By Milton Miller, CPA, Consultant
CPA planners are frequently questioned about the advantages of revocable trusts, prepared during the testator's lifetime, over the use of wills in estate planning. The conventional wisdom is that trust assets escape probate costs and can be managed during the testator's lifetime and after death in accordance with the testator's wishes. The questions frequently come from those that have moved to states where attorneys who prepare wills heartily endorse the living trust concept.
Estate planning is particularly important under our restructured tax laws. The maximum Federal income tax rate is now 39.6%. Pending passage of a 1999 tax bill (which, as proposed, would repeal estate taxes entirely), Federal estate tax rates begin at 37% and go to 55%. Estate planning is therefore often more critical than income tax planning, because of the large dollars involved. The question of revocable living trusts compared with wills as estate planning devices should receive the planner's careful consideration and must be decided on a case-by-case basis.
A revocable living trust is a trust that provides for management of trust assets while the individual is living and for the disposition of the assets upon the individual's death, at which point the revocable living trust operates essentially the same as a will. A revocable living trust should be accompanied by a "pourover" will, which provides that any assets of the individual that are not held by the trust at death are to be added after probate.
Probate Versus Nonprobate
The use of a revocable living trust generally entails the preparation of two separate documents, as contrasted with the one document required for a will. Thus, the legal fees and expenses for document preparation may be greater where a revocable living trust is used.
The primary advantages generally attributed to the use of a revocable living trust are as follows:
Avoidance of Probate. Probate expenses are avoided with respect to those assets that have actually been conveyed to the revocable living trust before death.
Nevertheless, probate must still take place for any assets that have not been conveyed to the revocable living trust before death. Other conventional wisdom about the benefits of avoiding probate, may be overstated as follows:
* Many law firms will agree to hourly fee schedules for probate work as opposed to a percentage of the estate. Therefore, the expenses saved in avoiding probate through a revocable living trust may actually be quite modest.
* The probate laws of most states provide specific procedures under which the claims of an individual's creditors can be expeditiously resolved or terminated after an individual's death. If the probate process is completely avoided through the use of a revocable living trust, an individual's beneficiaries may end up being subjected to the claims of creditors of the deceased with respect to the assets received.
* A revocable living trust provides no federal income tax or estate tax advantages that cannot also be achieved with a will that provides for the establishment of trusts following an individual death.
Asset Management. A revocable living trust may be an appropriate vehicle to provide an individual with investment management assistance from co-trustees or successor trustees. Assistance may be particularly important in the event of an individual's incompetency. However, the same management assistance, including assistance during an individual's incompetency, can be provided through the effective use of a durable family power of attorney. Such a power should be considered whenever a will is prepared, even if a revocable living trust exists. An attorney-in-fact can convey the individual's assets to the revocable living trust prior to the individual's death in the event of incapacitation.
It should be noted that there are occasions when some financial institutions will not readily accept a power of attorney other than their own form.
In some states, there are restrictions as to who may be named to the durable family power. For example, in Florida, a person may only designate his or her spouse, parent, child, brother, sister, niece, or nephew to such power. Therefore, if an individual wishes to name someone to assist with financial affairs that does not qualify for a family durable power, a revocable living trust will be more useful.
Privacy and Confidentiality. A revocable living trust provides greater privacy and confidentiality with regard to an individual's assets and financial affairs after death. Assets placed in the revocable living trust prior to death are not subject to probate, but a copy of the trust document must generally be filed. Specific assets, therefore, do not have to be disclosed through the probate process.
On the other hand, assets that are subject to probate must generally be disclosed through the filing of inventories and accountings with the court. The disclosures then become public documents. However, in some states, an estate inventory is subject to inspection only by the clerk of the court or the clerk's representative, the executor or personal representative and her attorney, and other interested persons unless otherwise ordered by the court for good cause shown.
Distribution of Assets. Use of a revocable living trust may expedite the process of distributing funds and assets to an individual's beneficiaries. In part, the delay of estate administration and distribution is caused by the period of time that assets are held pending identification, resolution, or termination of creditors' claims. As noted above, however, these delays may actually inure to the benefit of estate beneficiaries by leading to the termination of creditors' claims.
In addition, where a Federal estate tax return must be filed, a probate estate should not be terminated and assets distributed to estate beneficiaries until the estate tax return has been filed (generally within nine months of death), any audit by the IRS is completed, and additional taxes are paid. A trustee of a revocable living trust under similar circumstances would be ill advised to distribute trust assets prior to the receipt of a Federal estate tax closing letter. In this case, the use of a revocable living trust does not necessarily expedite asset administration and distribution unless no estate tax return is required to be filed.
An evaluation of the use of a revocable living trust versus a will should take into account certain subtle differences which primarily stem from aspects of Federal income taxation of trusts and estates. Generally, these Federal income tax aspects will favor the use of a will and probate where--
* an individual has significant Federal taxable income that is expected to continue after death, or
* a portion of an individual's assets are left to one or more charitable organizations, and such assets may produce income after the individual's death but prior to distribution to the charitable beneficiaries.
Pursuant to IRC section 645, all trusts, including revocable living trusts, must use the calendar year as their taxable year for income tax purposes. A probate estate may, on the other hand, elect a fiscal year for income tax purposes which is different than the calendar year and the fiscal years of estate beneficiaries. The flexibility of choices of fiscal year facilitates beneficial post-mortem income tax planning designed to reduce or defer income taxation of estate taxable income.
Pursuant to IRC section 642(c), an estate is entitled to a Federal income tax deduction with respect to its income set aside for ultimate distribution to certain charitable and educational beneficiaries, even though such amounts of income are not currently distributed. This income tax set-aside deduction is not available where a trust (including a revocable living trust) is used to ultimately pass such amounts to charity.
No Universal Answer
There is no universal right or wrong answer to the question of using a revocable living trust as opposed to just a will. Generally, if a revocable living trust and pourover will can be produced at a cost that is not significantly greater than that for a will, and the testator wishes to delegate asset management, then the use of a revocable living trust may be preferred. However, if an individual intends to use a revocable living trust primarily for probate avoidance purposes, it must be understood that probate will only be avoided if all assets are owned by the trust at the time of death. The testator must be willing to live with all assets titled in the name of the trust, must cooperate during the initial process of conveying assets to the trust, and must be prepared to stay with that arrangement. The potential income tax advantages of a probate estate must also be considered. Federal income tax planning after an individual's death may produce significant tax savings for an individual's beneficiaries and may favor the use of a probate estate for this purpose.
It is also important to recognize that many assets will not be subject to probate even if they are not part of a trust. The usually excluded assets are:
* Property held in joint name is generally not subject to probate if one of the owners dies.
* IRA accounts and pension plans that have named beneficiaries are paid directly to the designated individual or individuals without probate.
* Life insurance contracts will pass to the named beneficiaries without probate.
A summary of the issues explored in this article can be found in the accompanying Exhibit.
Milton Miller, CPA
William Bregman, CPA/PFS
Alan J. Straus, LLM, CPA
David Kahn, CPA
American Express Tax & Business Services, Inc.
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©2009 The New York State Society of CPAs. Legal Notices