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
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
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
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
5
Q
simple vs complex trust
A
- Simple - distributes ALL INCOME annually
- Complex - allowed to accumulate income within trust
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
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
8
Q
Types of trusts
A
- Living trusts
- Recovable OR irrevocable
- Testamentary trusts
- Recovable or irrevocable
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.
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
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
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
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
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
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
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)
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
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
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)
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
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
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
- If the grantor outlives the term of the trust:
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
- Revert backto grantor OR
- 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
