The What and Why of Trusts

Posted By : Glen R. McCluskey, Attorney At Law

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There are many types of trusts in the law. Those we will talk about here are related to estate planning.

A client recently asked: What is a trust and do I need one instead of, or in addition to, a will?
At its most simple, a trust is a legal concept that allows one or more persons, called “Grantors” or Settlers” to take something they own out of their own personal wealth and place it for safekeeping with another person or persons called a “Trustee.” The Trustee is given instructions and to what to do and what not to do with the item(s) placed in trust. The instructions are in writing and make up the trust document. The Grantor engages an attorney to draft the trust document for specific purposes in a form that is legal and makes logical sense. The Grantor signs the document and lets the Trustee know what they are supposed to do and when. A trust is effective when it is written, unless it states otherwise. This is unlike a will which only “Speaks after death.”

Why a Trust?
Trusts allow the Grantor to control the items placed in trust and the timing of their transfer out. The Grantor is not just giving them to some recipient who may do with them what they wish. Instead, the Grantor has certain reasons for placing the items in trust. These are generally reasons of control and reasons of tax. The Trustee must obey the trust instructions or they are in breach of their duties as Trustee.

Reasons of Control
The Grantor chooses not to given his items away now. Instead, the Grantor has a plan for the future. For estate planning purposes, such plans often involve how wealth that exists now or will be accumulated is transferred to children or some other person or even an entity, like a charity.

As for children, the law does not allow persons under the age of majority (18 in most states) to take title to the items in the trust and own them outright. An adult must be appointed to handle such items until the children reached the age of majority or are otherwise “emancipated.”

Placing money, stocks, real estate or any other item, tangible or intangible into a trust can allow the Grantor to state exactly when, how much, and who gets these items over time. Perhaps the plan is to distribute them after the Grantor’s death. Perhaps the plan it to distribute them to the children when they reach 21. Except for Johnnie. The Grantor plans to keep the funds away from him until his is 45.

There are as many different control reasons as there as Grantors. You should determine what you want to do in your trust instructions and why. Almost any combination of instructions and restrictions is permissible. Although not all make rational sense.

Reasons of Tax
An analysis of tax issue is beyond the scope of this writing. In generally however, the government; state or federal, has determined that you must pay tax on certain income that you accrue.

You do not have to pay tax on someone else’s income, just your own. A trust is a separate legal entity with its own Tax ID number. Like a corporation or limited liability company, a trust “owns” the items placed in trust when the Grantor places them there. It is the Trustee that acts as owner of the trust.

It is possible to create the trust as the accruer of certain income, rather than having it come to you. The trust itself may have tax liability, but you do not.

Inheritance Taxes
A common reason to create a trust as a part of an estate plan is to avoid estate taxes; so called “Death Taxes.” Currently, there is a high federal dollar level that you would need to inherit or own before you would have to pay estate taxes at all. However, the tax rate is also high. States have other levels and laws.

In 2021, the estate tax exemption is $11.7 million per individual. That means that no estate tax will be due if you or your loved one’s inherit less than that. However, many people have that much wealth and so look for legal ways to avoid paying it. As well, Congress may change the levels in the future which we cannot anticipate. The tax must be paid when the taxable event takes place, such as the inheritance. That may be many years from now.

A –B Trust
A common way to avoid inheritance taxes is to create an “A –B Trust.” This type of trust involves two people, usually married, who we will call A and B.

For this legal trust scenario to work A and B must place everything they own in their own trust. Looking at A as the Grantor, A is generally the trustee also and essentially gives himself written instructions so long as he is alive and competent. These are “Living Trusts” which means that the Grantor gives the trust written instructions that the Grantor has the power to get all the items back, if they choose and close the trust. However, once the Grantor dies or become legally incompetent, the trust is “irrevocable” and the items are permanently out A’s estate, never to return.

Meanwhile B does the same as A above.

Upon the death of either A or B, the trust states that all funds from the trust of the person who died, go to the trust of the person still alive. In this way, only the B trust inherits. The ownership changes from A to trust B. Trust A goes away.

At some time in the future, the person still alive will not be. Money and items may then go to next of kin, a charity of whatever the trust states. Such items may also remain in the trust, if that is what is written, and be distributed over time.

This scenario does not necessarily eliminate tax, but it provide a great deal of control as to when taxable events take place and allows some flexibility of payout so that educated decisions can be made as to who gets what, how much tax will be due, and what can be done, if anything to reduce it.

Special Needs and Social Security Trusts
There are many types of trusts and we will not examine them all here. However, special needs and social security trusts are common. They use the principles outlined above and keep income away from a person who is receiving income-based government benefits so that their personal incomes does not exceed the benefit income limitations.

A special needs person may be a mentally disabled child of any age. Often they receive benefits from the county, state, or federal government. These benefits are available only to those whose income is below a certain level. By setting up a trust for that person any income due them, including the benefits themselves can be paid into a trust. In this way, the Trustee can use the funds as they were intended, but there is no danger that the special needs person’s income will reach a point where the benefits would be lessened or cut off.

The same principles apply to Social Security recipients who must pay back some or all of the Social Security benefits if their income rises above a certain level.

Pour Over Will
While this writing is about trusts, we must talk about the “Pour Over Will.” In the above A-B Trust example, and most other trust scenarios, to take best advantage of the trust, the Grantor must place items they own into the Trust. A trust cannot exist with absolutely nothing in it. Paperwork, bills of sales, securities transfers, and real estate transfers may be involved to make this happen. As new items are obtained, the Grantor must remember to acquire them on behalf of the trust only or promptly transfer them in. Very few people remember to do this for every item they own. If they die before getting all the items into the Trust, they must have a will as a back up document to make the transfers. The Pour Over Will Speaks at their Death and will state that everything they own that can be transferred by will (Probate Assets) are thereby given to the Trust. This way there are no gaps of ownership.

Conclusion
Trusts are a useful tool in estate planning. They are not needed in every case and are therefore also not for everyone. If you contact me about your plans, questions, dreams, and desires, we will determine whether a trust is right for you and/ or which of the many estate planning tools best suit you and your situation.

Glen R. McCluskey

Attorney At Law

Glenlaw@glen-law-office.com

651-646-2669

THIS DOCUMENT IS NOT LEGAL ADVICE AND MAY NOT BE DEEMED TO BE LEGAL ADVICE. IT DEALS ONLY WITH THE MATERIAL SPECIFICALLY DISCUSSED HERE. YOUR SITUATION WILL BE BASED ON YOUR OWN FACTS AND CIRCUMSTANCES. YOU ARE ENCOURAGED TO SEEK THE ASSISTANCE OF YOUR OWN LEGAL COUNSEL AND TAX ADVISOR.