts, * Explain how and which trusts avoid probate, * Explain how trusts benefit spouses and other family members, and * Describe how trusts minimize estate and income tax liabilities.

Answer 26

Trusts can be **used to benefit a qualified charity**. **A charitable lead trust (CLT) pays a fixed income stream to a qualified charity for a period of years, usually not more than 20. At the expiration of the lead period, the remainder interest passes to one or more noncharitable beneficiaries**. The charitable lead trust **can provide the grantor with either income or estate tax savings, depending on when the use of such a technique is employed**. * The grantor **can obtain an immediate income tax deduction for a charitable lead trust established during the grantor's lifetime when the grantor is considered the owner of the trust income and if the remainder interest will revert back to the donor or the donor's spouse**. * The **deduction is measured by the present value of the income stream passing to the charity for the stated period**. * However, if the grantor takes an income tax deduction for the present value of the income to the charity, the **grantor must include the income earned by the trust on the grantor's annual tax return**. * There is **no gift tax on the portion going to charity**; however, **the remainder benefit is usually noncharitable**. * Note: **this remainder interest is a taxable gift if given to someone other than the donor or the donor's spouse - no annual exclusion would apply**. If the charitable lead trust is structured to take effect upon the grantor's death, the grantor's estate will receive a charitable deduction for the present value of the income stream passing to the charity.

Answer 27

20 years * A charitable lead trust pays a fixed income stream to a qualified charity for a period of years, usually not exceeding 20 years.

Answer 28

**A charitable remainder annuity trust (CRAT) is designed to permit a fixed amount to pay annually to a noncharitable beneficiary with the remainder going to charity**. Using a basic charitable remainder annuity trust, **the donor transfers money or securities to a trust, preferably low basis stock, since the charity can sell this stock without incurring any capital gains, and reinvest the proceeds to pay the donor a higher fixed dollar amount each year for life**. * If the income of the trust is insufficient to meet the required annual payment, the difference is paid from capital gains or principal. * If the income is greater than the amount required in any given year, the excess income is reinvested in the trust. **The income tax deduction is computed in the year funds are irrevocably placed in trust and is measured by the present value of the charity’s right to receive the trust assets upon the income beneficiary's death** (or at the end of the term of years). **The value of the remainder interest is determined by a combination of the term of the trust or the beneficiary’s age, the amount payable to the beneficiary, and the appropriate monthly applicable federal rate**. **In order to qualify for income (and estate and gift) tax deductions, a charitable remainder annuity trust must meet a number of tests**.

Answer 29

In order to qualify for income (and estate and gift) tax deductions, a charitable remainder annuity trust must meet a number of tests. * A **fixed amount or fixed percentage of the initial value of the trust must be payable to the noncharitable beneficiary**. * The annuity percentage **must not be less than 5% nor more than 50% of the initial FMV of all the transferred property**. * The specified amount must be **paid at least annually to the noncharitable beneficiary out of income and/or principal**. * The trust must be **irrevocable** and **not subject to a power by either the donor, the trustee, or the beneficiary** to invade, alter, or amend, the trust. * The trust **must be for the benefit of a named individual or individuals who must be living at the time of the transfer in trust, and their interests must consist of either a life estate or a term of years not exceeding 20 years**. * The **entire remainder must go to charity**. * The **value of the remainder must equal at least 10% of the assets transferred to the trust**. If all the necessary tests are met, the **donor of a charitable remainder annuity trust will be entitled to an income tax deduction equal to the value of the remainder interest assuming his contribution base is sufficient to utilize the full amount of the deduction**.

Answer 30

A **charitable remainder unitrust (CRUT), like a charitable remainder annuity trust, is designed to permit a periodic sum payment to a noncharitable beneficiary with a remainder to charity**. * The **key distinction is in how the periodic sum is computed**. * It is also important to note that **no additional contributions may be made to a CRAT once created and funded**. * However, **future contributions may be made to CRUTs**. For example, a donor irrevocably transfers money or securities to a trustee. In return, the trustee agrees to pay the donor (or other beneficiary) a unitrust amount from the property for life. The donor also requires that if he predeceases his spouse, she in turn will receive a unitrust amount from the donated property for life. **The donor will make payment based on a fixed percentage of the fair market value of the assets placed in trust. The assets will be revalued each year.** **In order to qualify for income, gift, and estate tax deductions, the structure of a charitable remainder unitrust must conform to guidelines**.

Answer 31

CRUT Conforming Guidelines * A **fixed percentage of the net FMV of the principal, revalued annually, must be payable to the noncharitable beneficiary**. * The percentage payable to the noncharitable beneficiary **must not be less than 5% nor more than 50% of the annual value**. * The unitrust may provide that the noncharitable beneficiary **can receive the lesser of: (a) the specified fixed percentage, or (b) the trust income for the year, plus any excess trust income to the extent of any deficiency in the prior years**. * The noncharitable income beneficiaries must be living at the time of transfer in into the trust, and their **interests must be for a life estate or a term of years not exceeding 20 years**. * The **entire remainder must go to charity**. * The **value of the remainder must equal at least 10% of the assets transferred into the trust**. If allowed at all, **an income tax deduction is permitted in the year funds are irrevocably placed in trust**. * The **deduction is measured by the present value at the date of the gift of the charity’s right to eventually receive the unitrust’s assets, subject to percentage limitation**. * The **portion of the deduction disallowed may generally be carried forward for five years**.

Answer 32

**Practitioner Advice:** * With charitable remainder trusts, the **income must be paid out for a term certain not to exceed 20 years, or the lifetime of the noncharitable beneficiary**. * Additionally, for the CRT to qualify as a CRT, each time a contribution is made into the trust, whether once with the annuity trust, or with each transfer into the unitrust, **at the time of transfer the calculation must show that at least 10% of the value of the assets contributed on the day of transfer will go to the charity**.

Answer 33

An irrevocable life insurance trust (ILIT) is a **vehicle for holding life insurance policies**. * The **primary goal of such a trust is to remove the death benefit proceeds of the life insurance policy(ies) from the estate of the grantor and the grantor's spouse and shift the ownership of the policies to a lower generation**. * This **effectively removes the policy proceeds from taxation at the death of the insured and/or his spouse**. * In that way, **the family can have a fund of cash which can be used to loan money to or purchase assets from a decedent's estate, thereby creating liquidity in the estate for payment of death taxes**, without the fund's causing additional death taxes at the death of the insured. * Where the life insurance continues to require payment of premiums after the initial gift, a typical irrevocable life insurance trust plan **will call for the insured to make annual gifts to the trust to cover the premium payments**. * **In order to make those gifts qualify as a "present interest gift" and therefore come within the annual exclusion, the trust gives a "Crummey" withdrawal right to the beneficiaries of the trust (usually the children, grandchildren, spouse, etc.)**. * Note: concerning **Crummey rights-it qualifies an otherwise future interest transfer as a present interest transfer**. * The name "Crummey trust" comes from the name of a party to a lawsuit, Crummey v. Comm. (9th cir. 1968).

Answer 34

* An irrevocable life insurance trust (ILIT) can be used to good advantage whenever an individual (or a couple) faces a death tax in his or her generation. * An ILIT can provide the decedent's estate with liquidity for payment of all death taxes with existing life insurance, or with insurance, the trust intends to purchase, without subjecting the proceeds themselves to depletion by estate taxes. * To provide the estate with liquidity, the trustee is given discretionary powers to lend funds from the insurance proceeds to the estate or to buy assets directly from the estate to transfer into the trust for professional management. The loan should be secured and structured as an "arms-length" transaction, with prevailing market interest rates applied. Property sold to the trust should be valued at its fair market value. * **Gifts of whole life insurance policies to the ILIT are generally valued for gift tax purposes at the "interpolated terminal reserve value," which is usually close to the cash surrender value for a reasonably healthy individual**. The face value for the policy is often many times greater than this gift tax value. * In such cases, **making gifts of life insurance policies is a way to "leverage" the donor's annual gift tax exclusions, applicable credit, and/or generation-skipping exclusion, by making gifts of policies that have a low current "gift value" in relation to their death benefit value at the insured's death**. * **Life insurance trusts can be funded or unfunded trusts**. * An unfunded ILIT means that the trust only contains a life insurance policy that the owner has transferred in. * Since life insurance premiums need to be paid each year, the owner must transfer money for these payments into the trust each year, so that the trustee has sufficient funds to pay the annual premiums. * **These transfers into the trust are subject to gift taxes, therefore the grantor wants to use annual exclusions for each trust beneficiary to offset these taxes**. * **For this reason, the grantor will include Crummey provisions into the ILIT, which gives the beneficiaries a present interest rather than a future interest in the trust**, due to the beneficiaries' annual rights of withdrawal. * **A funded ILIT means that the grantor has transferred a life insurance policy plus income-producing property into the trust, which is used to pay the premium payments**. * The **grantor does not need to give beneficiaries a Crummey power in this trust, since beneficiaries do not need to have a present interest in the trust**. * The **reason is that the grantor will not make annual transfers into the trust to pay for the policy's premiums, since the income generated from the assets in the trust will be used to pay for the premiums instead**.

Answer 35

**All trusts avoid probate if the trust is funded with assets prior to the death of the grantor**. * **Joint tenancy is applicable to all property types except retirement plans and individual retirement accounts (IRAs) * Beneficiary designations can be used for life insurance policies, retirement plans, and individual retirement accounts**. * **Revocable** trusts can be utilized with all types of property. The revocable living trust **avoids probate, as well as possible gift tax consequences**.

Answer 36

**A Totten trust is not a traditional revocable or irrevocable trust**. * It is a **type of revocable bank account or money market account that avoids probate**. * The **checking or savings account owner is considered the "trustee" who makes deposits for a named beneficiary**. * Since the account owner has full control over the money in the account until death, **it is included in their gross estate at death**. * The **account then passes automatically to the beneficiary as a payable on death (POD) transfer, which avoids probate in the owner's estate**.

Answer 37

**The marital/non-marital trust (also commonly referred to as the "A-B trust" or, more currently, the "A-B-Q" trust) is an arrangement designed to give the surviving spouse full use of the family's economic wealth, while at the same time minimizing, to the extent possible, the total federal estate tax payable at the deaths of both spouses**. **Married couples can usually eliminate federal estate taxes entirely at the first spouse's death through a carefully considered plan capitalizing on the marital deduction coupled with the unified credit**. * The **marital deduction is a deduction for gift or estate tax purposes for property passing to (or in a qualifying trust, for) a spouse**. * The **applicable credit** is a credit provided to each citizen or resident of the United States, which **can be applied against either gift taxes or estate taxes**. **The goal typically is to avoid "overqualification" of the estate for the marital deduction because of the "underutilization" of the applicable credit in the estate of the first spouse to die**.

Answer 38

* **The B-Trust or bypass nonmarital (family) trust is designed to receive property that is not allocated to the power of appointment trust, the estate trust, or the QTIP trust**. * **An amount equal to the exemption equivalent amount ($12,920,000 in 2023) is placed in this trust**. * The trustee may be directed to distribute the net income of this trust to the surviving spouse during his lifetime, or the income may be accumulated or directed to other persons in order to reduce the overall income tax effect on the family. * **If drafted properly, the trust can also allow the trustees to distribute principal to the surviving spouse during her life without having the balance of the principal at her death included in the surviving spouse's estate**. * Because the life estate terminates at the death of the surviving spouse, the surviving spouse did not create the life estate, and the surviving spouse has no "general" power of appointment over the trust property, **there will be no transfer of property that is includable in the estate of the surviving spouse**. * **Thus, this trust "bypasses" the survivor's taxable estate and is therefore often called a Credit Equivalent Bypass Trust (CEBT)**. * **The surviving spouse can be given a "limited" or "special" power of appointment under this family trust**. For example, a surviving spouse might be given the right to appoint, at his or her death, all or any part of the assets in the family trust to a limited class of beneficiaries, such as the children of the grantor. This means that the surviving spouse can distribute the assets in this trust only to the specified children, but can do so in any proportion the spouse desires. **Unlike a general power of appointment, this limited power of appointment does not cause the trust assets to be included in the surviving spouse's estate**. * **A surviving spouse can utilize the unused portion of a decedent spouse's unified credit**. The **deceased spouse's unused exclusion amount (DSUEA) is added to a surviving spouse's basic exclusion amount to reduce gift and/or estate taxes on their combined estates**. If a surviving spouse had more than one deceased spouse, then only the most recent spouse's DSUEA can be used.

Answer 39

**To take advantage of the DSUEA, an executor must take the following actions on the decedent's estate tax return, Form 706**. * File a timely return or file timely extensions * Compute the DSUEA * Make an irrevocable election to utilize the DSUEA

Answer 40

For estate planning purposes, the By-Pass trust may still be useful because: * The appreciation on assets transferred to the trust **escape estate taxation in the surviving spouse's estate**. * **The decedent can control who will receive the assets in the trust by selecting the beneficiaries**. If assets are given outright to the surviving spouse and the spouse remarries, the assets may not be used as the decedent spouse intended. * **The decedent's GST exemption is not portable, therefore the decedent's GST exemption could be allocated to a By-Pass trust if skip persons are trust beneficiaries**. * Couples who live in states that impose an estate tax may use the trust and other techniques to **reduce or avoid paying state estate taxes**.

Answer 41

The drawbacks: * **Assets in the trust do not receive a step-up in basis**, yet **assets bequeathed directly to the surviving spouse are stepped up to FMV**. * The value of the assets transferred to the bypass trust will reduce the amount of the decedent's unused exemption that is available to the surviving spouse.

Answer 42

* **For married couples with significant taxable estates, a Bypass trust is created first for each spouse with assets equal to the tax year's exemption equivalent amount**. That amount is $12,920,000 in 2023. * **Any excess amounts can be given directly to the surviving spouse or transferred into other marital trusts, so that the decedent's estate will receive a marital deduction to offset a potential estate tax liability**. Examples of **marital trusts that qualify for the marital deduction are general power of appointment trusts (A trusts) and Estate trusts.** **QTIP trusts can be subject to the marital deduction in the decedent's estate if the executor qualifies the terminable interest property "QTIP" for the marital deduction**. * **Placing assets in this QTIP trust can result in zero estate tax at the first spouse's death to the extent that the trustee or executor elects to take the marital deduction on Form 706, the estate tax form**. * **All of the income of this trust must be paid, at least annually, to the surviving spouse, and the spouse can have a 5 x 5 power over the trust corpus**. * No provision for invasions of the trust can be made for anyone other than the surviving spouse, or the marital deduction will be lost. Likewise, it would be lost if there were any condition (for example, remarriage) or power in anyone else which could prevent the surviving spouse from receiving all the trust income for life. * If the trustee has elected to take a marital deduction at the first spouse's death for assets going into that trust (usually 100%), **the QTIP (Q) trust will be included in the surviving spouse's estate**. **The value of the assets remaining in the QTIP will be included in the surviving spouse's estate**. Any assets remaining in this trust at the survivor's death will be distributed as the grantor decided. * **If generation-skipping is planned and if some of the grantor-decedent's exemption from the generation-skipping transfer (GST) tax is still available, the executor will make a "reverse Q-TIP" election, which will still allow a marital deduction in the decedent's estate, and will allocate the remaining GST exemption to the trust**. Provisions are usually made for the **QTIP trust to be divided into two trusts**: * **Trust Q-E:** Will **contain property to which some of the GST exemption will be allocated**. * **Trust Q-N**: **Will not be exempt from the GST tax** and, therefore, will often have different terms than the trust Q-E.

Answer 43

* An estate may claim an **unlimited deduction for the value of all property that passes from a decedent to the surviving spouse upon death**. However, **no marital deduction is allowed for the estate of a U.S. resident who leaves property outright to a surviving spouse who is not an American citizen**. * There are a couple of ways for deceased Americans to transfer property to their resident alien spouses. * One such way includes **using up their unified credit**. If the decedent was a U.S. citizen or resident, the estate can still qualify for the exemption equivalent ($12,920,000 in 2023) **allowing up to this amount to be passed tax-free even to a non-U.S. citizen spouse**. * **Section 2056A allows a marital deduction for property placed into a special trust for the benefit of the non-citizen spouse called the Qualified Domestic Trust (QDOT)**. This section also requires that there are safeguards to ensure that the trust property (if not used up by the alien survivor) is eventually subjected to the U.S. estate tax. * **The citizen spouse can establish the QDOT as a living trust or through their will**. At the spouse's death **the executor would designate the trust as a QDOT on the federal estate tax return (706)**. * If the citizen spouse does not establish this trust **the non-citizen spouse can establish their own QDOT before the decedent's estate tax return is due**.

Answer 44

The requirements for establishing a QDOT are: * The trustee must be a US citizen or a domestic corporation, or a US bank if trust assets exceed $2 million, * The trust **must retain sufficient assets to cover the non-citizen's spouse's estate taxes**, * The **trust must be set up as a QTIP trust or an Estate Trust**, and * The trustee must approve all distributions of principal, and withhold estate taxes from principal distributions that are not subject to an ascertainable standard (HEMS). Emergency or hardship distributions are possible and are exempt from transfer tax.

Answer 45

A disadvantage to transferring assets into a QDOT is that the **assets remaining in the trust at the non-citizen spouse's death are taxed as if they had been included in the citizen spouse's estate**. * However, non-citizen spouses can use their applicable credit to offset their own estate tax liability. * Non-citizen spouses can also become US citizens, making them eligible for the unlimited marital deduction. * **QDOTs can be useful estate planning tools for married couples where one of the partners prefers to keep his/her foreign citizenship**. Withdrawals by a noncitizen surviving spouse from a QDOT established before 2010 will continue to be subject to the deferred estate tax provisions through 2023.

Answer 46

**A disclaimer trust allows the surviving spouse, or any other beneficiary, the opportunity to do post-mortem (after death) estate planning**. In the spousal situation, the disclaimer trust is utilized in smaller estates to avoid visiting with an attorney regularly while providing a mechanism for tax planning by surviving spouse. The trust is **also frequently used when the surviving spouse wishes to have the decedent's estate take full advantage of the applicable credit available to it or when the survivor does not need property bequeathed to the survivor under the terms of the decedent's will**. This **occurs when the decedent's estate has overqualified the estate for the marital deduction and has failed to take full advantage of the applicable credit.** * By taking advantage of a disclaimer trust, **the surviving spouse disclaims a portion of the assets that would have been received from the grantor's estate**. * Instead, these assets pass into a disclaimer trust, the income from which can be used to benefit the surviving spouse. The **property that is disclaimed remains in the taxable estate of the decedent and takes full advantage of the applicable credit, so there is usually little if any estate tax liability** for the grantor's estate after 2010. In effect, the property contained in the disclaimer trust **usually passes to someone other than the surviving spouse in order to take advantage of both the applicable credit (the disclaimed portion) and the marital deduction (that portion of the property which is not disclaimed but which instead is enjoyed by the spouse or is that property over which the spouse enjoys postmortem control)**. The language for the trust is in the estate planning documents and the surviving spouse may elect to disclaim some or all of the property he or she is entitled to. **Once the valid disclaimer is filed, the assets so disclaimed transfer into the disclaimer trust**. The election of the disclaimer trust by the surviving spouse is an **important postmortem election since it ensures both estates of overall estate tax savings by using the combined estate tax savings provided by the use of both the marital deduction and the applicable credit**.

Answer 47

* Marital Trust - Provides the decedent's spouse with control over the decedent's property. The amount placed avoids estate tax liability of the first decedent. * Non-marital or Bypass Trust - Appropriate when the grantor wishes to leave a life income interest to their spouse as well as, other family members such as children or grandchildren. * QTIP - Used when the grantor provides income to a spouse for lifetime, but passes the remainder interest to someone else. * Disclaimer Trust - Used when the surviving spouse wishes to file a qualified disclaimer over a portion of the property passing to the survivor from the grantor's estate.

Answer 48

Two specific types of trusts may occur by operation of law: * A resulting trust * A constructive trust These trusts **protect the rights of the grantor when all beneficiaries die. They also protect the rights of a beneficiary who has been cheated fraudulently by another individual, depriving the beneficiary of a right to the estate**.

Answer 49

**A resulting trust is a trust occurring in favor of the grantor**. * It is **used when a trust originally designed for another beneficiary fails because all beneficiaries have died,** or when the trust has been declared void. * The **grantor becomes the beneficiary** in such a trust arrangement.

Answer 50

A** standby trust is usually structured to take effect when the owner is no longer capable of managing the assets**. * Frequently, this occurs in situations where the grantor has become **disabled or where the grantor has left the country for a period of time** (for example, three years leave of absence to develop a business enterprise in a foreign country). * The standby trust is **usually revocable in nature**. * In fact, most standby trusts are revocable inter vivos trusts, in which the **grantor is also the trustee and beneficiary**. * The grantor would name a successor trustee to manage his assets if he were to become incapacitated since the grantor would be the trust beneficiary. * **If the trust is not funded when the grantor becomes incapacitated, then the agent of the grantor's durable power of attorney could transfer assets into the trust for the trustee to manage**. * However, if the trust is already funded, this will avoid delays in managing the grantor's assets at a critical point in his life.

Answer 51

* **Marital/Non-marital Trust (also commonly referred to as the "A-B trust" or, more currently, the "A-B-Q" trust)** is an arrangement designed to give the surviving spouse the use of the family's economic wealth, while at the same time **minimizing, to the extent possible, the total federal estate tax payable at the deaths of both spouses**. * **The "B" or Bypass Non-marital (family) Trust is designed to receive property that is not allocated to the power of appointment trust, the estate trust, or the QTIP trust**. Is **generally funded with the applicable credit amount**. * **Qualified Domestic Trust (QDOT)** is created to utilize a marital deduction in a US citizen's estate for property passing to a non-citizen spouse. * **Disclaimer Trust** is utilized to allow the surviving spouse, or any other beneficiary, the opportunity to do post-mortem (after death) estate planning. * **Totten Trust is not a trust**. It is a **revocable bank account or money market account that automatically transfers on death (TOD) to the account beneficiary**, therefore avoiding probate. * **Resulting Trust** is a trust occurring in favor of the grantor. * **Standby Trust** is usually structured to take effect when the owner can no longer manage the assets.

Answer 52

20 years * A charitable lead trust pays a fixed income stream to a qualified charity, usually for a period not exceeding 20 years.

Answer 53

* Marital Trust - It provides the decedent's spouse with control over the decedent's property. * Non-marital or Bypass Trust - It is used when the grantor leaves a life income interest to his spouse and other family members. * QTIP - It is used when the grantor provides income to a spouse for her lifetime, but the remainder interest to some other beneficiary. * Estate Trust(c) - It provides income to the grantor's spouse only when the trustee deems it proper.

Answer 54

To ensure that you have a thorough understanding of the income taxation of trusts, the following topics will be covered in this lesson: * Grantor Trust Rules * Trusts and Estate Tax Liability * Gift Tax Implication of Trusts * Termination Conditions Upon completion of the lesson, you should be able to: * Explain the tax implications of trusts, * Explain tax liabilities of trusts, and * Explain the conditions under which trusts terminate.

Answer 55

* Income taxation of irrevocable trusts follows certain general rules. **Beneficiaries are taxed on the trust income that is or can be distributed to them, while income that is accumulated in the trust is taxed to the trust**. * This is **known as the "sharing" concept**. Trusts are either simple trusts or complex trusts. * **Simple trusts are required to distribute all net income to the beneficiaries in the year the income is earned**. **Beneficiaries are taxed on the income received at their marginal tax brackets and the trust receives a deduction for the income distributed to the trust beneficiaries**. With simple trusts, **the trust corpus cannot be distributed and no charitable gifts can be made from the trusts**. Simple trusts are separate tax entities and have a **$300 personal exemption**. * **If the corpus is distributed to beneficiaries, then the trust becomes a complex trust**. Note that capital gains are not considered trust income and are treated as additions to corpus. **If the trust distributes capital gains the trust cannot take a deduction for the distribution**. * **Trusts are generally taxed on capital gains retained by the trust, therefore even a simple trust may be subject to income tax**. **Trusts that do not require income to be distributed, such as "sprinkling" trusts, are considered complex trusts**. * **Complex trusts can accumulate income, make distributions of principal, and make gifts to charities**. * The trust **takes deductions for income distributed to beneficiaries but is taxed on income that remains in the trust**. * Therefore, **a complex trust is a separate tax-paying entity that has a $100 personal exemption**. * **Trust income is taxed to the trust at the highest 37% bracket when trust taxable income exceeds $14,440 in 2023**. * By comparison, individuals are taxed at the 37% bracket when their taxable income exceeds $578,126 in 2023.

Answer 56

**The trust beneficiary is taxed on income that is required to be distributed to the beneficiary, regardless of whether the income is actually received**. If the income accumulates in the trust and is retained by the trust, the trust pays the income tax on it. If the trust allows Trustee discretion to distribute income, then **when the trust passes the income to the beneficiaries, the trust receives a distribution deduction and the beneficiaries must pay the tax on the distribution**. * In effect, **the beneficiary is taxed on his or her proportional share of the distributable net income (DNI)**. **DNI is taxable income prior to applying the personal exemption for trusts and deductions for distributions and after the exclusion of capital gains and losses**. DNI is used in the following ways. * Provides a limit for the deductions a trust or estate can take for the amounts distributed to beneficiaries. * Limits the amount of trust income taxable to beneficiaries. * Determines the types of distributions made to beneficiaries. **DNI ensures that a trust or estate receives a deduction for the amounts distributed to the beneficiary, so the distribution is not taxed twice**. For example, a trust earns income of $10,000 and distributes $6,000 to a beneficiary. The DNI is $10,000. The trust would receive a deduction of $6,000 and the trust is taxed on the remaining $4,000. **DNI limits the amount of trust income the beneficiary is required to report**. The trust deduction is the lesser of the amount distributed to the beneficiary or the DNI. In the example above, if the trust had distributed $12,000 to the beneficiary the trust would deduct $10,000- the DNI. Under the "income first rule," $10,000 is considered to be income and the remaining $2,000 is a tax-free distribution of trust corpus. **The beneficiary is taxed on $10,000 of the $12,000 received**. **DNI ensures that the character of the income the trust receives is distributed in the same manner to the beneficiaries**. For example, if the trust receives tax-free income, the income distributed will be tax-free to the beneficiary. **Deductions for depreciation and transaction and investment expenses can be deducted by the beneficiary as well**.

Answer 57

An important concept that is frequently employed in the taxation of trusts is the concept of the throwback rule. **This rule is designed to tax the beneficiary of a trust that accumulates income**. The throwback rule applies only in certain situations, however, and **applies only where the actual distributions from the trust exceed the amount of the DNI**.

Answer 58

**A grantor trust is a trust in which the grantor has unexpired interest or residual control over the trust assets**. "Control" as used in this definition does not mean the type of control that a trustee has over assets which he administers as a fiduciary. The technical definition of a grantor type trust is any trust where the "grantor" retains any unexpired or reversionary interest. There is a great deal of difference between having an unexpired interest or residual control, and being trustee. **The point of the grantor trust rules is to allow the grantor to be treated as the owner of a trust**. The grantor trust rules provide that if the owner of property transferred to a trust retains an economic interest in, or control over, the trust, the owner is treated for tax purposes as the owner of the trust property, and all transactions by the trust are treated as transactions of the owner. **A grantor trust for income tax purposes can effectively remove assets from the estate and give the grantor the requisite control so that the income earned within the trust will be taxed back to the Grantor**.

Answer 59

The grantor pays the income tax on any income produced by the trust if the following conditions occur: * The grantor receives the income directly. * The grantor may have the income payable to himself or herself, under the terms of the trust. * The grantor indicates that the income from the trust is to be paid to the grantor's spouse. * The grantor indicates that the income is to accumulate for the benefit of the grantor, or the grantor's spouse. * The grantor indicates that the **income is to be used to pay life insurance premiums for a policy owned by the grantor or the grantor's spouse**. * The grantor indicates that the **income is to be used to satisfy a legal obligation of support for a family member of the grantor (for example, minor children) or for the grantor's spouse**. * The grantor has the ability to revoke the trust or alter its terms so that the trust terminates or reverts back to the grantor at any time. * The grantor retains the power to control the beneficial enjoyment of the trust property, including the power to determine who shall receive the property and the terms under which the property can be enjoyed. (For example, "$20,000 per year to my son, Charles, aged 24, as long as he achieves good grades in his medical studies, but if he does not achieve good grades in his medical studies then the income terminates upon the discretion of the grantor.") * The **grantor possesses specific administrative powers over the trust**. He is allowed to borrow against the trust and use the trust corpus as collateral. **If any of these conditions are present, the grantor will be deemed to be the recipient of the income produced by the trust and will be liable for income tax on any income produced by the trust**. If the grantor can substitute assets for 50% of the trust property, then the grantor will be required to report 50% of all income, deductions, and credits on the grantor's income tax return. **If the grantor wishes to avoid being taxed on trust income, the grantor should avoid any and all of the nine situations described**. **A trust that is defective for income tax purposes should also be defective for estate tax purposes**. * However, **the IRC provisions for income, gift, and estate taxes were enacted at different times**. * Therefore, **there is not consistency of treatment, which means that a trust can be effective for estate and gift tax purposes, but defective for income tax purposes**. * This divergence invites planning opportunities, and you will learn more about **Intentionally Defective Grantor Trusts (IDGTs) in the Business Planning module**.

Answer 60

When a grantor establishes a **revocable** living trust, the grantor should realize that the **assets in such a trust are still included in the grantor's gross estate**. Because the grantor can terminate the trust at will, or revoke it at any time, the grantor possesses incidents of ownership over the trust and its corpus and undistributed income. The ability to revoke the trust will cause the inclusion of the corpus and all undistributed income in the gross estate of the grantor. Thus, such a trust **should be thought of primarily for its flexibility and not as a saver of estate tax**.

Answer 61

**A revocable trust becomes irrevocable upon the earlier of the death of the grantor or when the grantor gives up the right to revoke**. Generally, a grantor lacks the power to revoke a trust during incompetency. It is possible to specify that as soon as the client is deemed to be incompetent, the trust becomes irrevocable. This would block a person acting under a durable power of attorney from changing the plan of disposition in the revocable trust. **Irrevocability of a trust may trigger adverse gift tax implications**. * **A taxable gift can be made when a client parts with dominion and control over property**. * **But immediate gift taxation can be blocked**. * The **client could retain a life interest in the trust's assets and delay taxation on the gift of the remainder interest (the portion going at his death to the ultimate beneficiaries of the trust) by the reservation of a testamentary power of appointment over that remainder interest**. This should work even if the grantor is mentally incompetent since it is assumed that he may regain competency at any time before death.

Answer 62

In general, **a revocable trust is not considered a completed gift because the grantor has not parted with dominion and control over the property**. Thus, **a revocable trust will not be subject to gift tax liability**. However, because the grantor has not parted with ownership of the property, **it will be included in the grantor's gross estate**, **even if the trust is a life insurance trust**. **An irrevocable living trust will normally result in a gift and possibly some gift tax liability**. * The **value of the gift is the fair market value of the property at the time it is transferred**, not its value at the date of the grantor's death. * Thus, if the grantor has property that is highly appreciable in nature, it **might be a good idea to transfer the property into the irrevocable living trust in order to avoid having the future appreciation included in the gross estate of the grantor**. * **If the trust pays income, it may qualify for the annual exclusion amount on the stream of income being distributed to the beneficiary**. **As long as the income is distributed to the beneficiary, or as long as the beneficiary has a demand right of the greater of $5,000 or 5% of the corpus, or can demand the lesser of an annual addition to trust corpus, or the maximum amount allowable under a five and five power (5% of the value of the corpus, or $5,000, whichever is greater) the income produced by such trusts qualifies for the gift tax annual exclusion amount and can reduce the grantor's gift tax liability**. In trusts where the beneficiary does not have a demand right over a portion of the corpus, or where the income from such a trust must accumulate, the gift tax annual exclusion is not available to offset any gift tax liability the grantor may have to pay.

Answer 63

There are significant tax implications if a trust is terminated in a fashion other than on purpose. In the case of a constructive trust that is imposed in cases of fraud, the conditions under which a trust can terminate should to be examined. These conditions include: * **Termination of Trust**: Most trusts terminate in an orderly fashion, according to the terms of the trust agreement. Thus, the trust will terminate when the stated condition in the trust agreement occurs. For example, a non-marital trust may last as long as the surviving spouse is alive. Upon the surviving spouse's death, the trust terminates and the remainder interest in the property passes to the children of the decedent and spouse (the income recipient of the non-marital trust). **When the specified condition occurs upon which the trust will terminate, the corpus and all undistributed income must be distributed to one or more designated remaindermen**. **Conversely, all undistributed income and corpus must be distributed to the grantor as a reversionary interest**. * **Trusts that Violate the Rule Against Perpetuities**: **A trust that is established for a noncharitable beneficiary must be capable of being measured. The trust cannot be perpetual but can only last for a period of time that is measured by the lives of any persons alive at the time the trust is created (plus any life in vitro) plus 21 additional years**. * Thus, **a trust can only last for a time period that does not exceed the life of any person in existence at the time the trust is created, plus a period of 21 years and 9 months (to account for any lives in vitro**). If the trust is structured to last longer than this time period, then the trust is in violation of the rule against perpetuities and is **regarded as void from its inception**. Note that some states have legislatively modified or done away with the rule against perpetuities. * **Termination by Agreement of the Beneficiaries**: If all the beneficiaries are legally and mentally competent, **they can agree to terminate the trust and distribute the corpus and undistributed income, provided the material purpose of the trust has first been achieved**. In most states, the grantor's intentions take precedence over the beneficiaries' wishes. However, if the grantor has a specific purpose for creating the trust and that purpose is yet to be achieved or has not been substantially achieved, then the decision by the beneficiaries to terminate the trust will not be binding. Where the material purpose has already occurred ("to provide financial assistance to my children and grandchildren so that they may attend college"), then the beneficiaries of the trust by agreement may terminate the trust and receive the corpus and undistributed income.

Answer 64

* **Illegal Purpose of the Trust**: Should the trust or any of its purposes be designed for illegal activities, so that the trustee or any of the beneficiaries must commit an act that is illegal or that would be considered an example of **tortious conduct**, **the trust is illegal and will terminate on the occurrence of the act deemed illegal or tortious**. A trust that is **designed for the sole purpose of evading the grantor's creditors is an act of fraud (a tort) and the creditors may reach the assets in trust or the court may declare the trust to be invalid**. Subsequently, the trust terminates when the grantor attempts to use it in an attempt to defraud a creditor. * **Merger of Legal and Equitable Title in the Same Beneficiary**: In some states, when the trustee and beneficiary of the trust are the same individual, there may be a merger of legal and equitable title in the individual. **When this occurs, the trust may terminate by the operation of law**. For a trust to be recognized, there should be vesting of the legal title in the trustee. The equitable title should be in possession of the trust beneficiary. When these titles merge in the same person, there may no longer be a reason to have a trust. **Therefore, in some states, when merger occurs, the trust terminates**. As long as there are multiple trustees and multiple beneficiaries, the trust will still be operative. Also, if there is one trustee but several beneficiaries, or there are several trustees and one beneficiary, the trust is still an operative instrument. **It is when the sole trustee is also the sole beneficiary that the merger doctrine applies and at that point the trust may cease to exist**. * **Termination Due to Impossibility of Purpose**: If the purpose for which a trust was created cannot be performed due to impossibility of the purpose, then the **trust will terminate if a similarly related purpose cannot be found**. For example, if a private trust (noncharitable trust) were created for the sole purpose of providing a stream of income to a disabled beneficiary to provide that beneficiary with living expenses and assistance, but the beneficiary died shortly after the trust was created, the trust would terminate unless the terms of the trust specifically provided either: * The trust would continue in the event of the death of the beneficiary, or * The trust would continue for the express purpose of providing living expenses and assistance to other disabled persons living within the same metropolitan area. * If neither of these provisions existed in the terms of the trust agreement, then the trust could fail because of impossibility of purpose.

Answer 65

In this lesson, we have covered the following: * **Trusts**: A grantor retained trust, as its name implies, is an **irrevocable** trust into which the grantor places assets and retains an interest for a fixed period of years. **An irrevocable life insurance trust is a vehicle for holding life insurance policies**. The marital/non-marital trust (also commonly referred to as the "A-B trust" or "A-B-Q" trust) is an arrangement designed to give the surviving spouse full use of the families economic wealth. * **Grantor Trust Rules** establish that a grantor of the trust rather than the trust itself or the trust beneficiary is to be taxed on the income produced by the trust in a number of situations. * **Estate Tax Liability** occurs because the ability to revoke a trust causes the inclusion of the corpus and all undistributed income in the gross estate of the grantor. * **Gift Tax Implications**: A revocable trust is not to be subject to gift tax liability. However, **an irrevocable living trust results in gift tax liability**. * **Termination of Trusts** occurs when a stated period of time or conditions expire. These conditions include situations where the purpose of the trust has been achieved or if the trust outlives its time or if the beneficiaries agree to terminate the trust. It can also terminate if the trust performs an illegal activity. **A trust also terminates if the trustee and beneficiary of the trust are the same individual**. When this occurs, the trust may terminate by operation of law because of the merger.

Answer 66

Tax the beneficiary of a trust that accumulates income. Tax that portion of the accumulated income as if the income has been distributed. * **The throwback rule is designed to tax the beneficiary of a trust that accumulates income**. * The throwback rule taxes that portion of the accumulated income as if the income had been distributed. * The throwback rule applies only in certain situations, however, and **applies only where the actual distributions from the trust exceed the amount of the DNI**.

Answer 67

Gifts or bequests of a specific sum of money or property Distributions that do not exceed the trust's accounting income. * **Gifts or bequests of a specific sum of money or property and distributions that do not exceed the trust's accounting income are not subject to throwback rules**. * **Distribution of income that accumulates before the beneficiary's birth and before the beneficiary reaches the age of 21 are not subject to throwback rules**. * **A specific amount set aside, paid or used for specific charity alone qualifies for non-imposition of throwback rules**.

Answer 68

The grantor indicates that the income is to be used to pay life insurance premiums for a policy owned by the grantor or the grantor's spouse. The grantor may have the income payable to him, under the terms of the trust. The grantor has the ability to revoke the trust or alter its terms so that the trust terminates or reverts back to the grantor at any time. * It is necessary that a grantor pay income tax on any income produced by the trust when the grantor indicates that the income is to be used to pay life insurance premiums for a policy owned by the grantor or the grantor's spouse.If the grantor receives the income, then the grantor pays income tax returns.

Answer 69

* **Powers of the Trustee**: In order to achieve the objectives of a trust, the trustee is entrusted with certain powers. * **Kinds of Trusts**: There are different kinds of trusts tailored to suit the needs of the grantor or the beneficiaries. These include: **the Pour-over Trust, GRAT, GRUT, GRIT, Discretionary Trust, Spendthrift Trust, Sprinkling or Spray Trust, Generation-skipping Trust, UGMA, UTMA, 2503(b) Trust and 2503(c) Trust**. * **Charitable Trusts**: Such trusts are popular and **effectively save on gift and estate taxes**. Different trusts which fall under this category include **charitable lead trust, CRAT, CRUT and life insurance trust**. * **A/B TRUSTS**: These trusts take advantage of a decedent's unified credit and marital deduction. These include the **Marital Trust, Non-marital or Bypass Trust, Q-TIP, Estate Trust and Disclaimer Trust**. * **Specific Trusts**: These **occur by operation of law**. Examples of such a trust would include **a resulting trust and a constructive trust**. A resulting trust occurs in favor of the grantor **when all beneficiaries have died or when the trust has been declared void**. A constructive trust is in favor of a person who is unjustly deprived of property by another individual. * **Income Taxation of Trusts**: The trust and the beneficiaries of the trust are considered as separate entities for tax purposes. The grantor pays income tax only if certain conditions occur. * **Termination of Trusts**: occurs under certain conditions expressed in the trust document or according to state law.

Answer 70

QPRT * A qualified personal residence trust (QPRT) is an irrevocable trust that holds a person's residence, allowing couples or individuals to live in the house rent-free for a specified period of time. * At the end of the term, the home will pass gift-tax free to the trust beneficiaries.

Answer 71

Both I and II * 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.

Answer 72

I only * A sprinkling trust can distribute income to beneficiaries. * A spray trust can distribute both income and corpus.

Answer 73

marital deduction * Section 2056A allows a marital deduction for property placed into a special trust for the benefit of the non-citizen spouse called the Qualified Domestic Trust (QDOT). * This section also requires that there are safeguards to ensure that the trust property (if not used up by the alien survivor) is eventually subjected to the U.S. estate tax.

Answer 74

Creditor protection when established solely for supplemental 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.

Answer 75

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.

Answer 76

2503(b) * A 2503(b) trust can provide a beneficiary with a stream of income during the time in which the beneficiary is a minor. * The trust must distribute the income to the minor on an annual or more frequent basis. 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.

Answer 77

a gift of present interest * 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**.

Answer 78

Corpus * Trust property is often referred to as corpus or principal.

Answer 79

Allow for testamentary transfers. Flexibility. * UTMAs are a flexible type of trust that can be used for the benefit of a minor. * They **allow for testamentary transfers into the minor's account & terminate at age 21 or 25, depending on the state**. * UTMAs **permit the use of various investments, including transfers of real estate, partnership interests, and oil and gas interests**.

Bryant - Course 6. Estate Planning. 9. Trusts Flashcards

(109 cards)