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Estate Planning > Types, Features, and Taxation of Trusts > Flashcards

Types, Features, and Taxation of Trusts Flashcards

1
Q

What is a trust?

A
  • A separate legal entity that allows a person (a grantor or trustor) to transfer assets to another person (the trustee) for the benefit of the bene’s
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2
Q

Explain the parties in a trust

A
  • Grantor
    • The one who establishes the trust and funds the trust
    • Can also be trustee and bene (if revocable trust)
  • Trustee
    • Responisble for managing trust assets and fullfilling instructions outlined the trust document
    • Considered a fudiciary
  • Bene
    • Hold beneficial interest in trust assets and/or trust income
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3
Q

What are some reasons of using a trust?

A
  • Avoid probate
  • Reduce gross estate
  • Assist those who are not capable of property management
  • Creditor protection
  • Spendthrift clasue can be included so that bene’s cannot assign, pledge, or promise to give assets of the trust to anyone
  • Can allow trustee to make distributions on a discretionary basis
  • Can split interests in property
  • Avoid taxes due to future appreciation
  • Avoid transfer tax on subsequent generations

NOT ONE SINGLE TRUSTS CAN DO ALL OF THESE, so financial planner must use different kinds for different situations

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4
Q

Creating a trust - trust agreement

A
  • A legal document that cleraly establishes how a trust’s assets should be managed and distributed, including in cases when the grantor dies or becomes incompetent
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5
Q

simple vs complex trust

A
  • Simple - distributes ALL INCOME annually
  • Complex - allowed to accumulate income within trust
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6
Q

Funding the trust

A
  • This means that the grantor needs to change TITLE OF OWNERSHIP from their name to the name of the trust
  • Pretty much any asset that is titled can be included in a trust
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7
Q

Managing trust assets

A
  • Done by a trustee who can be an entity or a person
  • Are considered fiduciaries
    • So they can be personally liable for any unreasonable losses within a trust
  • Responsibilities include:
    • Receiving and managing trust assets
    • Distribiuting and collecting income
    • Accounting and tax reporting
    • Following provisions in trust document
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8
Q

Types of trusts

A
  • Living trusts
    • Recovable OR irrevocable
  • Testamentary trusts
    • Recovable or irrevocable
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9
Q

Living trusts

A
  • Established while grantor is STILL ALIVE
  • Sometimes called grantor trusts
  • Must also have a will to distribute property not specifically owned by the trust.
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10
Q

Testamentary trusts

A
  • Establisihed THROUGH A WILL when grantor idies
  • Trustee is named in the will
  • Revocable until death or incapacity of grantor
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11
Q

Revocable trust

A
  • Grantor can amend, alter, or terminate trust without notice
  • Grantors are usually also the trustee is these instances
  • Becomes irrevocable at death of grantor and DOES NOT AVOID estate taxes
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12
Q

Irrevocable trusts

A
  • Grantor CANNOT alter, amend, or terminate trust
  • The transfer of property to these trusts are considred a complete gift, and so gift taxes apply to these transfers
    • However, once assets have been transferred, they WILL NOT be included in the grantor’s gross estate for tax purposes
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13
Q

Consider these four things when selecting a trust

A
  • Purpose of the trust
  • What the trust can accomplish
  • The features/characteristics of the trust (how it works)
  • The tax situation for the grantors and beneficiaries
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14
Q

Credit shelter trust

A
  • Also known as bypass, family, and B trust
  • Primary purpose is to shelter the deceased spouse’s avaialble credit against the estate tax
    • Remember that there is an unlimited estate tax deduction for property left to a surviving spouse, but may not protect the property from estate tax when THE SURIVIVNG SPOUSE DIES (so that’s why we use this)
  • Surviving spouse has LIMITED access to income from trust
    • Trust is not required to distribute all income (complex trust)
  • Helps surviving spouse avoid estate taxes as well
  • Children can be bene’s of the trust and can receive income at the trustee’s discretion
  • Surviving spouse HAS LIMITED POWER OF APPOINTMENT AND DOES NOT HAVE DIRECT CONTROL
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15
Q

A trust

A
  • Also called marital trust
  • Can be part of a A-B arrangement
  • Purpose of A trust is to give MORE DIRECT CONTROL of assets held in the A trust compared to those held in the B tust
  • Assets are TAXABLE at death of the surviving spouse (because of the more control)
  • Good for preserving decedant’s GST tax
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16
Q

QTIP trust

A
  • Qualified terminable interest property trust
  • Also known a C-trust
  • Allows a decedent to use martial deduction at death but STILL CONTROL ULTIMATE DISPOSITION OF THE ASSETS
  • Mainly used in second-marriage situations, for remarried couples, families with remarriages, and families with stepchildren
  • Decedant still controls disopoition of property even when dead and when surviving spouse dies, it goes to who they wanted it to go (usually children from first marriage)
  • Surviving spouse receives LIFETIME INCOME (life estate)
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17
Q

QTIP trust - process

A
  • Decedant funds the trust and then at death, the exeuctor of the estate makes the QTIP election, which allows an estate tax marital deduction to avoid paying estate taxes
  • Then, the survivng spouse is entitled to ALL INCOME in the trust for lifetime, and must be paid at least annually (required to receive)
  • At the death of the surviving spouse, the assets transfer to the bene’s of the trust (the reaminder interest)
  • REMEMBER THAT ASSETS ARE FULLY TAXABLE AT DEATH OF SURVIVING SPOUSE
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18
Q

GST trust

A
  • Also known as a dynasty trust
  • Allows a grantor to transfer assets to beneficiaires who are at least two generations removed, such as grandchildren.
    • If bene if NONRELATIVE, anyone who is 37.5 years younger than the grantor is considered two generations removed
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19
Q

GST trust - Process

A
  • Grantor funds trust with APPREICATING ASSETS or life insurance up to the GST exemption amount (applicable credit amount)
  • Grantor’s children may receive income from the trust (middle generation)
    • Not taxed on this until death of last GRANDCHILD
  • Then, once the last child dies (the last child who receives the income), the assets transfer to the SKIPPED GENERATION (the grandchildren)
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20
Q

Explain direct skips

A
  • Can happen when someone from one generation (grandparents) passes assets to someone in a younger generation (grandchildren)
    • Meaning that they skipped the MIDDLE generation (the grandparents’ children)
  • Can occur through gifts or bequests
    • After taking the annual exclusion, a taxpayer’s GST tax exemption is allocated FIRST to DIRECT skip transfers
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21
Q

QPRT

A
  • Qualified personal residence trust
  • Purpose is to REMOVE the value of a personal residence OR vacation home from the estate of a client
  • Very useful for when property values are INCREASING QUICKLY
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22
Q

QPRT - Process

A
  • Grantor transfers OWNERSHIP of home to an IRREVOCALBE TRUST
  • Grantor retains the right to use and live in the property for a PREDETERMINED number of years
  • The value of the transfer for gift tax purposes is determined using IRS tables
  • At the end of the predetermined number of years, the property is transferred to the trust BENE TAX FREE, (can’t be the grantor)
    • If the grantor outlives the term of the trust:
      • The value of the property is EXCLUDED from the grantor’s gross estate
      • If the grantor DIES before the term is up, the FMV of the home will be included in their gross estate
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23
Q

ILIT

A

Should have provision within the trust that final expenses and taxes of the decedent’s estate may be paid from trust proceeds

24
Q

Crummey trust

A
  • Can be used to postpone the age of ownership while allowing the donor of the property to maintain control of the asset for the CHILD’S BENEFIT
  • Usuallly funded with amounts equal to the annual gift tax exclusion
25
Q

Crummey trust - Provision

A
  • Crummey trusts MUST INCLUDE provision that allows the child a NON CUMULATIVE RIGHT to withdraw the annual contribution to the trust, restricted to the amount of annual exlusion OR the GREATER of 5k or 5% of the corpus
  • Usually restricted to 30 days where the bene can withdraw
  • Reason for this provision is it confers a PRESENT INTEREST in the trust so that the grantor can take annual exclusions to reduce taxable gifts to the trust
26
Q

Special needs trust

A
  • Sometimes called supplmenetal needs trust, is created to provide for the needs of a disabled child or adult
  • They coordinate with disability and medical benefits the bene may receive from governmental sources
  • Can be terminated or changed in order to ensure that the bene reamins eligilble for other benefits
27
Q

Medicaid Disabilty Trusts

A
  • Available ONLY to persons who are disabled and YOUNGER than age 65 and who qualify for public benefits
  • A nonprofit organization manages the assets in the trust
  • This is the ONLY TYPE of trust that is EXEMPT from rules regarding Medicaid eligilbity and trust use
  • Medicaid can recover any remainining assets UPON TRUST TERMINATION
28
Q

Blind trust

A
  • Mostly used by politicians and others in poisitions of power who have real or perceived conflicts of interest
  • Property from grantor is managed by an indepedent trustee, who manages the assets indepdnetly of the grantor
  • It is revocable
29
Q

Totten trust

A

Used to hold bank account assets for a client with a named beneficiary

Client retains full control over the account during the client’s life and then no gift tax is imposed until after client’s death (because it is revocable)

30
Q

Spendthrift trust

A
  • Prohibits bene from assinging his/her income or asset rights within the trust
  • it ensures the bene will not imprudently use trust assets and it is effective in sheltering assets from creditors
31
Q

Asset protection trust

A
  • ONLY FOUR STATES allow this trust, which provides income to the grantor or other bene’s but PROHIBITS the distribution of assets for the payment of creditor claims
  • Can be perpetual (trust that last forever)
32
Q

Standy trust

A
  • An unfunded entity that becomes active ONLY WHEN AN EVENT OF A NAMED OCCURRENCE HAPPENS, such as disability or incapciatiion of the grantor
  • Provides continuity of asset management in the even of the triggering event
33
Q

2503b trust

A
  • Held for minors and can be held for the bene’s lifetime or period of years and ultimately passed to another bene
  • All income must be distributed from the trust annually
  • Portion of gifts is considered interest income (gift tax exlclusion) and remainder interest (no gift tax exclusion allowed)
34
Q

2503c trust

A
  • For children under age 21
  • Bene must be given the right to withdraw income AND principal from the trust age AGE 21
  • All gifts are subject to annual gift tax exclusion
35
Q

Power of appointment

A
  • This grants the bene of the trust the right to determine what happens to assets held in the trust
  • It’s usually limited, such as only using the income for health, edcuation, support, etc.
  • Assets will NOT BE included in the power holder’s gross estate
36
Q

General power of appointment

A
  • Does NOT have limited scope to what they can do with trust assets
  • Will be included in gross estate becuse this holder of power would be considred the owner of the trust assets
37
Q

5-and-5 provision

A
  • If someone is holding a GENERAL power of appointment AND releases power OR fails to exercise this power, the IRS may determine that a gift has been made to the remainder beneficiary
  • To avoid this:
    • The 5 and 5 provision states that the trust beneficiary can take OR appoin the GREATER of 5k or 5% of trust assets on an ANNUAL BASIS to avoid the gfit tax
38
Q

Perpetuities

A
  • Some states have limit on duration of trusts to 21 years and 9 months BEYOND the point when any person was alive at the time of trust creation
  • Trusts desinged to benefit charitable organizations are exempt
  • Some states don’t even have this rule
39
Q

Discretionary provision

A
  • Allows trustee COMPLETE DISCRETION in terms of distributing income and assets from a trust to a bene
40
Q

Sprinkling provision

A
  • For trusts with more than one bene, it allows the trustee to distribute income and assets from the trust to each bene in DIFFERENT PROPORTIONS
    • Usually based on abilities, talents, and financial needs
41
Q

Trust interests - Income bene

A
  • CANNOT change or direct who ultimatley receives the trust assets
  • So trust assets are NOT included in their estates
42
Q

Trust interests - Remainder bene

A
  • Receives trust assets AFTER trust income interests have ended
  • Trust assets WILL BE INCLUDED in their gross estate
43
Q

Taxation of revocable trusts

A
  • Transfers from grantor are NOT a completed gift (not gift taxable)
  • Transfer from trust to another person/entity is taxable gift over annual exclusion amount
  • Gift tax paid by grantor
  • Assets are included in grantor’s gross estate
  • Income taxed to grantor
44
Q

Taxation of irrevocable trusts

A
  • Transfers to trust by grantor is taxable gift
  • Assets at grantor’s death not included
    • Except when assets are held in GENERAL power of appointment and grantor has right to change trust bene’s or could distribute trust income
    • Except in the life insurance rules
  • Income is NOT taxed to grantor
45
Q

Form 1041

A
  • Income tax return for trusts (and estates) for income not distributed to beneficiaries
46
Q

Trust income - 1041

A
  • Must report all income earned by trust
  • Eligible to reduce income with exemptions and deductions, such as expenses related to trust managmenet, charitable expenses, and interest paid.
  • Also certain tax credits for trusts may apply
47
Q

Penalties for trust income return

A
  • Failure-to-file - same as personal income tax
  • Failure to pay tax - 10% penalty
  • All other penalties are same as personal income
48
Q

Advantages of Charitable Trusts

A
  • The transfer of assets to charities help avoid capital gains taxes on amounts transferred
  • The donor can elect to receive income interest from the trust, based on the value of the assets it hold
  • The donor can also receive a charitable income tax deduction EQUAL TO the FMV of the asset, LESS any income interest the donor may receive
49
Q

CRAT

A
  • Charitable remainder annuity trust
  • Allows donor to make a charitable gift and receive income stream from it
  • Pays out FIXED DOLLAR every year in an amount of AT LEAST 5% of the value of the trust
  • Charity must receive AT LEAST 10% of the originial contribution at the death of the trust bene’s OR a fixed term of 20 years
  • Best used for LOW BASIS appreciated assets since no capital gains tax is used when the trust sells the stock
  • Donor receives a charitable income tax deduction for the PV of the charity’s remaiinder interest in the year the trust is funded
50
Q

CRUT

A
  • More fleixlbe than CRAT
  • Same rules at CRAT EXCEUPT
    • Guarantees payment of AT LEAST 5% payout
    • Payout is based on actual value of assets in trust, not on the beginning value
    • Income will fluctuate, which can be used as a hedge against inflation
51
Q

CLT

A
  • Charity receives income from trust for a predetermined amount of years
  • Can be CLAT or CLUT
  • At end of income period, assets held in the trust either:
    • Revert backto grantor OR
      • Transferred to a named bene
  • Assets transferred to a NONCHARITABLEE BENE are subject to gift tax
  • When grantor retains reversionary interest in the trust:
    • A charitable income tax deduction is available for PV of the income stream to charity
  • With a NONGRANTOR CLT, grantor does NOt receive an immediate tax deduction
    • Rather, the grantor’s taxable income is reduced by transferring income to a charity
52
Q

CLT - reversionary interest

A
  • A CLT is generally established in a way that the donor retains a reversiioanry interest in the property while directing income from the trust to go to a charity for stated number of years
  • At trust termination:
    • Property is returned back to the donor or donor’s bene’s
    • Donor receives income tax deduction in the year of the initial property transfer
53
Q

Pooled-income fund

A
  • Used very frequently by charitable organizations
  • Provides income to a NUMBER of existing and future donors
  • Each member of the pool receives income based on their proportional share of the assets in the account for life
  • Charity receives assets AFTER death of donor or death of subsequent named bene
  • Donor receives charitable tax deduction for the PV of the charity’s remainder interst
  • Donor can also make future contributions to receive a greater share of income and take additional charitable income tax deductions
54
Q

Gift Annuity

A
  • Donor transfers assets to a charity in return for a life or joint-and-survivor life annuity
  • Resembles traditional insurance contract (pays fixed or variable)
  • Donor receives tax deduction for the amount of transfer that EXCEEDS the actuarial basis of the annuity
55
Q

Donor-advised fund

A
  • Rather than transfer assets directly to a charity, client can establish a charitable fund trhough an investmetn firm
  • Donor will receive tax deduction when established
  • Donor retains right to manage fund assets and determine what charitable organization will receive grant from the fund
56
Q

Bargain sale

A
  • Selling property to a charity for less than its FMV
  • Value of gift, for tax purposes = FMV - selling price

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