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LIVING TRUST OUTLINE

copyright © 1996-2009 Peter Bassing


Prepared by Peter J. Bassing
Attorney at Law

(Member, California Bar--State Bar No. 63315)
Note: The following discussion is in some instances specific to California law.


WHAT IS A LIVING TRUST?

"LIVING TRUST" is the popular term applied to a Revocable Inter Vivos Trust. This is a way by which property (the trust estate) is held by one person (the trustee) for the benefit of another person (the beneficiary). The person who creates the trust and contributes the trust estate is known as the settlor or the trustor. One person, or a couple, might occupy more than one, or all, of these roles, as settlor, trustee and beneficiary. Usually, the settlor or settlors are in fact the initial trustees.

The trust is created by a written Declaration of Trust which spells out all of the terms of the trust and the distribution of the trust estate and its income, both during the lifetime(s) of the settlor(s)/beneficiaries(s) and after death.

The living trust is revocable. This means that the person or couple who created it can change or undo it. Many trust declarations provide, however, that upon the death of the first spouse, portions of the trust become irrevocable.

A Living Trust may provide some or all of the following advantages:

  1. Avoidance of Probate

  2. Flexibility in the distribution of an estate (Compare to Joint Tenancy)

  3. Avoidance of a Conservatorship

  4. Avoidance of some post-death income taxes

  5. Estate tax savings for married couples

  6. Privacy

PROBATE

Probate is the legal proceeding by which a person's assets are distributed after death. Assets which have been held in a Living Trust do not have to go through Probate since the decedent transferred them to the trust while alive and, upon his or her death, has no estate to probate. Much has been written about the disadvantages of Probate, including the following:

  1. Delay: It is almost impossible to complete the probate of an estate in less than 6 months, and it may take years.

  2. Expense: Unless they agree to take less, the executor and the attorney are each entitled to a fee set by law and calculated from the size of the estate (without reduction for mortgages or other debts). For example, for a $100,000 estate, the executor's and attorney's fee would each be $3,150, for a total of $6,300. For a $1,000,000 estate, they would each be $21,150, for a total of $42,300.

  3. "Red Tape": Court approval and extensive notice requirements are still required in many situations. For example, some sales of real estate require court approval and an auction.

  4. Possible Duplication: If the decedent owned real estate in more than one state, a probate proceeding (with its own local attorney) may be required in each state.

  5. Loss of Privacy: Anyone may view the Court's probate file, which will normally contain the name, address (and sometimes age) of each relative and heir, and a description of all property in the estate and its disposition.

In a few situations there are advantages of probate. The probate proceeding requires creditors to file their claims within a period of months, rather than simply within the longer statute of limitations. If claims appear likely, a Living Trust can be put through probate to gain this advantage.

Even without a trust, a probate is not always required. In the case of a married couple, on the death of the first spouse a simpler court proceeding (a spousal property petition) may be available if that spouse's property passes outright to the survivor. However, if the estate tax savings device of a bypass trust is used (see below), probate of a will would usually be necessary.

JOINT TENANCY

Joint Tenancy should not be confused with "tenancy in common" or "community property." When property is in Joint Tenancy, there is a right of survivorship. This means that on the death of one joint tenant, his or her interest automatically goes to the other joint tenant or tenants, no matter what the decedent's Will says. Joint tenancy has some advantages: a. Joint tenancy is not very flexible: the interests of all joint tenants must be equal and they are distributed immediately and automatically upon the death of a joint tenant.

But there are serious disadvantages:

  1. Joint tenancy is not very flexible: the interests of all joint tenants must be equal and they are distributed immediately and automatically upon the death of a joint tenant.

  2. It might not give the advantage of stepped-up basis (see below) which the community property form of ownership gives a married couple.

  3. Property in joint tenancy can be reached by the creditors of each joint tenant. For example, if you hold property in joint tenancy with your children so that they will get the property on your death, an under-insured automobile accident in which they are involved could jeopardize the asset during your lifetime.

For married couples it is now possible to hold property as "community property with right of survivorship", thereby overcoming the problem regarding stepped up basis on the death of the first spouse, although not avoiding the inflexibility problems inherent in a right of survivorship.

POSSIBLE INCOME TAX SAVINGS

As mentioned above, one of the disadvantages to holding property in joint tenancy is possible inability to take advantage of the "stepped-up basis" advantage. When a person dies, the income tax basis of his property is "stepped-up" to its current value. If the property is sold before further increase in value there will be no income tax payable because the sales price is equal to its basis.

If a married couple holds property as joint tenants or tenants in common, it is not certain that the IRS would consider it to be community property, and only the decedent's half might receive the stepped-up basis. The survivor's half would keep the old basis and on any subsequent sale there could be a taxable capital gain. Although the other advantages of a trust would not be obtained, a married couple should ordinarily hold community property as "community property with right of survivorship" (under Civil Code Section 682.1) rather than as joint tenants.

For Example: Husband and wife purchased an apartment building years ago for $200,000. They took title as joint tenants to avoid probate when either died. They have taken a total of $50,000 in depreciation. Their basis is, therefore, $150,000. If they were to sell the building for $350,000 they would have a taxable gain of $200,000 and might pay about $55,000 in federal and state income taxes.

If Husband dies before they sell the building, the basis of his one-half which passes to wife by joint tenancy right of survivorship is increased to current value, or $175,000. The IRS might take the position that the wife's half was her separate property, and its basis of would remain at $75,000. If Wife sells the building for its $350,000 value, she will have a taxable gain of $100,000 and might pay federal and state income taxes of about $28,000.

But if the couple had held the property as community property instead of as joint tenants, the law provides that BOTH halves of the property receive a stepped up basis on the death of either spouse. The decision of the couple in the example to avoid probate by use of joint tenancy rather than with a Living Trust might cost Wife about $28,000 in avoidable income taxes.

ESTATE TAX SAVINGS FOR SOME MARRIED COUPLES

In California there is no state death tax. The Federal death tax is called the estate tax.

The federal estate tax is based on the net value of the estate of the decedent. In most cases, for persons dying after January 1, 2004, the first $1,500,000 of the estate was tax free. Under legislation passed in mid-2001 (the "Tax Relief Reconciliation Act of 2001") this amount, called the "Unified Credit Equivalent", increased to $3,500,000 in 2009. Unless there is a change in the law, the Estate Tax will be repealed for the year 2010. It will be automatically reinstated, in 2011, at 2001 levels. Also, assets passing from one spouse to the other are exempt from the tax. Non-exempt assets are taxed at rates varying from 37% to 45%.

Because of the complete exemption for property left outright to a spouse, the estate tax may not seem to be an immediate concern for married couples thinking only about the death of the first of them to die, no matter how large the estate. However, a transfer of all of the property of the first spouse to die to the surviving spouse may have the effect of increasing the estate of the surviving spouse to the point that on his or her death the estate will exceed the present $3,500,000 Unified Credit Equivalent and estate tax would be due.

A Living Trust declaration may provide that on the death of the first spouse to die the trust is split into two (or sometimes three) trusts. One of these trusts (sometimes called the "survivor's trust" or the "A" trust), remains revocable by the surviving spouse who typically is given the right to all principal and income on demand. The other trust (sometimes called the "bypass" trust, the "exemption" trust, or the "B" trust) usually contains enough property to take maximum advantage of the Unified Credit Equivalent without producing any estate tax. It becomes irrevocable on the death of the first spouse to die, but by its typical terms, the surviving spouse is entitled to receive its income and, to the extent necessary to maintain his or her standard of living, its principal. On the surviving spouse's death, the balance of the trust will be distributed, either immediately or over time, to beneficiaries the couple have selected.

The bypass trust does not become part of the surviving spouse's estate and does not increase that estate for tax purposes. On the death of the surviving spouse, his or her estate is entitled to its own "exemption", reducing, or possibly avoiding estate tax liability.

While the use of a bypass trust to save estate taxes is common in Living Trusts, it may also be done by Will. It cannot be accomplished by holding property in joint tenancy, though. Of course if a Will rather than a Living Trust is employed, probate will be necessary.

FLEXIBILITY OF DISTRIBUTION

Both Living Trusts and Wills provide substantial flexibility in disposing of property. If property is held in joint tenancy, upon the death of any joint tenant his interest in the property immediately passes to the other joint tenant or tenants. With a Living Trust, property need not pass immediately. It can be held, for example, to benefit a number of beneficiaries according to particular written standards or in the discretion of a trustee. While legally "adults" at age 18, many children are not mature enough to wisely use a lump sum.

A Living Trust can be made the beneficiary of life insurance policies so that the death benefits can be similarly invested, managed and distributed, rather than paid out in a lump sum which may or may not be used for the purposes the decedent had in mind.

AVOIDING CONSERVATORSHIP

A Living Trust, particularly when coupled with a general durable power of attorney for financial management and personal affairs, can provide property management for a person who might someday be unable to manage his or her own assets due to advanced age or illness.

A Conservatorship proceeding in court will involve added expense and, often, embarrassment and psychological debilitation to both the Conservatee and the person petitioning for the Conservatorship. Also, many transactions undertaken by a Conservator, including most sales of property, require Court approval. An alternate trustee, or co-trustee under a Living Trust, can manage financial matters without the necessity of a Conservatorship. Since the trust is revocable, a settlor who disputes his or her incapacity will not have given up any control.

ENHANCING PRIVACY

As is discussed in the sections about Probate and the avoidance of Conservatorships, both involve court proceedings. The court's file is available for inspection and copying by anyone visiting the county clerk's office. Names and addresses (and sometimes ages) of beneficiaries will be made known.

In contrast, the provisions of a Living Trust are not normally matters of public record. Neither the extent and disposition of assets nor the names and addresses of beneficiaries need become generally known.

DISADVANTAGES OF A LIVING TRUST, or "NO FREE LUNCH"

While for many people they will be outweighed by the benefits, a Living Trust has disadvantages and limitations:

  1. Initial Paperwork: A Living Trust often involves somewhat more paperwork than some of the alternatives discussed in this outline, and much more than others. Because of this, attorney's fees in preparing the estate planning documents are typically higher.

  2. Need to Transfer Assets: As to many of the things a Living Trust is designed to do, it simply "won't work" unless assets are transferred to it. For example, real property deeds must be signed, acknowledged ("notarized") and recorded with the County Recorder. This is usually quite simple, but not as simple as doing nothing. As assets are acquired or transferred, title must be taken and given by you as trustee(s).

  3. Borrowing Against Property: While a Living Trust is a perfectly legal way to hold property, some commercial lenders use pre-printed forms and train personnel to deal only with typical situations. When you want to refinance property held in the trust, it is sometimes easier to "switch than fight"; to transfer the property out of the trust, borrow the money, and transfer the property back into the trust. The transfer back into the trust cannot, by law, be considered by the lender a sale on which it can "call" the loan.

  4. No Protection Against Creditors: It should be understood that putting your property into a Living Trust will not put it out of reach of the claims of your creditors. Neither will a Will or joint tenancy. The law provides certain exemptions from the claims of creditors --the "homestead" exemption, for example. Putting your property into a living trust does not deprive you of any of those exemptions.

  5. Extra Accounting: If a married couple have "A-B trust" provisions in their Living Trust declaration (see Possible Estate Tax Savings), after the death of the first spouse to die, the surviving spouse must keep separate records for the "B" trust, and have a separate tax return filed for it. For simple estates, this is likely to mean additional expense of a few hundred dollars per year. Of course, if the same estate tax saving devices were accomplished by a will, the same record keeping and tax requirements would arise.

COMMON QUESTIONS ABOUT LIVING TRUSTS, AND THEIR ANSWERS

Question: How will a living trust affect our income tax liability while we are alive?

Answer: If, as is usual, you are the beneficiaries of the trust you create, there will be no income tax effect at all. You will continue to file your form 1040; all income, deductions, etc. of the trust will, properly, be shown as yours.

Question. What happens to the income tax basis of property when it is transferred to the Living Trust?

Answer: Nothing. On transfer to the trust the basis is unaffected.

Question: Does it make sense for an unmarried person to set up a living trust?

Answer: While one benefit of a Living Trust, possible estate tax savings by use of an "A-B" trust arrangement, is not available to a single person--through a trust or otherwise--other benefits of a Living Trust, like the ability to avoid conservatorship , might be even more important to a single person. Since the relatively simple procedure of a spousal property petition, discussed above is unavailable on the death of an unmarried person, probate avoidance may be an equal or greater consideration for him or her.

Question: What happens on the death of a person who has set up a Living trust?

Answer: The successor trustee should take steps to remove the decedent's name from accounts, etc. and substitute his or hers, as Trustee. This is usually not very complicated and typically involves about as much paperwork as if the property had been held in joint tenancy. In some cases, following the first to die of a married couple, the surviving spouse must make a decision whether or not to "disclaim" all or a portion of the decedent's estate, a decision which should be made before property is "re-arranged" and within a few months following the death. If the estate of the deceased exceeds the "Unified Credit Equivalent", a Federal Estate Tax return must be filed within 9 months after the death. Under legislation passed in mid-2001 (the "Tax Relief Reconciliation Act of 2001") the "Unified Credit Equivalent" for the years 2007 and 2008 was $2,000,000 and increased to $3,500,000 in 2009. Unless there is a change in the law,  which is likely, the Estate Tax will be repealed for the year 2010. It will be automatically reinstated, in 2011, at 2001 levels ($1,000 Unifed Credit Equivalent). While any given estate will almost always require less "lawyering" if a trust has been properly employed than if a will has to be probated, there is no guaranty that lawyers (and accountants) can be completely avoided following the death.

Question: Will transfer of real estate to a Living Trust increase property taxes?

Answer: No. The law implementing Proposition 13 specifically exempts from the definition of "change of ownership" transfers to a trust of which the transferors of the property are the beneficiaries.

Question: Should IRAs, 401's or Keogh plans be transferred into a Living Trust?

Answer: No. Under Federal law, such transfer might be considered a premature distribution on which not only income tax but a 10% penalty might have to be paid. Conceptually, such plans are already held in a specialized form of "living trust."

Question: If I/we once set up a Living Trust, can the trustees or beneficiaries be changed?

Answer: Yes. During your lifetime (or the joint lifetimes of married couples), the trust can be freely amended in that or any other respect.

FEES AND SERVICES

Note: These fees and services are offered for the great majority of "typical" estates. Of course, for particularly complicated matters, fees may be higher but if a fee different from those shown here would be charged, you will be advised BEFORE you incur any commitment to pay fees at all.

The basic fees charged for "packages" containing the documents listed below are. indicated on a separate Estate Planning Fee Schedule.  These fees include an initial consultation with Peter Bassing and the preparation of papers listed below. Of these amounts, $500 must be paid at the end of the consultation if you want to proceed; if you choose not to proceed, the consultation is free. The balance is payable when the documents are completed or 60 days after drafts are provided, whichever is earlier.

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Documents Provided:
  • Declaration of Revocable Inter-Vivos Trust

  • "Pour Over" Will. This is a Will which provides that any property which is not held in joint tenancy and which has not been transferred into the trust during your life will be transferred to it. It is a "backup" measure.

  • Durable Power of Attorney for Financial Management and Personal Affairs. A power of attorney that give another person (often the alternate trustee) the power, among others, to transfer assets to the trust which you neglected to, in case you are incapacitated, mentally or physically.

  • Advance Health Care Directive (formerly generally known as a Durable Power of Attorney for Health Care). This allows another person to make decisions about medical treatment in case you are not in a condition to make them yourself.

  • Quitclaim Deed. This will transfer one piece of real property (often your residence) to the trust. We will take care of recording. You will be charged $60 each for additional deeds.

  • Certification of Trust. A "summary" of certain trust provisions you can conveniently provide to third parties.

PLEASE NOTE: LIMITATION ON FUTURE REPRESENTATION. The advice Peter Bassing will furnish is based on present applicable laws. If these laws change, it is imperative that the estate plan be reviewed and (if necessary) changed. Changes in the law may not affect all clients, or all clients in the same way, and as a practical matter it would be difficult or impossible for Peter Bassing to undertake to keep all clients updated about changes in the law. For this reason, Peter Bassing does NOT undertake the responsibility of advising you of future changes. Should it come to your attention through the news media or other sources that there has been a change in the tax (or other) law relating to estate planning, you are urged to contact Peter Bassing, or another professional advisor, for an appointment.

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