Inter Vivos Trusts

An inter vivos or “living” trust is a trust which is created during the lifetime of the person who establishes the trust, also referred to as a “testator.” The key feature of the inter vivos or living trust is that the testator may revoke the trust at any time. Frequently, trusts are sought in order to avoid the probate process. Probate is the formal submission of a will to court where the will is administered pursuant to court oversight.

The inter vivos trust must meet certain requirements. First, the trust must contain the testator’s intent to create the trust. In addition, the trust must contain assets or property, also known as the “res” of the trust. Furthermore, the trust must have identifiable beneficiaries. Also, the trust must have a trustee appointed who will oversee the administration of the trust property. The trustee could be the testator or there could be more than one trustee, such as you and your spouse to serve as co-trustees.

Use of the trust avoids this process, in addition to the costs involved in probate, which include both court costs and legal fees. Also, the use of a trust eliminates the delay of the transfer of property, as the property is not tied up with the probate of a will. Moreover, use of a trust avoids the trust property and distribution from becoming a public record. The use of an inter vivos trust does not result in any tax advantages; thus, the trust does not eliminate federal or state estate or inheritance taxes.

Bypass Trusts

One of the most common Bypass Trusts is the credit shelter trust, also called the exemption trust. This trust is one of the primary estate-planning tools. It employs one of the main provisions of federal estate tax law, the unified credit, which gives each person a $1 million total exemption from estate and gift taxation. It’s called a bypass trust because as much as $1 million bypasses the surviving spouse’s taxable estate and goes directly to a trust that ultimately benefits the children, grandchildren, or other beneficiaries when the second spouse dies.

Here’s how it works. Assume that you die survived by your spouse and child. The adjusted gross estate (estate after deducting funeral expenses, expenses of administration, and claims) totals $2 million. Your will (or trust) creates a marital trust or gift of $1 million for your spouse; the remaining $1 million goes into a family trust. If a gift is left to your spouse in trust, the income of both trusts are payable for as long as they live. They also are entitled to the principal of the family trust under an ascertainable standard of living, and they can have special power of appointment and act as trustee. On their death, their estate and trust go to your child.

This arrangement minimizes or eliminates federal estate taxes. On your death, the estate owes no estate taxes. Because unlimited property can be passed to a spouse without being taxed, the gift to your spouse is exempt for federal taxes. It is added to your spouse’s taxable estate, but then her available exemption kicks in, so no taxes will be owed on her death if her taxable estate is not larger than the available exemption amount. The family trust utilizes your exemption as a credit shelter trust on his estate, but is not included in your spouse’s adjusted gross estate on her death.

Spousal Trusts

If you and your spouse’s combined estate exceeds $2 million under active law, a bypass trust alone won’t be enough to avoid the estate tax. If so, we recommend that you next use a spousal or marital deduction trust (in addition to the bypass trust) to help you take full advantage of the second major estate tax planning device, the marital deduction. Spousal trusts allow one spouse to pass his or her entire estate, regardless of size, to the other–and not pay federal estate taxes.

No matter how large your estate, no taxes are due where it is passed to the spouse. If you only cared about leaving your property to your spouse, your tax worries would end. Most people, however, want to leave property to their families at the death of the second spouse–and this is where tax planning pays off. Special rules, however, apply to qualify for the marital trust if your spouse is not a U.S. citizen.

Using the marital deduction properly, usually in conjunction with a tax-saving trust (as explained below), you should be able to transfer at least $2 million free of estate taxes to your children or other beneficiaries no matter which spouse dies first or who accumulated the wealth.

Irrevocable Life Insurance Trusts

These trusts are a popular way of accomplishing the same goals as a spousal trust. Here’s how they work. A married couple has a combined taxable estate of over $2 million after using other tax-avoidance devices. They set up a life insurance trust in which the trust owns the policy on their lives–they do not.

This can be accomplished with an existing policy (by transferring ownership to the trust) or a new one. Each year, the husband buys $10,000 worth of premiums in the policy. When he dies, the policy pays off $400,000–none of it taxable as a part of his gross estate–to the trust. The wife lives off the income from the trust. When she dies, the children, take the principal remaining–again, tax-free.

Charitable Trusts


Irrevocable Family Trusts

An irrevocable family trusts allow the grantor to establish set rules for when the beneficiary may begin to collect from the trust. Grantors often set up irrevocable family trusts to provide for a child or grandchild’s education or to provide family members a set monthly income after the reach a certain age. These provisions must be outlined in the initial agreement for them to be legally binding.

The irrevocable trust is its own taxable entity, and tax returns are filed under the trust’s EIN. Generally, the attorney drafting the trust will help the grantor establish an EIN with the IRS. The trust must file its yearly tax return using IRS Form 1041. Once the funds are distributed to the beneficiary, the beneficiary may assume the tax burden rather than the trust. Because the grantor no longer has control over the assets of the trust, he or she is not responsible for the taxes it accrues yearly. Likewise, creditors may not seek the funds gifted to an irrevocable trust after they are transferred by the grantor.

A trust is generally used to will property, assets, and money to a beneficiary after the grantor is deceased. Establishing an irrevocable trust and gifting assets to it allows the grantor to avoid some tax penalties. It also ensures that the trust’s beneficiaries do not have to go through probate hearings after the grantor is deceased.