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Chapter 28: Revocable trust.


An inter vivos (living) trust is a relationship, created during the lifetime of the grantor (the person establishing the trust), in which one party (the trustee) holds property for the benefit of another (the beneficiary).

It can be established for a limited period of time, last until the occurrence or nonoccurrence of a specific event, or it can continue after the death of the grantor.

A revocable living trust (RLT) is one created by the grantor during lifetime, in which during his lifetime, the grantor retains the right to totally revoke the trust, change its terms, and/or regain possession of the property in the trust.

A revocable trust becomes irrevocable when the grantor, during his lifetime, relinquishes title to property placed in the trust and gives up all right to alter, amend, revoke, or terminate the trust, or when the grantor dies.


1. Where the grantor wishes someone else to accept management responsibility for all or a portion of the grantor's property.

2. Where the grantor wishes to assure continuity of management and income flow of a business or other assets in the event of death or disability.

3. Where the grantor wishes to protect against the investment and asset management problems that would be brought on by his own physical or mental incapacity or legal incompetency, or the physical, mental, or emotional incapacity or legal incompetency of beneficiaries.

4. Where the grantor desires privacy in the handling and administration of his assets during lifetime and at death.

5. Where the grantor wishes to minimize estate administration costs and delay at death by avoiding probate.

6. Where the client would like to see how efficient, competent, and costly the trust (and the trustee) are in operation.

7. Where the client wishes to avoid ancillary administration of assets situated in other states by placing title to those assets in the trustee of a revocable living trust.

8. Where the client would like to reduce the potential for an election against, or a contest of, the will. However, in some states, the statutory estate that can be elected against is expanded to include revocable living trusts.

9. Where the client would like to select the state law under which the provisions of the dispositive document will be governed.


1. In order for a trust to exist, there must be trust property (also known as trust principal, res, or corpus).

2. There must be the following parties, although in a few jurisdictions it is possible for the same individual to hold all these positions:

(a) a "grantor," sometimes referred to as a "settlor," or "trustor"--any person who transfers property to and dictates the terms of a trust;

(b) a trustee--a party to whom property is transferred by the grantor, who receives legal title to the property placed in the trust, and who generally manages and distributes income according to the terms of a formal written agreement (called a trust instrument) between the grantor and the trustee;

(c) a beneficiary--a party for whose benefit the trust is created and who will receive the direct or indirect benefit of the use of income from and/or principal of the trust property, as follows:

(1) income beneficiary--the beneficiary who receives income, generally for life or for a fixed period of years or until the occurrence or nonoccurrence of a particular event;

(2) remainder person--the ultimate beneficiary of trust property, who can also be the income beneficiary.

3. The grantor and trustee must be legally competent.


Russ Miller, a successful real estate broker, feels that if his wife survives him, she will be able to handle the assets in his estate and properly manage them. However, he is afraid that if his spouse predeceases him, his children will be unable to properly manage the assets left to them. His estate is not subject to significant estate taxes.

Russ makes his life insurance proceeds and/or other assets payable to his wife, if she survives him. However, if Russ's wife predeceases him, those assets are payable to a trust Russ set up during life. This inter vivos trust is revocable; Russ can always revoke the trust and repossess the property or change the terms of the trust. Often, such a trust is designed as a "contingent," or "step up," or "stand by" trust, since it will take effect only in the event of the contingency that the grantor's wife predeceases him.

Under different circumstances or to meet different objectives, an irrevocable living trust would be indicated. For example, if Russ were in a high income tax bracket, as well as a high estate tax bracket, he might consider transferring assets to an irrevocable trust for the benefit of his wife or children. The trust could accumulate income during Russ's life or distribute that income to, or use it for the benefit of, his children (but not for Russ's own benefit). At Russ's death, the trust could provide income to his wife for life and at her death, provide income and eventually principal for his children. However, the tax rates for income retained by a trust have been substantially compressed so that in 2006 the highest federal rate of 35% (which applies to individuals at a level of $336,550 of income) applies to trusts at a $10,050 level.

As another example, Philip and Kay Martin, living in a community property state, have decided to avoid the costs, delays, and publicity attendant to probate and also to avoid the possibility for conservatorship by putting their assets during their lifetime into a revocable trust. With a medium-sized estate they decide to use the marital deduction provisions described in Chapter 24 in order to have each of them be able to take advantage of the unified credit.

The insurance on Philip's wife was arranged so that the revocable trust is both the owner of the policy and the beneficiary of the proceeds. Philip and Kay each have a will that has the two major functions of (1) naming a guardian for their children and (2) "pouring over" to the trust any assets that they neglected to place in the trust during their lifetime. At the death of either Philip or Kay, the trust becomes irrevocable and the mechanism described in Chapter 24 to reduce federal and state death taxes comes into play.

As long as Philip and Kay are competent, each has the right to be able to remove their share of community property from the trust. In some community property states, however, both spouses will need to consent to such withdrawals. Most well drafted trusts for circumstances such as the Martins have three "pockets" or subtrusts: one for the separate property of the husband; one for the separate property of the wife; and one for community property. In this fashion, the revocable trust can still maintain the beneficial ownership of the property as the clients may desire.


1. For federal income tax purposes, all income of a revocable living trust is taxed directly to the grantor at the grantor's tax rate, since he is considered the owner of the trust corpus. (1)

2. No gift tax is generated by establishing or funding a revocable trust since the gift is not completed until the trust becomes irrevocable. (2)

3. Since the grantor has not irrevocably disposed of any assets, the entire trust corpus will be included in the grantor's estate for federal estate tax purposes. (3) EGTRRA 2001 repeals the estate tax for one year in 2010.


In dealing with community property, the inter vivos trust would have two grantors, the husband and the wife. For a revocable trust, where the grantors intend to retain the beneficial ownership of the property, care must be taken to ensure that accidental gifts under state gift tax law are not made by giving either spouse ownership rights over the other spouse's half of the property. The unlimited gift tax marital deduction eliminates a federal gift tax problem on interspousal gifts. Thus, if the trust is revoked, the property should be clearly indicated as being returned to the husband and wife, as co-owners, and not to one spouse or the other.

Is the character of community property altered by a transfer to a revocable trust that does not have separate subtrusts for separate property of each spouse and for community property? If the transfer is simply by husband and wife to trustee, and each retains a right to revoke, and the instrument specifically provides that the character of the property remains community in the trust and also if it is withdrawn from the trust, and state law recognizes the ability of the parties to achieve the intended result, the character of the property will remain unchanged. This means that, upon the death of the first spouse, the decedent's one-half and the surviving spouse's one-half interest in the trust will receive a new basis equal to fair market value at death or the alternate valuation date, and only the decedent's one-half of the property in the trust will be included in his estate. [EGTRRA 2001 repeals the estate tax for one year in 2010, and stepped-up basis is replaced by a modified carryover basis for property acquired from decedents dying in 2010.] There will be no gift at the time the trust is created and there will be no gift upon the death of the first spouse unless, at that time, the trust becomes irrevocable. This is avoided by language that divides the trust into two or three trusts upon the death of either of the donors with the formulas described in Chapter 24 coming into play to optimize the "use it or lose it" type of effective exemption provided by the unified credit. This type of revocable trust is used extensively in community property states to deal both with community property and to deal with separate property assets of the spouses.

Much care must be taken in determining the source and nature of title holding of property before taking the position that it is community property, as one may when the property is transferred to a trust that indicates that it is held as community property. Taxable gifts under state law may result if the property is the separate property of either spouse or is joint tenancy real property originally acquired with the separate property of one spouse. Although the unlimited marital deduction for federal gift tax purposes reduces the gift tax risks, (4) there still may be state gift tax implications. In addition, it could well inspire litigation in the event of a dissolution if there was not a clear intent between the parties that a gift take place.

Where insurance has been purchased with community property (and therefore belongs one-half to each spouse), care must be taken that the terms of a trust, becoming irrevocable at the death of the insured, do not result in a taxable gift by the surviving spouse of all or part of the survivor's half interest in the insurance proceeds. Such gifts are usually to the remainder person(s) of the trust and are not protected by the marital deduction.

Where the clients have come to the point where the non-insured spouse does not require the financial benefit of the life insurance policy, such policies are often given to irrevocable life insurance trusts as described in Chapter 31, noting with caution that the insured spouse must live three years past the date of that gift in order for the transfer to be effective. More and more frequently now, spouses are planning for dealing with estate tax by the purchase of survivorship policies that will never be owned by their revocable trusts, but that would be owned from the beginning by an irrevocable trust to which they make gifts to fund the annual premiums.

Great care must be taken in drafting the provisions regarding the division of property at the death of one community property owning spouse so as to avoid unintended gifts by the surviving spouse. At times, such trusts may be intended to benefit the survivor more if he agrees to have his property also be managed and distributed according to the terms of the trust. Such "election" provisions may also result in gifts by the surviving spouse and, if used, should be drafted carefully by an experienced estate planner.

The marital deduction rules make it important that all inter vivos trusts be examined carefully and revisions considered to take advantage of the very important provisions which make it possible to have completely tax-free interspousal transfers. Chapter 24, on the marital deduction, reviews this in more detail.

Community property and separate property states generally have similar rules as to how long property can be held in trust and as to other trust law matters. However, property rights are different as to separate and community property, and estate plans involving trusts must be reviewed and probably revised when one moves from a separate property state to a community property state and vice versa.


Question--Why, if there are no federal income or estate tax savings specifically due to the creation of RLTs, are such trusts so appealing?

Answer--There is a substantial difference in planning practice between the northeastern part of the United States, where revocable trusts are less popular, and the West Coast and Florida, where revocable trusts are fairly popular. In some of the southern states and some of the midwestern states, the revocable trust is gradually becoming more popular.

There are two major arguments for the use of revocable trusts, the avoidance of probate and potential conservatorship savings. In some states, the probate costs are relatively low and the argument for the use of revocable trusts for avoiding probate is not as strong. However, in some states, the costs of probate can be substantial, with the fees often set by statutory formula. However, some costs may be reduced or eliminated if a family member is involved and agrees to serve with no fee.

Whether probate is avoided or not, there will be additional costs incurred in terms of dealing with estate tax returns for larger estates and, in some cases, for dealing with income tax matters. However, the probate costs are typically the area of focus.

Another area of concern for those persons who decide to use revocable trusts is that, if they are unable to function, the assets maintained in their own name (as opposed to those titled originally or re-titled in the name of the trustee of the revocable trust) will require the appointment of a conservator or guardian by state court and a continuing proceeding and annual charges for the maintenance of the conservatorship or guardianship. By having a revocable trust, the potential for guardianship or conservatorship is avoided since the trustee would take over the management of the assets if the grantor is incompetent.

The other major reason for the use of the revocable trust is the optimum use of the various credits and deductions available under the estate tax laws. As the laws become more complicated, formulas have been developed to optimize the available unified credit.

The same revocable trust that is used to avoid probate and potential conservatorship, as well as to reduce estate taxes, has the separate function of protecting the assets after the death of the spouse for the benefit of the children. Thus, the revocable trust usually has provisions for the trust continuing on for the children at the death of both spouses.

Where there has been good planning, the trust may take advantage of the rules relating to the generation-skipping tax and provide for one or more generations to have the use, control, and benefit of property from parents that will not be subject to estate tax at their deaths. The amount that a married couple can protect in this manner ranges from $4,000,000 in 2006 to $7,000,000 in 2009 (i.e., two times the GST exemption). This concept is discussed in Chapter 18 relating to generation-skipping transfers.

However, the creation of a revocable trust is only the beginning. It is necessary to actually transfer the title of assets to the trust in order to be able to avoid probate. In complicated estates, there may be more costs in the transfer of assets to the trust than in drafting it, but that is very unusual.

As long as the grantors are the trustees, no separate income tax return is required to be filed for the trust. Furthermore, a revocable trust is a grantor trust and income is generally taxable to the grantor. Thus, the revocable trust has little impact upon income tax planning or income taxation of the grantors until one of them dies and the trust becomes irrevocable.

Although the revocable trust is recognized as a valuable estate planning tool, in many circumstances there are still many attorneys who, for various reasons, prefer to have their clients' assets go through probate.

Question--What is a "Pour-over Trust?"

Answer--As its name implies, a pour-over trust is one into which assets can be "poured" or funneled from the client's will, life insurance, pension or profit sharing plan, or other employee benefit plan. (5) This type of revocable trust is set up by the client during life and serves as a receptacle for any asset the client would like to pour into it. This unification is particularly useful if the client owns property in more than one state since it may save heirs a great deal of aggravation in addition to the cost savings inherent in avoiding multiple probates. Almost all states have laws regarding the validity of pourovers to trusts established during the client's lifetime.

Question--What is a "Contingent Trust?"

Answer--A contingent trust (also known as a step up or standby trust) is one that takes over and manages and invests assets if and when the client is no longer able to do so. A contingent trust is triggered upon the occurrence of one or more specified contingencies such as the client's physical, mental, or emotional incapacity. It may also be triggered by the client upon an extended trip. Such a trust works well when coordinated with a durable power of attorney (see Chapter 56) and can help avoid the need for cumbersome and expensive probate proceedings. The client could appoint himself as trustee. The trust would provide that the grantor (client) would be succeeded by a corporate fiduciary and/or another person if the grantor becomes incompetent. Typically, but not necessarily, this would be the same trustee designated to serve upon the client's death.

Incapacity could be defined in a number of ways--as broadly or as narrowly as the client desires. Quite often, the step up trustee takes over (a) upon the decision of a third party such as a child or friend, or (b) upon the trustee's decision that incapacity has occurred but only after a determination of incompetency by one or more specified doctors, or (c) upon a decision solely by the trustee that the grantor is incompetent, or (d) upon a judicial proceeding of incompetency, or (e) upon the determination of an independent arbitrator.

Question--When is a revocable trust funded?

Answer--Funding of a revocable trust can occur at the establishment of the trust or at any later date although most states require at least a token funding at the creation of the trust. The holder of a durable power of attorney may be authorized to make transfers of assets or shift the title to property to a previously established revocable trust. In some cases, courts have allowed such transfers even where not specifically authorized by the terms of the durable power although specific authorization is, of course, preferable. This court assistance is most likely where the dispositive terms of the revocable trust track closely with the terms of the client's will.

Question--What provisions should a revocable living trust contain if it is designed to provide property management during the grantor's incompetency?

Answer--The trust should:

1. provide for income distribution to or for the grantor's benefit,

2. authorize that trust assets could be distributed to others to implement or continue a gift program (within the limits of the gift tax annual exclusion) by a duly-appointed agent,

3. specify that any pledges already made to a qualified charity be satisfied, and

4. state that the management of a business interest be delegated to certain family members.

Relatively recently, a number of states, including California, have adopted the Uniform Prudent Investor Act (UPIA). This act is based upon the idea that all trustees should be required to follow the investment concept known as the "Modern Portfolio Theory." The UPIA also requires substantial diversification and recognizes that inflation is a risk. As a result, it is no longer proper for a trustee (assuming no exculpation or specific direction to the contrary in the trust instrument) acting under the rules imposed by this law to invest solely in fixed income assets such as government bonds. The diversification rules are such that, in addition to diversifying the types of assets, it is also necessary to diversify the investments so as to benefit both the current income beneficiary and the possible future beneficiaries (the remainder).

Thus, a trustee for a client whose trust becomes irrevocable, or for a surviving spouse, cannot really invest for the benefit of the current beneficiary but must invest in the stock market or some other equity investment to provide growth for future generations. Many trustees object strenuously to these rules being imposed but in many states they have been imposed upon all trusts, both those in existence and those created after the date of the enactment of the law.

Many practitioners now are specifically providing in their trusts that the trustee is exempt from the rules of the UPIA so as to give the trustee much more flexibility to benefit the current beneficiary as opposed to having to invest so as to benefit the future beneficiaries. The law may be helpful in some circumstances and, for the first time in some state jurisdictions, may permit the shifting away from the trustee the responsibility for investments, so that an investment manager or financial planner may be engaged to manage the assets and thus assume responsibility for them. As people become more aware of the law, substantial new opportunities may be coming for investment managers and financial planners.

Question--When does a revocable trust become irrevocable?

Answer--A revocable trust becomes irrevocable upon the earlier of the death of the grantor or when the grantor gives up the right to revoke. Generally, a grantor lacks the power to revoke a trust during incompetency. It is possible to specify that as soon as the client is deemed to be incompetent the trust becomes irrevocable. This would block a person acting under a durable power of attorney from changing the plan of disposition in the revocable trust. Note that the irrevocability of a trust may trigger adverse gift tax implications. A taxable gift is made when a client parts with dominion and control over property. But immediate gift taxation can be blocked. The client could retain a life income in the trust's assets and delay taxation on the gift of the remainder interest (the portion going at his death to the ultimate beneficiaries of the trust) by the reservation of a testamentary power of appointment over that remainder interest. This should work even if the grantor becomes mentally incompetent since it is assumed that he may regain competency at any time before death.

Question--What happens to the assets in a revocable trust when a client dies?

Answer--Assuming a trust is funded at the time of a client's death, assets can be paid directly and immediately to the named beneficiaries and the trust can be terminated. Alternatively, the trust can be continued. However, it should be recognized that if there is any potential estate tax due, the trustee is individually responsible for payment of any estate tax if assets have been transferred out of the trust and there are not sufficient assets left to pay the estate tax. For this reason, in trusts where there may be any potential estate tax due, the trustee may require the retention of a certain amount of assets to deal with any potential estate tax.

The trust, which is now irrevocable, can serve as a receptacle to receive assets poured over into it. It can then continue to exist until its purpose or term has been completed. A third possibility is that the assets in the trust can be consolidated with another trust.

Assets in the trust at the grantor's death are subject to federal estate tax that will be based, not on the value of the assets when contributed to the trust, but on the value as of the date of death. EGTRRA 2001 repeals the estate tax for one year in 2010.

More and more in recent years, planners have been suggesting steps to reduce the value of assets for transfer tax purposes (estate tax and gift tax) of the assets held. In some cases, the family limited partnership, discussed in Chapter 43, is a tool by which the value of the assets can be significantly reduced. Additionally, a number of actuarial and charitable programs can reduce the value of assets for transfer tax purposes. However, the financial interests of the client may preclude the use of some of these concepts since, to achieve their gift or estate tax objectives, they must prohibit or limit the client's access to the principal and/or income from the assets.

Question--What is the easiest way to shift joint property into a revocable trust?

Answer--For most couples, the most effective way may be to create a single revocable trust which has subtrusts for each of the separate property of the husband, separate property of the wife, and for community property. By having only one trust, as opposed to two trusts, it is much easier to do planning for estate tax minimization. To the extent that either spouse has separate property or an interest in property held in tenancy in common, those would be held in the subtrust for the person's separate property.

In some circumstances, it may be appropriate for the spouses to each have a separate revocable trust, but that practice has been declining in recent years. It is possible for the clients to convert property to trust property by merely placing title to it in the trust. However, even though this can result in the property being controlled by the trust, in most states it is also necessary to go to the probate court in order to actually have the title of the property transferred to the trust in a way that will be accepted by title companies. The result, in this circumstance, is that a failure to actually transfer the title during lifetime results in a much more expensive legal process to have the probate court assume the responsibility to transfer the assets. It also leaves room for doubt or possible argument that is not present if there are actual recorded deeds or other indicia of title that clearly show the transfer to the trust.

Question--What factors should be considered in selecting a trustee?

Answer--A trustee should possess business judgment (even if there is no business), honesty, and integrity. The trustee must be able and willing to exercise a high degree of care over trust property and avoid (however tempting) investments or acts that are likely to result in losses.

A trustee must have legal capacity to contract. This precludes the appointment of a minor or incompetent adult. Geographical considerations generally contraindicate an individual who lives a considerable distance from the client or his heirs.

The type and size of assets to be placed into the trust, as well as the client's goals, are important considerations in selecting a trustee. Obviously, if the client's primary asset is a business, the trustee will have much more responsibility and must have higher and broader competence than if the trust's assets consisted mainly of cash.

Investment skill is necessary. Under the "prudent person" rule, a trustee will be liable to the beneficiary for losses unless he exercises the same care and skill that a person of ordinary prudence would exercise in dealing with his own property. But the Uniform Probate Code, now in effect in some form in most states, raises this standard for professional trustees by providing: "If the trustee has greater skill than that of a man of ordinary prudence, he is under a duty to exercise such skill."

Because a trustee must examine and review the trust periodically, administrative and legal skills and knowledge are important. Accountings must be made to the client and eventually to the other beneficiaries. All parties must be advised accurately on the tax and other legal effects. Provisions in the trust must, from time to time, be interpreted.

Question--Does a family member, close friend, or business associate make a good trustee?

Answer--There are significant advantages and disadvantages to naming a family member or business associate as trustee. A nonprofessional trustee is indicated where the minimum fee charged by local professional fiduciaries is higher than it's feasible to pay.

Is it appropriate for a family member, a close friend, or a business associate to serve as trustee? The obvious advantage is that such a person may have a working knowledge of the client, the family, and the finances and business. But selection of a person as trustee must also consider conflicts of interest and ethical problems. For instance, how will a trustee who is also a beneficiary react when faced with a choice that favors him at the expense of other beneficiaries or that favors other beneficiaries at his expense? Will the trustee favor other beneficiaries at his own expense? Will the fees charged by a family member or business associate as trustee be understood and accepted without resentment or will it cause conflict? Will the trustee's "hard choices" be injurious to family relationships? Is the trustee likely to show favoritism or be easily persuaded?

Can an untrained individual deal with the legal, tax, and investment functions of being a trustee? Even though a trustee is legally entitled to hire agents to serve as investment counselors, accountants, and attorneys to assist on special problems, the trustee remains responsible for the ultimate decisions. Would an untrained individual know whom to call? Would the trustee know if the advice he is receiving is both legally and practically correct? Does the trustee understand that he is personally liable for unpaid federal estate taxes if a distribution is made to beneficiaries before the estate tax liability is fully paid (even if the trust specifically allows for immediate distributions from the trust on the grantor's death)? If a distribution is made that can't be recovered, the trustee will be personally liable to the extent remaining trust assets are insufficient to pay the estate's estate tax liability.

Question--When is a corporate trustee indicated?

Answer--A corporate fiduciary (with or without individuals as co-trustees) is clearly indicated where it is likely that the trust will span more than one generation. Corporate fiduciaries are also indicated where the amount placed into the trust is large and/or will require skillful and constant attention. If there is likelihood of family conflict, corporate fiduciaries can make decisions on a more objective disinterested basis than family members.

Question--What role does state law play in the choice of trustee?

Answer--A trust will be invalid if it does not meet state law requirements. Planners should be aware of two potential problems: (1) the Doctrine of Merger and (2) The Passive Trust theory.

In some states, when the same person is both trustee and beneficiary, the trust ceases to exist as a separate entity. Legal title to the property (held by the trustee) merges with the equitable (beneficial) title (held by the beneficiary). The result is that if the sole beneficiary of the trust is also the sole trustee, the beneficiary becomes the absolute owner of the total rights in the trust assets. This is known as a "fee simple" or "fee simple absolute." The trust, as such, ceases to exist. However, in many states the same person may be both trustee and beneficiary.

A second potential problem occurs in the case of a so-called "passive trust." This is a trust that gives the trustee no meaningful duties to perform and gives the beneficiary unfettered enjoyment and management control of assets. The result is a merger of the legal title and the equitable title; the trust ceases to exist. Either through operation of law or through judicial action, where the trustee's duties are purely ministerial and all significant authority and decision making are placed in the hands of the beneficiary, the beneficiary receives total title to the property that was in the trust.

Question--What is the effect of a revocable trust on creditors?

Answer--The ability of a revocable trust to protect assets from the claims of the client's creditors will depend on state law and the provisions of the trust document. As a general rule, if the grantor has retained the right to trust assets or the right to alter, amend, revoke, or terminate the trust, there will be little, if any, protection from the claims of creditors. In the typical revocable living trust, the client retains too many rights over the trust assets to put those assets beyond the reach of creditors.

Question--Are there advantages to making the trust the beneficiary of qualified plan benefits?

Answer--First, naming a revocable trust as beneficiary of qualified pension or profit sharing plan or IRA or HR-10 payments helps to unify the administration of the estate and achieve the client's objectives. Second, a trust serves as a means of deferring the distribution of assets to beneficiaries who may not be ready or able to handle large sums of money. Third, a trust enables the sprinkling of capital and the spraying of income to those beneficiaries who need or deserve it the most or who are in the lowest tax brackets. Fourth, payment of qualified plan benefits to a trustee makes it possible for the trustee to make certain advantageous tax elections on behalf of the estate.

In addition, under new regulations, if the trust qualifies as a "designated beneficiary," it is possible to defer the payments from the plan over the life expectancy of the beneficiary of the trust. This allows a longer period for the plan assets to continue to grow on a tax-deferred basis. There are, however, certain strict requirements that must be met in order for a trust to qualify as a designated beneficiary. Also, the spouse of the participant cannot elect to be treated as the owner of plan proceeds if a trust is named beneficiary. These requirements are discussed in more detail in Chapter 51. If the trust does not qualify, the plan proceeds will have to be paid out either (1) over the participant's remaining life expectancy if the participant died after reaching age 70 1/2, or (2) no later than the end of the fifth year after the year of the participant's death if the participant died before reaching age 70 1/2. While a longer period of tax deferral may not be possible if the trust does not qualify, in some cases it may still more beneficial to name the trust as the beneficiary rather than individual persons.

Question--Can a revocable trust safely hold the stock of an S corporation?

Answer--To be eligible to elect the "pass through" taxation similar to a partnership, a corporation must meet stringent requirements. The only trusts which qualify as eligible shareholders of S corporations (see Chapter 46) are:

1. Voting trusts

2. A trust receiving stock under a will (but only for the first 2 years after the stock is transferred to the trust)

3. IRC Section 678 trusts (relating to trusts where a person other than the grantor is treated as the owner)

4. Grantor trusts (which includes revocable living trusts over which the grantor has retained all powers or to whom income is taxable under IRC Sections 671-677, and for 2 years after the grantor's death)

5. A qualified subchapter S trust (QSST)

6. An electing small business trust (ESBT)

If any other type of trust owns stock in an S corporation, the S election is automatically nullified. The result is that the corporation would be taxed as a regular corporation and the pass through of income or deductions would be denied. Question--Are there situations in which a revocable living trust is contra-indicated?

Answer--Yes. A revocable living trust may not make sense if there is no specific reason to set it up other than to save probate and administration costs--and the certain immediately payable present value cost of drafting the trust and maintaining it will exceed the future possible savings. A revocable living trust is not indicated where the client is not likely to follow through with the re-titling of property and the other prerequisites and operating procedures to assure the continued validity of the trust and to assure it will be legally recognized when the client dies. Stock in a professional corporation may not be able to be transferred to a revocable trust because of the prohibition against ownership by anyone other than a professional. If IRC Section 1244 stock is held by a revocable living trust, it may not qualify for ordinary loss treatment. The deduction allowed to estates for the amount of income permanently set aside for charitable purposes is not allowed to trusts. A living trust is not necessary if the client's estate is modest, the mortgage paid off, there is no reason to keep probate proceedings private, the executor of the estate is a family member who will probably waive executor's fees, and the client lives in a state where the attorney fees are modest. Finally, a revocable trust is not indicated if a less complex less expensive durable power of attorney can satisfy the need. For instance, a broadly drawn durable power of attorney will enable the holder to do many of the same ministerial tasks (such as preparing and filing tax returns) as the trustee of a trust.

Question--Are there disadvantages in putting investment real estate in a revocable trust?

Answer--There may be several. The impact on real property taxes must be considered. Some states have provisions for reassessment of real property for property tax purposes if it is transferred. If highly appreciated property is transferred to a revocable trust, this could result in a costly reassessment. Some states, such as California, exempt property transferred to a revocable trust from reassessment. Also, it should be determined whether or not the transfer will accelerate the payment of any mortgage or deed of trust on the property under so-called "acceleration" provisions in the note or mortgage. Again, many transactions are exempt.

Finally, great care should be taken to determine if the real property is presently generating losses or will be expected to do so after the death of the owner. Under IRC Section 469, losses from various activities, including some rental real estate activities, are characterized as passive losses, not deductible except under limited circumstances. However, Section 469(i) allows deduction for losses of up to $25,000 per year if the owner is actively participating in the management of the property. Section 469(i)(4) permits continued deduction of such losses for two years after the death of the owner by the owner's estate. It is generally assumed the use of the term "estate" could not be extended to cover revocable trusts. The safer course is to allow such property to pass through an estate, which after two years could distribute it to the trust under pour-over provisions discussed above.

Question--What, if any, are the other downsides of a revocable trust?

Answer--Recent criticism has focused more on the overuse and misuse of RLTs, than on inherent problems. There has been some valid criticism of books and mass marketing presentations that emphasize the exclusive use of revocable living trusts to avoid probate, mainly because they amount to little more than incredibly expensive one-size-fits-all cookie-cutter "trust mills" that provide little or no advice based on a careful analysis of the client's needs and circumstances. Likewise, all too often, the printed forms and/or web page materials that are provided for "do it yourself trusts" are, generally, not useful (and can even be harmful), since planning for clients must be individualized and based upon their particular goals, estates, and circumstances.

Question--What is an "administrative" trust?

Answer--Practitioners generally use this term to refer to the revocable trust immediately after the death of the grantor where it is to be further divided into separate trusts, such as the marital deduction and bypass trusts discussed in Chapter 24. Since the actual funding of such separate trusts may take months or even years, most practitioners believe the revocable trust continues to be a separate trust entity for a period commencing with the death of the grantor and ending on the date any separate trusts are finally funded. Unfortunately, many living trust documents fail to indicate what to do with that trust during the interim period, which could have important tax consequences.

Question--Will the use of revocable trusts present any problems if the grantor or husband and wife grantors are seeking public assistance for medical care?

Answer--The requirements for federal and state assistance for medical care, generally called "Medicaid," are discussed in Chapter 55. As noted in that chapter, the use of revocable trusts could have an adverse effect on the eligibility of the grantors for such assistance.


(1.) IRC Sec. 671.

(2.) Burnet v. Guggenheim, 288 U.S. 280 (1933).

(3.) IRC Sec. 2038.

(4.) IRC Sec. 2523.

(5.) It should be noted that retirement plans payable to a trust might not permit distributions to be "stretched-out" over the lifetimes of the beneficiaries. See Treas. Reg. [section]1.401(a)(9)-4.
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Title Annotation:Part 5: Trusts
Publication:Tools & Techniques of Estate Planning, 14th ed.
Date:Jan 1, 2006
Previous Article:Chapter 27: Defective trust.
Next Article:Chapter 29: Tax basis irrevocable trust.

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