Types, Features, and Taxation of Trusts

Question 1

Simple and Complex Trusts

Answer 1

• a simple trust is entitled to a personal exemption of $300
• A complex trust is entitled to a personal exemption of $100
• an estate which is taxed as a trust for income tax purposes, is entitled to a $600 exemption
• A simple trust requires distribution of all income in the year it is earned, no amount can be given distributed for charitable purposes, and distributions cannot exceed the current year’s income.

Question 2

Testamentary Trust

Answer 2

-set up by transferring assets from the decedent’s estate into a trust specified under the will.

Question 3

Totten Trust

Answer 3

• a bank account set up in the name of the depositor, which is in trust for a named beneficiary.
• depositor retains access, so there is no completed gift
• the beneficiary does not obtain possession until after the depositors death
• essentially a revocable trust

Question 4

Bypass Trust

Answer 4

• also called a credit-shelter trust, nonmarital trust, or “B” trust.
• set up by a will to take advantage of the applicable credit amount under estate tax laws
• the trust is created to provide an income for the surviving spouse and the remainder to the decedent’s children.

Question 5

QTIP Trust

Answer 5

• also called a “C” trust
• requires an election by the executor for QTIP treatment
• qualifies for the marital deduction, however the decedent can direct who will inherit the assets after the surviving spouse dies.

Question 6

Pour-Over Trusts

Answer 6

• established to receive assets that will “pour over” from different sources
• useful in receiving and distributing an individual’s non-probate assets such as employee benefits, IRA benefits, and life insurance proceeds.
• can be used to avoid ancillary probate

Question 7

Spendthrift Trust

Answer 7

-a trust containing spendthrift provisions that will prevent a beneficiaries creditors from obtaining trust assets, so the beneficiary is protected from their own “spendthrift” propensities.

Question 8

Support Trust

Answer 8

• provides income to fulfill the grantor’s legal obligation to provide support for children and a spouse.
• generally used as part of the terms of a property settlement in a marriage dissolution

Question 9

Standby Trust

Answer 9

• does not become operational and is essentially unfunded until the grantor becomes disabled or incapacitated.
• primary benefit is to provide management expertise for the grantor’s assets, in the event the grantor cannot manage them.

Question 10

Dynasty Trust

Answer 10

• an irrevocable trust that postpones vesting and continues as long as is permitted under state law.
• are established in states where trust life are much longer than normal (250 to 1000 years)
• they must contain provisions protecting assets from an heir’s creditors and from being marital property in a divorce.

Question 11

Special Needs Trust

Answer 11

-irrevocable trusts set up by the grantor to provide supplemental support for loved ones with special needs, without infringing upon the beneficiaries ability to receive government benefits

Question 12

Sprinkling Provisions

Answer 12

-allows the trustee to allocate income and, sometimes, corpus among the trust beneficiaries, according to their needs, abilities, or talents.

Question 13

Rule Against Perpetuities

Answer 13

• in some states, the rule limits noncharitable trust essentially to a max duration of 21 years and 9 months beyond the life span of any persons alive at the time the trust was created.
• if the beneficiary is a charity, the trust can have a perpetual duration
• the rule is intended to prevent removal of property from the stream of commerce for long periods of time.

Question 14

Gift Tax Rules for Trusts

Answer 14

• transfers to revocable trusts are not completed gifts, so no gift tax consequences
• transfers to irrevocable trusts are completed gifts, so the grantor is responsible for any gift tax liability.
• a grantor can make use of the gift tax annual exclusion to the extent that the gift passes a present interest to the donee

Question 15

Power of Appointment

Answer 15

• the right or authority given to another to designate who shall possess or enjoy certain property.
• the persons who are to receive the property subject to the power are called the beneficiaries or appointees.
• when the donee designates a person (or persons) to receive property, the power has been exercised
• can be created by a trust, a will or other document
• this is a way to provide flexibility in an estate plan because decisions over the disposition of property can be delayed and delegated to other persons.

Question 16

General Power of Appointment

Answer 16

• the holder can exercise the power in favor of anyone, including the holder themselves
• holding a general power of appointment over property is considered the same as “owning” that property.

Question 17

Special or Limited Power of Appointment

Answer 17

• restricts the persons whose favor the power may be exercised.
• the donor of the power designates the persons or class of persons to whom the property may be appointed, and these designations may NOT be the holder, the holders creditors, the holders estate, or the creditors of the holders estate.

Question 18

Ascertainable Standard

Answer 18

• a power is limited if it can be exercised only in accordance with an ascertainable standard (HEMS), the following powers to invade principal contain ascertainable standards:
• for support in the holder’s accustomed manner of living
• for support in reasonable comfort
• for the holders education
• for all medical expenses, including convalescence
• for maintenance in reasonable health and reasonable comfort.

Question 19

Release or Lapse of Power

Answer 19

• when a power is exercised in favor of a beneficiary, a gift has been made to that person
• a release of a power is deemed a gift because property passes to a different person
• for gift tax purposes the release of a power is treated the same as the exercise of the power.
• lapses are subject to gift tax to the extent the value of the property not appointed was in excess of $5,000 or 5% of the total value of the property subject to the power.

Question 20

5-and-5 Power

Answer 20

• the beneficiary has the right annually to appoint the greater of $5,000 or 5% of the trust assets.
• since the holder of a general power can appoint to themselves, the beneficiary can obtain from the trust a payment that is at least $5,000
• if the power has not been exercised in the year of death, the beneficiaries gross estate will only include the greater of $5,000 or 5% of the property and not all of the trust assets.

Question 21

Tax treatment of distributions to beneficiaries

Answer 21

• the income of a trust or estate is taxed to the beneficiaries if it is distributed, and it is taxed to the trust if it is retrained.
• beneficiaries are also taxed on the amount that is required to be distributed even if it is not distributed.

Question 22

Grantor Trusts

Answer 22

• the following powers, if held by a grantor, will make a trust a grantor trust:
• trust income is paid to the grantor or to his or her spouse
• the trust income may be payable to the grantor or their spouse
• the trust income is accumulated for future distribution to the grantor or their spouse
• the trust income is or may be used to purchase life insurance on the grantor or his or her spouse
• the trust income is or may be used to discharge a legal obligation of the grantor’s family , except where the income may be, but is not, used for the support of dependents
• the trust principal or corpus will return to the grantor or spouse
• the grantor retains the power to revoke or amend the trust
• the grantor can dispose of income or corpus at less than full value
• the grantor can borrow from the trust without adequate security or interest