Revocable type living trusts are great for creating some stability in your finances for the future. A revocable living trust is not a separate legal entity as is an LLC or a corporation. You are not required to obtain a federal tax identification number. The trust’s income is taxed to the grantor, regardless of who actually receives it. This is because the Grantor retains control over the trust’s assets and income. Your revocable trust owes no income taxes.
Definitions
| Term | Definition |
|---|---|
| Trust | A legal arrangement in which one person (the trustor) gives another person (the trustee) the legal right to hold and manage property or assets for the benefit of a third person (the beneficiary). |
| Trustee | The person who is legally responsible for holding and managing the property or assets in a trust. The trustee must act in the best interests of the beneficiary. |
| Beneficiary | The person who is entitled to receive the benefits of a trust. The beneficiary can be a single person, a group of people, or a charity. |
| Trustor | The person who creates a trust. The trustor can also be the beneficiary, but this is not always the case. |
| Grantor | Another name for the trustor. |
Two main types of trusts
Simple trusts are trusts that must distribute all of their income to the beneficiaries each year. They cannot accumulate income or make charitable distributions. Simple trusts are taxed in the same way as individuals, with the beneficiaries taxed on the income they receive from the trust.
Complex trusts are trusts that are not subject to the same restrictions as simple trusts. They can accumulate income, make charitable distributions, and distribute principal to beneficiaries. Complex trusts are taxed in a different way than individuals, with the trust itself being taxed on the income it earns. The beneficiaries are only taxed on distributions they receive from the trust.
The main difference between simple trusts and complex trusts is the way in which income is distributed. Simple trusts must distribute all of their income to the beneficiaries each year, while complex trusts can accumulate income or make charitable distributions. This difference in distribution rules has a number of implications for the taxation of trusts and their beneficiaries.
Simple trusts are generally simpler to set up and manage than complex trusts. However, they may not be as flexible as complex trusts, which can be used to achieve a wider range of goals.
Revocable Trusts
Revocable trusts are a type of trust that can be a valuable estate planning tool. They can help to avoid probate, control the distribution of assets after death, and provide for the care of minor children. If you are considering creating a revocable trust, it is important to speak with an attorney to discuss your specific circumstances and how a revocable trust can benefit you.
Trusts are a strange animal, many people do not understand what a trust is and still more do not understand how it works with all other elements such as income tax reporting and who is responsible for what. This article will try to explain about trusts and why they are a good thing for many people to set up.
A revocable trust is based on state law. The Uniform Trust Code (UTC), which has been adopted by all 50 states, provides the basic framework for revocable trusts. However, there are some differences in how revocable trusts are created and administered from state to state.
The grantor must sign a trust agreement
To create a revocable trust, the grantor (the person who creates the trust) must sign a trust agreement. The trust agreement must specify the terms of the trust, including the names of the trustee (the person who manages the trust) and the beneficiaries (the people who will receive the trust assets). The trust agreement must also be signed by the trustee.
Once the trust agreement is signed, the grantor must transfer ownership of the trust assets to the trustee. This can be done by transferring the assets into the name of the trust, or by giving the trustee a power of attorney to manage the assets.
The grantor of a revocable trust can change or revoke the trust at any time. However, once the grantor dies, the trust becomes irrevocable and cannot be changed.
I often recommend a qualified revocable trust as a method to hold investment real estate. The first step is to create a limited liability company for each investment property. Create the revocable trust document then add an addendum that describes the property that you are giving to the trust.
No legal protections
Moving the property to the trust does not add or delete any legal protections, what it does is accomplishes what is indicated below. Your successor trustee and/or surviving spouse will have control of the property. Making this move does not change your individual income tax return either.
In addition to income taxes, beneficiaries may also be responsible for paying capital gains taxes on distributions from trusts that hold appreciated assets. The capital gains taxes are calculated based on the difference between the fair market value of the asset when it was transferred to the trust and the fair market value of the asset when it is distributed to the beneficiary.
Often the trust will pay any taxes that would be due before the transfer to the trust beneficiaries. You should seek tax advice from a CPA at this point to be sure that there there is no tax due which has not already been considered.
Some benefits of creating a revocable trust:
- Avoid probate: Probate is the legal process of transferring assets after death. It can be time-consuming, expensive, and public. A revocable trust can avoid probate, which can protect your privacy and save your family time and money.
- Control the distribution of assets: A revocable type of trust allows you to control how your assets are distributed after death. You can specify who will receive your assets and when they will receive them. This can help to prevent family disputes and ensure that your wishes are carried out.
- Provide for the care of minor children: If you have minor children, a revocable trust can provide for their care after your death. You can name a guardian for your children and specify how your assets will be used to support them.
Irrevocable Trust
An Irrevocable trust differs from a revocable trust in that an irrevocable trust can not be changed or revoked by the grantor once it has been created. The grantor gives up complete control to the trustee. At this point, the irrevocable trust does become a separate legal entity requiring a federal tax id number.
Irrevocable living trusts are legal creations in both state and federal law. The Uniform Trust Code (UTC), which has been adopted by all 50 states, provides the basic framework for irrevocable living trusts. However, there are some differences in how irrevocable living trusts are created and administered from state to state.
To create an irrevocable living type of trust, the grantor (the person who creates the trust) must sign a trust agreement. The trust agreement must specify the terms of the trust, including the names of the trustee (the person who manages the trust) and the beneficiaries (the people who will receive the trust assets). The trust agreement must also be signed by the trustee.
Once the trust agreement is signed, the grantor must transfer ownership of the trust assets to the trustee. This can be done by transferring the assets into the name of the trust, or by giving the trustee a power of attorney to manage the assets.
Benefits of an Irrevocable Trust:
- Avoid probate: Probate is the legal process of transferring assets after death. It can be time-consuming, expensive, and public. An irrevocable living trust can avoid probate, which can protect your privacy and save your family time and money.
- Reduce estate taxes: By transferring assets into an irrevocable living trust, the grantor may be able to reduce their estate tax liability.
- Protect assets from creditors: In some cases, assets that are held in an irrevocable living trust may be protected from creditors.
- Provide for long-term care: An irrevocable living trust can be used to provide for long-term care costs. The trust can be structured to allow the grantor to access trust assets for long-term care expenses without having to spend down their assets to qualify for Medicaid.
Protection from judgments
One of the key reasons as mentioned above to consider a revocable trust is to protect your assets from those who would have your property. If you engage in a risky business e.g. working with the public, owner-operator of your own truck or you have lots of assets, someone at some time will want them. This is a true story that I read in a book about trusts and asset protection.
This person operated a retail business. He decided to create a revocable trust into which to transfer his considerable assets. Rather than create trust in the state where he lived, he decided to create trust in a Caribbean island. Essentially another country that had laws that made it very difficult to grab assets without an extensive process. Not impossible as we shall find out but possible.
About one year after creating the irrevocable type of trust and transferring his assets, he was sued by someone claiming damages. The court awarded a substantial-high six-figure award. As it happened, this person did not have sufficient funds to pay this award, in fact, he was significantly deficient.
The business was not his
He was required to appear in court and explain why he was not paying the award. The explanation was simple, while he operated a business, it was not his. He told the judge that he worked for a company and that company was owned by a revocable trust.
The judge understood what was happening and ordered the man to instruct the trustee to pay the award. The man wrote a letter and sent it registered to the trustee. The trustee wrote back and stated that he could not honor the request. The man produced this letter in court. After reviewing the letter, the judge told the person who sued the man that they could try to get the award but was unlikely to.
Advanced planning
Two things occurred here. First, the revocable trust made it very hard to get assets (trust property) that were not actually owned by the individual being sued. Second, as part of estate planning, the man instructed the trustee that if he ever received a letter with a demand from a court for payment, he was to refuse payment.
The letter was explicit. No amount of requests on his part would permit the trustee to pay out if the man was considered “under duress”.
About this story, don’t rush out and do what he did. These actions on his part required planning and the help of a professional financial advisor and legal advice. Most of us do not have sufficient assets to protect in this way nor do we have the type of legal exposure requiring a non-revocable trust. Also, trust laws change.
A word on timing. If you try to set up a revocable type of trust and transfer assets after you have been notified that you will be sued by someone, it’s too late. Most state and federal laws will indicate that you did this specifically to avoid paying. There is a difference between advanced estate planning and evading the law. Don’t wait to set up your trust until you are in trouble.
Some types of Irrevocable trusts
Here are some of the common types of irrevocable trusts and their tax implications:
- Income trust: An income trust is a trust that is created to generate income. The income from the trust is taxed at the trust’s tax rate.
- Spendthrift trust: A spendthrift trust is a trust that is created for someone who is financially irresponsible. The trustee of the trust has the power to manage the trust’s assets and to prevent the beneficiary from spending the money unwisely.
- Charitable trust: A charitable trust is a trust that is created to benefit a charitable organization. The income from the trust is tax-deductible for the trustor, and the assets of the trust are not subject to estate taxes.
Family Trust
A family trust, also known as a testamentary trust or a trust under will, is established through a person’s last will and testament and comes into effect upon their death. Unlike a living trust, which is created and funded during the grantor’s lifetime, a family trust is created within the terms of a will and is funded with assets upon the grantor’s death.
Key features of a family trust include:
- Asset distribution: A family trust allows the grantor to specify how their assets will be distributed among family members or other beneficiaries after their death.
- Minor or incapacitated beneficiaries: Family trusts can be used to manage assets on behalf of minor children or beneficiaries who may be unable to handle their inheritance directly.
- Trustee selection: The grantor designates a trustee who will manage and distribute the trust assets according to the terms outlined in the will.
- Probate involvement: Since a family trust is created through a will, it is subject to probate proceedings, which can involve court supervision and potential delays.
Are you confused now? Do you need a revocable living type of trust or a nonrevocable trust or a family trust? As you can see, each type of trust is different. Seek legal counsel to help you understand which is best for you. Check out our FAQs below:
Frequently Asked Questions:
What is a revocable living trust?
A revocable living trust is a legal document that allows you to control how your assets are distributed after you die. It is called a “living” trust because it is created while you are still alive. It is called a “revocable” trust because you can change or revoke it at any time while you are alive.
What are the benefits of a revocable living trust?
One benefit is that it can help you avoid probate. Probate is a court process that is used to distribute your assets after you die. It can be a lengthy and expensive process. This means that when you die, your assets will pass to your beneficiaries outside of probate.
Who can be a trustee of a revocable living trust?
Anyone who is competent to sign a contract can be a trustee of a revocable living trust. This includes you, your spouse, a friend, a family member, or a professional trustee.
How do I create a revocable living trust?
work with an attorney. The attorney will help you draft the trust document and ensure that it is properly executed.
How much does it cost to create a revocable living trust?
The cost of creating a revocable living trust will vary depending on the complexity of your situation and the fees charged by the attorney. However, it is generally expected that the cost will be between $1,000 and $3,000.
What happens to my revocable living trust after I die?
When you die (death of the grantor) your revocable living trust will become irrevocable. This means that your beneficiaries will receive the assets in the trust according to the terms of the trust document. The trust will not be subject to probate.
Can I put my real estate in a revocable living trust?
Yes, you can put your real estate in a revocable living trust. This will allow you to avoid probate when you die, which can save time and money. It will also allow you to name a trustee to manage your real estate if you become incapacitated.
What happens to my real estate after I die if it is in a revocable living trust?
After you die, your real estate will pass to your beneficiaries according to the terms of your type of trust. The trust will not be subject to probate.
What is an irrevocable trust?
An irrevocable trust is a legal document that allows you to transfer ownership of assets to a trustee, who then manages those assets for the benefit of one or more beneficiaries. Once you create an irrevocable trust, you cannot change or revoke it.
Who can benefit from an irrevocable trust?
Anyone can benefit from an irrevocable trust. However, irrevocable trusts are most commonly used by people who have significant assets and who want to reduce taxes, protect assets, or plan for incapacity.
What happens to my assets after I create an irrevocable trust?
After you create an irrevocable type of trust, the assets that you transfer to the trust will be owned by the trust. The trustee will then manage those assets for the benefit of the beneficiaries that you have named in the trust document.
What is the legal status of an irrevocable trust?
An irrevocable trust is a legal document that creates a fiduciary relationship between the trustor (the person who creates the trust) and the trustee (the person who manages the trust). Once the trust is created, the trustor cannot change or revoke it.
Can an irrevocable trust be terminated?
In general, an irrevocable trust cannot be terminated by the trustor. However, there are a few exceptions to this rule. For example, a trust may be terminated if the trustor becomes incapacitated or if the trust’s purpose becomes impossible or impractical to fulfill.
What are the tax implications of creating an irrevocable trust?
The tax implications of creating an irrevocable type of trust vary depending on the type of assets that are transferred to the trust and the purpose of the trust. In general, however, transferring assets to an irrevocable trust can have significant tax benefits.
Does a revocable trust file a tax return?
No, the Grantor must pay any income taxes when due on trust income that is taxable income. You would add revocable taxable income for federal income tax purposes with your own federal income tax return.
Does an Irrevocable trust file a federal tax return?
Yes, an irrevocable trust must file a federal tax return if it has an income of $600 or more. The trust will file Form 1041, U.S. Income Tax Return for Estates and Trusts. The trust’s income will be taxed at the trust’s tax rate, which is usually lower than the individual tax rate. The trust will also be able to claim deductions for expenses incurred in carrying out its purpose. For all intents and purposes, an Irrevocable trust in the view of the Internal Revenue Service is a legal entity and will require a separate income tax return from your usual 1040 form.
Resources for Planning
You may want to learn more about trusts or dig deeper into a specific trust. Check out this link to the American Bar Association.
National Conference of State Legislatures (NCSL) – The NCSL is a bipartisan organization that serves state legislatures in the United States. Their website provides information on state-specific laws and regulations related to trusts. Visit their website at www.ncsl.org.
Sample revocable living trust. Check this link to see what a revocable living trust document looks like. Yours will probably be different. This will give you an idea of the information you must provide to the individual creating the trust.
Information required to prepare a Revocable Living Trust
The information that must be included in a revocable living trust varies from state to state, but typically includes the following:
- The names of the grantor(s) and trustee(s)
- The date the trust was created
- The terms of the trust, including how assets will be managed and distributed
- The names of the beneficiaries
- The signature of the grantor(s) and a notary public
In addition to this basic information, you may also want to include the following in your revocable living trust:
- A provision for changing the trustee if necessary
- A provision for distributing assets if one or more of the beneficiaries die before the grantor
- A provision for distributing assets if the grantor becomes incapacitated
- A provision for how the trust will be funded
Creating any type of trust is just one element in estate planning. Estate planning can be part of retirement planning. I strongly suggest that you read our series on Generation X, 20 years to retirement. This series of blog articles on this site will provide a rich basis for retirement planning.
We are creating an educational course all about retirement. Check out this page to see if the course is available yet.
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One of our sources for information on this article comes from the Braddock Law Firm. The managing partner, Gerald has been practicing law in Mississippi for decades. We recommend that our readers seek legal council when creating not only a revocable living trust but, also wills, advanced health care directives, and other elements of a complete estate planning portfolio.
