Common knowledge these days says to avoid probate and use a trust to transfer assets to your heirs. Is that a good idea? The answer is often "yes" but not always. Modest-sized estates can often be probated with a simplified process and are not worth the expense of an elaborate trust estate plan. Additionally, having a trust may disqualify a person from receiving Medicaid benefits to pay for nursing home care in some instances. So, whether or not to have a Trust in your estate plan is a complex question which requires specialized legal advice.
Even if a Trust is a good idea, then the question becomes "Which type of Trust?" The most commonly used estate-planning trust is the Revocable Living Trust. But there are many more types of Trusts, many of which have tax implications. Here is a quick list of some of the different types of Trusts.
Common Law Trust
Contrary to the claims of promoters, "common law trusts" no longer exist since Florida now has statutes relating to the creation and operation of trusts.
Personal Residence Trust
A personal residence trust involves the transfer of a personal residence to a trust with the grantor retaining the right to live in the residence for a fixed term of years. Upon the shorter of the grantor's death or the expiration of the term of years, title to the residence passes to beneficiaries of the trust. This is an irrevocable trust with gift tax implications.
Qualified Personal Residence Trust
A qualified personal residence trust (QPRT) involves the transfer of a
personal residence to a trust with the grantor retaining a qualified
term interest. If the grantor dies before the end of the qualified term
interest, the value of the residence is included in the grantor's
estate. If the grantor survives to the end of the qualified term
interest, the residence passes to beneficiaries of the trust. A QPRT is
a grantor trust, with special valuation rules for estate and gift tax
purposes, governed under IRC 2702.
Grantor Retained Income Trust
In a grantor retained income trust, the grantor creates an irrevocable
trust and retains the right to all trust income for: (a) the earlier of
a specified term or the death of the grantor; or (b) a specified term.
If the grantor survives the specified term, the trust principal passes
to others according to the terms and provisions of the trust
instrument. For federal tax purposes, this trust is treated as a
grantor trust.
Grantor Retained Annuity Trust
In a grantor retained annuity trust, the grantor creates an irrevocable
trust and retains the right to receive, for a specified term, an
annuity based on specified sum or fixed percentage of the value of the
assets transferred to the trust. A grantor retained annuity trust is
specifically authorized by Internal Revenue Code Section 2702(a)(2)(B)
and 2702(b). For federal tax purposes, this trust is treated as a
grantor trust.
Grantor Retained Unitrust
A grantor retained unitrust is similar to a grantor retained annuity
trust. However, in a grantor retained unitrust, the grantor creates an
irrevocable trust and retains, for a specified term, an annual right to
receive a fixed percentage of the annually determined net fair market
value of the trust assets (Treasury Regulation Section 25.2702-(c)(1)).
For federal tax purposes, this trust is treated as a grantor trust.
Charitable Trusts
- Charitable Lead Trust
A charitable lead trust pays an annuity or unitrust interest to a designated charity for a specified term of years (the "charitable term") with the remainder ultimately distributed to non-charitable beneficiaries. There is no specified limit for the charitable term. The donor receives a charitable deduction for the value of the interest received by the charity. The value of the non-charitable beneficiary's remainder interest is a taxable gift by the grantor. - Charitable Lead Annuity Trust
A charitable lead annuity trust is a charitable lead trust paying a fixed percentage of the initial value of the trust assets to the charity for the charitable term. - Charitable Lead Unitrust
A charitable lead unitrust is a charitable lead trust paying a percentage of the value of its assets, determined annually, to a charity for the charitable term. - Charitable Remainder Trust
In a charitable remainder trust, the donor transfers assets to an annuity trust or unitrust. The trust pays the donor or another beneficiary a certain amount each year for a specified period. In an annuity trust, the payment is a specified dollar amount. In a unitrust, the payment is a percentage of the value of the trust, as valued each year. The term of the trust is limited to 20 years or the life of the designated recipients. At the end of the term of the trust, the remaining trust assets must be distributed to a charitable organization. Contributions to the charitable remainder trust can qualify for a charitable deduction. This charitable contribution deduction is limited to the present value of the charitable organization's remainder interest. Revenue Procedures 89-20, 89-21, 90-30, and 90-31 provide sample trust forms that the Service will recognize as meeting charitable remainder trust requirements. - Pooled Income Fund Trust
A pooled income fund is an unincorporated fund set up by a public charity to which a person transfers property, reserving an income interest in, and giving the charity the remainder interest in that property. The Code and Regulations under Section 642 establish trust requirements. These funds file Form 1041.
Life Insurance Trust
An insurance trust is generally an irrevocable trust that owns
insurance on the life of the grantor or grantor and spouse. The trust
is designed to avoid federal estate taxation of the insurance proceeds
on the deaths of the grantor or spouse. When premium payments or other
gifts to the trust are made, the trust instrument grants specified
beneficiaries Crummey withdrawal rights over the gifts so that they
will qualify for the federal gift tax annual exclusion. These trusts
would generally file a Form 1041 as a complex trust, if the $600 income
requirement were met.
Qualified Subchapter S Trust (QSST)
A QSST is a statutory creature established by IRC Section 1361(d)(3).
By meeting the requirements of a QSST, a trust may own S Corporation
shares. An election must be made to be treated as a QSST and once made
is irrevocable.
Electing Small Business Trust (ESBT)
An ESBT is a statutory creature established by IRC Section 641(d). By
meeting the requirements of an ESBT, a trust may own S Corporation
shares. ESBT's must file Form 1041 and the S Corporation income is
taxed at the trust's highest marginal rate. No income distribution
deduction is allowed to beneficiaries. To be treated as an ESBT, an
election must be made.
Funeral Trust
This is an arrangement between the grantor and funeral home/cemetery to
allow for the prepayment of funeral expenses. The funeral trust is a
"pooled income fund" set up by a funeral home/cemetery to which a
person transfers property to cover future funeral and burial costs.
These are grantor trusts with the grantor responsible for reporting
income. The trustee may make an election on qualified pre-need funeral
trusts to not be treated as a grantor trust, with the tax being paid by
the trustee.
Rabbi Trust
An irrevocable trust that functions as a type of retirement plan or
deferred compensation arrangement that offers a limited amount of
security to the deferring employee.
Business Trust
The term "business trust" is not used in the Internal Revenue Code. The
regulations require that trusts operating a trade or business be
treated as a corporation, partnership, or sole proprietorship, if the
grantor, beneficiary or fiduciary materially participates in the
operations or daily management of the business. If the grantor
maintains control of the trust, then grantor trust rules will apply.
Otherwise, the trust would be treated as a simple or complex trust,
depending on the trust instrument.
Pure Trust
The term "pure trust" is not used in the Internal Revenue Code.
Whatever the name of the arrangement, however, the taxation of the
entity must comply with the requirements of the Internal Revenue Code.
The requirements are based on the economic reality of the arrangement,
not its nomenclature. If the pure trust meets the definition of a
trust, then it would be taxed under simple, complex, or grantor trust
rules, depending on the trust instrument.
If you have questions regarding your estate plan or Trust, you should seek advice from a competent attorney. The law office of Bogin, Munns & Munns, P.A. has many attorneys who practice in the area of estate planning, including attorneys who assist with planning for Medicaid eligibility as well as a tax attorney with an LLM in Taxation who has extensive experience planning large estates. You can call (352) 332-7688 for a consultation in North Florida or (407) 578-1334 for a consultation in Central Florida.
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