United States: The Use Of Trusts In Estate Planning

As Published In "The CPA Journal"

Except with respect to "I love you" all-to-spouse or all-to-children Wills, almost all modern estate plans incorporate one or more trusts.

Some types of trusts are utilized in an attempt to postpone or even eliminate estate taxes. Others may be utilized to deal with particular problems, such as an incapacitated beneficiary or a second (or third) marriage. Still others are created to deal with multi-generational planning, or to protect a beneficiary against creditors, future spouses or even the beneficiary’s existing spouse.

In certain instances trusts are utilized to avoid state income taxes, such as those with appropriate Trustees and asset locations which are run from states which have no income or capital gains taxes on trusts for the benefit of non-residents. In others trusts are used to obtain estate and/or gift tax discounts, to avoid or postpone capital gains taxes, to deal with assets passing to spouses who are not U.S. citizens, to aid charities, etc.

There are also a few entities which are called trusts but really do not fit into the typical trust image, such as mortgage arrangements which, in some states, are denominated as trusts, and certain business ventures which are called trusts.

Over the years some trusts have acquired multiple names. In fact, in connection of the preparation of this article we ascertained that the 50 or so trusts (or arrangements denominated as trusts) that the article deals with are known by an aggregate of 75 different names.

The accountant who works on a client’s estate plan, usually working with the client’s attorney and potentially his other financial advisors (banker, insurance professional, financial planner, etc.), will frequently be called upon to recommend types of trusts, or to comment upon trusts recommended by others. Because the accountant is often unsure of the expertise and sophistication of the client’s other advisors, it is important that the accountant himself or herself be familiar with the principal types of trusts that exist which might (or might not) be appropriate for a particular client.

This article is not meant to be a detailed discussion of every type of trust in existence. Its purpose to provide an overview of the types of trusts typically utilized by clients of moderate to substantial wealth whom an accountant might well encounter and be asked to advise. Thus, whereas this article includes a brief description of many types of trust, it is not meant to be an exhaustive discussion of any type of trust, what its particular benefits or detriments may be, etc. Readers are advised to consult other articles in this and other publications as well as with other estate planning professionals if they desire more details on the types of trusts mentioned herein.

The following is a listing of the types of trusts that one might expect to encounter in connection with one’s estate planning practice:

A-B Trusts. Before the adoption of the unlimited marital deduction, and while the marital deduction was limited to fifty percent of an individual's adjusted gross estate, it was common to create two trusts for the benefit of an individual's spouse, one of which qualified for the marital deduction and one of which did not. These were frequently referred to as "A-B" Trusts.

Alaska Trusts. These trusts combine the benefits of multi-generational planning (see Generation Skipping Trusts and Dynasty Trusts, below) with an attempt at protection from the Grantor’s creditors.

Blind Trust. This is a trust, often created by a politician after election to office, pursuant to which certain assets of the Grantor are managed by one or more Trustees without the Grantor being advised of (or having any continued input as to) what is taking place. The assets, however, are managed for the benefit of the Grantor of the trust.

By-Pass Trust. See Credit Shelter Trust .

Cemetery Trust. This is typically a trust for the purpose of maintaining one or more graves or grave sites in a cemetery.

Charitable Lead Trust. This is a trust pursuant to which a specified sum (expressed as a fixed percentage of the value of the trust at inception [in effect, an annuity] or as a fixed percentage of the value of the net assets of the trust, calculated annually) is to be paid to a charity, at least annually, for a specified period, with the remainder then passing to one or more individuals. If an annuity is utilized it is a Charitable Lead Annuity Trust (a "CLAT"); if a percentage of the net assets valued annually is utilized the trust is a Charitable Lead Unitrust (a "CLUT"). Such trusts may save estate, gift and/or income taxes.

Charitable Remainder Trust. This is a trust pursuant to which one or more individuals receive, at least annually, either a sum equal to a fixed percentage of the assets valued at the trust's inception (in effect, an annuity) or a sum equal to a fixed percentage of the net assets of the trust valued annually, either for a set number of years or for one or more lifetimes. If an annuity is utilized the trust is a Charitable Remainder Annuity Trust (a "CRAT"); if a percentage of the net assets valued annually is utilized, the trust is a Charitable Remainder Unitrust (a "CRUT"). Such trusts may save estate, gift, income and/or capital gains taxes.

CLAT. See Charitable Lead Trust.

Clifford Trust. This type of trust, no longer being created (although some previously created ones still exist), provided that its assets were to be held for a period of at least ten years, with the income payable to a person other than the Grantor, and with the assets reverting to the Grantor at the end of the term of the trust. Its purpose was to shift income and reduce income tax liability. Tax law changes have eliminated its usefulness.

CLUT. See Charitable Lead Trust.

Constructive Trust. This is a trust which is created by law. No trust documents are involved. If a person receives assets he should not have received he may be deemed by law to be holding those assets for someone else in a Constructive Trust.

Contingent Trust. This is a trust which comes into being only in the event that a contingency occurs. For example, a document may provide that if any assets would be distributable to a person under the age of 21 years, those assets are held in a Contingent Trust for the benefit of that person until that person attains 21 years of age.

CRAT. See Charitable Remainder Trust.

Credit Shelter Trust. This is a trust customarily designed to receive the maximum amount which can pass free of federal estate tax upon the death of the first of two spouses to die. It has numerous variations. Frequently the terms of the trust provide that all of its income will be payable to the surviving spouse for life, with the assets then passing to or in trust for one or more others upon the surviving spouse's death. Another variation involves a Sprinkling Trust (see below).

Crummey Trust. This is a type of trust which permits one or more individuals to withdraw a limited amount from the assets added to the trust in a specified manner during a specified period. Its purpose is to avoid gift taxes with respect to assets placed in the trust. Insurance Trusts (see below) are often designed as Crummey Trusts.

CRT. See Charitable Remainder Trust.

Defective Grantor Trust. This is a type of trust purposely made "defective" so as to be a Grantor Trust (see below) for income tax purposes but an Irrevocable Trust (see below) for estate and gift tax purposes. It may result in increased tax savings.

Delaware Business Trust. Similar to a family limited partnership or limited liability company, as opposed to a traditional trust, a Delaware Business Trust is a way to hold and invest assets, possibly including life insurance, with greater flexibility than most trusts allow, with the Grantor of the trust retaining far more control than the tax laws permit as to traditional trusts, and with opportunities for limited liability, creditor protection and valuation discounts.

Disclaimer Trust. This is a type of trust which is meant to receive property which is disclaimed (renounced) by a beneficiary. For example, if a husband writes a Will and wants to provide that all of his assets are to benefit his wife, but he is not sure whether he has sufficient assets so that he would want to utilize a Credit Shelter Trust (see above), he may provide in his Will that any assets disclaimed by his wife pass to a trust for her benefit, and thus give his wife the option of either taking the assets outright or of disclaiming some, such as the maximum amount which can pass free of federal estate tax, with the disclaimed assets to pass into the Disclaimer Trust from which the surviving spouse herself may receive the net income. Note that such an arrangement is only possible with respect to a spouse.

Discretionary Trust. This is any trust as to which the Trustees have discretion to distribute (or not distribute) income and/or principal to or among one or more beneficiaries. The discretion may apply to income, to principal or to both. The Trustees may have the right to give or not give income and/or principal to a single beneficiary, or to distribute some or all of the income and/or principal among members of a group, excluding one or more members if desired (see Sprinkling Trust, below).

Dry Trust. This is a trust which has no assets. A Dry Trust is usually created either to receive assets upon the death of an individual, such as a pour-over under the individual's Will (see Pour-Over Trust, below), or to receive assets transferred to the trust via a power of attorney in the event of an individual's incapacity (see Standby Trust, below).

Dynasty Trust. This is a name customarily used for a Generation-Skipping Trust (see below) which is continued for an extended period of time, such as for multiple generations, limited only by the applicable Rule Against Perpetuities, if any. In certain states such a trust may run for a very extended period of time. Its purpose is to avoid estate taxation for several generations, and to provide for an individual's descendants (or equivalent) for a very long period.

Educational Trust. See Section 2503(c) Trust.

Escher Trust. See Supplemental Needs Trust.

Estate Trust. This trust is a type of Marital Deduction Trust (see below) which provides that, upon the death of the surviving spouse, the assets in the trust, or at least the accumulated income of the trust, are payable to her estate.

Generation-Skipping Trust. This is a trust which either skips over an entire generation or provides for members of more than one generation, normally geared to utilize the exemption from the tax on generation-skipping transfers. Under federal law this exemption may be as much as $1,000,000 per trust creator (not per trust and not per grandchild).

Grantor Retained Annuity Trust. This is an irrevocable trust created by an individual (the Grantor) which provides for the payment to the Grantor, at least annually, of a sum equal to a fixed percentage of the value of the assets placed in the trust (in effect, an annuity) for a fixed period of time (or until the Grantor's death, if sooner), with the balance in the trust, upon its termination, passing, usually, to the Grantor's estate if the Grantor does not survive the term of the trust, or to (or in trust for) another individual (or individuals) if the Grantor survives the term of the trust. Its purpose is to reduce gift and estate taxes. It serves little, if any, tax purpose if the Grantor dies during the term of the trust. Note, also, that it does not yield a step-up in basis (tax cost) of the assets of the trust if the trust terminates during the Grantor’s lifetime, and that it is possible for the gift tax and the resulting capital gains tax (assuming that the assets are then sold) to exceed the tax saving resulting from the creation of the trust. Note, also, that, for income tax purposes, it is a "Grantor Trust".

Grantor Retained Income Trust. This trust, now useable in only limited situations, is an irrevocable trust as to when the Grantor retains the right to income for a fixed period of years geared to end before the Grantor's death. Upon the termination of the trust the assets in the trust pass to another. The main purpose of such a trust is to reduce the gift tax value of the transfer, because the value today of a gift of an asset in the future is less than the present value of that asset. Grantor Retained Income Trusts are now used for gifts to non-immediate family members (e.g., nieces or nephews). Such a trust serves little or no tax purpose if the Grantor dies before it terminates.

Grantor Retained Unitrust. This is very similar to a Grantor Retained Annuity Trust (see above), except that, rather than a fixed sum (a percentage of the assets of the trust valued at the creation of the trust), the Grantor is to receive an annual (or more frequent) payment equal to a fixed percentage of the value of the net assets of the trust valued annually during the term of the trust.

Grantor Trust. This is a type of trust the income and capital gains of which are taxed to the Grantor even if not payable to him.

GRAT. See Grantor Retained Annuity Trust.

GRIT. See Grantor Retained Income Trust.

GRUT. See Grantor Retained Unitrust.

GST Trust. See Generation-Skipping Trust.

Illinois Land Trust. This is a type of arrangement commonly utilized in Illinois in connection with mortgage-like transactions. It is not used for normal trust purposes.

Insurance Trust. This is a trust, generally irrevocable, meant to own insurance on the life or lives of one or more individuals and to provide for the disposition of the proceeds of such insurance. Unless irrevocable, an Insurance Trust serves no tax purpose whatsoever.

Inter Vivos Trust. This is any trust created during the lifetime of the person creating the trust.

IRA QTIP. This is a type of QTIP Trust (see below) which is specifically designed to receive the proceeds of an IRA. It requires specific provisions in the IRA and in the IRA QTIP Trust in order to qualify for the marital deduction and to avoid adverse income tax consequences.

Irrevocable Trust. This is any trust which may not be amended or revoked by the Grantor. Transfers to such a trust may be subject to gift tax.

Living Trust. See Inter Vivos Trust. In many instances the term "Living Trust" is used to refer to a Revocable Living Trust.

Loving Trust. This is the name given by some trust salesmen to Living Trusts.

Marital Deduction Trust. This is any trust which qualifies for the estate tax (or gift tax) marital deduction. A Marital Deduction Trust may provide, for example, that the individual's spouse receives all of the net income for life, with the assets remaining in the trust passing to a specified other individual or individuals upon the spouse's death. It may also provide that the net income is payable to the spouse for life, and give that spouse the right, either by Will or by another specified instrument, to determine who receives the assets remaining in the trust upon that spouse's death.

Marital Trust. See Marital Deduction Trust

Massachusetts Trust. This is not what is commonly considered a trust at all but, rather, a corporation-like arrangement customarily utilized only in Massachusetts.

Medicaid Trust. This is typically an Inter Vivos Trust (see above) created by an individual for himself or his spouse, for the purpose of protecting his assets and permitting himself or his spouse to qualify for Medicaid benefits. In most instances such a trust is ineffective to obtain such benefits. Note, however, that a Testamentary Trust (see below) may provide the benefits being sought (after the death of the person under whose Will it is created). See also Supplemental Needs Trust

Minority Trust. This is a trust geared to hold assets during an individual's minority, although it frequently runs until the individual attains the age of 21 years (the age of majority is generally 18). See Section 2503(c) Trust

Net Income Makeup Charitable Remainder Unitrust. This type of CRUT, often used to supplement a retirement plan, permits the Trustee to invest for maximum growth of capital since only the net income of the trust need be distributed currently. In the future (e.g. at retirement) the trust investments are rearranged to increase the trust’s income, and the "unpaid" past distributions may be made up.

NIMCRUT. See Net Income Makeup Charitable Remainder Unitrust

Non-Marital Trust. This is a trust which does not qualify (or has not been qualified) for the estate or gift tax marital deduction.

Offshore Trust. This is a trust administered outside of the United States, frequently for the purpose of hiding funds from the Grantor's creditors.

Pour-Over Trust. This is a type of trust which is fed from another instrument. For example, in a person's Will his Executor may be instructed to transfer (pour over) all or a portion of the assets of the estate to a trust created under another instrument.

Power of Appointment Trust. This is a trust over which an individual has a power of appointment, being the right to designate who will receive some or all of the assets of the trust at a specified time or times. A power of appointment may be exercisable either during life (an "Inter Vivos Power") or by Will (a "Testamentary Power").

QDOT. See Qualified Domestic Trust

QPRT. See Qualified Personal Residence Trust

QTIP Trust. See Qualified Terminable Interest Trust

Qualified Domestic Trust. This trust is very similar to a QTIP Trust (see above), but is meant for a surviving spouse who is not a citizen of the United States. A Qualified Domestic Trust must have specific provisions regarding the distribution of its income and principal, dealing with who may be Trustees and, unless a bank or trust company is a Trustee, securing the IRS with respect to future taxes. It is subject to special tax rules applicable only to such trusts. Large Qualified Domestic Trusts almost always have a bank or trust company as a or the Trustee.

Qualified Personal Residence Trust. This is a variation of a Grantor Retained Annuity Trust (see above). It is a trust funded with the Grantor's residence or vacation home. It provides that the Grantor may reside in the residence (or in another purchased with the proceeds of the sale of the residence) for a specified number of years, at the end of which the property passes to or in trust for one or more other persons.

Qualified Terminable Interest Trust. This is a Qualified Terminable Interest Property Trust, and is one of several types of trust designed to qualify for the estate or gift tax marital deduction (see Marital Deduction Trust, above). It provides that the Grantor's spouse receives all of the net income for life. It may (but need not) provide for invasions of principal for the benefit of that spouse. Upon the death of the spouse for whose benefit the trust was created the assets in the trust are includable in that spouse’s estate for estate tax purposes and are distributed in accordance with the provisions of the trust and applicable law.

Rabbi Trust. This is not a typical trust arrangement but, in fact, a type of retirement plan or deferred compensation arrangement. The first was created for a rabbi (thus its name).

Residuary Trust. This is any trust (there are numerous varieties) funded with the assets remaining (the residue) after the payment of all prior ("pre-residuary") bequests, as well as debts, expenses, etc. and, sometimes, taxes.

Revocable Living Trust. This is a trust created during the Grantor's life which may be revoked by the Grantor. It is sometimes used to avoid probate, sometimes to provide management during the Grantor's lifetime, sometimes to permit the administration, without additional ("ancillary") probate proceedings, of assets (e.g. real estate) located in a jurisdiction other than the one in which the Grantor resides, and sometimes for other purposes. Such trusts save absolutely no income, gift or estate taxes, as compared to Wills, and may, or may not, reduce administration expenses and legal and accounting fees. Revocable Living Trusts must be executed in accordance with applicable state law. Clients often receive totally inaccurate information as to the benefits (and detriments) of Revocable Living Trusts.

Revocable Trust. This is any trust which may be revoked or amended by the Grantor. See Revocable Living Trust

Second-to-Die Insurance Trust. This is a type of Insurance Trust (see above) geared to own one or more second-to-die (also called Survivorship or Last-to-Die) life insurance policies insuring the lives of two (generally) people, who may (but need not) be husband and wife.

Section 2503(c) Trust. This is a trust for a minor (actually a person under the age of 21 years) and is designed to receive the annual $10,000/$20,000 gifts on behalf of the minor. Section 2503(c) Trusts are an alternative to the use of the Uniform Gifts (or Transfers) to Minors Act and are often a better way of planning with respect to gifts to children, particularly if under the age of 14 years, whose parents are in a high income tax bracket. A Section 2503(c) Trust can have provisions allowing more flexibility than is available under the Uniform Gifts (or Transfers) to Minors Act. Variations of this trust permit the trust to continue beyond the date on which the beneficiary attains the age of 21 years.

SNT. See Supplemental Needs Trust

Spill-Over Trust. See Pour-Over Trust

Spray Trust. See Sprinkling Trust

Sprinkling Trust. This is a discretionary trust for the benefit of the members of a specified group, such as the Grantor's spouse and descendants. See Discretionary Trust

Standby Trust. This is a trust created during life (see Inter Vivos Trust) which is normally unfunded (see Dry Trust) until assets are added to it via a power of attorney upon the incapacity of the Grantor of the trust.

Supplemental Needs Trust. This is a trust for the benefit of an incapacitated person. It typically provides that all of its assets are available to be used for the benefit of that person, but that the Trustees are not to use trust assets in the normal course to the extent that the incapacitated person would otherwise be receiving governmental benefits. Accordingly it is possible, for example, for a parent to create a Supplemental Needs Trust for an incapacitated child without interfering with the child's Medicaid benefits. Supplemental Needs Trusts often deal with a beneficiary's non-essentials, such as paying for a vacation, a television set, etc. The use of Supplemental Needs Trusts was expanded under provisions of the tax law enacted by Congress in 1993, and EPTL §7-1.12 (as to New York), but such trusts can be used only for certain beneficiaries and only under certain circumstances.

Testamentary Trust. This is any trust created under a Last Will and Testament.

Totten Trust. This is the name given to a type of bank account (not a trust) established by a person which, upon the death of that person, passes to one or more other named persons without going through probate. A Totten Trust can only be created using a bank account or certificate of deposit, and, in New York, not with mutual funds, other securities, etc. Legislation designed to expand the use of such trusts in New York is under consideration at the time this article is being written.

Unified Credit Trust. See Credit Shelter Trust.

Voting Trust. This is an arrangement for a specified, limited period by which one or more individuals authorize one or more other individuals to vote the shares of stock owned by the individual(s) creating the Voting Trust. It has no other typical trust attributes.

Wealth Replacement Trust. This is the name give to a type of insurance trust the purpose of which is to hold insurance on the life of an individual, or an individual and his spouse, and to utilize the proceeds of that insurance to replace assets passing to charity, such as upon the termination of a Charitable Remainder Trust.