With a revocable living trust under current Texas law, you can:
(1) Avoid the necessity of probate administration to transfer ownership of assets after your death, so that:
* the identity and valuation of your assets and the identity of the recipients of your assets need not be filed in the public records,
* the legal and other costs of handling your affairs after your death may be reduced.
(2) Provide for the management of your financial affairs in the event of your disability without the necessity for a costly guardianship, as well as after your death.
You can accomplish all of the above while retaining your right to control and your right to use the assets yourself for the rest of your life, and without losing any federal estate tax advantage that can be obtained in a will.
This memorandum contains a brief discussion of revocable trusts, the advantages and disadvantages of revocable trusts, the tax consequences of revocable trusts and how to transfer assets to a trust.
I. INTRODUCTION TO REVOCABLE TRUSTS
Texas law, like the laws of most other states, recognizes two types of “title” to property: (1) legal or record title (the name in which property is held), and (2) equitable or beneficial title (the name of the person who has the right to benefit from the property).
The trustee of a trust is the person in whose name the property in the trust is held, or the record owner. The beneficiary of a trust is the person for whose benefit property is held in the trust, or the owner of the beneficial interest in the trust property. The person who puts property in trust is called the “grantor” (or the “settlor” or “trustor”) of the trust.
If you create a revocable trust, you will be the grantor. If you wish, you may also be the trustee for as long as you are able, and the beneficiary of the trust for as long as you are living. You may name one or more other beneficiaries after your death.
A “living” or “inter vivos” (Latin for “during life”) trust is a trust created by you during your lifetime, as opposed to a “testamentary” trust, which is provided for in your Last Will and Testament and is established at death. With a revocable trust, you reserve the right to revoke the trust and revest in yourself full title to the property of the trust estate. An irrevocable trust is a trust in which you have not retained the right to amend or revoke.
A “funded” revocable trust is one to which assets have been transferred. An “unfunded” trust is one which has been prepared and signed, but to which you have transferred only a nominal amount of assets. You may transfer additional assets to a trust at a later date, if the trust agreement so provides, or you may give someone else a power of attorney to transfer assets to the trust at the agent’s discretion or upon occurrence of a specified event, such as your disability. A trust having a life insurance policy as its only asset is a typical “unfunded” trust.
II. ADVANTAGES OF A REVOCABLE LIVING TRUST
The major advantages of a revocable living trust may be grouped into two categories: lifetime management of assets and probate administration at death. The points are discussed in reverse order:
A. Avoidance of Probate Administration
1. Assets held in a revocable trust at your death avoid the necessity of probate, even though the trust can provide for disposition of the assets after your death, as in a Will. Legal title to the trust property passes to the trustee on execution of the trust agreement or your subsequent transfer of property to the trust (or upon transfer by a person having a power of attorney to transfer your assets to the trust) so that trust properties are not owned by you at the time of your death and are not subject to the probate administration of your estate. By avoiding probate administration, the cost of clearing title to assets in the trust is reduced. Although the cost of probate administration in Texas is much less than the cost in some states, if you own real estate or mineral interests in other states, any assets you own in those other states would have to be administered through a probate process in those states, even if you are a resident of Texas at the time of your death. A revocable living trust may hold, and transfer, title to real estate and mineral interests located in those other states, thereby avoiding the necessity for probate.
2. Neither your testamentary plan as provided in the trust nor the value of the assets owned by you would be made a matter of public record, because administration of the revocable trust would not be part of a probate.
3. A revocable trust may help to avoid a will contest.
B. Management of Assets
As indicated above, you may serve as the trustee (either alone or with one or more other persons, for example a spouse) of a revocable trust which you establish. If so, you can retain full management and control over the assets in the trust, and also designate the persons who will assume management and control if you are unable to serve. Or you may designate another person as trustee initially, and give that person management responsibility.
A revocable trust offers the following advantages with respect to the management of assets:
1. A revocable living trust may serve as a management device if you desire assistance in property management and do not want the responsibility or burden of investment management. A durable power of attorney (one which survives the disability or incompetence of the person giving the power) might be used for a similar purpose, but a revocable trust is preferable. With a revocable trust, the trustee is the legal title holder, and the trust property is held in the name of the trustee. In Texas, a durable power of attorney terminates when a guardian is appointed. The guardian takes control over all the property, frustrating your original intention if the appointed guardian is someone other than the agent appointed under your power of attorney. With a revocable trust, the guardian has no power to revoke or otherwise control the trust.
2. A revocable living trust may serve as a substitute for guardianship of the estate in the event of your disability or incompetence. A court guardianship involves expenses, including an annual bond premium, cumbersome court procedures, and in some instances, undesirable and unnecessary publicity. The trust arrangement offers a preferable vehicle to manage your property. It avoids interruption of income for the beneficiaries of the trust. As explained above, a revocable trust arrangement is superior to a durable power of attorney arrangement because the revocable trust may not be frustrated if guardianship proceedings are instituted. If the trust is not completely funded when established, you may give another individual a power of attorney to transfer assets into the trust at any time, including upon your disability or incompetence.
3. In the case of a funded revocable living trust, you may view the trust in operation and make changes as experience and changed circumstances suggest. You are provided with an opportunity to train or supervise a selected trustee before your death or incompetence, and you may evaluate the trustee with respect to administration of the trust assets.
C. Vehicle for Life Insurance Proceeds and Other Death Benefits
The spendthrift provision in the revocable trust should protect the interest in any life insurance policy or other death benefits from creditors of the grantor’s estate after the grantor’s death. (Note that a revocable trust will give no asset protection during the grantor’s life. Only an irrevocable trust can give protection from creditors.)
Proceeds from life insurance on the life of the insured, even if payable to a revocable living trust, are includable in the grantor’s estate for federal estate tax purposes if the grantor owns any of the “incidents of ownership” of the policy at the time of death, including the right to designate the beneficiary of the policy. A transfer of life insurance to an irrevocable trust with an independent trustee can remove the proceeds from the estate.
III. DISADVANTAGES OF A REVOCABLE LIVING TRUST
A. Current Cost
While the trust may save future probate costs, it is at the expense of the present cost of preparing the trust and transferring the property to the trust. However, the cost of preparing the trust and “pour-over” wills will probably be comparable to the cost of wills containing testamentary trust provisions.
B. Managing the Trust
When property is transferred to a revocable trust, future transactions involving the property are handled by the trustee in his, her, or their capacity as trustee. However, signing as trustee rather than as an individual should be a very minimal inconvenience. A separate memo concerning the administration of a revocable trust is provided.
C. Potential Disadvantage of Avoiding Probate
Claims of creditors of an estate in probate are not payable unless properly presented. If the executor rejects a claim against the estate, the statute of limitations on the claim is shortened.
IV. TAX EFFECTS OF A REVOCABLE LIVING TRUST
A. Income Tax
1. Lifetime
If you establish a revocable trust, you will incur no income tax disadvantages. You will continue to be taxable on the income of the trust, as would be the case if the trust had not been created. If you serve as trustee or co-trustee of a revocable living trust, no separate income tax return for the trust is required to be filed. The trust income, deductions, and credits are reported directly on your individual income tax return. However, if you select someone other than yourself to be the trustee or co-trustee, IRS Form 1041, U.S. Fiduciary Income Tax Return, must be filed for the trust.
2. After Death
Upon a grantor’s death, the trust becomes irrevocable (with respect to assets placed in trust by the decedent) so that income tax savings may then become available to the beneficiaries of the trust. However, the use of a revocable living trust may reduce flexibility in post-mortem income tax planning, because the executor can not accumulate income in the estate and thereby affect income tax savings by having an additional taxpayer. Furthermore, losses between an estate and an estate beneficiary are allowable, but not between a trust and its beneficiaries (Internal Revenue Code section 267(b)(6). An estate’s personal income tax exemption is $600 while that of a trust is $100 or $300, the latter amount being applicable if income must be distributed annually (Internal Revenue Code section 642(b)). Trusts must adopt the calendar year as their taxable year, but no such requirement applies to estates. The throwback rules apply to trusts, but not to estates.
B. Estate Tax
There are no federal estate tax disadvantages in using a revocable living trust. Internal Revenue Code sections 2036(a)(1), 2036(a)(2), and 2038(a)(1) would make the assets of a revocable living trust includible in your gross estate upon your death, as would be the case without the trust. However, the trust may be structured to take full advantage of the credit against estate tax. The trust may also be structured so as to eliminate estate tax for property passing to your surviving spouse and to avoid a second death tax on the deaths of its primary beneficiaries (other than your surviving spouse).
The trust may provide your surviving spouse with a life income interest which qualifies for a “qualified terminable interest property” (QTIP) election. This election qualifies the trust property passing to your surviving spouse for the unlimited marital deduction from estate tax, so that no estate tax will be due for such transfer of property upon the settlor’s death. Such property is required to be included in the surviving spouse’s gross estate, subject to estate tax upon the death of the surviving spouse.
Beneficiaries of the trust other than your surviving spouse may be given a life income interest with a limited right to principal subject to an ascertainable standard, so that the principal would not be included in their gross estates for estate tax purposes and would pass to the next generation of beneficiaries free of estate tax. Such a transfer may be subject to the generation-skipping transfer tax rules.
In short, the estate tax planning techniques which are used in Wills may also be implemented through revocable trusts.
C. Gift Tax
Transfers to the revocable living trust during your lifetime are not subject to gift taxation.
V. TRANSFERRING ASSETS TO A REVOCABLE TRUST
The procedures for, as well as the difficulty and expense of, transferring different categories of assets to revocable trusts vary considerably. Therefore, you may wish to transfer some assets to your revocable trust immediately, but wait to transfer other assets at a later date. You may wish to place some assets in your revocable trust as you acquire them. There are some assets which you may prefer not to transfer to your revocable trust during your lifetime.
However, only those assets which you transfer into or which are acquired by a revocable trust during your lifetime are governed by the trust at your death and avoid probate. (If you have a “pour over” will, assets which have not been transferred at your death will be transferred to the trust as part of the probate administration process. However, these assets will be included on the probate inventory.)
The way to “transfer” an asset into a trust is to change the name in which an asset is held to the name of either the trust or the trustee of the trust. For example, if a tract of real estate is held in the name of an individual, the title to the land could be transferred to the trust by a deed signed by the individual, as grantor, conveying title to the trust, as grantee in the deed.
Procedures for transferring to the trust various types of assets (whether by initial or subsequent contribution) are discussed below.
Historically, the most common form of designation of trust ownership was to name the trustee in his capacity as such for the trust, usually indicating whether the trust was created by will or agreement and the date of the will or agreement. For example, real property could be conveyed to “John Doe and Jane Doe, Co-Trustees of the John Doe Family Trust created by agreement dated December 1, 2005”.
However, the Internal Revenue Service keeps its income tax records for trusts under the taxpayer identification number matched with the name assigned to the trust, for example, “The John Doe Revocable Trust”. (See the discussion of the necessity of obtaining a taxpayer identification number on page 6.) Probably for that reason, it is becoming increasingly more common to use the name of the trust to designate ownership. Both forms, as well as variations of those forms, are proper; however, certain institutions with which you deal may prefer (or require) the first style, while other institutions may prefer the second style. If a particular institution has no preference, use your preference.
A. Bank Accounts and Certificates of Deposits
Accounts in financial institutions may be transferred to your revocable trust by changing the name on the account. As discussed above, the new style of the account can be either:
(1) “The John Doe Family Trust”, or
(2) “John Doe and Jane Doe, Co-Trustees of the John Doe Family Trust Under Agreement Dated December 1, 2005.”
Some financial institutions will change the name on an existing account without closing the account, but some institutions may require that the account be closed and a new account be opened with the trust name.
If you transfer a certificate of deposit into the name of the trust at the same financial institution, there should be no penalty for early withdrawal, because there is no “withdrawal” of the funds from the institution. You should confirm with the financial institution that there will be no forfeiture of interest. If a particular institution will not allow the transfer without some loss of interest, you may want to wait until the CD matures to change the name, depending on the interest rates, maturity date, and penalty for early withdrawal.
Transfer of bank accounts to a revocable trust may affect deposit insurance coverage, particularly if you have more than $100,000 in the same institution.
If your personal checking accounts are transferred to the trust, it will be necessary to have new checks printed. Following are several alternatives for the upper left-hand corner of the checks, all of which are proper:
(1) JOHN DOE FAMILY TRUST
[address]
(2) JOHN DOE AND JANE DOE, CO-TRUSTEES
of the JOHN DOE FAMILY TRUST
[address]
(3) JOHN DOE AND JANE DOE, CO-TRUSTEES
[address]
(4) JOHN DOE FAMILY TRUST
JOHN DOE AND JANE DOE, CO-TRUSTEES
[address]
The signature line of the checks could be printed as either:
(1) JOHN DOE FAMILY TRUST
By: or
(2) JOHN DOE FAMILY TRUST
John Doe, Trustee
B. Tangible Personal Property
The category of tangible personal property includes most property other than bank accounts, real estate, stocks, bonds, life insurance and partnership interests. Automobiles, furniture, furnishings, works of art, sports, business or other equipment, silver, jewelry, and other similar items are considered tangible personal property.
Transfer of tangible personal property is accomplished by a written assignment to the trustee executed by the transferor. Property of significant value should be specifically described on the assignment. If any property is subject to a lien, the security agreement should be reviewed to determine whether the lender must consent to the transfer. You should consult with your insurance agent to determine whether any changes in your casualty insurance coverage are necessary. It is advisable to obtain written confirmation from your agent that the company is aware of your transfer of ownership of any assets to your trust.
If you hold title to automobiles or other motor vehicles, boats, or airplanes in the trust, the trust would be named in a lawsuit if such asset were involved in an accident. Although the assets in a revocable trust are subject to debts of and judgments against the creator(s) of the trust, if the trust were to become irrevocable, for example by the death or incapacitation of the grantor(s) prior to, or possibly even at the time of such an accident, the assets of the trust may not be subject to the personal debts of and judgments against the creator(s) of the trust.
If you want to transfer to the trust property requiring title registration, such as motor vehicles, all of the statutory procedures for transferring title must be followed. Section 501.021.K.23 of the Texas Transportation Code, reported in the Texas Vehicle Title Manual, requires that either the Trust Agreement or a Statement of Fact must be supplied for transfer of title to a named trust (unless the name includes “Living Trust”), but not for transfer to the name of the trustee(s) without reference to the name of the trust.
C. Real Estate and Minerals
Real estate, including any mineral interests, may be transferred to the trust by deed to “John Doe and Jane Doe, Co-Trustees of the John Doe Family Trust Under Trust Agreement Dated December 1, 2005. After deeds have been executed and acknowledgements completed by a notary public, each deed can be filed in the Deed Records of the county in which the real estate is located. The risk of holding a deed, but not recording it until a later date is that you may lose the deed.
If the real estate to be transferred is subject to a mortgage, the mortgage should be carefully reviewed to ascertain whether it requires consent from the lender to avoid the effects of a “due on transfer” clause.
With respect to the personal residence of the grantor(s), if the home continues to be occupied by the grantor(s) after assignment to the trust, the assignment should not affect the homestead exemption for property tax purposes.
There is no Texas case of which I am aware which considers whether property transferred to a revocable trust retains homestead protection with respect to creditors.
D. Stocks, Bonds and Mutual Funds
Stocks and bonds in publicly-held companies may be transferred either by transferring the securities through the company’s transfer agent, or, if the stock and bonds are held in a brokerage account, by changing the name on the account. The name on the securities, brokerage account, or mutual fund would be either “John Doe Family Trust” Or “John Doe and Jane Doe, Co-Trustees of the John Doe Family Trust Under Trust Agreement Dated December 1, 2005.”
Stock in closely-held corporations, if not subject to a buy-sell agreement, may be transferred into the trust merely by properly completing the stock transfer provisions on the back of the stock certificate or a stock power. The corporation should then issue a new stock certificate for the shares in the name of the trust. If a buy-sell agreement concerning the stock is in effect, then the provisions of such agreement must be met.
E. Life Insurance, Annuities and Retirement Benefits
It is not necessary to transfer ownership of insurance policies owned individually to the revocable trust in order to accomplish the intended purpose. However, the primary beneficiary on insurance policies can be changed to “The Trustee or Successor Trustee Under The John Doe Family Trust Under Trust Agreement Dated December 1, 2005”.
A change of beneficiary form should be obtained from each insurer and completed with respect to each policy under which you wish to name the trust as beneficiary. Some insurance companies may require inclusion of additional language in the beneficiary designation.
Generally, distributions from IRA’s, qualified plans and section 403(b) tax-sheltered annuities are taxable for income tax purposes. Transfers of ownership of those accounts to the trust, or naming the trust as beneficiary of the funds after your death, could give rise to income tax. However, a surviving spouse, if named as beneficiary, can create a rollover IRA and rollover such funds without current income tax consequences. A qualifying trust can be named as contingent beneficiary after designated relatives.
F. Partnership Interests
Transfer of interests in general and limited partnerships will be governed by the applicable state law and the written partnership agreement.
In Texas, unless a particular partnership agreement provides otherwise, an assignee of an interest in a general partnership cannot become a “member” with full rights as a partner “without the consent of all the partners”. Some partnership agreements allow a majority, or super-majority (e.g. 2/3) of the partners, rather than requiring unanimity, to admit a new partner, or “member”. Some specifically allow revocable trusts created by a partner to become members.
The Texas Revised Limited Partnership Act (the “TRLPA”), which controls all limited partnerships after August 31, 1992, eliminates the concept of the “substituted limited partner”. Section 7.04 of the TRLPA provides that an assignee of a partnership interest “may become a limited partner if and to the extent that: (1) the partnership agreement provides; or (2) all partners consent.
If a partnership is not a Texas partnership, then an attorney in the applicable state should be consulted.
VI. ADMINISTRATION
A. Buying, Selling and Other Transactions
After property has been transferred to the trustee of the revocable trust, future transactions involving the property must be taken by the trustee in his capacity as trustee, rather than in his individual capacity. Deeds, stock transfers, and other similar documents would be signed by “John Doe, Trustee” rather than by “John Doe”, individually.
B. Income Tax Matters
1. Form 1041, Fiduciary Income Tax Return
As long as either or both of the grantors are the trustees of the revocable trust, it will not be necessary to file a separate Form 1041 with the Internal Revenue Service. All income, deductions, and credits, of the trust will be reported on the grantors’ individual income tax return, Form 1040. Treasury Reg. Sec. 1.671-4(b).
When a grantor is not serving as trustee, a Form 1041 will be required with respect to the revocable trust.
After the death of the grantors, a separate 1041 will be required for each of the trusts provided for in the revocable trust agreement.
2. Taxpayer Identification Numbers
There is no need to obtain a separate taxpayer identification number for the revocable trust as long as a grantor of the trust is serving as trustee. Instead, the grantor must furnish his or her social security number to payers of income, and payers must report income as if paid to the grantor, not to the trust. See Treasury Reg. Sec. 1.671-4(b).
If the trustee is not the grantor, however, then the trustee must obtain a separate taxpayer identification number for the trust by filing IRS Form SS-4 with the Internal Revenue Service.