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A primer on trusts.

Trusts are common but complex

estate planning tools.

Oliver Wendell Holmes said, "Don't put your trust in money; put your money in trust." In estate planning, most individuals try to minimize the taxes on their estates and control how their property will be distributed at death. These seemingly straightforward objectives are complicated by federal estate and gift tax laws and applicable state tax and nontax laws. Creative use of trusts as part of a comprehensive estate plan can help ensure

* Property is transferred according to an individual's wishes.

* Probate headaches are avoided.

* Federal and state tax burdens are minimized.

This, article examines the use of trusts in estate planning. Although a comprehensive discussion of estate and gift tax provisions is beyond the article's scope, brief explanations are included when appropriate and a glossary of relevant trust terms appears on page 60.


A trust is a legal entity established by a person (known as the grantor, settlor, testator or trustor) either while living or through a will at death. The grantor transfers legal title to property, known as the trust corpus or principal, to the trustee, who manages the corpus for the benefit of named beneficiaries. The trustee also distributes income and corpus according to the instructions in the trust instrument or, in the absence of instructions, according to state law.

Trusts offer planning flexibility. Grantors generally can design trusts to meet specific planning objectives, limited only by the restrictions of applicable state law and the practical considerations of federal and state tax laws.

Trusts have a price. Besides the legal costs of establishing trusts, there generally are trustee fees, accounting and record-keeping costs and expenses of filing annual income tax returns. Noncompliance with federal and state laws in creating or operating trusts can be costly, resulting in an unexpected tax bite or failure to satisfy the grantor's objectives.


Trusts can be valuable when planning for death taxes, probate administration, continued control of property or some combination of all three.

Death tax planning. Federal estate tax and state estate or inheritance taxes generally are imposed only on property in which an individual holds an interest at death. Transferring property to an irrevocable living trust in which the grantor surrenders all ownership interests excludes the corpus from the grantor's taxable estate. A transfer to a revocable trust does not produce the same result because the grantor is able, until his or her death, to reclaim the corpus or terminate the trust; the actual corpus transfer is deemed to occur at death.

The transfer of property to a trust is considered a gift under most estate and gift tax laws. Any death tax savings should be evaluated in light of potential gift tax liability when the property is transferred to the trust.

Probate estate planning. For probate purposes, property transferred to a living trust - revocable or irrevocable - is not considered owned by the grantor at death. The corpus passes to the beneficiary under the terms of the applicable trust instrument rather than by will or state intestate succession laws. This normally facilitates the transfer of ownership and reduces associated court costs and legal fees.

Planning for continued control. A trust may be structured so the grantor retains some degree of control over the corpus. Some common situations in which trusts are used to fulfill this control objective are described in the checklist on page 61.

Because satisfying one estate planning objective may compromise another, trusts must be designed carefully to ensure the grantor's objectives are met. For example, George Roberts transfers an apartment building to a revocable living trust, the income from which is paid to his niece. The use of a revocable trust allows Roberts to control the building's ultimate disposition and to exclude it from his probate estate; however, the building will be included in his taxable estate.


Some trusts are specifically designed to achieve particular estate planning objectives. Many, such as qualified terminable interest property (QTIP) trusts, take advantage of specific federal estate tax provisions. Charitable remainder trusts, discussed in the article on page 64, enable the grantor to reduce estate taxes while fulfilling a philanthropic goal. The rest of this article focuses on a few of the trusts commonly used in estate planning.

Marital deduction trusts. These trusts, which are designed to take advantage of the marital deduction for spousal transfers of property, may be structured as living or testamentary trusts. Common marital deduction trusts are QTIP and power-of-appointment trusts.

All income from a QTIP trust must be paid at least annually to the surviving spouse and, on his or her death, the corpus must pass to named remainder beneficiaries. An election must be made on the grantor's estate tax return to treat the corpus as QTIP property. If a valid QTIP trust is created, the corpus escapes e-state tax on the grantor's death but is subject to tax on the surviving spouse's death.

A power-of-appointment trust also involves annual income payments to the surviving spouse but gives him or her an unrestricted general power of appointment over the corpus. No election is required. Once this trust is established, the surviving spouse can transfer ownership of any or all of the corpus by exercising the power of appointment. The corpus is excluded from the grantor's taxable estate. Corpus transfers during the surviving spouse's lifetime are subject to gift tax and any corpus remaining at the surviving spouse's death is subject to estate tax.

Example. Before her death, Mrs. Tang and her husband agreed their children ultimately should inherit all their property. According to her will, all of her property was transferred to a testamentary trust, the income from which is paid annually to Mr. Tang, who holds an unrestricted general power of appointment over the corpus. The corpus was included in Mrs. Tang's probate estate but excluded from her taxable estate.

If Mr. Tang exercises his power of appointment and eventually transfers all corpus to the children before his death, the corpus will be used up and excluded from both his taxable and probate estate. Assuming the transfers to each child are carefully planned and, coupled with Mr. Tang's other gifts, do not exceed the $10,000 annual gift tax exclusion, the lifetime transfers will escape gift tax as well. If instead Mrs. Tang had created a QTIP trust, Mr. Tang could not make lifetime transfers to the children and the entire corpus would be included in his taxable estate.

This example illustrates a major difference between QTIP and power-of-appointment trusts - the control retained by the grantor. A power-of-appointment trust enables the surviving spouse to transfer corpus to a third party or to terminate the trust at any time; the grantor retains little or no control over its ultimate disposition. Mr. Tang can use his power of appointment to transfer corpus to someone other than the children, such as a new spouse, defeating Mrs. Tang's objective that the children ultimately inherit all the property.

Nonmarital deduction trusts. A trust can be structured to provide income to a surviving spouse without qualifying as a marital deduction trust. The corpus therefore is included in the grantor's taxable estate and income can be distributed according to the grantor's wishes.

Depending on their purpose, these trusts are known as family trusts, credit equivalent bypass trusts or credit shelter trusts. Generally, such trusts are designed to take full advantage of the unified credit in the grantor's estate and exclude the corpus from the surviving spouse's estate.

Nonmarital and marital deduction trusts often are used together to achieve estate tax savings. A common example of this is the A-B trust.

Example. Mr. Kennedy's will creates two testamentary trusts, both of which will terminate at the death of Mrs. Kennedy assuming she survives him. At her death, any remaining corpus will be distributed to their children. Neither of the Kennedys has used any of their unified credit.

At Mr. Kennedy's death, $600,000 (the current exemption equivalent amount) will be transferred into trust B; income from this trust will be paid as needed for Mrs. Kennedy's living expenses. The balance of the estate will be placed in trust A; income from this trust will be distributed annually to Mrs. Kennedy.

Assuming the proper election is made by Mr. Kennedy's executor, trust A will be a QTIP trust and the corpus will be excluded from Mr. Kennedy's taxable estate. Trust B, the nonmarital deduction trust, escapes taxation in Mr. Kennedy's estate because the $600,000 corpus equals the exemption equivalent amount. At Mrs. Kennedy's death, the corpus of trust A, but not trust B, will be included in her taxable estate.

Life insurance trusts. Life insurance can satisfy many estate planning objectives, including providing estate liquidity and the financial security of beneficiaries. without proper planning, however, the policy proceeds may be included in the insured's estate, increasing probate costs and potential estate tax liability. A popular way to avoid this possibility is to use an irrevocable life insurance trust, which can be established by

* Creating an irrevocable living trust in which the grantor has no beneficial interest.

* Funding the trust with sufficient cash to pay the premiums on an insurance Policy on the grantor's life.

* Acquiring a policy insuring the grantor's life, naming the trust as beneficiary and giving the trustee the incidents of ownership in the policy. (An existing policy may be transferred to the trust; however, if the grantor dies within three years of the transfer, the proceeds are subject to estate tax.)

There are gift tax considerations. Funds transferred to life insurance trusts may be subject to gift tax, generally do not qualify for the gift tax exclusion and, if made within three years of death, are included in the grantor's taxable estate.

The use of an irrevocable trust requires surrendering policy ownership and control to the trustee; however, the grantor may, within limits, direct the use of policy proceeds. For example, the grantor can provide funds for the care and welfare of minor children, or children with special physical or financial needs, without subjecting the funds to estate tax. The grantor may not, however, direct the trustee to use the proceeds for the benefit of the grantor's estate, such as to pay creditors or estate taxes, which subjects the proceeds to estate tax. If life insurance is needed to provide estate liquidity, the trust instrument instead should empower the trustee to purchase assets from or make loans to the estate.

Generation-skipping trusts. A grantor can create a trust - living or testamentary - that transfers an income or remainder interest in property to second-generation beneficiaries (usually grandchildren). By skipping a generation, the grantor excludes the property from the probate and taxable estate of first-generation beneficiaries (usually children). Generation-skipping trusts generally are used when the grantor's children already have sizable estates or when the grantor wants to preserve the corpus for the grandchildren.

The grantor's estate and gift tax considerations are complicated by the generation-skipping tax imposed on transfers in excess of a $1 million lifetime exclusion, made directly or in trust, during life and at death, to a beneficiary at least two generations below the grantor's generation. However, the tax is imposed on the property's value when transferred, effectively excluding any future appreciation from tax. This technique is appropriate, for example, when a grantor wants to transfer to grandchildren property expected to appreciate significantly.

Example. Mrs. Brown established an irrevocable living trust, the income from which is paid to her son for his lifetime and, on his death, to her grandchildren. The trust terminates on the date her youngest grandchild reaches age 30, at which time the corpus will be distributed to her grandchildren.

Because Mrs. Brown established an irrevocable living trust, the corpus is excluded from her probate and taxable estates; however, Mrs. Brown would have been subject to potential gift and generation-skipping tax liability in the year she transferred property to the trust. On the death of Mrs. Brown's son, the trust corpus will be excluded from his taxable and probate estate.

If Mrs. Brown had established a testamentary or a revocable living trust to transfer the corpus to her grandchildren, the transfer would be deemed to occur at her death for estate tax purposes. The corpus would be included in her taxable estate and the grandchildren's remainder interest would be subject to the generation-skipping tax. If a testamentary trust had been used, the corpus would be included in her probate estate as well.


Estate planning involves accumulating property during life and providing for the preservation and protection of that property for the next generation. Anyone owning property needs an estate plan, if only to ensure the orderly transfer of property to intended recipients. The plan may consist of a simple will or a complex arrangement of lifetime and testamentary gifts, trusts, life insurance and other instruments. The uncertainty of death makes today the best time to start planning.

Because of their flexibility and the interaction of tax and substantive law, trusts are common but complex estate planning tools. An experienced attorney should assist in designing trusts and drafting trust instruments. Properly used, trusts can effectively satisfy many estate planning objectives.

PHYLLIS J. BERNSTEIN, CPA, is director of the personal financial planning divisions of the American Institute of CPAs. STEPHEN J. ROJAS, CPA, JD, is a senior technical manager in the AICPA PFP division, MURRAY B. SCHWARTZBERG, JD, is a technical manager in the AICPA PFP division.

Ms. Bernstein, Mr.Rojas and Mr.Schwartzberg are employees of the American Institute of CPAs and their views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation.


* CREATIVE USE OF TRUSTS as part of a comprehensive estate plan can help ensure property is transferred as desired, probate headaches are avoided and estate taxes are minimized.

* SOME TRUSTS ARE DESIGNED to achieve particular estate planning objectives. These trusts include marital deduction trusts, nonmarital deduction trusts, life insurance trusts and generation-skipping trusts.

* MARITAL DEDUCTION trusts, both QTIP and power-of-appointment trusts, permit the grantor to take advantage of the unlimited marital deduction for transfers of property to a spouse.

* NONMARITAL DEDUCTION trusts include family trusts, credit equivalent bypass trusts and credit shelter trusts. These generally are intended to take full advantage of the unified credit in the grantor's estate and exclude the corpus from the surviving spouse's estate.

* LIFE INSURANCE TRUSTS can satisfy a number of estate planning objectives. With proper planning, these objectives can be met without including the insurance proceeds in the insured's estate.

* GENERATION-SKIPPING trusts transfer income or a remainder interest to second-generation beneficiaries. Skipping a generation excludes the property from the probate and taxable estates of the first generation.


Beneficiary. The person, generally an individual or charitable organization, for whose benefit a trust is created. A beneficiary may have an interest in trust income, corpus or both; and a present interest, commencing with the trust's creation, or a future interest, commencing when a stipulated event occurs, or both.

Contingent interest. A beneficial interest that comes into being only when a stipulated event occurs, such as the death of a named beneficiary.

Exemption equivalent amount. For federal estate and gift tax purposes, taxable transfers (currently $600,000), made during life or at death, that are offset by the unified credit.

Irrevocable trust. A living trust the grantor cannot revoke or alter during his or her life or at death.

Living trust. A trust, also known as an intervivos trust, a grantor creates during life,.

Marital deduction. For federal estate and gift tax purposes, an unlimited deduction for the full value of qualifying property transferred during life and at death to a surviving spouse. A married couple is effectively treated as a single economic unit for federal estate and gift tax purposes.

Probate estate. Property Passing, by will or by operation of state intestate succession law, from an individual to his or her heirs or other beneficiaries. Remainder interest. A beneficiary's right to trust corpus at the termination of the trust.

Reversionary interest. A remainder interest held by the grantor.

Revocable trust. A trust that may be revoked or altered by the grantor during life or at death.

Testamentary trust. A trust created by the grantor's (testator's) will.

Trustee. The person who holds legal title to property placed in trust and is responsible for administering that property for the benefit of the trust beneficiary or beneficiaries. The trustee can be one or more individuals (including the grantor), a corporation empowered by state law to act as trustee or a combination.

Trust instrument. The legal document, often called a trust agreement or deed of trust, that creates the trust and stipulates its term, trustee, beneficiaries, income and corpus disposition and other attributes. A will can act as a trust instrument.

Unified credit. For individuals dying after 1987, a credit (currently $192,800) available to offset federal estate and gift tax liability (currently on taxable transfers up to $600,000 during life or at death).


Trusts often are designed so the grantor retains some control over the trust corpus to

* Conserve the corpus and provide support for beneficiaries unable to manage property directly, such as minors; individuals with physical, mental or emotional disabilities; spendthrifts; and individuals without investment management experience.

* Provide professional management of the corpus.

* Provide a beneficiary with funds for a specific purpose or period of time, such as for college education expenses.

* Provide a proven method of ensuring care for a beneficiary without court intervention or a guardianship proceeding.

* Protect the grantor's assets from the claims of creditors. (However, state law often limits a grantor's ability to defeat creditors"valid claims by transferring property to a trust.)

* Ensure privacy, Unless real estate is involved, transfers to a living trust are not made public either during life or at death. In contrast,, if state law requires disclosure of estate assets during probate, the nature or amount of property passing under a will or the laws of intestacy becomes public information.

* Spread income to a number of beneficiaries when the corpus cannot be divided easily. For example, the income from the ownership and operation of an apartment house can be divided easily among several beneficiaries.

* Maintain equality among beneficiaries. For example, if the grantor believes the value of some estate assets may appreciate while the value of others may not, all assets can be transferred to a trust in which all beneficiaries share the risks and rewards of ownership in proportion to their interests in the estate.

* Protect family members from the claims of other family members and forestall will contests or other similar litigation. For example, a grantor may create a trust to defeat a possible claim of a separated spouse or the statutory claim of a surviving spouse against the estate.

* Provide income for family members during their lives or a period of years, with the remainder interest held by a charity.

* Simplify property ownership. For example, the grantor may place property in trust and empower the trustee to sell interests in the trust.

* Retain family ownership of property. For example, the grantor can provide income from a family business for his or her children but prevent the children from selling the business.
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Article Details
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Title Annotation:includes glossary of estate and trust terms
Author:Schwartzberg, Murray B.
Publication:Journal of Accountancy
Date:May 1, 1993
Previous Article:President Clinton's tax proposal: a fiscal balancing act.
Next Article:Charitable remainder trusts.

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