You may have heard it is a good idea to create a trust for you and your family but you may first need to learn about what is a trust and whether you actually need one. The answer on whether you really need a trust will depend on what your goals are, the dynamics of your family and the value of your estate.
What Do Most Estate Plans Consist of?
Most estate plans consist of a will, medical power of attorney, health directive, and general power of attorney. Whether somebody wants a trust included as part of their estate plan is usually determined on a case by case basis.
A Will names somebody to act as personal representative of your estate, and allow the personal representative to transfer any assets into a trust, pay creditors, liquidate assets and provide distributions to beneficiaries. A will may also include the disposition instructions that state what somebody would like to happen to their remains after they pass away.
A Power of Attorney is to name somebody to manage your finances if they are ever incapacitated.
A Power of Attorney for Health Care nominates a person to manage your health care if you are unable to do so yourself.
An Advance Health Care Directive includes what types of health care you would like if you are ever incapacitated or in a terminal condition. For example should there be a do no resuscitate provision (“DNR”).
What is a Trust?
There are several types of trusts, but the most common are a living trust, created during a persons lifetime which is commonly referred to as a revocable trust and irrevocable trusts, in which assets may not be removed from the trust after it is created.
A trust allows for an individual’s property to avoid probate, and directs their assets in the trust to go where they would like them to go upon passing away. It also appoints a trustee to oversee management and distribution of these assets as well as names any beneficiaries.
Upon trust creation, individuals may name themselves as both the trustee (revocable trust only) and beneficiary and then name successor a trustee and beneficiaries upon passing away.
Why Create a Trust?
In Washington, any individual who passes away owning more than $100,000 worth of assets, including real estate, must go through the probate process through the superior court. This is a legal process in which creditors of a person’s estate will be paid, and distribution of assets will be handled by a personal representative named in a persons will or an administrator appointed by the court.
If property is placed in a trust prior to a person passing away, that asset does not have to go through the probate process and may pass to any beneficiaries per the terms of the trust immediately.
A trust is also a private document and does not have to be filed with the court like a will. Therefore, if a family wishes to keep their affairs private, they can direct any assets go into a trust upon passing and have the trust direct how to dispose of the assets at the direction of a named trustee per the terms of the trust.
What is the Difference Between a Revocable and Non-Revocable Trust?
A revocable trust may be revoked at any time if a person changes their mind on how they want their estate to be handled, for instance changing beneficiaries, trustee’s or removing assets from a trust. In comparison, a non-revocable trust may not be modified after it is created.
A revocable trust for most people provides the flexibility, privacy and probate avoidance that is sought, but it does not protect against creditors of a person while alive as the trust assets may be revoked from the trust at any time and assets of an irrevocable trust may still be subject to both state and federal estate taxes.
Compare this to an irrevocable trust in which the terms and assets named in the trust are set in stone the minute the agreement is signed. Irrevocable trusts remove the assets from the benefactor’s taxable estate, meaning they are not subject to estate tax upon death, and they also relieve the benefactor of tax responsibility for any income generated by the assets. In order to create an irrevocable trust a third-party trustee would need to be named to manage the trust on behalf of the beneficiaries.
What is a Testamentary Trust?
A testamentary trust is created by a will, which begins its existence upon the death of the person making the will, when property is transferred from the decedent’s estate. A testamentary trust is irrevocable by definition, as it comes into being at the death of the grantor.
These types of trusts are good if you have minor children and want to makes sure a trust is created for their benefit if something were to happen to you.
What do I Need to do With My Assets if I create a Trust?
If a trust is created, then you will need to transfer assets into the trust in order for the trust to be affective. For example, if you own real estate, you will need to transfer the real estate from an individual’s personal or business name into the trust name and record the document with the county recorders office where the real estate is located.
It is typical in real estate transactions that a Quit Claim Deed be drafted which transfers the clients’ interest in their real property to their trust, so it will avoid going through probate. Excise affidavits must also be filed with the county assessor’s office so that no tax will be assessed on the transaction if there is no money involved and the property is not being sold.
What if I Only Have Real Estate that I don’t want to go through Probate?
If an individual only has real estate that they want to keep out of probate upon their passing away, they may want to consider drafting a transfer on death deed and recording it with the county. This document may be revoked at any time and would keep the real estate out of probate upon passing away and avoids the cost and hassle of setting up a trust.
Designating a beneficiary is not an immediate transfer, so no federal gift tax is owed. The beneficiary acquires ownership on the current owner’s date of death. If the beneficiary later sells the property, any capital gain will be based upon the value of the property at the original owner’s date of death, not the value when the original owner acquired the property.
Does My Trust Need to File a Tax Return?
Trusts must file a Form 1041, U.S. Income Tax Return for Estates and Trusts, for each taxable year where the trust has $600 in income or the trust has a non-resident alien as a beneficiary. However, if the trust is classified as a grantor trust, it is not required to file a Form 1041, provided that the individual grantor reports all items of income and allowable expenses on his own Form 1040 or 1040-SR, U.S. Individual Income Tax Return. Thus, the grantor/individual would pay the total tax liability upon the filing of his return for that taxable year.
Although all revocable living trusts are considered grantor trusts during the lifetime of the grantor, most irrevocable trusts are not. In most cases, the grantor of an irrevocable trust does not report the trust’s income on their own tax return because they have irrevocably given up ownership and control of the assets funded into the trust. They no longer own them—the trust does. Grantors of irrevocable trusts cannot act as trustees of their own trusts. They must hand over the reins of operation to someone else.
What is the Current Estate Tax Rate?
In Washington State if a person passes away in 2020 with less than $2,193,000 in assets, the estate would not be subject to an estate tax. If a person’s assets exceed that number the estate can be taxed between 10-20% by the state. The current federal estate tax rates for 2020 start out at $11.58M or $23.16M for a married couple.
The $23.16 million number per couple isn’t automatic. An unlimited marital deduction allows you to leave all or part of your assets to your surviving spouse free of federal estate tax. But to use your late spouse’s unused exemption—a move called “portability”—you must elect it on the estate tax return of the first spouse to die, even when no tax is due. The problem is if you don’t know what portability is and how to elect it, you could be hit with a surprise federal estate tax bill