I. Background Information
A revocable living trust is a non-probate asset. The grantor of a revocable living trust retains the power to revoke and amend the terms of the trust. The grantor is typically the trust’s initial trustee or co-trustee as well as its lifetime beneficiary. Upon the grantor’s death, the living trust becomes irrevocable and either 1) continues as a trust for the benefit of successor beneficiaries; 2) is split into separate trusts; or 3) terminates and distributes trust assets to the named beneficiaries1.
II. Advantages of a Revocable Living Trust
There are numerous advantages of a revocable living trust. Such advantages include reduction of probate costs, avoiding publicity associated with probate proceedings, some protection against potential will contests, expedited distribution of assets, flexibility, and property management.
Those involved with the creation of a revocable living trust have the luxury of being able to confer with the grantor regarding various details of the assets that will be funding the revocable living trust. Such is not the case with a testamentary trust, which is created upon the death of the grantor. The grantor usually knows more than anyone else regarding the location of the records and details of the property being transferred. Thus, since the grantor is alive when the trust is funded, the grantor can assist with the title transfers and other administrative matters.
A. Reduction of Probate Costs
Property in a revocable living trust that continues after the grantor’s death is not part of the grantor’s probate estate2. This generally results in a reduction in probate court filing fees, executor’s commissions, legal fees and delays associated with probate administration.
Despite the benefits of “avoiding probate”, there are protections and some benefits offered by the probate administration process. An executor is protected by court approval of his decisions, making him less vulnerable to lawsuits by the estate’s creditors or beneficiaries. Because probate court approval is required (for example, the filing of an accounting) it is more difficult for the executor to defeat a testator’s intent. The probate process can guard against an executor’s ability to illegally remove assets from the probate estate, make mistakes borne of inexperience or otherwise cause harm to the estate.
B. Avoid Publicity/Privacy
Unlike a Will, and the related filings, i.e., inventory, accounting, which become part of the public record, the assets of a living revocable trust can be administered and disposed of in privacy after the grantor’s death.
C. Potential Will Contests
If a Will contest is anticipated, a living trust can be created without informing the future beneficiaries. If the existence of the trust were to be uncovered during the grantor’s lifetime, beneficiaries whose interest in trust assets will vest in the future may be unable to initiate lawsuits due to a lack of standing.
After the grantor’s death, individuals who might want to challenge the trust may never be aware of its existence. It is also more difficult to obtain information about the trust assets.
D. Facilitating the Distribution of Assets
Revocable living trusts generally allow the grantor’s assets to be distributed more expeditiously to beneficiaries than in a typical probate situation.
Further, non-probate planning (such as the creation of a revocable living trust) is generally a good idea if one owns real estate in several jurisdictions. Typically, this will avoid ancillary probate administrations in other states, which can be expensive and time consuming. However, one must be careful to ensure that the trust is valid and will be recognized in every state in which the real property is located.
E. Flexibility
In comparison to an irrevocable trust, a revocable trust offers considerable flexibility; i.e., an irrevocable trust may cause problems where family, economic, or other circumstances change unexpectedly. The revocable trust can be amended or even revoked, generally, at any time prior to grantor’s death or incapacity.
F. Managing Property
1. Living revocable trust arrangements can be attractive by providing the grantor with professional management of his/her property. This may be beneficial to those people who are either inexperienced in managing investments or who are too busy to devote time to managing their financial affairs.
2. Individuals also choose living revocable trusts as a means of planning for their own potential incapacity. Often, a competent grantor will serve as trustee of a trust, which is initially either fully or partially funded. A revocable trust’s terms may provide that, in the event of the grantor’s incapacity, a successor trustee (individual or corporate) will take over trust management on behalf of the grantor. Usually, the certification of one to two or more licensed physicians is required to determine incapacity. If the revocable living trust is only partially funded at first, the grantor should grant any successor trustee a durable power of attorney so that the grantor’s assets can be transferred to the trust when or if incapacity occurs.
The above strategy, a funded revocable living trust or a durable power of attorney, enables one to avoid the potential need for a court-supervised guardianship which is expensive and time-consuming. Further, the trustee can manage the trust’s assets free of court involvement3.
III. Post Mortem Tax Planning Considerations
The income from a revocable living trust is generally taxable to the grantor on his/her individual income tax return. The grantor trust rules of IRC Section 671 apply and thus the income of a revocable trust during the grantor’s lifetime is taxable directly to the grantor (even if paid to a beneficiary other than the grantor). Generally during the grantor’s lifetime, all transfers to others from the trust are considered gifts made by the grantor (assuming that they would have been gifts if made directly by the grantor).
At the grantor’s death, however, all assets of a revocable trust are included in the grantor’s gross estate for estate tax purposes4. Subsequent to a grantor’s death, the trust will be subject to income tax as a trust, not as an estate.
1 NOTE: A revocable trust is usually accompanied by a pour-over will, which generally leaves all or the remaining property in the deceased grantor’s name to the trust.
2 NOTE: Such property may still be included in the Grantor’s estate for estate tax purposes.
3 We have already indicated that there can, at times, be benefits to court involvement.
4 Your attention is called to recent estate tax changes in the Tax Relief Reconciliation Act of 2001.