Trusts are perhaps the most dynamic tool in the estate planner’s toolbox. Trusts have a variety of benefits that include establishing rules with respect to the management and disposition of your assets and the potential provision of significant tax savings. There are many types of trusts, and this blog post provides a brief summary of some of the more common ones.
A revocable trust (also referred to as a living trust) is the workhorse of a client’s estate plan in that it typically disposes of most, if not all, of the assets of the grantor (also known as the settlor or the trust’s creator) upon the grantor’s death. Further, if the grantor’s assets are transferred to the revocable trust during the grantor’s life, the revocable trust can assist with asset management during the grantor’s incapacity and also minimize or avoid the need for probate.
An irrevocable life insurance trust (or ILIT) is an irrevocable trust designed to be the owner and beneficiary of a life insurance policy on the grantor’s life. If set up and maintained properly, the proceeds from the life insurance policy should be excluded from the grantor’s gross estate (i.e., not subject to federal estate tax at the grantor’s death) and can be used to provide liquidity for the payment of the grantor’s estate tax.
An intentionally defective grantor trust (or IDGT or sometimes referred to as a grantor trust) is an irrevocable trust whereby the grantor is treated as the owner of the trust assets for federal income tax purposes. Typically, this is caused by the grantor’s retention or the possession by others of certain powers with respect to the trust. As a result of this status, the trust income must be reported on the grantor’s income tax return, and the grantor is required to pay the resulting income tax. This permits the trust assets to essentially grow income-tax free during the grantor’s life, and, importantly, the grantor’s payment of the trust’s income tax liability is not a taxable gift. Further, any sale between the grantor and the trust will be ignored for income tax purposes.
A qualified terminable interest property trust (or QTIP trust) is a testamentary trust whereby a decedent’s surviving spouse is the sole beneficiary eligible to receive current distributions from the trust and must receive all trust income at least annually. Assets passing to a QTIP trust from a decedent qualify for the estate tax marital deduction (provided the surviving spouse is a U.S. citizen), and any remaining assets of the QTIP trust upon the surviving spouse’s death are included in his or her gross estate and subject to estate tax at that time.
A reverse QTIP trust operates the same way as a QTIP trust, with the exception being the decedent allocates his or her remaining generation-skipping transfer (GST) tax exemption to the assets funding the reverse QTIP trust. Upon the surviving spouse’s death, the remaining assets of the reverse QTIP trust are included in the surviving spouse’s gross estate, yet the decedent remains the transferor of such assets for GST tax purposes. This is a powerful tool to ensure that the decedent’s GST exemption is not wasted because the decedent’s unused GST exemption cannot otherwise be transferred to the surviving spouse as the portability rules do not apply to GST exemption.
A qualified domestic trust (or QDOT) is a special type of marital trust for the benefit of a noncitizen spouse that qualifies for the estate tax marital deduction. Generally speaking, principal distributions to the surviving spouse are subject to estate tax, and any remaining assets of the QDOT upon the surviving spouse’s death are potentially subject to estate tax at that time. In addition, a separate set of provisions apply to “large” QDOTs funded with more than $2,000,000 of assets.
A bypass trust (also referred to as a credit shelter trust) is a testamentary trust created on the grantor’s death funded with assets equal to the grantor’s remaining estate tax exemption. Unlike a QTIP trust, the assets of the credit shelter trust are not included in the beneficiary’s gross estate and, as a result, are not subject to estate tax at the beneficiary’s death (in other words, the assets bypass the beneficiary’s estate).
A spousal lifetime access trust (or SLAT) is an irrevocable trust created by a spouse during life for the benefit of the other spouse. A SLAT permits the beneficiary-spouse to have access to the trust assets, and on his or her death, the remaining assets typically divide into separate trusts for descendants. A SLAT is usually an intentionally defective grantor trust.
A grantor retained annuity trust (or GRAT) is an irrevocable trust whereby the grantor transfers assets in trust and retains a right to annual annuity payments during the trust term. Although not required, the annuity amount is typically calculated so that the present value of the grantor’s expected annuity stream equals the value of the transferred assets (or results in only a small gift), thereby zeroing out (or reducing to a nominal amount) any gift associated with the transfer to the trust. Provided that the trust is properly structured and the grantor survives until the end of the trust term, any appreciation in the trust assets above the amount required to satisfy the grantor’s annuity payments will pass free of further gift tax to the remainder beneficiaries at the end of the trust term.
A qualified personal residence trust (or QPRT) is an irrevocable trust whereby the grantor transfers a residence to the trust and retains the right to occupy such residence for a term of years, after which time the residence will pass to the remainder beneficiaries. The grantor will often pay the remainder beneficiaries rent to continue to use the residence at the end of the trust term. The value of the grantor’s initial taxable gift is the value of the residence reduced by the present value of the grantor’s retained occupancy right.
A charitable remainder trust (or CRT) is an irrevocable trust whereby a noncharitable beneficiary receives a payment stream from the trust either for a term of years or the beneficiary’s lifetime, after which the remaining assets will pass to a charitable beneficiary. CRTs can be structured as either a charitable remainder annuity trust (or CRAT), where the noncharitable beneficiary receives an annual fixed distribution amount, or as a charitable remainder unitrust (or CRUT), where the noncharitable beneficiary receives an annual distribution based on the value of the trust assets. If the CRT is created during life, the grantor will be treated as having made a taxable gift to the noncharitable beneficiary but can claim an income tax charitable deduction with respect to the remainder interest passing to the charitable beneficiary. If the CRT is created upon the grantor’s death, the grantor can claim an estate tax charitable deduction with respect to the remainder interest passing to the charitable beneficiary.
A charitable lead trust (or CLT), essentially the flipside of a CRT, is an irrevocable trust whereby a charitable beneficiary receives a payment stream for a term of years, after which the remaining assets will pass to a noncharitable beneficiary. Again, similar to CRTs, CLTs can be structured as either a charitable lead annuity trust (or CLAT) or as a charitable lead unitrust (or CLUT). If the CLT is created during life, the grantor can claim an income tax charitable deduction with respect to the charitable beneficiary’s income interest and will be treated as having made a taxable gift based on the remainder passing to the noncharitable beneficiary. If the CLT is created upon the grantor’s death, the grantor can claim an estate tax charitable deduction with respect to the income interest passing to the charitable beneficiary.
A 2642(c) trust is an irrevocable trust that entitles the grantor to a GST annual exclusion. The trust is named after Internal Revenue Code Section 2642(c), which provides for this special GST annual exclusion gift typically unavailable to gifts in trust. The trust must have only a single beneficiary (typically a grandchild of the grantor) and the remaining assets upon the beneficiary’s death must be included in the beneficiary’s gross estate (such inclusion usually caused by the beneficiary’s possession of a general power of appointment).
A beneficiary deemed owned trust (or BDOT) is an irrevocable trust where the beneficiary is treated as the owner of the trust assets for federal income tax purposes as a result of granting the beneficiary a certain power over the trust. BDOTs are used in very specific situations and are generally drafted by lawyers who specialize in the area.
Chris Weeg prepares trusts for clients throughout the State of Florida. You can reach Mr. Weeg or the estate planning department’s attorneys of Comiter, Singer, Baseman & Braun, LLP at (561) 626-2101.