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Revocable trusts: appealing, but beware; there's more to revocable trusts than just avoiding probate.

The revocable trust is a valuable estate planning tool. But it isn't the estate planning cure-all as marketed by some. As a result of the aggressive marketing of revocable trusts in recent years, CPAs are likely to find their clients inquiring more and more about their use. A revocable trust's main selling point is its ability to avoid probate. Since probate can be a costly and lengthy process, the revocable trust has become popular as a probate-avoidance tool.

Most promoters of revocable trusts are familiar with their probate-avoidance aspects. However, CPAs, as financial advisers, are in a position to evaluate all the advantages and disadvantages of recoverable trusts and should be able to make objective determinations about whether such trusts meet client needs.

Once a decision is made to use a revocable trust, the CPA can work closely with the client's attorney in the early stages of the drafting process. The CPA's early involvement will accomplish two goals:

1. It will ensure the trust is drafted to meet all the client's appropriate financial planning objectives.

2. It may reduce fees by avoiding costly rewrites if the client's objectives have been communicated properly to the attorney.

What is a revocable trust? Also known as an "inter-vivos," "living" or "family" trust, a revocable trust is one established during the lifetime of the grantor, who retains the power to change or revoke it as he or she wishes. Since the trust is revocable, the grantor has complete control over the assets assigned to it. Typically, the grantor serves as trustee and may appoint a professional trustee (such as a CPA) as successor trustee. The trust document outlines instructions for managing and distributing trust assets.


Incapacity. With a living trust, a trustee can be appointed to manage the grantor's financial affairs in the event he is incapacitated; without such a trust and trustee, someone has to ask the court to declare the individual incompetent. This process can be expensive and embarrassing. Some states require the incapacitated person to appear in court during guardianship proceedings. Such proceedings can also spur family conflicts and the result in nasty and expensive court battles.

A revocable trust can avert such an outcome by providing a contingency plan to deal with the inability of the grantor to manage his own financial affairs. With a revocable trust, an individual can specify in advance who he wants to manage his affairs in the event of incapacity. A revocable trust is not, however, the only vehicle to provide for such a contingency. Similar results can be achieved by granting someone a durable power of attorney, although that durability is often challenged. Some financial institutions, such as banks and insurance companies, may not accept a power of attorney without a clear legal ruling in the state involved as well as the prior approval of the institution itself.

Probate. A revocable trust avoids the delay and expense of probate. Probate can be expensive, particularly for largest estates in states where attorney and executor fees are fixed by law as a percentage of the probate estate. Legal fees and court costs can amount to 5% to 10% of the estate's gross value. Probating an estate generally will take at least six months, and often longer. In the meantime, the executor may have to petition the court for distributions from the estate to support the family.

In contrast, the cost of settling a revocable trust is typically 1/2% to 1% of the estate. A trust may be settled in a matter of weeks. Also, the trust document may specifically provide for interim distributions to the surviving spouse.

Publicity. A revocable trust avoids the publicity of probate. The grantor can name beneficiaries in a trust he does not want the public to know about. However, some states require estate tax returns, which typically include copies of all trust documents, to be filled with the probate court even when probate is not needed. The trust also may become public when

* The trustee asks the court to interpret the trust's instructions.

* Any of the decedent's beneficiaries (or creditors) feel shortchanged and sue the trustee.

Some jurisdictions require the trust document to be filled in probate court when there is a pour-over will (a will that transfers all property to the trust at death). If the individual is concerned about privacy, his attorney should study local laws to determine if a trust will satisfy his privacy concerns.

Multistate administration. The revocable trust avoids administration in multiple jurisdictions when assets, particularly real estate, are held in different states. Joint ownership of real estate also will avoid probate but may frustrate other estate planning goals.

Family disputes. Since family members who are not beneficiaries don't have to be notified about a revocable trust's terms, squabbling among members of the decedent's family is minimized. In contrast, all family members (including those not named in the will) are notified about the terms of a will; probate provides an opportunity for the family to argue over the tems of the will. A revocable trust may be appropriate when an individual wishes to quietly disinherit a particular family member.

In most jurisdictions, a trust is less susceptible to challenge (based on the granto's lack of capacity, fraud or duress) than a will. Moreover, in many jurisdictions, when a will is contested, nobody has access to the estate assets until the will's validity is established. But a trustee generally is allowed use of trust assets to defend its validity, creating an additional deterrent to challenges to the trust.

Disinheriting a spouse. In most states, a surviving spouse doesn't have the choice to elect a statutory share in lieu of what is provided in a trust. However, a surviving spouse not well provided for under a will can elect to take against the will and receive a statutory share. Disinheriting a spouse may not be a responsible action, but for those who wish to do a revocable trust may be the best way.

Situs of trust. The situs of a trust need not be the same as the grantor's domicile. A trust can be established in any state whose laws are more favorable to the grantor's estate planning goals. Moreover, the grantor may wish to empower the trustee to shift the situs of the trust, if necessary. The benefits of this flexibility must be weighed against the cost and delay of settling an estate when the trust is not located in the state where the grantor lived. For example, if the trust is not located in the same state where probate of the pour-over will is required, the probate proceedings may be complicated. This will be particularly true when the trustee is not the same as the executor.

Tax planning. According to Internal Revenue Code section 663(b), the trustee of a revocable trust may elect to treat any distribution made during the first 65 days of any taxable year of a trust as made on the last day of the preceding taxable year. Such tax planning flexibility does not exist with an estate.



Cost. Establishing a revocable trust involves legal and other expenses. A custom-designed trust can cost between $700 and $3,000 or more, depending on the estate's size and complexity and prevailing attorney fees in the local area. Funding the trust (transferring title to various assets to the trust) also can be expensive and time-consuming. For example, an attorney's services are needed to transfer any real estate. Similarly, if a professional trustee is used, annual trustee fees may be as high as 2% of trust assets.

Property titling. A client must understand the differences between holding property individually and holding it as a trustee of a revocable trust. The trust itself holds title to property in the trust and acts accordingly. Some financial institutions may not provide a mortgage on property owned by a trust because of the difficulty a lender might have in selling such a mortgage on the secondary market. Also, some people may not be comfortable having property in the trust's name instead of their own.

Insuring trust property. Some insurance companies may not insure property owned by the trust. For example, an insurance company may not insure a trust-owned vehicle to avoid covering an unknown number of individuals who make up the trust or who have permission to drive the vehicle.

Tax returns. While trusts must file calendar year tax returns, probate estates can file fiscal year returns. The use of a fiscal year allows valuable tax deferral for estates. Not having the option to select a fiscal year reduces a trust's tax planning flexibility. A deceased's probate estate can elect to file a joint income tax return with the surviving spouse for the year of the death; this option also is not available under a trust. And estimated tax payments must be made by a trust but aren't required for the first two years of an estate.

Throwback rules. Trusts are subject to IRC section 665-668 "throwback rules" while estates are not. Although the accumulation of income in an estate as a tax shelter is not a major advantage with today's tax rates, it may become a factor in the future.

Loss disallowance rules. IRC section 267 also applies to trusts: Losses are disallowed when assets are distributed to beneficiaries. This would typically apply after the grantor's death when property is distributed from a revocable trust to a beneficiary to fund a pecuniary bequest. Estates are not subject to this provision.

Rental losses. Under IRC section 469(i), rental losses of up to $25,000 a year can be used to offset other income under a probate estate, provided the decedent had actively participated in the management of the property before his death. This rental loss deduction is not permitted under a trust.

S corporation stock. The IRC also says trust can hold S corporation stock for no more than two years after the grant's death. No such restriction applies to probate estates.

Claims by creditors. With a trust, there is no deadline for filing claims by creditors; such suits can be filed years (within the applicable statute of limitation) after the grantor's death. However, in the case of a will, there is a deadline. Creditors usually have four to six months after a will is admitted to probate to present claims.



The creation and funding of a revocable trust has no gift tax consequences. No gift is involved because the grantor has full control of trust assets. Since these assets may be reclaimed at any time by the grantor, trust income is taxable to him. For federal estate tax purposes, trust assets are included in the grantor's estate.

A trust may be set up, however, to avoid estate taxes at the death of the surviving beneficiary. This is generally accomplished by giving the first beneficiary only a life income interest with a limited right (subject to ascertainable standards) to principal. On the death of the first beneficiary, the property passes to other beneficiaries designated by the grantor. For large estates, such transfers may be subject to the generation-skipping tax.

Similarly, a trust may give the grantor's surviving spouse an interest in assets qualifying for treatment as qualified terminable interest property (QTIP). Normally, the executor or court-appointed administrator of the decedent's estate makes the QTIP election. However, the grantor may specify that the trustee, not the administrator or executor, make the election. Alternatively, the grantor may execute a will to distribute assets not in the trust and name the trustee of the living trust as the will's executor.


Even if a client transfers substantially all assets to a revocable trust, a simple will is still necessary. First, only a will can appoint guardians for minor children. Second, a will determines the distribution of assets such as automobiles, furniture, clothing and other personal property the grantor may have neglected to transfer to the trust. In fact, to take advantage of the deadline for filing claims by creditors, it's advisable to keep a small portion of the grantor's assets out of the trust. The simple will can have a pour-over provision to transfer assets to the trust at the grantor's death. As a result, these assets will be distributed according to the trust's terms.

A provision in a will referring to a trust created after the will was executed may not stand up in court. It is imperative the trust instrument be executed before the pour-over will. Further, it's advisable that the trust and the will have a common fiduciary.

An anticontest provision in a pour-over will may be combined with a revocable trust to reinforce the privacy and incontestability afforded by the trust. Anticontest provisions are designed to inform beneficiaries that any attempt to challenge the will could result in forfeiture of their inheritance. An anticontest provision is effective only if the beneficiary's inheritance is large enough for this to constitute a true deterrent.

It is advisable for clients to execute a durable power of attorney at the same time a revocable trust is established. For example, if the grantor chooses not to transfer some assets to the trust when creating it but wishes to do so in the event he is incapacitated, the durable power of attorney permits a designated agent to transfer these assets to the trust. The trust also should have a back-up trustee to manage it if the grantor is incapacitated.

Unlike a will, an "antilapse" provision does not apply to a trust. If the intent is to pass a beneficiary's share of the estate to his or her children if he or she predeceases the grantor, the trust document must specifically state such an intent. Children born after a will is executed are provided for automatically, even if the will does not specifically state so. However, a trust makes no such provisions automatically; the document itself must provide specifically for this contingency.

The client with minor children should set up a children's trust within the revocable trust. The children's inheritances will go immediately from the living trust to the children's trust. Unlike a children's trust under a will, such a trust goes into effect immediately (and without probate) at the parent's death. The court cannot use probate guardianship to control the children's inheritance.

In two recent private letter rulings (9015001 and 9016002), the Internal Revenue Service said gifts made from a revocable trust within three years of the grantor's death are part of the grantor's estate for federal estate tax purpose. It's main argument was that property was transferred directly from the trust to the donee. There are two ways a client can avoid this trap:

1. The trust document should permit distributions during the grantor's lifetime to him alone.

2. If such a restriction is not practical or desirable, these distributions should first be paid to the grantor, who can then make a gift to the recipient.

Although life insurance proceeds are payable directly to designated beneficiaries, it may be a good idea for the insured to transfer ownership of life insurance policies to his living trust and also appoint the trust as beneficiary of these policies. In the event the grantor is incapacitated, the back-up trustee of the living trust will have the ability (if necessary) to borrow against the cash value of the policies.

No separate tax return is required for a trust if the grantor serves as one of the trustees. This makes it advisable to appoint the grantor at least as a co-trustee.


The revocable trust may not be worth the cost and inconvenience for everyone. However, it can be a valuable tool if

* The cost of probating an estate in the individual's state of residence is high. Probate costs vary among states, and for purposes of determing probate costs, states compute estate sizes differently. Some states, for example, include the value of the decedent's home.

* There are likely to be dissatisfied heirs. For example, if the individual plans to leave most of his estate to a second spouse, this may upset children from the first marriage. Trust can be contested, but not as easily as a will. Unlike a probate estate, trust assets are not frozen at the grantor's death. These assets can be distributed immediately. Disgruntled heirs would then have to sue each beneficiary.

* It's important to keep settlement of the estate private.

* It's important for the client to avoid a court-appointed conservator in case he is incapacitated.

* The client has real estate in another state. The revocable trust is a useful tool to avoid probate in the state where the property is located.


CPAs as financial advisers can review with their clients the pros and cons of revocable trusts and help decide whether such trusts will meet their needs. If, after careful consideration, a decision is made to use a revocable trust, a CPA can get involved during the early stages of trust planning. Many pitfalls can be avoided by carefully drafting trust documents and properly coordinating a pour-over will with the trust.

The revocable trust is a flexible estate planning tool. It provides privacy and greatly reduces the time and expense of settling an estate. A trust can deal with the eventual death of the grantor as well as contingencies such as incapacity. Such a trust does not remove assets from the grantor's estate, nor does it affect the determination of an asset's tax basis at the grantor's death.

The revocable trust is widely promoted as a probate avoidance tool. The benefits of probate avoidance are, however, attainable only to the extent the grantor transfers assets to the trust. If probate avoidance is the client's only goal, revocable trusts may not be worth the cost in time and dollars. Certain couples have little need for revocable trusts: those who own their homes jointly, who have few other assets and who have designated beneficiaries for most (list insurance, retirement plans). While most individuals should consider a revocable trust in their estate plans, a revocable trust is not essential to every plan.

LABH S. HIRA, CPA, PhD, is associate professor and chairman of the departments of accounting and finance at Iowa State University, Ames. A past member of the American Institute of CPAs employee benefits taxation committee, he is a member of the American Accounting Association, the Iowa Society of CPAs and the American Taxation Association.
COPYRIGHT 1991 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1991, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:Hira, Labh S.
Publication:Journal of Accountancy
Date:Oct 1, 1991
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