LIVING TRUSTS
By Roger C. Hurd
HURD & ROSS, P.A.
Palm Beach Gardens, FL
Living trusts are revocable arrangements that are established during the life of the trust creator, the grantor. They are also referred to as inter-vivos trusts. As discussed below, they are primarily intended to serve as devices to save probate costs and to simplify estate administration.
The typically funded living trust holds assets for the benefit of the grantor during that individual's life. During the grantor's life, the trust typically serves as his/her alter ego. Income flows through the trust to the grantor (and possibly others) as beneficiaries. The grantor may revoke, or alter, the trust document at any time.
At the grantor's death, however, the trust either becomes irrevocable, terminates, or assets flow into entities established in other documents. Any assets that are in the trust at death, or added to it, are distributed to successor beneficiaries or held for them by the living trust.
Because living trusts are revocable, they provide no estate or income tax advantages to the grantor.
There are no estate tax savings because the grantor has the ability to revoke or alter the trust document. As such, the grantor is deemed to control assets in the trust and those assets will be taxable in his or her estate. These trusts may offer some estate savings if the document incorporates use of the unified tax credit and the marital deduction. The savings, however, come from the use of these estate planning devices and not via the trust itself.
Additionally, any taxable income must be reported by the grantor. There are no separate tax filings by the trust. In fact, during the grantor's life, there is no need to receive a separate tax identification number for the trust. Where the grantor is a trustee or co-trustee, the grantor's social security number is utilized. A separate tax identification number is only required when the grantor is not a trustee or following the grantor's death.
Because there are no tax savings offered by these arrangements, the primary advantages offered by living trusts are probate savings and simplified estate administration. In a typical estate, an executor must probate any assets owned by an individual before those assets can pass to the heirs named in the will. This can be a time-consuming process. However, it is intended to protect the heirs and to provide for an orderly disposition of assets. Probate proceedings are also part of the public record and there will be substantial costs involved. Assets in a trust, however, are intended to automatically pass by terms established in the document. The trustee directs the assets to named individuals or holds the assets for their benefit. Because assets that pass via living trusts are not probated, these assets are not part of the public record. As such, living trusts speed the assets transfer process, provide privacy, and protect heirs that might not otherwise be able to manage assets for themselves.
To take full advantage of a living trust, the property must be retitled into the name of the trust. Typically, the property would be titled as "The John Doe Living Trust, Dated 1/1/9X, For the Benefit of (FBP) John Doe" or "The Doe Family Trust, dated 1/1/9X, John Doe and Mary Doe, Trustors and/or Trustees." Failure to do this is a common error in establishing living trusts. Without making the effort to retitle property, assets will never be considered as owned by the trust and they will require probate. Tax-deferred investments such as IRA's, pension plans, annuities, etc. are not transferred into the Trust. The Trust is named the beneficiary following the deaths of the grantor and his or her spouse. With regard to life insurance, the Trust has named the beneficiary.
Living trusts offer advantages to grantor/beneficiaries if they become incompetent or disabled subsequent to the trust's creation. In these situations, a successor trustee can apply assets held in the trust for the benefit of the grantor/beneficiary. Although the grantor is typically the initial trustee in these cases, there should be a successor trustee named in the document in the event the grantor/trustee dies or becomes incompetent.
Although a grantor typically serves as the initial trustee, it is not absolutely necessary that he or she does so. Some thought should be given as to whether a grantor should serve as a trustee. In many cases, it may be advantageous to have someone other than the grantor simply for purposes of property management. Additionally, thought must be given to the selection of a trustee successor.
Even if a living trust is established it is necessary for an individual to also execute a will. This is called a pour-over will and is intended to capture assets that have not been or are not capable of being retitled to the trust. A pour-over will typically have terms that will transfer these assets to the living trust, or other estate documents, at an individual's death.
IRREVOCABLE LIFE INSURANCE TRUSTS
By Roger C. Hurd
HURD & ROSS, P.A.
Palm Beach Gardens, FL
An Irrevocable Life Insurance Trust is a Trust established by the grantor to hold or own insurance policies on the life of the grantor/grantors. By retaining no control over the Trust those proceeds are not considered part of the grantor's estate for federal estate tax purposes.
For example, a $1,000,000.00 insurance policy owned by the decedent at the time of death will incur federal estate tax of between $370,000.00 and $550,000.00. The same policy owned by the Trustee will incur no federal estate taxes. (Note: there is a three-year recapture of policies transferred by the decedent to the Trustee. New policies purchased by the Trustee are not subject to recapture).
Even the transfer of a $100,000.00 policy will save at least $37,000.00 in federal estate taxes.
The greatest advantage of the irrevocable life insurance trust is, of course, the potential tax-free appreciation between (a) the relatively small amount of dollars paid as insurance premiums plus any gift tax cost, and (b) the tax-free proceeds received from the insurance policy upon the estate owner's death.
Another important advantage is that the trust receives the tax-free proceeds the very moment the estate owner's estate taxes accrue. The trustee can use the proceeds to lend money to the insured's estate or to purchase assets from the estate, and thus provide the funds needed to pay Federal estate tax and state death taxes. The significant point, of course, is that the funds used to pay the death taxes are not themselves included in the insured's taxable estate.
Often, the use of these funds makes it possible to keep the family business in the family. The trustee can purchase stock in the corporation or make a short-term or long-term loan to it. With the assurance that these tax-free funds will be available when needed, there is a comfortable feeling among the parents and the children that the business will continue down the line.
The gifts of the money to the trust to pay the premiums on the insurance policy will be subject to gift tax because they are gifts of "future interests." There is, however, a reliable way to use $10,000 of the annual gift tax exclusion for each beneficiary. It is called the Crummey power, named after an important court opinion. Under this arrangement, the donor makes a gift to the beneficiary of the trust estate and provides in the trust that he or she has 30 days to withdraw the gift. If he or she does not draw the gift down within that time, then the option lapses and the property remains in the trust-free of gift tax.
If the estate owner wishes to have his estate continue for two or more generations and if his and his wife's estates exceed $3,000,000, the trust makes it possible to avoid the confiscatory 55% generation-skipping tax (GST). There is a highly technical point, however, that must be scrupulously observed. When the estate owner contributes the amount of the insurance premium to the trust, he must not use the GST annual exclusion. Rather, he must each year use a small part of his $1,000,000 lifetime GST exemption. The reason is that to use the annual exclusion, the donor must give it to the trust beneficiary in such form that it will be taxable in the beneficiary's estate.
The trust instrument must have certain provisions regarding the investment of trust funds in insurance policies on the estate owner's life or on the life of any person in whom a beneficiary has an insurable interest. These powers should be included in the trust instrument with the other investment powers.
If it is contemplated that the trustee will purchase the stock of the family corporation or make loans to it, there should be both a detailed section regarding the trustee's powers and the exoneration of the trustee from any losses resulting from its exercise of these powers.
Another paragraph should cover the trustee's power to purchase assets from the insured's estate or the spouse's estate at a fair market price.
There are a variety of ways the insurance premiums can be paid. All of the following have been used in the decided cases:
1. Direct gifts of money to pay the premiums.
2. A pre-authorized right to the trustee to withdraw funds from one of the insured's bank accounts.
3. A pre-authorized right to the trustee to withdraw funds from one of the family corporation's bank accounts. Presumably, the amounts withdrawn would be treated as loans to the insured stockholder-officer. The loans should be evidenced by promissory notes bearing the customary interest rate.
THE CHARITABLE REMAINDER TRUST
By Roger C. Hurd
HURD & ROSS, P.A.
Palm Beach Gardens, FL
Looking to increase income, decrease gains tax and reduce estate taxes?
If you have these objectives and also want to help a good cause, you might want to consider establishing a charitable remainder trust. It allows you to draw income on your property for a period of time or for life, while letting you defer your donation to the charity until the time when the income stream ends. To illustrate: Let's assume you have stock worth $500,000 which had cost you $50,000 and provides $10,000 (2%) in dividends per year. If you sell the shares, you would have a gain of $450,000 and a capital gains tax of $90,000. You could invest the remaining $410,000 and perhaps obtain 8% with relative safety, giving you an income stream of $32,800. Alternatively, if you do nothing before your death, you receive much less income, and your estate would be subject to as much as $225,500 in estate taxes on the property, leaving your heirs with only $184,500. Suppose, however, that you donate the property to a charity by establishing a charitable remainder trust.
By establishing a charitable remainder trust and donating the stock you will receive an income tax charitable deduction in the year of the gift. The charitable remainder trust could then sell the stock and because it has charitable beneficiaries it would not have to pay any income tax on the gain. The full $500,000 could be invested at 8%, giving you an annual income stream of $40,000 for life. Furthermore, the income tax savings could be used to purchase and prepay a $300,000 joint and survivorship life insurance policy on your life and that of your spouse. Placed in an irrevocable life insurance trust, it does not become part of your estate and avoids estate tax. The result:
1. You have increased your retirement income by about 22%.
2. You have made a significant charitable gift that can help a good cause.
3. The value of the gift has been virtually fully replaced by the insurance trust.
4. Up to $275,000 in estate taxes has been avoided, increasing the inheritance of your heirs.
How do you do this?
Initially, the grantor creates a charitable trust. He has a choice of trusts between an "annuity trust" and a "unitrust."
1. In an "annuity trust," a sum certain, but not less than 5% or more than 50% of the original value of the trust estate, must be paid to the trust beneficiary annually. No subsequent additions may be made to this trust.
2. In a "unitrust," a fixed percentage, but not less than 5% or more than 50% of the fair market value of assets, determined at least annually, must be paid at least annually to the trust beneficiary. Additions may be made to this trust from time to time. Since the unitrust assets must be revalued every year, it would be wise not to transfer to the trust assets that may present a valuation problem. The unitrust, with its annual revaluation, is an excellent hedge against inflation.
A second common use of the charitable remainder trust is to provide current income for someone outside the family, such as a grandparent or a nephew, or a former employee. At the same time, the grantor assures that upon the end of the term or the death of the beneficiary, his favorite charity will receive all the trust assets, including any appreciation over the years. The actuarial value of the beneficiary's interest will be subject to gift tax. Where the grantor and his wife are beneficiaries, there will, of course, be no gift tax.
A third, and rare, use of the charitable remainder trust arises where the grantor wishes ultimately to make a large gift to his or her college, but, in the meanwhile, he wants to provide a less expensive source of funds for his or her children's secondary, college and graduate school tuition. The charitable remainder trust, for example, would provide income to the child between ages 14 and 26. The trust would be for 12 years. The income would be taxed in the child's lower income tax bracket and used as planned. When the child reached age 26, the trust assets would pass to the college or other charity. If the grantor transfers to the trust a highly appreciated asset, that might make the plan more attractive dollar-wise. Bear in mind that the grantor could make his gifts to the trust over a period of years.
THE QUALIFIED PERSONAL RESIDENCE TRUST
By Roger C. Hurd
HURD & ROSS, P.A.
Palm Beach Gardens, FL
One of the goals of good estate planning is to transfer assets to the younger generation at the lowest tax cost. In certain cases, the estate and gift tax laws allow the taxable value of an asset to be reduced below its actual value before the tax is assessed. One of those cases is the " Qualified Personal Residence Trust" or "QPRT."
Let's say you are 55 years old and divorced, and have a home (primary or secondary residence) worth $300,000. Let's also assume that you have used your $600,000 gift and estate tax "equivalent exemption." An outright gift of the home to your children in March of 1994 would have generated a gift tax of $114,000. But if instead, you had given the home to a QPRT (reserving the right to use the house yourself for 20 years), your gift tax would have been $32,099 (a savings of almost $82,000).
This may sound too good to be true, but there is a logical reason for the difference. Under the QPRT you give the home to a trust, but reserve the legal right to use the home for a specified period (20 years in our example); at the end of that period, the home can be transferred outright to your children or other beneficiaries. The IRS says that your retained right to use the home for 20 years has a substantial value (at March 1994 interest rates, about 71% of the $300,000 total value of the property). Accordingly, when you put the home into the trust you have only given away about 29% of the value and that is the amount upon which the tax is assessed.
A few points to remember are as follows:
1. The reduction in taxable value varies with the length of the term for which your use is retained; the longer the term, the greater the reduction (and the lower the tax).
2. If you create a QPRT and die before the end of the term, the entire date of death value of the home is taxed in your estate, and the tax benefit of the QPRT is lost. This obviously puts a premium on selecting a term that is long enough to provide a good-sized tax benefit, but short enough to give you a fighting chance of surviving it.
3. After the term ends and the home passes to the children, your continued use of it will require you to pay a fair rent to your children. But as long as you can afford it, this can actually be a good way of getting additional funds out of your estate without gift tax.
4. The basis of the home for the purpose of determining capital gains tax on sale will be the same for your children as it was for you (your cost plus capital improvements). A home unlikely to be sold by the children (such as a long-time family vacation spot) is thus a particularly good candidate for QPRT.
5. A QPRT is a popular estate planning tool but it is very technical in nature.
SWITCHING DOMICILE TO FLORIDA FROM ANOTHER STATE
By Roger C. Hurd
Hurd & Ross, P.A.
Palm Beach Gardens, Florida
If you have already moved to Florida and filed your Declaration of Domicile with the Clerk of the Court or if you are planning such a move, there are several things you must do in order to clearly establish your Florida domicile. This is necessary to avoid New York State from challenging the new domicile of a Florida resident who left New York. New York may challenge the domicile of a Florida resident if it suspects that the resident has only declared domicile in Florida to avoid the tax consequences in New York for such things as income tax and income from other sources such as real estate. New York is becoming increasingly vigilant in auditing non-resident income tax returns and estate tax returns of former residents.
In 1993, New York promulgated written audit Guidelines wherein the Guidelines tell auditors to look first at six "primary" factors in determining the intent to abandon New York as a domicile and establish a new one. These factors are: retention of a residence in New York; business connections in New York; location of personal items; allocation of time between states; location of family members; and membership in New York social organizations.
The Guidelines state that "retention of a residence in New York is not, by itself, sufficient evidence that the taxpayer did not change domicile, but however, retention of the New York home is a strong contact to be considered." Thus, when maintaining two homes New York will look at how much time is spent at each residence in addition to the other factors discussed below.
The Guidelines state that "active involvement in New York business entities, by managing a New York corporation or actively participating in a New York partnership or sole proprietorship will not substantiate or confirm a declaration or a change of domicile." The test will be the extent of the taxpayer's involvement in the business. Suspicions may not be aroused if you only have a minority partnership interest or can demonstrate that you do not participate in the running of an out-of-state corporation.
Taxpayers with two residences must be sure to remove "personal items which enhance the quality of lifestyle" from the New York residence to the Florida residence. Examples of such items are antiques, family heirlooms, works of art, jewelry, book collections, stamp, and coin collections. If these items are left in the New York residence it indicates that you intend to return to that residence which is contrary to the requisite state of mind necessary for a domicile in Florida.
Auditors will frequently ask for diaries, appointment logs, or calendars to analyze "where the individual spends time and for what purpose" and also to make a "comparison of daily expenditures and the type of expenditures made at each location." Other items looked at by auditors include expense account records, credit card receipts, utility bills to determine usages, ATM access records or other bank information, and telephone bills.
Auditors will also look to the location of minor children and determine whether "quality time" with children and grandchildren in New York "is an essential part of the taxpayer's lifestyle." Florida residents should also withdraw and resign from membership in New York social organizations such as churches and synagogues.
In addition to the six primary factors discussed above, the Guidelines also discuss secondary and tertiary factors. Examples of the secondary factors include: address to which bank statements, financial data, and correspondence concerning family business is received; physical location of safe deposit boxes; location of automobiles, boats, and airplane registrations as well as the individual's personal drivers license; where the taxpayer is registered to vote and the exercise of that privilege; frequency and nature of the business conducted in New York for legal, medical and other professional services in relation to the services performed in other locations; analysis of telephone services at each residence.
Some of the tertiary factors are: the place of interment; the state where the Will is executed and probated; passive interest in partnerships and small corporations; location of bank accounts; casual membership in clubs and organizations; contributions made to political candidates or causes; the location where tax returns are prepared and filed.
It is extremely wise and advisable to adhere to as many of these Guidelines as possible within a short period of time after declaring domicile in Florida. It is also advisable that in the year after you change your domicile that you file a non-resident income tax return with the New York tax authorities. Upon the filing of the non-resident tax return, the statute of limitations usually starts to run which will prevent the state from taxing you as a resident for more than three prior years.
If you have any questions regarding your domicile it is better to consult an attorney before a taxing authority summons you for an audit regarding your domicile.
CHARITABLE LEAD ANNUITY TRUSTS
By Roger C. Hurd
HURD & ROSS, P.A.
Palm Beach Gardens, FL
A charitable lead annuity trust is a trust which pays a set amount to a charity for a period of years. After that period of years is over, the trust will terminate and be distributed to the benefit of beneficiaries, such as children or grandchildren. In your Federal Estate Tax Return, you are able to take a deduction for the present discounted value of the income stream payable to the charity.
For example, if you were to establish upon your death, a twenty-year 8% charitable lead trust with a principal value of $1,000,000.00, $80,000.00 per year would be paid to charity. Assuming the IRS Monthly Interest Rate Tables utilized a 6.6% interest rate, then your estate would receive a charitable deduction in the amount of $765,205.00. Hence, over 75% of the property transferred to this trust would be deductible.
At the end of 20 years, this property could pass to your designated beneficiaries. Money that would otherwise go to the Internal Revenue Service as estate taxes are used to fund the trust and eventually return to the family.
Two factors influence the amount of the deduction: 1) the length of the term of years and 2) the interest rate factor chosen. The longer the terms of years, the greater the deduction. The higher the annuity rate factor, the greater the deduction.
The charitable lead annuity trust is an extremely effective vehicle, however, it is essential that the amount paid to the charity be at a reasonable rate that can be obtained over a long period of time. Obviously, if payments have to be made from the principal in order to supplement the amount payable to the charity, then the charitable lead trust's effectiveness is greatly diminished.