THE BASICS OF A REVOCABLE INTER VIVOS TRUST
Prepared by James, Potts & Wulfers, Inc.
I. INTRODUCTION.
1. Definitions.
(a) "Revocable Inter Vivos Trust" means a Trust created
by written instrument during the lifetime of the "Grantor"
which may be revoked or
amended by the Grantor during his/her lifetime or other designated
period. The term "Revocable Living Trust" has the same
meaning as
Revocable Inter Vivos Trust.
(b) "Grantor" is usually the person who establishes the
Trust and whose property makes up the trust corpus. The terms "Grantor"
and "Settlor"
are synonymous.
(c) "Trustee" means the person or corporation or bank
which has the duty and responsibility of administering the Trust.
2. General. A Living Trust is a separate, distinct legal entity
recognized by law as having the power through its Trustee to own
and administer property, both real and personal. Property transferred
to and owned by the Trust is administered and controlled by the
Trustee. The Trustee in
turn can only act in the manner directed or allowed by the Trust
instrument or the law applicable to the Trust. Therefore, a Grantor
can, within the bounds of the law, exercise as much or as little
control over the actions of the Trustee as he/she desires through
his/her power to draft, revoke,
or amend the Trust.
3. Purpose of a Living Trust. A Living Trust is usually created
to serve as a vehicle for:
(i) management of property during the Grantor's lifetime;
(ii) transfer of property to designated beneficiaries at the death
of the Grantor without the necessity of probate; and
(iii) management of property after the death of the Grantor.
4. Alternatives to Trust for Management of Property During a Grantor's
Lifetime. When an individual desires assistance in the management
of all
or some portion of his/her assets, a variety of possibilities are
available. He/she may give a power of attorney or he/she may transfer
the property
to a person as agent, such as custodian accounts, safekeeping arrangements,
etc. Fundamentally, however, powers of attorney, custodianships,
safekeeping arrangements, etc., are all forms of the legal relationship
of principal and agent. The authority of the acting party flows
from his/her principal and ceases with the death and sometimes,
incapacity of the principal.
In contrast, a Trustee acts as a principal; his/her discretion,
authority and power to act continue unabated after the death or
incompetency of the Grantor. A Trust, rather than an agency relationship,
is generally used when the Grantor desires the powers, discretion,
and authority of the acting party to continue uninterrupted by the
death or incompetency of the Grantor.
II. ADVANTAGES, DISADVANTAGES AND TAX EFFECTS OF A LIVING TRUST
DURING THE GRANTOR'S LIFETIME.
1. Age as a Reason for a Trust. One of the factors to be considered
concerning lifetime management is the problem of age. The declining
ability
of the aged to cope with the complexities that are often involved
in managing their estates highlights one of the most important uses
of the Living Trust. It is a sad truism that the aged person is
usually the last to recognize and accept his/her own increasing
tendency to take erroneous or
erratic actions, or fails to act when action is in his/her best
interests. If the individual possesses substantial property, eventually
those close to
him/her may have to petition for the appointment of a guardian or
conservator. A Living Trust is not a universal solution to property
management
for the aged. However, in most cases it is sufficiently preferable
to the available alternatives that it warrants investigation.
2. Living Trust as a Testing Ground. A funded Living Trust allows
a trial run of the Trust during the Grantor's lifetime. If he/she
is not fully satisfied
with the Trust operations, he/she can change Trustees or the administrative
provisions or make such other changes as experience indicates, including
revocation of the Trust and recovery of the assets of the Trust.
This possibility is not available with a Testamentary Trust (a trust
created
by a will) for it comes into operation at death, too late to make
any changes.
A trial run may be particularly valuable when the assets of the
Trust are a going business, stocks, or other investments that require
attention,
because the Trustee has an opportunity to become familiar with the
problems of managing the assets while the Grantor is still available
for consultation.
3. Relief from Responsibility. The Grantor's reasons for using
a Living Trust often are not only to obtain investment advice and
direction during
his/her lifetime, but also to be relieved of the technical problems
of keeping records, managing property, and preparing tax returns.
Relief from
the mechanical problems of managing property is particularly welcome
when the Grantor is older, ill, retired, or inclined to enjoy traveling
or other interests that make management difficult. By creating a
Living Trust and appointing an independent Trustee, the Grantor
is then relieved of management and has the opportunity to observe
the Trustee's ability to perform.
4. The Mobile Grantor. The Living Trust has substantial advantages
for handling the business and financial affairs of a mobile Grantor.
For
individuals who travel, whose occupations require that they move
around the countries of the world, a Living Trust centralizes management
and places authority and responsibility with the Trustee, still
reserving the final word to the Grantor through the powers of amendment
and revocation.
A Living Trust may also minimize tax problems, particularly as they
relate to the Grantor's domicile and residence. Retention of corpus
by the
Trustee places the assets beyond the jurisdiction of the taxing
authorities where the Grantor temporarily resides.
5. Pre-Death Administration. A potential disadvantage of a Living
Trust is the pre-death administration. In the case of a Will, no
pre-death
formalities are required other than the execution of a Will. A Living
Trust necessarily involves a number of pre-death actions. In the
usual case,
the Trustee must open one or more bank accounts for the Trust, the
Grantor must formally transfer assets from his/her name to that
of the Trustee, and the Trustee should operate the Trust as a legal
entity separate and independent from the affairs of the Grantor.
The Trustee must retain
records of Trust activity.
The extent to which pre-death administration will be a problem
depends upon the type of Trust created, the beneficiaries, and the
choice of the Trustee. If the individual is willing to name a bank
or other professional Trustee, the professional can effectively
perform the administrative
functions, and the only disadvantage to the Grantor is the cost.
If the Grantor wishes to be Trustee himself or to name a friend
or relative as
Trustee, the administrative requirements may then be a burden.
A majority of our clients appoint themselves and their spouse as
Trustees. This allows administration of assets in virtually the
same manner as
if the Trust were not created, the major difference being that administration
of assets is done in the name of the Trust, not the individual.
This
method of Trust administration is recommended when the client is
fully capable and willing to manage his or her assets.
6. Amendment of Trust. A potential disadvantage deals with the
amendment of the Trust. If the Grantor of a Living Trust wishes
to change the beneficiaries designated to receive property following
his/her death, he/she can readily do so by amendment, but if he/she
does not wish the beneficiaries, whose rights have been diminished,
to become aware of the previous terms of the Trust, he/she faces
a more difficult
administrative problem. Generally, the original Trust instrument
and any amendments to it are part of the Trust and its history,
and the Trust beneficiaries probably have a legal right to them.
Therefore, the superseded provision will usually be available to
them unless the Grantor
exercises his/her rights to completely revoke the prior Trust and
go through all the necessary mechanics of creating a new Trust and
transferring assets to it.
If this is a problem, the Trust can be drafted so that this problem
is diminished or even eliminated by restating the Trust. This means
the Trust is rewritten in full including the desired wording thereby
eliminating prior wording.
7. Transfer of Assets. Another potential disadvantage is that the
Grantor, to achieve full benefit of a Living Trust, must transfer
the Grantor's
assets to the Trust. If private assets are not transferred to the
Trust prior to the death or incapacity of the Grantor, it is probable
that a probate or guardianship proceeding will be necessary to deal
with those particular assets. We work closely with each client to
transfer all assets to the
Trust to avoid this possibility. The need to transfer also means
the Grantor must expend effort to identify and transfer assets during
his or her
lifetime. Although this may be a problem, it is significantly less
a problem while the Grantor is living, than after the Grantor's
death or incapacity.
8. Tax Effects. Creation of a Living Trust generally has no substantive
income tax effects during the Grantor's lifetime. Because the Grantor
has retained the power to revoke, he/she is treated as the owner
of the Trust and therefore the income, credits, and deduction of
the Trust are
reported in the Grantor's individual tax return. The Living Trust
does not file a separate income tax return. The bottom line is that,
in a vast
majority of cases, the Grantor will file an individual income tax
return as if the Trust were not in existence. All income, credits
and deductions
of the Trust are treated as income, credits and deductions of the
Grantor.
III. ADVANTAGES, DISADVANTAGES, AND TAX EFFECTS OF A LIVING TRUST
AFTER THE GRANTOR'S DEATH.
1. General. Use of a Living Trust is frequently urged as a means
of avoiding probate at the death of the Grantor. If title to property
has been transferred to a Living Trust before death, the property
(if retained by the Trust) is not subject to probate as part of
the Grantor's estate, even if
he/she was the Trustee at the time of death. Although the avoidance
of probate is a factor to be considered, there are numerous additional
benefits.
2. Avoiding Delay in Transferring Assets to Beneficiaries. The
speed with which assets may be distributed to a beneficiary after
death is
dependent, primarily, on the provisions of Oklahoma law permitting
distributions and, secondarily, on the provisions of federal or
state law that
may make the fiduciary liable for death taxes, unpaid income taxes
of the decedent, or claims of the decedent's creditors if the effect
of the distribution is to leave inadequate property to pay those
taxes and claims.
If the Trustee is the sole beneficiary, or enjoys a relationship
with the other beneficiaries such that his/her potential liability
for unpaid taxes or
claims is unimportant to him/her, a Living Trust will allow most
of Grantor's property to be distributed to his/her beneficiaries
within a short time
after his/her death. As an example, if the sole beneficiary is the
surviving spouse, distribution from the Living Trust to the surviving
spouse can be immediate. In contrast, except for family allowance
to dependents, distribution of a probate estate cannot usually be
made to the beneficiaries
until an order of distribution is entered by the probate court which
is usually many months, even years, after death.
When the Trustee is not the sole beneficiary and is concerned about
his/her possible liability to the various taxing authorities and
creditors, major distribution generally should not be made from
a Living Trust any sooner than they could be made from a probate
estate. Even though there
may be limitations upon the distribution of the corpus from a Living
Trust because of the foregoing considerations, income generated
by the Trust assets can be currently distributed to the beneficiaries,
in most instances the surviving spouse, with immediate availability
of income from the
assets of the Trust. This immediate availability may not be the
case if the estate must be probated.
3. Costs of Administration. Whether the executor's commissions in
a probate estate will exceed the fees of the Trustee of a Living
Trust depends
on the circumstances of the particular case, including the amount
of property involved, the period of administration, and whether
administration
will be followed with a continuing Trust. The executor's commissions
in Oklahoma are fixed by law. Trustees' fees are not fixed by law,
but must be reasonable. The fees of banks and trust companies are
generally published by them and is a guide for "reasonable"
fees to be charged by individuals. Trustees' fees, in the aggregate,
may be greater than executors' fees, depending on the length of
time the Trustee must act, the
property in the Trust, and other factors. If the Trustee did not
act prior to the Grantor's death, some banks request an acceptance
fee for accepting the Trust assets, but we usually draft our trusts
so that the bank will not be required to impose an acceptance fee
and, in exchange for that, the
bank will not be liable for any action or inaction of the predecessor
Trustee. In most cases, the spouse and/or children of the Grantor
are
successor Trustees and therefore Trustee fees are not an issue.
4. Attorneys' Fees. Attorneys' fees for probating an estate are
generally negotiated. Many attorneys will charge a reasonable fee
for the services actually rendered in a probate based on time expended,
nature of services required, responsibility assumed, and results
produced. It is our experience that attorney fees for the most simple
probate will be $3,000 to $5,000. Since property transferred to
the Trust does not require
probate, it is reasonable to assume that attorney fees in connection
with the transfer of property upon death when the property is in
a Trust will be less than if the property required probate. This
does not mean that attorney fees will not be incurred if property
is transferred by a Trust, because
the same problems such as tax problems, disputes between heirs and
beneficiaries, etc., can arise even though the property is in Trust.
If these problems do arise, attorney fees will be incurred but they
should not be any greater than if those problems arose during the
probate administration
of an estate. It has been our experience that, absent the foregoing
problems, no attorney fees are incurred on the death of the Grantor
for transfer
of property for the benefit of the surviving spouse.
The attorney fees for creating a Living Trust and companion Will
are more than the fee of preparing a Will alone, so that pre-death
legal expenses are greater with the Living Trust.
5. Administration of Assets after Death. When a Living Trust is
used, the Trustee can continue to exercise all investment and other
administrative powers given it by the Trust instrument, without
court approval. Those powers are not interrupted by the death of
the Grantor unless he/she was the Trustee. Even if the Grantor were
the Trustee, if the successor Trustee is designated and is willing
to serve, no court proceedings will be required and the successor
Trustee can act immediately. In contrast, there is generally some
delay in having an executor appointed.
6. Multi-State Assets. An important advantage of a Living Trust
is the avoidance of ancillary administration when the Grantor owns
real property in several states. Ancillary administration is usually
expensive in that it requires a duplication of many of the efforts
in the main probate. In some instances, it may be advisable to create
a Living Trust just to hold the multi-state assets.
7. Publicity. Freedom from publicity is an advantage of a Living
Trust. Wills and probate administrations are matters of public record.
The
principal provisions in the Wills of prominent persons are frequently
published in the newspapers. Inventory of assets for a probate estate,
showing the nature and the value of the decedent's estate, is also
generally a matter of public record. Although a Living Trust is
not entirely
private, since copies must be filed with taxing authorities and
certain transfer agents require submission of copies of the Trust,
it is definitely a
more private method of administering and passing a person's property
on death than probate.
8. Contest of the Trust. The legal requirements for contesting
a Living Trust are generally similar to those for a Will contest,
e.g., mental
competence or undue influence. There may, however, be a difference
in time limitations within which the instrument must be contested,
the
period being shorter for a Will than for a Trust. But, it may be
more difficult to contest a Living Trust that has been in active
operation for a period prior to the Grantor's death as compared
to the contest of a Will.
9. Taxability of Income of the Trust. Generally, a decedent's estate
and a Trust are treated in the same manner for federal income tax
purposes except that during normal administration, the income of
a probate estate is taxable to the estate, except for distributions
actually made to the beneficiaries, which are taxable to them. The
Executor, by timing some distributions, can affect the income tax
liabilities of the estate and its beneficiaries. However, a Trustee
may not be able to do so, because trust income that must be distributed
to beneficiaries currently is taxable to them whether or not it
is actually distributed. Accordingly, there is less flexibility
in income tax planning for a Trust and its beneficiaries than for
an estate and its beneficiaries.
10. Basis of Property in the Trust. For federal tax purposes, property
placed in a Living Trust receives on death the same treatment as
to basis as property of the same character which passes by Will.
Property acquired from a decedent, including property of Living
Trusts, receives a new basis equal to its fair market value at the
date of death or at the alternate evaluation date.
11. Estate Tax. Separate property transferred to a Living Trust
is included in the Grantor's gross estate for estate tax purposes.
The use of a
Living Trust, therefore, does not affect the taxability of the property
and any estate tax advantage, which can be obtained by the use of
a Will, can
be obtained by the use of a Living Trust.
IV. PLANNING THE TRUST.
1. Selection of Trustee. The appointment of a Trustee must meet
certain minimal legal requirements. Because the Trustee must deal
with the
Trust property, he/she must be legally competent to hold title and
to contract. Appointment of a guardian or conservator of the Trustee's
person or estate generally vacates the office. A grantor is not
prohibited from acting as Trustee, but this situation has disadvantages
which must be considered, especially with a funded Trust. Thus,
when the Grantor acts as Trustee, use of the Trust as a testing
ground is lost. Although the cost
of maintaining and administering the Trust is reduced, it may be
more difficult to find a qualified successor Trustee willing to
act because of
possible liability for failure to discover and redress breaches
committed by his/her predecessor. Although this has been a problem
in some localities, we have not found this to be a problem with
our clients. Also, when the successor Trustee is the Grantor's spouse
and/or children, the foregoing is not a problem.
A beneficiary may act as Trustee. However, when a beneficiary acts
as Trustee, conflicts of interest may develop because of his/her
rights as beneficiary are affected by his/her acts as Trustee. This
situation arises, for example, when a parent is a life tenant and
children are
remaindermen, or when one sibling is Trustee for himself and other
siblings. The conflict of interest problem may be met in several
ways, such as defining Trustee powers or the appointment of a Co-Trustee.
Furthermore, when a beneficiary is a Trustee, certain income and
estate tax
problems may arise which would be adverse to the interests of the
Trustee/beneficiary. However, if this is a problem the Trust can
be drafted to
avoid the problem.
2. What Property Should be Transferred to Trust. The Grantor who
establishes the Trust must determine at the outset whether all or
only part of the property is to be transferred to the Trust. Because
the Grantor of a Living Trust is considered the owner of the Trust
property for income tax purposes, he/she need not concern himself
with many tax considerations, such as the effect of transferring
property with low basis. Nevertheless,
tax considerations do play a role, e.g., in the transfer of stock
of a Sub-Chapter S corporation the election may be lost, or the
transfer of stock options to the Living Trust has disadvantages.
A point to remember is that if all property subject to probate is
not transferred to the Trust, the advantage of avoiding probate
is lost.
The following is a general discussion of factors considered when
transferring specific property to a Trust:
(a) Installment Notes Receivable. The Grantor's assets may include
installment notes from an earlier sale of assets on which the Grantor
has deferred income under the Installment Sale provisions of the
Internal Revenue Code. The Internal Revenue Service has ruled that
a transfer to a Living Trust is not such a disposition and, therefore,
does not accelerate income because, for tax purposes, the Grantor
is treated as the owner of the Trust.
(b) Nonproductive Property. Nonproductive property, such as stock
in a closely held corporation or unproductive land, is an appealing
asset for transfer to a Living Trust. The inconveniences that normally
arise during the Grantor's lifetime, such as need for separate trusts,
bank accounts,
and tax returns are absent with this type of property.
(c) Encumbered Property. When encumbered property is transferred
to a Trust, an analysis should be made to determine whether the
property is likely to be self-supporting and produce sufficient
income to continue payments on the encumbrance.
(d) Property Subject to Restrictive Agreements. Among the assets
being considered for transfer to a Living Trust may be shares of
stock in a
closely held corporation or interest in a partnership or limited
liability company that are subject to an agreement restricting their
sale or disposition. The agreement should be examined to determine
if it permits transfer of the interest to a Trust during the owner's
lifetime.
(e) Interests in Professional Partnerships and Corporations. The
Grantor may be a member of a professional or commercial partnership.
The
interest in the professional partnership, e.g., law or medical partnership,
cannot usually be transferred to a Living Trust because each partner
must be a licensed member of the profession. There is generally
a similar restriction on professional corporations. However, the
Grantor's
interest in property used by the corporation or partnership and
death benefits may be properly transferred to the Trust, just as
any other asset.
(f) Out-of-State Real Property. Transfer to a Trust of real property
located in another state eliminates the need for ancillary probate
proceedings
when the Grantor dies.
3. Powers of the Trustee. The powers and duties of a Trustee are
governed by the Trust and state law. Oklahoma law is not overly
restrictive in the powers and duties which it allows the Trustee,
and in most instances, allows the Trust instrument to expand upon
the powers granted by law. Therefore, within reason, the powers
and duties of a Trustee can be drafted in the Trust to suit the
particular needs and desires of each Grantor.
4. Distribution of Trust Assets. Since the Trust assets may be
distributed to beneficiaries to the same extent as one could do
by Will, the Grantor
of a Trust needs to make the same decisions concerning distribution
of his/her assets as he/she would in making a Will. In addition
to the
flexibility, the management and distribution can be controlled after
death by the terms of the Trust. After death, management and distribution
is, in many instances, one of the primary reasons for the creation
of a Trust.
V. CONCLUSION.
It is hoped that the foregoing will be helpful to our clients in
making the decision of whether their estate plan should include
a Living Trust. A Living Trust is a tool that should be seriously
considered in most estate plans.
David F. James, Esq.
David W. Wulfers, Esq.
JAMES, POTTS & WULFERS, INC.
2600 Mid-Continent Tower
401 South Boston Avenue
Tulsa, Oklahoma 74103-4015
(918) 584-0881 (telephone)
(918) 584-4521 (facsimile)
|
