Legal Advantages of a Trust in Estate Planning

Written as a paralegal in July, 2006. Obviously, this document is for information only, and is not intended to be construed as legal advice, nor am I a licensed attorney in any state, anywhere. Also, it’s crazy out of date.

What makes the use of trusts so popular with estate planning professionals?

Assets held in trust are not part of your taxable estate. So, by creating a trust, you reduce—or even eliminate—estate taxes by reducing the value of your estate. A trust also assures privacy, as assets held in trust are not subject to probate, which is a public, published process. Avoiding probate also saves probate fees (filing fee, legal notice and publication fee, appraisal fees, etc.), executor fees and attorney fees.

Another advantage of a trust is that if the settlor becomes incapacitated, the successor trustee can take over managing the trust assets on the settlor’s behalf. This can be an important end-of-life consideration, and can potentially preserve family assets during a long period of incapacity.

There are many kinds of specialized trusts, each offering tax savings and options for preserving the trust assets for the beneficiaries. For example: a life insurance trust with Crummey powers enables the settlor to pass money to heirs tax free, a credit-shelter trust allows a married couple to maximize the marital deductions of both spouses, and a QTIP trust allows you to provide for a surviving spouse while preserving the right to control the disposition of the remainder of the trust assets.

How can I reduce estate tax liability by making monetary gifts as part of a comprehensive estate planning strategy? 

Currently, there is a lifetime gift exclusion of $1,000,000. You can also make annual gifts of up to $12,000 to an unlimited number of different recipients without being subject to the gift tax; these annual exclusion gifts are not part of your lifetime gift exclusion. Additionally, there is no gift tax on transfers between spouses (as long as both spouses are US citizens), gifts made for another person’s education (tuition only) and gifts for medical expenses. These gifts reduce the value of your estate, thereby reducing estate tax liability. This is an excellent strategy; those who would inherit your assets can receive the same assets through a well thought out gifting plan without incurring the gift tax and without your estate paying the estate tax. Simply put, your assets remain with your beneficiaries rather than being paid in estate taxes.

For people who have a taxable estate and the ability to make annual exclusion gifts, it is a good idea to do the maximum amount of gifting to the persons who will be their heirs. Not only does this remove the funds from the estate, all the future growth that these funds would have generated are also out of the estate.

Gifts you make to charity are also exempt from the gift tax, and you receive the same savings benefit as you do for other gifts by removing these funds from the estate. Additionally, gifts made to charities during your lifetime are deductible from your income tax.

What are postmortem estate planning devices?

Even after your lifetime, there are estate planning devises that can be used to minimize your estate’s tax liability.

The disclaimer is one example of a postmortem estate planning device. Often is possible to your reduce estate’s tax liability by having property pass to a family member other than the recipient named in the will. If the intended recipient renounces or disclaims the gift, and it passes to other family members via intestacy, the tax savings can be significant. The use of the disclaimer means that the property won’t have to be transferred twice, and thereby taxed twice.

Alternative valuation is another postmortem estate planning device. Normally the standard date of death valuation is used to determine the value of property included in the gross estate for estate tax purposes. However, if the property included in the gross estate is declining in value, it may make sense to use the alternate valuation, which is determined 6 months after death. This reduces the value of the estate, thereby reducing estate taxes.

Another excellent post mortem estate planning device is the QTIP (qualified terminable interest property) trust. This type of trust allows the settlor to pass the entire estate to someone other than his or her surviving spouse, while providing the surviving spouse income from the trust for life. While the surviving spouse is still living, no one can appoint trust property to anyone else. Upon the death of the surviving spouse, the trust principal passes to the beneficiaries. What makes this a postmortem estate planning device is that the decision to use the QTIP provision of the trust is made after the death of the settlor. A QTIP trust does not automatically qualify for the marital deduction treatment. This treatment must be selected by the personal representative of the deceased spouse on the federal estate tax return. This means that important financial and economic circumstances at death can be considered when making key financial decisions, rather than the circumstances at the time the trust is executed.