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Estate Planning and Taxes

Living Trusts and Taxes

You, Your Trust and Taxes

We talk a lot about Living Trusts as an important part of estate planning. What we don’t talk about is a Trust and your taxes. But if you’re creating a Trust, thinking about transferring property, or naming a Successor Trustee, taxes are an important consideration. This is about your, your Trust and your taxes.

A Living Trust is typically a Revocable Trust, meaning that the person who’s creating it, the Grantor, may add or remove the Trust’s assets and beneficiaries at any time. The Grantor may even terminate or revoke the Trust at any time. Many people want to know about the tax implications of a Trust before they move forward with creating one.

 The Trust is in the Grantor’s name and will be recorded in his taxes

Because the Trust is in the Grantor’s name, he remains entitled to receive the income and the principal of the Trust during his lifetime. As a result, the IRS still taxes the Grantor on the Trust’s income. Because this is still in the Grantor’s name, it uses his social security number to establish investments and bank accounts, so all of the Trust’s income is recorded on the Grantor’s tax return. It is not necessary to have a separate tax return for the Trust because everything is still in one person’s name—the Grantor’s.

 Having a Trust means your heirs will avoid Probate

However, while the Grantor is taxed on the Trust income, the Trust’s assets are legally held by the Trust, which will survive the Grantor’s death. For this reason, the assets in the Trust do not need to go through the Probate process when the Grantor dies. This is one of the reasons we encourage everyone to create a Living Trust. You will be sparing your heirs the expense and the time-consuming process of going through Probate.

Special circumstances during Grantor’s life

If the Grantor becomes mentally incapacitated, the Successor Trustee designated in the Trust documents may choose to obtain a separate tax ID number for the Trust. This number is called a “Federal Tax ID Number”, an “Employer Identification Number”, or an “EIN”.

A Successor Trust may choose to obtain an EIN for the Trust in order to limit his own liability for the Trust’s income tax or to help fulfill his fiduciary duties. If the Trust is using an EIN, a separate tax return for the Trust will be required for each year. The Trust’s taxes will be filed on Form 1041 and would be filed by the same date as personal taxes. If it’s a simple estate, this may not be necessary. But even in straightforward situations, it often takes a year or more to settle the estate. There are cases where the Grantor is not incapacitated and still may choose to establish an EIN for the Trust.

If the Grantor has complex personal taxes and would prefer not to report the income and losses of the Trust on his own tax return. He would still pay taxes on the income of the Trust but he would be paying those taxes under the Trusts EIN number.

Living Trust tax after Grantor’s death

After the Grantor’s death, the Trust remains in place and continues to hold legal ownership of all the Trust’s assets. If you’re the Successor Trustee, the Trust holds all of the assets that you inherit and you will be responsible for dividing among your family members, as per the Trust. The tax implications impact the outcome of both the Grantor and the beneficiaries.

  • The Grantor’s final tax return is filed by the Trustee or Executor of the Grantor’s Estate, and it declares all the income earned by the Grantor through the Grantor’s death.
  • However, any income earned by the Trust assets or principal after the date of the Grantor’s death is reported in a separate tax return for the Trust.

After death, the Trust converts from a Revocable to an Irrevocable Trust

The requirement that the Trust files its own tax return is a result of the Trust changing from a Revocable Trust during the Grantor’s life to an Irrevocable Trust upon the Grantor’s death. This makes perfect sense because it was Revocable before death—meaning that the Grantor can revoke, or make changes to the assets and beneficiaries. After death, of course, the Grantor can no longer make changes. The result: The Trust must file its own tax return each year.

 What about estate taxes?

Thanks to changes in the estate tax laws, only those estates worth more than $11.4 million will owe federal estate taxes.

Estate Planning

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No-Contest Clauses in Wills and Trusts

 

No-Contest Clauses in Wills and Trusts

Is there a chance that any of your beneficiaries could be so disgruntled about what you’ve left them in your last will and testament or trust that they would bring a legal challenge against it?

If so, you may consider adding a “no-contest clause” to your will, which provides that anyone who disputes the validity of the document in court will end up inheriting nothing at all.

What exactly happens in the case of a contested will or trust, and can a no-contest clause really help you avoid that whole mess? Read on.

The Process of Contesting a Will or Living Trust

A last will and testament communicates your wishes regarding the distribution of your property after your death. A living trust holds your assets for your benefit during your lifetime and for transferring to your chosen beneficiaries at your death by the person you have designated as your “successor trustee.”

So what happens if someone wants to contest a will or trust?

Contesting a will requires that a beneficiary file a formal legal challenge against the validity of the will. A person must have standing to bring a will contest, which means he or she must have a financial interest in the estate, usually as a named beneficiary or someone who is entitled to inherit based on existing law.

Grounds for a will contest may focus on the testator’s capacity—that he or she was not of sound mind when the document was executed—or external forces such as undue influence, fraud, or duress, all of which allege that someone had forced the hand, so to speak, of the testator in drawing up the will.

Additionally, a will contest may seek to present a newer version of the document, alleging that it is the valid one.

Challenges to the validity of a trust are similar in nature and generally call into question whether the trust accurately reflects the trust creator’s wishes. As with a will, duress, fraud, undue influence, and even ambiguity in the trust’s terms may be alleged.

The process for disputing a will or trust can mean additional costs for the estate—and less inheritance for beneficiaries. And since we’re talking about court processes, it’s no surprise that all of this can take quite a bit of time—years even—to sort out.

None of these side effects of a will or trust contest are desirable for your beneficiaries, so it’s likely something you’ll want to try to avoid.

Enter the no-contest clause.

What Does a No-Contest Clause in a Will Do?

A no-contest will clause uses the threat of no inheritance at all—even what is bequeathed to the person within the document—to dissuade beneficiaries from challenging the validity of a will.

A sample no-contest clause in a will looks something like this:

“Notwithstanding anything herein to the contrary, if any beneficiary contests the terms of this Will, including, without limitation, filing a contest of admission of this Will to probate under [applicable section of the state Probate Code], that beneficiary shall not be entitled to any property under the terms of this Will, and for all purposes of this Will, that beneficiary shall then be deemed to have predeceased me.”

A no-contest clause in a trust would contain similar language, but remember that your state may have specific requirements, so it’s always best to consult a professional when incorporating legal language into your will or trust.

Pros and Cons of No-Contest Will Clauses

The main “pro” to including a no-contest clause is that it often does effectively deter beneficiaries from bringing a legal challenge to the will. On the flip side, however, if there actually were any errors in the will or trust, the existence of the no-contest clause leaves no recourse for that beneficiary.

Something else to keep in mind is that a no-contest clause doesn’t automatically mean there will be no issues or disagreements over the estate. One big caveat, for example, is that some states actually allow a beneficiary to bring a will contest—even in the presence of a no-contest clause—so long as she has probable cause to do so. And some states, such as Florida, will not enforce no-contest clauses at all.

Another important limitation of no-contest clauses is that they don’t apply to a person who is not a named beneficiary in the will. That is, even if there is a no-contest clause, a person omitted from the will who brings a contest will have no fear of repercussions of non-inheritance. He or she simply isn’t covered by the clause.

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A Lesson in Estate Planning

A Lesson in Estate Planning from David Bowie

Few pop stars have endured or left a legacy as diverse and successful as that of David Bowie. He died last week of liver cancer, just two days after his 69th birthday and the release of his latest album, Blackstar. He was inventive and cutting edge; the fans who transcended generations adored him. Those who didn’t know what to make of the androgynous pop star nevertheless remained fascinated by his ever-evolving, iconic personas. Over more than 50 years, he produced an extraordinary body of work that spanned music and film.

Bowie amassed considerable wealth

Bowie died a very wealthy man—his estate is worth an estimated $100M—and that’s before the inevitable spike in sales that will continue with his death. (In the 6 years since Michael Jackson’s death, his estate has grossed nearly $2B.) Yet in the 70s and 80s, Bowie struggled financially, reportedly nearing bankruptcy.

A brilliant plan for creating—and sustaining–wealth: Bowie Bonds

With the help of an investment banker, Bowie developed a brilliant plan for creating and sustaining wealth: Bowie sold a stake in his catalog of music. Instead of outright selling his songwriting, performance and licensing rights to his many successful songs, Bowie created “Bowie Bonds.” These allowed him to sell – for $55M– a 10-year investment, which operated like an annuity, providing a fixed-rate of return of 7.9%. The payouts were secured by all of his royalties and copyrights from the music. Prudential Insurance purchased the Bowie Bonds and was paid off in full during the 10-year timeframe. The Bowie Bonds transaction provided tax savings and ensured that his estate would benefit from his music catalogue.

Apparently Bowie was motivated by the desire to protect his family—his wife, Iman, their daughter, and a son from a former marriage. He had apparently always been interested in estate planning and wanted to make sure his assets passed on to his loved ones.

Bowie likely used one or more Revocable or Irrevocable Trusts

Given Bowie’s careful attention to financial planning, it’s likely that he used one or more Revocable or Irrevocable Trusts. In this way, he could have maximized the value of assets with the lowest tax consequences, but his assets could also pass privately, without the public scrutiny that accompanies Probate Court, which is the case with those who do not create a Living Trust.

Bowie’s final wishes

It was just revealed that Bowie’s $100M fortune will be distributed among his family and several loyal employees. Iman will receive half of his fortune as well as their Soho apartment; his children will each receive an estimated $25M. Bowie was a longtime Buddhist and requested that he be cremated in Bali in accordance with Buddhist rituals. He noted that if that was not practical, he could be cremated elsewhere, with his ashes scattered in Bali. The Bali cremation may have been problematic, for Bowie was cremated in New Jersey, but we can assume that his family scattered his ashes in Bali, according to Bowie’s final wishes.

A Living Trust ensures that your heirs will not have to deal with Probate and that your estate will remain a private matter. We assist our clients through every step of the Living Trust process.