D. THE USE OF A REVOCABLE LIVING TRUST
1. What is a "Trust?"
The use of the term "trust," is confusing to many parties. There are many types of "trusts". Just as the set of terms printed on the back of a parking lot receipt and the terms of an agreement for selling a building are both "contracts," trusts can vary from the very simple to the extremely complex. Each trust is prepared based upon the specific goals to be accomplished.
A trust involves three parties. The first is the "grantor," "settlor" or "trustor" which are all interchangeable names for the person who transfers property into the Trust. For purposes of convenience, we will use the term "grantor" in this discussion. The second party is the trustee, who is the person who serves as the manager of the trust. The third party is the beneficiary, the person for whose benefit the trust is established.
When a trust is established, a grantor transfers property into the hands of the trustee which is to be managed under the terms of a Declaration of Trust for the benefit of the trust’s beneficiary. The terms and conditions upon which the property is to be managed vary tremendously, and in determining the trust purpose or function, it is necessary to review carefully the terms of the Declaration of Trust. Trusts generally fall into two categories, irrevocable (where they are established on a permanent basis and are not subject to change in most instances), and revocable (which can continue to be changed by the grantor amending the trust from time to time).
2. What is a "Living Trust", "Revocable Trust" or "Family Trust?"
The most common type of trust encountered in estate planning is referred to as the "Living Trust," the "Revocable Trust," the "Family Trust" or by means of similar terminology. Irrevocable Trusts are used for more sophisticated planning techniques which are discussed under the heading "SOPHISTICATED TAX PLANNING." The "Revocable Living Trust," the term we will use for convenience, is an estate planning device that is relatively common today.
The principal purpose of a Revocable Living Trust is to avoid probate. See discussion under "USING A WILL" above. Probate is necessary when the death of an individual occurs and property is held in the name of that individual. The Revocable Living Trust avoids the necessity for a probate proceeding by assuring that nothing is held in the name of the decedent at the time of death. This would be accomplished by having you transfer everything that you own, while you are living, into the name of your own Revocable Living Trust. Because you are both the trustee and the grantor as long as you are living, it interferes very little in your ongoing affairs. At the time of your death, however, because a successor trustee will continue to manage the property under the terms of the trust, and because the trust itself does not die, it is not necessary to go to probate court to get property transferred out of the name of the decedent. The terms of your Revocable Living Trust instruct the trustee as to how to distribute your property at the time of your death. The Revocable Living Trust, as a result, allows you to avoid the public, expensive, complex and time-consuming probate process.
3. How a Revocable Living Trust Avoids Probate.
In other words, the Revocable Living Trust is designed to avoid probate by a rather simple concept. Because it is necessary to probate things that I own at the date of my death, we make sure that I do not own anything at that time. During my lifetime, I transfer everything that I own into my Revocable Living Trust. This Revocable Living Trust is treated as a separate legal entity for title purposes. Fortunately, the Internal Revenue Service generally ignores the Revocable Living Trust because I, as the grantor, retain the power to manage the trust for my benefit during my lifetime. Because I do not own anything individually (i.e., I have transferred everything into the name of the trust) at the time of my death I do not have to go to probate court. Instead, because the trust continues to exist, the trustee (who will be the person that I have named as my successor) distributes the property contained in the trust in the manner described in the trust instrument. As a result, I have completely avoided the process of probate if I have accomplished two things:
a. I have created the Revocable Living Trust in an effective manner; and,
b. I have transferred the title to all of my property into the name of the Revocable Living Trust.
One of the most common mistakes that estate planning attorneys encounter is someone who has established a Revocable Living Trust by signing the trust documents, but has not transferred all of their property into the name of the Revocable Living Trust. In such a case, it will still be necessary to probate the assets that have not been placed in the Revocable Living Trust. Since the administrative complexity of probate is usually the same whether you are transferring small amounts of assets or large amounts of assets, this is not a very desirable result.
A Revocable Living Trust does not save estate taxes. In fact, for practical purposes it is totally ignored for income tax and estate tax purposes. In most instances, you will continue to file the normal form 1040 to report income tax obligations after you form a living trust. Property within the living trust is generally taxed for estate tax purposes at its fair market value at the time of your death. See "FEDERAL ESTATE TAXES" .
Many marketers of living trusts have, in recent years, been extremely misleading as to the purpose and function of a Revocable Living Trust. It is rather typical for "Trust Mills" to market standard form documents, to advertise that the use of a living trust will reduce or eliminate estate taxes, and to promise all types of other substantial benefits which may or may not be available by use of the living trust. It is important to understand that the only function of the living trust for most purposes is to avoid probate at the time of death.
While certain trusts can be used to save death taxes (see discussion at "FEDERAL ESTATE TAXES" ), a Revocable Living Trust is designed to avoid probate, not to save death taxes. Many of the Trust Mills have also utilized standard forms that, while they appear comprehensive and complex, turn out not to accurately reflect the personal planning that you want in these documents. This is one of the principal reasons why it is critical that documents not be executed if you do not understand them thoroughly. Your estate planner should be the "scrivener," not the dictator of what you should do with your own property. Finally, many of the Trust Mills do not provide documentation to follow up in assuring that your properties are transferred into the name of the Revocable Living Trust. As discussed above, failure to transfer property into the name of the Revocable Living Trust eliminates its usefulness for practical purposes.
There is one other area where the Revocable Trust provides assistance it is difficult to obtain with a Will. Specifically, if you have established a Revocable Living Trust, and you become physically or mentally incapacitated, your successor trustee will be able to manage the assets comprising the trust estate for your benefit. This allows you to avoid a conservatorship proceeding, which is also usually a relatively complex and expensive process.
Generally speaking, any plan for distribution of your property which can be implemented by a Will can also be implemented by use of a Revocable Living Trust. As a result, the tax and family planning discussions at this Site are generally applicable to either device.
Keep in mind that the statements above are a simplification of the planning aspects of the use of these vehicles, and that exceptions can be found. But an understanding of the basic concept is important, and the exceptions usually arise only in specialized circumstances.
For additional information as to the use of Living Trust, please refer to "Do I Need A Living Trust?" prepared by the California State Bar Association and reproduced at Appendix IV.