Trusts, Estates, wills how do you make sense of all of this. Today, trusts are not used only by the very wealthy. People of a wide variety of income levels use them as estate planning tools. Trusts are complex and costly to set up and run, requiring a higher level of services from an attorney than wills. They are useful in accomplishing various estate planning and financial planning goals.

What They Are

A trust owns its own property (holds the title). When it is set up, the trust appears on official papers and records as the legal owner of any property that is placed into it. The trust’s principal is the property that the trust owns, as distinguished from the interest or dividends earned by that property. The terms of the trust dictate who will get the benefit of the income from the trust property, how long the trust will last, and so on. The trustee is the person or entity whose job it is to administer and manage the trust: make investment decisions, pay taxes, make sure the terms of the trust are carried out, and take care of the trust’s property. Generally speaking, the trust must pay income tax on any of its undistributed interest or other income. There are basically two types of trust:
  • An irrevocable trust is a separate entity, for both legal and tax purposes, and pays its own taxes. The irrevocable trust cannot be revoked or changed.
  • A revocable trust is not considered a separate entity for tax purposes, although it may be considered a separate legal entity. The revocable trust can be changed or revoked-taken back-by the creator of the trust.
Another way to categorize trusts: A living (or inter vivos) trust is set up by a living person while a testamentary trust is created by a will.

What They Can Accomplish

Trusts can be used for many worthwhile purposes:
  1. Give property to children.
  2. Reduce estate taxes.
  3. Leave assets to a spouse.
  4. Provide for life insurance used to pay estate tax.
Giving property to children. People generally do not want to just give property to a minor child outright because of the financial risks involved (e.g., the child could squander it). Many people give property to a minor through a trust. The trust’s terms can be written so that the child does not get outright ownership until he or she has achieved a certain age, so that the child receives only the income from the trust property until that time. Another way to give property to a minor is via the Uniform Gifts to Minors Act or Uniform Transfers to Minors Act. These provisions, which apply in most states, provide for a custodianship over property given to a minor. Reducing estate taxes. As noted earlier, if you leave everything to your spouse, it passes free of federal estate tax. However, when your surviving spouse dies, anything in his or her estate over the exclusion amount (also called “exemption amount”) would be subject to estate tax. The exclusion amount for 2009 is $3,500,000. No limit in 2010 and reverts back to $1,000,000 in 2011. The credit shelter trust, or bypass trust, is used to shelter up to the exclusion amount from the estate tax. Here’s a simplified example of how it might work:
Example: Simon and Sylvia have an estate worth $4 million. Simon’s will puts $2,000,000 worth of assets in a bypass trust. The ultimate beneficiary of this trust is Simon and Sylvia’s daughter. (The beneficiary can be anyone other than Sylvia.) Sylvia is to receive the income from that trust for her life, but her rights in the trust are limited, so that she is not considered the owner. The rest of Simon’s estate ($2,000,000) is left to Sylvia in his will. Assuming Simon dies in 2009, the $2,000,000 in the bypass trust is sheltered by his estate tax exemption. The $2,000,000 that goes to Sylvia is deducted from the estate because of the marital deduction. Thus, on Simon’s death, the federal estate tax due is zero. When Sylvia dies, her estate will include only the $2,000,000 (if she still has it), plus any other assets she has accumulated. It will not include the $2,000,000 put into the bypass trust, which will be exempt from tax because of the $2,000,000 estate tax exemption. Thus, the federal estate tax on Sylvia will apply only to her assets in excess of $3,500,000. Result: The family has sheltered assets worth $4 million from estate tax in the Simon/Sylvia generation. Without the bypass trust, the estate tax would have applied to an additional $2,000,000 of the estate.
Caution: Wills may be drafted to leave a bypass trust an amount equal to the exclusion amount in the year of death, rather than a specific dollar amount. However, because amounts change, review of the estate plan may be needed to keep the desired balance between what the spouse is to get and what trust beneficiaries are to get. Leaving an asset to a spouse. The marital deduction trust allows the first spouse to die to place estate assets in a trust for the surviving spouse, instead of leaving them to him or her outright. If the legal requirements are met, the estate gets the marital deduction, but can still preserve assets for heirs other than the surviving spouse. Typically, the income of such trusts will go to the surviving spouse for life and the principal will go to children. All of the income must go to the surviving spouse for the trust to qualify for the marital deduction. It must be paid out at least once a year. The spouse may have some access to the principal. When the second spouse dies, the property is included in his or her estate for estate tax purposes. Pay estate tax. Complex and expensive arrangements, life insurance trusts are usually used to finance future estate taxes on an estate that contains a business interest or real estate. If you need help or have questions please seek a trusted professional.  Feel free to visit us as well. FOOTNOTE: re posted from the website written by CPA site solutions.
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