Firm Articles

REVOCABLE LIVING TRUSTS

by Nhaman Phan

What is a Revocable Living Trust?

A revocable living trust is an estate planning tool that allows you to remove assets from your personal estate into a living trust allowing it to hold legal title over those assets.  You retain all the same rights and powers over the assets as you would absent the living trust and each asset retains its original character as community property, separate property, or quasi-community property.  Like its name suggests, a revocable living trust is created during your lifetime and can be changed or terminated by you at any time.  Generally, as grantor, you transfer your property into a living trust for the benefit of yourself during your lifetime (as the lifetime beneficiary), and then for the benefit of your spouse or children (as successor beneficiaries) upon your death.  In addition, you are also the trustee of your living trust and as such you will have unlimited access and complete control over all trust assets during your lifetime, including the power to buy, sell, borrow or transfer trust property.  Upon your death or incapacity, you may appoint a successor trustee to take control over your trust assets in accordance with the guidelines that you set forth in the trust instrument. 

Avoidance of Probate

One advantage of having a living trust is the avoidance of probate.  Probate is the legal process for transferring your property when you pass away.  It is a state court proceeding that is open to the public and it usually involves the court appointment of a personal representative, collection of your assets, notification and payment of your creditors, and the transfer of your property to your beneficiaries either under a will or to your heirs at law.  A revocable living trust avoids the probate process because probate only affects assets owned by you, individually, at the time of your death and assets placed in a living trust are no longer owned by you, individually, but rather by you, as trustee of your trust.  Also, probate will cost approximately three percent (3%) to four percent (4%) of the value of your probate assets and will take anywhere between nine (9) months to two (2) years to complete, absent any litigation or contested claims.  It is generally for these reasons that a revocable living trust is often favored over a will.

Confidentiality and Continuity of Ownership

Since probate is a court proceeding, the provisions of a will and any valuations made of a testator’s assets will be open to public inspection.  A living trust, however, is confidential and the transfer of trust assets is kept private.  Additionally, a living trust provides greater continuity in the administration of the trust upon the death or incapacity of the grantor because the designated successor trustee will immediately continue the administration of the trust.  On the other hand, if you only have a will, there is a gap period between the time death and the appointment of an executor by the court to administer the estate.

Tax Planning using a Revocable Living Trust

During the grantor’s lifetime, having a revocable living trust will generally have no significant income tax advantages because the grantor retains the right to exercise control over the trust assets and therefore, the IRS treats the trust property as it does as if the grantor owned the trust assets outright.  Any income generated by the trust assets would be income to you and would be reported on your personal state and federal income tax returns during your lifetime. 

Next, there is the estate tax exemption.  The IRS allows for an estate tax exemption, up to a specified amount, on assets owned by the grantor at the time of the grantor’s death which essentially allows the trust beneficiaries to take without having to pay estate taxes on the trust property.  The following is a list of the estate exemption amounts for the next several years.

Therefore, estate taxes only become an issue if the value of your estate exceeds the applicable exclusion amounts.& There are several strategies that may be employed to maximize your applicable exlcusion amount.

The Bypass Trust

The Bypass Trust permits each spouse to take advantage of his or her estate tax exemption, as described above, by funding this trust with the deceased spouse’s assets up to the exemption amount. This trust is created upon the death of the grantor and is irrevocable. Net income or principal from this trust may be used to support the surviving spouse, however, the grantor designates the beneficiaries of this trust’s assets and only those named shall be permitted to take a share under this Trust.

The Marital Deduction Trust/Q-TIP Trust

The Marital Deduction Trust permits the grantor to leave the balance of his or her estate that exceeds the applicable exclusion amount to his or her spouse for their lifetime benefit. There are no estate taxes due until the death of the surviving spouse and generally the trust provides that Q-TIP provisions attach to this trust.; Q-TIP stands for “Qualified Terminable Interest Property.” This property can be used to provide for the health, maintenance, welfare and support of the surviving spouse; but may not be given away by him or her to anyone other than the beneficiaries designated by the decedent spouse. Thus, upon the death of the surviving spouse, the remaining assets in the Marital Deduction Trust shall pass to the beneficiaries designated by the deceased spouse as directed in the living trust. Q-TIP provisions are particularly useful for couples who may have children from prior marriages and who wish to ensure that those children ultimately receive a portion of their estate.

Generation Skipping Transfer Tax/Trust

Closely related to the Q-Tip trust is the Generation Skipping Transfer Trust (GST Trust). The GST Trust enables the grantor to “skip” a generation when designating his or her beneficiaries. For example, when the grantor bypasses his adult children and designates his grandchildren as the successor beneficiaries of his trust assets. In such an event, the GST Trust shall be created to allow for such a skip in generation, to exempt the grantor’s adult children from paying any estate tax on the trust assets designated to the grantor’s grandchildren. However, GST Trusts are governed by specific rules, for example, it must satisfy the Rule Against Perpetuities. In California, a non-charitable trust must terminate within “a life-in-being plus twenty-one (21) years” after the death of the last beneficiary designated under the living trust at the time of the creation of the trust. There are also tax rules that apply to GST Trusts. A GST Trust may not shelter more that the estate tax exemption amount set by the IRS during the life of the “skipped” generation.

Funding a Revocable Living Trust

For a living trust to be effective you must transfer property from your name to the trust’s name. The cost to transfer property or “fund the trust” is usually minimal, but it does require a separate transaction for each asset. The following information is usually needed in order to transfer title into the living trust:

• Deeds to all properties, and the names and addresses of all lien holders of record on the properties
• Copies of all mortgages, trust deeds, and installment obligations held by the grantor under which payment is being made to the grantor
• The real property tax bills
• Account information for all bank accounts, brokerage accounts, and mutual funds
• The name and address of all general partners for any partnership interest held
• The name and address of all transfer agents for all stock certificates held and a copy of any stock certificate held in a closely held corporation
• Copies of all leases and promissory notes and the name and address of the parties to the leases and promissory notes
• Title documents for cars, boats, or other like properties

Advantages of a Revocable Living Trust

• Avoidance of probate; specifically, avoidance of expensive multiple probate proceedings when you own real estate in several different states
• Continuity of trust administration upon your incapacity or death and reduction of delays in the distribution of your property upon your death
• Having property in a living trust avoid the disclosure of your assets in the public probate process because a living trust is a private document and the distribution of such assets shall also remain private
• If the beneficiaries of your living trust are minor children or others who may not use their share of the trust assets wisely, the trust can continue to hold the assets until they reach a more mature age with income and principal distributed as described in the trust instrument
• A living trust may provide for management of assets in the declining years when the grantor may not be able to physically or mentally manage his or her property by appointing a successor trustee to carryout the provisions of the trust

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