Revocable Trust (Revocable Living Trust) vs. Irrevocable Trusts
Be open and notorious, Sue me! You’ll never get a dime. If you reposition (transfer) your assets through the use of an IRREVOCABLE TRUST, you will no longer own them. If you don’t own assets, no one will want to sue you; no one will want to track your spending habits; no one will call you to interrupt your dinner.
You don’t have to go offshore. US Laws, US courts will defend and support your asset protection system. These laws have been defined by numerous court cases, over and over, right up to the Supreme Court. You must however, give-up control over your assets to a true independent trustee.
Legitimate repositioning (transfer) of assets from you to an irrevocable trust is perfectly legal. The fact is, if your assets are owned by a subchapter S. Corporation or a Limited Liability Company and in turn the shares of the Sub S or membership units of the LLC are owned by an irrevocable trust, it’s the fortress of US Asset Protection. The ultimate asset protection device is the use of an offshore asset protection trust.
REVOCABLE TRUSTS VS. IRREVOCABLE TRUSTS:
1) On Asset Protection -
Revocable Trust (Revocable Living Trust) - NO Protection, NONE. The Grantor, The Trustee, and the Beneficiary are generally the same person. The Grantor did not give-up control of the asset(s).
Irrevocable Trust - YES. The Grantor no longer owns the assets. Assets have been transferred to the INDEPENDENT Trustee who has a fiduciary duty to manage the assets for the benefit of all beneficiaries, which may include the Grantor.
2) On Eliminating Probate -
Revocable Trust (Revocable Living Trust) - YES.
Irrevocable Trust - YES.
3) On Eliminating Estate Taxes -
Revocable Trust (Revocable Living Trust) - NO.
Irrevocable Trust - YES. Assets are not subject to the Estate Tax. The deceased did not have “ownership” of assets nor have assets in his possession at the time of his death.
4) On Deferring or Reducing Capital Gains Taxes -
Revocable Trust (Revocable Living Trust) - NO.
Irrevocable Trust - YES. Assets transferred to the Trust can be structured without capital gains taxes.
5) On Deferring or Reducing Income Taxes -
Revocable Trust (Revocable Living Trust) - NO.
Irrevocable Trust - YES, if combined with international structure.
6) On Form 1040 income tax benefits -
Revocable Trust (Revocable Living Trust) - YES. You have done nothing. You still "own" the assets. All Income and Expenses flow-through to the Grantor’s form 1040.
Irrevocable Trust - YES. If this is a Grantor-Type Trust, for income tax purposes, all income and expenses flow-through to the Grantor’s form 1040.
7) Comments -
Revocable Trust (Revocable Living Trust) - The Revocable Trust is designed to eliminate probate. DOES NOT eliminate estate taxes; ABSOLUTELY NO asset protection, nothing more than an extension of your will.
Irrevocable Trust - For asset protection purposes the trust is irrevocable. Under certain conditions, the trust can be designed to be a pass-trough trust for income taxes.
THE REVOCABLE TRUST (REVOCABLE LIVING TRUST):
What’s wrong with a revocable trust (revocable living trust) is that the owner of the assets (the Grantor) retains too much power over the disposition of the trust assets. This direct control nullifies any defenses against potential frivolous lawsuits. His deemed control is equivalent to ownership, and if you still own the asset you are liable to lose them in a lawsuit. And if you own the asset you will incur an estate tax.
The laws of most states permit the formation of a variety of revocable trust instruments (AB “Family” Trust, QTIP Trust, Crummey Trust, Retained Interest Trusts such as GRITS, GRATs, GRUTs, and QPRT), whereby the trust creator (Grantor) contributes assets for the benefit of others to be managed by a Trustee. While it is also possible for the creator to be either the Trustee or a Beneficiary of the trust he or she has created, such dual capacities will usually destroy the trust's ability to shelter its assets from creditors of the Grantor.
When a Grantor reserves an unqualified power of revocation, he or she is deemed the absolute owner of the trust property, as far as the rights of creditors are concerned. This is true even if a Grantor of a trust does not retain a beneficial interest in the trust, but simply reserves the power to revoke it.
THE IRREVOCABLE TRUST:
Unlike a revocable trust, (revocable living trust), assets transferred to an “irrevocable” trust cannot be changed or dissolved by the Grantor once it has been created. The Grantor no longer owns the assets. An independent Trustee is your best defense.
With an independent trustee, you generally can't remove assets, change beneficiaries, or rewrite any of the terms of the trust. An irrevocable trust is a valuable estate-planning tool. First, you transfer assets into the trust--assets you don't mind losing control over. You may have to pay gift taxes on the value in excess of $1million of the property transferred at the time of transfer or you may be able to set-up a mock sale by using a device known as a private annuity to avoid capital gains taxes.
With an irrevocable trust, all of the property in the trust, plus all future appreciation on the property, is out of your taxable estate. That means your ultimate estate tax liability may be less, resulting in a more tax efficient way to transfer your accumulated wealth to your beneficiaries. Property transferred to your beneficiaries through an irrevocable trust will also avoid probate.
As a bonus, property in an irrevocable trust may be protected from your creditors. Of late this irrevocable trust device is being utilized by many planners for avoiding the Medicare nursing home spend-down provisions whereby if the elderly has to enter a nursing home he must first spend all his money until he does not have any money left.
THE INDEPENDENT TRUSTEE:
A quick word about the independent trustee: most people don’t like to give-up control over their assets because of their perceived notion that giving up control is equivalent to leaving the wolf in charge of the henhouse. The law imposes strict obligations and rules on trustees including a duty to account for any benefits the trustee may have gained directly or indirectly from a trust. This goes beyond fraudulent abuse of position by a trustee.
The courts regard a trust as creating a special relationship which places serious and onerous obligations on the trustees. The law regards the special "Fiduciary" relationship of a trust as imposing stringent duties and liabilities on the person in whom confidence is placed - the trustees - in order to prevent possible abuse of that confidence. A trustee is therefore subject to the following rules:
1) No private advantage. A trustee is not permitted to use or deal with trust property for direct or indirect private advantages. If necessary the court will hold him personally liable to account for any profits made in breach of this obligation
2) Best interests of beneficiaries. Trustees must exercise all their powers in the best interests of the beneficiaries of the trust.
3) Act prudently. Whether or not a trustee is remunerated he must act prudently in the management of trust property and will be liable for breach of trust if, by failing to exercise proper care, the trust fund suffers loss. In the case of a professional the standard of care which the law imposes is higher. Failure to exercise the requisite level of care will constitute a breach of trust for which the trustee will be liable to compensate the beneficiaries. This duty can extend to supervising the activities of a company in which the trustees hold a controlling interest.
Legal safeguard: In cases of substantial assets, you may add one other safety measure, "the Trust Protector." The trust protector’s sole function is to hire and fire trustees, at will and without explanation. We use limits on how much a trustee can be authorized to spend without a second signature.
Living Revocable Trust
A Living Trust or Revocable Trust, or a Revocable Living Trust, are the same Trust. The word “revocable” says it all. The “Grantor” the guy with the assets, transfers his assets to a “Trust” where he is the “Trustee” for the benefit of all “Beneficiaries”, which includes him and others. In other words he has kissed his hand and declares himself to be the “Pope.”
The revocable trust is not worth the paper it’s written on. The revocable trust does not protect the assets from potential frivolous lawsuits. The revocable trust does not eliminate the estate tax. The revocable trust was designed to avoid the probate process but nothing else.
SO, WHAT'S A "TRUST"?
A “Trust” is nothing more than a contract. The concept of a trust was first used in Anglo Saxon times and is contractual arrangement whereby property is transferred from one person (The Grantor) to another person or corporate body (The Trustee) to hold the property for the benefit of a specified list or class of persons (The Beneficiaries).
Although a trust can be created solely by verbal agreement it is normal for a written document to be prepared which evidences the creation of the trust (the Trust Deed), sets out the terms and conditions upon which the trust assets are held by the Trustees and outlines the rights of the Beneficiaries. In essence, a trust is not dissimilar to a will except that assets are transferred to trustees during lifetime rather than those assets being transferred to executors on death. The trust deed is analogous to the deed of will.
WHAT'S A "GRANTOR"?
He’s the guy with the buck; the owner of the asset(s). The grantor’s motivation is to get asset(s) out of his name for either some or all of the following:
- Asset protection / wealth preservation
- Reduce potential frivolous lawsuits
- Elimination of the "probate process"
- Elimination of estate taxes
- To gain some tax benefit or some other tax deferral benefit.
If the "Grantor" initiates the trust (contract), it’s called a "Grantor Trust," otherwise it’s called a "Non-Grantor Trust." To me, it’s just legal garbage so lawyers can charge you more.
If the "Grantor" wants to retain certain control over his asset(s), it’s called a "Revocable Trust"; otherwise, it’s an "Irrevocable Trust."
Revocable / Irrevocable has significant asset protection and tax differences.
"Revocable," is like the kid next door that brings the ball to play basketball with the other kids. Everything is fine, as long as he makes the rules, and he makes the rules as he goes along. If you don’t agree with the rules as he makes them up as you play, he takes the ball and goes home. The ball game is over.
LIVING TRUSTS ARE OUTRIGHT DANGEROUS
The Living Trust can destroy your estate in the event of a lawsuit, serious illness, or elderly care. One name given to a "revocable" trust is the "Living Trust” The sole purpose of the Revocable Living Trust is:
- to "eliminate the probate process."
- Assets in a trust, avoids probate.
- Assets that are NOT in a trust goes to probate, with or without a will.
The living Trust is outright dangerous for asset protection, wealth preservation, and estate tax elimination.
It's obsolete for assets greater than $1,000,000. With the Living Trust the owner of the assets retains significant power over his wealth and will NOT insulate assets from the lawsuit explosion. There’s absolutely no tax benefit, no asset protection and no wealth preservation benefits with the "Living Revocable Trust.
THE "TRUSTEE"
The Trustee is the guy who manages your trust assets. Great care should be taken in your selection of your trustee.
The trustee is bound by the trust document (contract) and he has a duty to protect trust assets for the beneficiaries. The independent Trustee manages, holds legal title to trust assets, and exercises independent control.
The trustee can be your lawyer (worst person you would ever want to trust), your accountant, best friend, or anyone you TRUST who’s not a relative by blood or marriage. You may have more than one trustee. I usually recommend two trustees in all cases of $750,000 or more.
ACCOUNTABILITY OF TRUSTEE
The law imposes strict obligations and rules on trustees including a duty to account for any benefits the trustee may have gained directly or indirectly from a trust. This goes beyond fraudulent abuse of position by a trustee.
There is a basic rule that a trustee may “not” derive any advantage directly or indirectly from a trust unless expressly permitted by the trust; for example, where he is a professional trustee and the trust provides specifically for a right to make reasonable charges for services.
However, full disclosure of the basis and amount of charges is required.
The trustee of an "Irrevocable Trust" has sole discretion over trust assets. Your selection of your trustee must be a carefully planned decision.
The significant item to remember is that an "Irrevocable Trust" gets the assets completely out of your (Grantor’s) name and in return you get complete asset protection, elimination of probate, elimination of estate or inheritance taxes, in certain cases a tax deduction for the assets contributed to the trust, and finally, under certain conditions other uncommon tax benefits not otherwise available. Did I mention it’s the most tax efficient way to transfer your wealth to your next generation?
Duty of trustee is to obey the trust document for the benefit of beneficiaries.
The most important rule relating to the duties of a trustee is that requiring them to obey the directions in the trust deed both with regard to the interests of the beneficiaries (i.e. who is entitled to what) and with regard to the administration of the trust (managing the trust property). Trustees are also subject to very strict standards as to the way in which their powers and discretions may be exercised.
FIDUCIARY RELATIONSHIP OF TRUSTEE
The courts regard a trust as creating a special relationship which places serious and onerous obligations on the trustees. Thus the law regards the special "Fiduciary" relationship of a trust as imposing stringent duties and liabilities on the person in whom confidence is placed - the trustees - in order to prevent possible abuse of that confidence. A trustee is therefore subject to the following rules:
1) No private advantage - A trustee is not permitted to use or deal with trust property for private direct or indirect advantage. If necessary the court will hold him personally liable to account for any profits made in breach of this obligation.
2) Best interests of beneficiaries - Trustees must exercise all their powers in the best interests of the beneficiaries of the trust.
3) Act prudently - Whether or not a trustee is remunerated he must act prudently in the management of trust property and will be liable for breach of trust if, by failing to exercise proper care, the trust fund suffers loss. In the case of a professional the standard of care, which the law imposes, is higher. Failure to exercise the requisite level of care will constitute a breach of trust for which the trustee will be liable to compensate the beneficiaries. This duty can extend to supervising the activities of a company in which the trustees hold a controlling interest.
ADDITIONAL SAFEGUARDS OF ASSETS
In cases of substantial assets, you may add one other safety measure, "the Trust Protector." The trust protector’s sole function is to hire and fire trustees, at will and without explanation. The Trust Protector can save unwanted and often unpleasant results (i.e. your wife runs away with the trustee).
"BENEFICIARIES"
The beneficiaries are the reason for your trust (contract). Your beneficiaries are the guys that will enjoy the benefits of your trust assets. They include, wives, children, grandchildren, charitable organizations of every color and variety.
The length of your beneficiaries is unlimited. Beneficiaries could include the original grantor, but that would be self-defeating. Generally, trusts are irrevocable. The grantor gives-up his assets to gain asset protection, elimination of probate, elimination of estate taxes, and gain certain uncommon tax advantages. Any degree of control by the grantor will render the trust revocable and subject to court discretion.
The period of time of the trust depends on the selection of your trust’s legal jurisdiction. Most states and countries have rules against "perpetuities." That’s to say, that your trust must have an end. Selection of your trust's Jurisdiction in the United States or outside the United States depends on the degree of risk to be assumed by you. Foreign Asset Protection Trusts (FAPT) are significantly stronger than domestic trusts. Judgments are generally not enforceable outside the United States.
Estate Planning and Trusts
A CONTRACT is defined from the Latin word contractus. An agreement between two or more parties, especially one that is written and enforceable by “law.” To enter into by contract; establish or settle by formal agreement. An agreement between two or more parties which creates obligations to do or not do the specific things that is the subject of that agreement.
OWNERSHIP from the word possessore, is defined as someone who has the legal right to possession with the legal right to transfer possession to others.
ESTATE, (inheritance) patrimonio (possession) a term used in common “law” used to denote the sum total of all possessions by a person at the time of his/hers death.
A TRUST is a CONTRACT. A legal arrangement between two or more persons defining the ownership and distribution of his/hers possessions, under the “law.”
ESTATE PLANNING AND TRUSTS therefore is the written legal agreement (contract) outlining a contractual obligation between the parties.
WHAT IS AN ESTATE TAX?
An ESTATE TAX is a tax on your possessions on the date of your death, up to 55%. Take inventory of what you own: Cash, Savings and checking accounts, CDs, Stocks, Mutual Funds, Bonds, Treasuries, Exempts, Jewelry, Cars, Stamps, Boats, Paintings, and other collectibles, Real Estate ... main home, vacation spot, investment realty, your Business, Interests in other businesses, Limited Partnerships, Partnerships, Mortgages and notes receivable you hold, Retirement plan benefits, IRAs, Amounts that you expect to inherit from others.
Your federal death (estate) tax, up to 55%, is based on the "fair cash value" of your property on the date of your death, not what you originally paid. State probate and death taxes are based on the "location" of your property. Thus, if you own property in different states, each state has to be probated and each will want their fair share.
The only real alternative to a will arrangement is to set up a trust structure during lifetime which, with careful planning, can operate to eradicate these delays, administration costs and taxes as well as giving a large number of additional benefits. For these reasons the use of TRUSTS is increasing dramatically.
The problem is: Many Americans have no plan. They incorrectly assume joint ownership takes care of things, or they believe that their property is not worth enough to be concerned.
Such practices can be shortsighted, cost money, and raise unnecessary and unexpected problems, long time delays, and high administration costs. For one thing, most people have a larger estate than they may realize. For another, joint ownership will not necessarily beat probate hungry lawyers or the estate tax man and will often mean that considerable sums become payable in inheritance tax or estate duty.
A will is not a substitute for a trust. A will does not avoid probate. Many individuals seek to put order to their affairs by making a comprehensive will. Under this arrangement the Executors named in the will would apply for a grant of probate, take possession of the assets of the deceased and then distribute those assets according to the terms of the will.
ITEMS INCLUDED IN YOUR TAXABLE ESTATE:
For example, many people believe the higher exemption amounts that can pass tax free eliminate any need for estate planning. This type of thinking is fundamentally flawed, for example:
1) Certain Types of Property have special rules for estate taxes. Property that spouses jointly own, half the value is included in the estate of the first spouse to die, no matter whose funds bought it or that survivor automatically inherits it. And the full value is counted in survivor's estate could result in a bigger estate tax at that time.
Example: H + W own a private home, fair market value at time of H death is $750,000. 1/2 of $750,000 is included in H's estate; therefore W now owns 100%. On the death of W the full $750,000 would be in her taxable estate; thus, a larger estate tax on the death of W.
2) What the Insurance Man Won't Tell You - Life insurance is taxed in your estate "if" you had any incidental ownership at death. This occurs if you can name new beneficiaries or borrow against policies or take out the cash value. Even insurance you give away, can come back to taxable in your estate if the donor dies and leaves it to you. Group insurance may be included too.
3) Pensions & IRAs - are taxable, except for pensions fixed before 1985.
Then there are several items the law also adds to your estate: Large gifts, non-charitable gifts that exceed $12,000 beginning in 2006 and property partly given away, where you retain the right to use it.
Example: A house that you give to your children but still use rent-free. (Incidentally giving your house to your children creates a problem for them, and for you, if they get sued, or they die before you.)
And stock you give away, but keep voting rights, if in a company that you control. Or the property of others over which you have certain rights such as the power under another's will to name who will get part of that estate. If you could name yourself, your estate or creditors, it's taxable in your estate. Including assets you give a child and keep the right to control.
ESTATE TAX LAWS CAN CHANGE:
Finally, estate tax laws can change. Thirteen times in 25 years, overhauls, tightenings for some, headaches for all. Congress is always tinkering with the idea that they know better than you, where your money should go.
Planning your estate is not an easy task. It takes time and effort. The place to begin is with yourself, your own goals and consideration of your heirs, their ages, abilities, needs and so on at a time when there's no pressure to implement.
