REVOCABLE LIVING TRUSTS
A Trust is a legal entity set up by a Settlor (sometimes called a “Trustor” or “Grantor”) to pass assets directly to your beneficiaries upon your death without requiring the formalities of probate. Assets are transferred to the Trust and managed by the Trustee. A Trust can be revocable or irrevocable. A revocable Trust can be amended or revoked at any time by the Settlor. An irrevocable trust cannot be amended or modified.
Living Trusts
In a Living (or “Inter Vivos”) Trust, since in setting up the trust, you usually appoint yourself as initial trustee, you still maintain complete control over those assets. A Living Trust may have more than one settlor; for example when the trust is created by a married couple. Upon the settlor’s death, a Living Trust – or a part of it if there is more than one settlor – becomes irrevocable. Upon the death of both settlors, the entire trust becomes irrevocable.
A Living Trust appoints one or more Successor Trustees to act over the Trust upon the death of the settlor(s). Assets in the Trust are distributed to the designated beneficiaries by the then acting successor trustee.
There are generally two reasons for setting up a living trust: to avoid Probate and/or to avoid Estate Taxes.
Avoiding Probate
As discussed above the Successor Trustee distributes the trust assets to the beneficiaries designated in the Trust upon the death of the settlors without filing a probate proceeding with the court of jurisdiction. The trust estate may then be settled without the time and expense that a probate proceeding generally entails.
One caveat: If your Trust is not carefully drafted, your beneficiaries may avoid probate, but may wind up in court nonetheless. Trust litigation is very common and very costly!!
Estate Taxes and New Law
The Tax Cuts and Jobs Act of 2017 brought some long awaited changes to tax law affecting estate, gift, and generation skipping taxes. Most importantly for us is that the Federal Estate Tax, Gift Tax and Generation Skipping Tax exemptions were doubled. This means that for deaths occurring in and beyond 2018, only estates valued at more than $11.2 million (adjusted each year for inflation – $13.6 million in 2024) will be subject to Federal Estate Tax.
The “estate” for Federal Estate Tax purposes is comprised of all assets belonging to the decedent, including trust assets, IRA’s, assets held under joint tenancy, and other assets.
The new rules also included and made permanent the “portability” aspect of a spouse’s estate tax exemption (more on portability below), Any assets transferred to a surviving spouse of the decedent are exempt from estate tax (provided the proper election is made), and upon the death of the surviving spouse, estate taxes will be due on any amount over the personal exemption unless the surviving spouse elects to utilize the portability provisions.
Traditionally, in the past, for married couples, having a properly drawn Trust that allowed for utilization of estate tax exemptions for both spouses was the best way to avoid payment of excess Federal Estate Taxes. The portability feature permits a surviving spouse to use the deceased spouse’s estate tax exemption, or any unused remainder, thereby increasing the surviving spouses own exemption. Note that the deceased spouse’s leftover exemption must be preserved by the surviving spouse by an election pursuant to the filing of a timely tax return for the deceased spouse.
Consider the following example:
Mr. and Mrs. Jones own $15 million in assets (for simplicity we will assume that all assets are community property and that Mr. Jones has passed in the year 2024). Upon the death of Mr. Jones, his one-half of the assets ($7.5 million) is transferred to Mrs. Jones. No estate tax is owed because (1) his one-half of the estate is less than $13.6 million and (2) his entire estate is being transferred to his spouse so not subject to estate taxes under the unlimited marital deduction. One year later Mrs. Jones dies. On her death, her assets consist of $15 million (her $7.5 million plus her husband’s $7.5 million). In the past, her beneficiaries would have utilized her personal exemption of $13.6 million and would owe Federal Estate Tax on $1.4 million.
Prior to 2011 when portability was first introduced, Mr. and Mrs. Jones would have needed a Living Trust to utilize both spouses’ exemptions. Now, however, Mrs. Jones can add Mr. Jones’ remaining exemption of $6.1 million to her own, as long as Mrs. Jones makes a timely election to do so. Note: Mrs. Jones must make the election on a timely filed tax return following the death of Mr. Jones or she will lose this option!
Also note: Portability only applies to the most recent spouse so if a widow or widower remarries and the newest spouse also dies, the widow or widower will be limited to the current spouses unused exemption even if it is less than that of the previous deceased spouse.
While the living trust often referred to as A-B Trust, Credit Shelter Trust, Exemption Trust, Bypass Trust, Marital Deduction Trusts, QTIP Trust, may no longer be necessary for estate tax purposes, it still may be wise in some cases to ensure the decedent’s bequests to children from a prior marriage are carried out or to avoid a scenario that may restrict or negate portability such as the one given above.
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