Chapter 9 Part 4

Question 1

A trust is created when one person

Answer 1

“(a trustee) is placed in charge of managing property for the benefit of another (a beneficiary). The trustee has legal control of the trust property (corpus), but must manage it in the interests of the beneficiary. Therefore, legal and beneficial control of the property is separated. The person who creates the trust may be referred to as the trustor, grantor,
maker, donor, or settlor”

Question 2

A trustee has a duty to invest the trust’s assets

Answer 2

prudently in accordance with the Uniform Prudent Investor Act (UPIa). This duty includes diversifying the trust’s assets in order to limit risk. The investment adviser must keep this duty in mind when recommending investments for a trust. The adviser must also review the trust and remember that the investments must be suitable for the beneficiary based on her financial profile and objectives. The trustee’s own profile and objectives are not relevant for determining suitability

Question 3

The UPIA states that a trustee managing a trust with multiple beneficiaries must act

Answer 3

impartially when making investment decisions for the trust. It would be inappropriate for a trustee to favor the interests of one beneficiary over another when managing and investing the trust’s assets. So remember, all beneficiaries are equal unless otherwise stated in the trust

Question 4

A trust may be created for any purpose that is

Answer 4

not illegal or against public policy. Trusts are often used as an estate-planning tool-a way of passing property from one person to another, while avoiding probate and minimizing estate taxes

Question 5

There are two basic types of trusts

Answer 5

lrrevocable and revocable

Question 6

An irrevocable trust is the type of trust that

Answer 6

may not be modified or terminated without the permission of the beneficiary. Once assets are transferred to the trust, all rights of ownership are revoked from the grantor. Assets held in an irrevocable trust avoid probate and are not included in the grantor’s estate

Question 7

Also known as a credit shelter trust, or AB trust, a bypass trust is a type of

Answer 7

“irrevocable trust that is established to take advantage of the unified tax credit for estates. Normally when a spouse dies, his assets are passed lo the surviving spouse through the unlimited marital deduction. However, upon the death of the surviving spouse, her estate would consist of their combined assets and would be subject to estate taxes. Instead, when a bypass trust is established, the deceased spouse’s assets are transferred to the trust. The surviving spouse has access to the assets in the trust, but has no ownership or control over the
assets. Income may be distributed to the surviving spouse for support and maintenance, in addition to various other expenses. Once she dies, the assets in the bypass trust will pass to the beneficiaries
named in the trust and will not be included in her estale–climinating estate taxes”

Question 8

A revocable trust is the

Answer 8

opposite of an irrevocable trust. This type of trust allows the grantor to retain the power lo alter or cancel (terminate) the trust and reclaim the assets. Income earned during the life of the trust is distributed to the grantor. Similar to irrevocable trusts, assets placed in a revocable trust avoid probate. However, these assets are included in valuing the deceased’s estate

Question 9

In a complex trust, the

Answer 9

trustee may choose to retain some or all of the trust’s investment income. The trustee may also distribute the principal to the beneficiaries in accordance with the terms of the trust

Question 10

inter vivos (living) trust

Answer 10

A trust that is created during the grantor’s lifetime is an inter vivos (living) trust. Inter vivos is Latin for between the living. Most of these trusts are revocable. As with revocable trusts, the assets placed in an inter vivos trust also avoid probate hut are included in the grantor’s estate for tax purposes

Question 11

In a simple trust, the trustee is required to

Answer 11

distribute all income generated by the trust to the beneficiaries in the year in which the income is received. The corpus (principal) of the trust must be left intact—the trustee is not allowed to make distributions of principal to the beneficiaries. (Interest and dividend payments are normally considered income, while capital gains are considered part of the trust’s principal.)

Question 12

A testamentary trust is created based on the

Answer 12

instructions found in the grantor’s will. The trust becomes effective once the grantor dies. The assets must go through probate and are included in the value of the estate for tax purposes

Question 13

In a sole proprietorship

Answer 13

one person owns a business and has control over all management decisions. The owner is personally liable for all the company’s debts and is entitled to all the profits that the business generates. The owner, rather than the business, is the taxable entity

Question 14

A partnership is an association of

Answer 14

“two or more people (partners) who have agreed to pool their resources to operate a business. For tax purposes, the Internal Revenue Service (IRS) treats partnerships as an extension of the individual partners, not as a separate taxpaying entity. Therefore, any profits generated by the partnership are distributed (passed tllrough) to the partners and reported on their
personal tax returns”

Question 15

A general partnership may be created with a

Answer 15

verbal agreement of two or more people who agree to form a partnership. However, it is customary and recommended that the partners define their rights and duties in a written agreement (i.e., a partnership agreement). The agreement states the nature of the business, the capital contributed by each partner, and the rights and responsibilities of each partner

Question 16

If the partnership agreement specifies the business as a general partnership, then all the partners have an equal voice in

Answer 16

managing the business and are entitled to share in any profits, as stipulated in the agreement. All partners have personal liability for the partnership’s debts, and each partner has the right to bind the partnership to contracts. The partnership may be dissolved voluntarily by any partner, but will automatically be dissolved on the death or disability of one of the partners

Question 17

A business established as a limited partnership consists of one or more general

Answer 17

partners and one or more limited partners. The limited partnership is created by filing a Certificate of Limited Partnership with a state or local agency. The general partners are responsible for managing the partnership’s business and have unlimited liability for its debts

Question 18

The limited partners contribute capital, but otherwise

Answer 18

take no part in managing the business. For this reason, limited partners are often referred to as silent partners. Limited paitncrs are not held responsible for any oft he partnership’s debts. As the name suggests, a limited partner’s risk exposure is limited to the current value of her investment and any loan amounts (recourse loans) for which she cosigns. However, a limited partner who becomes actively involved in managing the partnership’s business may lose her limited liability status

Question 19

A family limiled partnership (FLP) is a variation of a limited partnership that

Answer 19

is used to minimize estate and gift taxes. For example, an older couple owns an apartment building that they would like lo pass on to their children. The couple establishes a partnership appointing themselves as the general partners and transfers the property to the partnership. The couple names their children as limited partners. Although the couple must pay gift taxes on the limited partnership interests that they give to their children, the rate is usually lower than if they simply transferred the assets outright

Question 20

The other advantage for the parents is that, as general partners, they

Answer 20

retain full managerial control of the assets. Since the children are limited partners, they may not sell their interests without the general partners’ permission. It is also difficult for creditors of the children to attach the partnership’s assets