The Why

So, why do you need a trust? Well, the answer is like the answer to many legal questions: “It depends!” In order to determine whether you need a trust, you must consider your specific estate planning needs or, in other words, which arrangement provides you the most favorable cost-to-benefit ratio. Recall that a trust agreement is a document that details the rules that you want followed for assets held in a trust for your beneficiaries. If appropriately drafted, the trust can act as the contractual agreement governing the trustee’s ownership of the property. Some common objectives for trusts are to reduce estate tax liability, to protect property in your estate, and to avoid probate.

The What

Trusts and estates can be divided into five general categories: (1) “Ordinary trusts,” which consist of valid, domestic trusts that don’t fall into one of the other four categories, (2) “Grantor trusts,” in which the grantor remains in control of and responsible for the income for income tax purposes, (3) “Foreign trusts” are trusts that don’t meet the domestic trust definition and receive special treatment, (4) Trusts that own stock of S-corporation are subject to involved rules governing when a trust may own S-corporation stock without voiding the benefit of the S-election, and (5) “Special trusts,” which are trusts used in particular situations such as charitable trusts and supplemental or special needs trusts. By and large, Grantor trusts are the most popular for managing most people’s estate planning goals.

Come Again?

Although all trusts are based on essentially the same legal framework, there are some distinctions among how trusts are categorized and the different benefits they offer. The rules governing taxation of trusts can become very complicated and nuanced, but there is a basic understanding. For tax purposes, the important distinction in a trust is whether it qualifies as a grantor trust, which means that the grantor is regarded as the owner of any portion of a trust. The income, deductions, and credits attributable to that portion of the trust are included in calculating the grantor’s taxable income and credits.

A revocable trust is one in which the grantor has retained the right to revoke the trust, or any portion of it, which logically includes the right to amend trust terms. This can be accomplished by either a trust amendment, which partially revokes some of the trust’s terms and sets forth the new terms, or by a restatement of trust, which is a restatement of the entire agreement except for some altered terms.  An irrevocable trust is one in which the grantor has relinquished these rights. A testamentary trust is created pursuant to terms in one’s will and doesn’t take effect until after death. As such, once a person dies, their will, and thus their testamentary trust, are irrevocable. An inter vivos trust, to the contrary, is created under a separate trust agreement that takes effect immediately during the grantor’s lifetime. An inter vivos trust can be either revocable or irrevocable as long as the grantor is alive.

One More Time

In a nutshell, the greatest benefits of setting up a trust are to: (1) Distribute assets to heirs efficiently without the cost, delay, and publicity of probate court; (2) Put conditions on how and when your assets are distributed after you die, which is best when the beneficiaries are minors, disabled beneficiaries, and the occasional problem child; (3) Reduce estate and gift taxes if you have a taxable estate; and (4) Better protect your assets from creditors and lawsuits.

This is why, particularly with trust creation and administration, it is crucial to consult with a competent professional, such as a trusted attorney who specializes in estate planning, to determine whether a trust should be part of your estate plan and, if so, how to structure the trust as to garner the most benefit for your individual situation.

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