Ode to the Trust – 1st Sonata

Type of Trust:  Understand the nature or type of trust involved. This will help you identify many other issues you will have to address to properly operate your trust: tax filing requirements (grantor trust, split-dollar loan statement, gift tax return, etc.). The tune of your trust can be classified in a myriad of ways: Revocable versus irrevocable (can’t change); Grantor (person establishing the trust is taxed on the trust) versus non-grantor (trust pays its tax, subject to the complex “DNI” rules on when distributions carry income out to beneficiaries); Testamentary (formed at death) or inter-vivos (formed while you’re alive); etc. The type of assets held by a trust can have a significant impact on the terms of the trust and required operational steps: life insurance, S corporation stock, etc. Each note has importance to operational steps: Life Insurance Trust: In most instances, Irrevocable Life Insurance Trusts (“ILITs”) are grantor trusts. This means that income (which is usually negligible) is taxed to the grantor/insured. It also can have benefits to minimizing tax rules when transferring or selling policies. ILITs are typically set up to assure that the proceeds are excluded from the grantor/insured’s estate and not reachable by creditors or ex-spouses. These latter benefits will remain vital whatever the tax finale Congress sings. There are many variations on this type of planning and the types of trusts that might own insurance. Evaluate transferring new policies to the ILIT in light of the large $5M exemption, or unwinding split dollar loans. Dynasty/GST Trusts: These perpetual trusts are typically (2010 remains an oddity) intended to continue for a loooong time, often in perpetuity, without triggering estate or GST tax at generational levels. This may require an allocation of GST exemption on a gift tax return unless it is confirmed that the GST automatic allocation rules apply. Plan now, the Obama budget has proposed limitations on these trusts. Child’s Trust: Confirm whether Crummey powers are used, whether the trust fulfills a parent’s obligation to support income may be reported to the parent. Alternatively, the trust may have intentionally been structured as a grantor trust so that the parent/grantor’s payment of income tax leverages greater asset growth in the child’s trust.

Payments to Be Made: Many trusts require exacting payment schedules. Are they monthly, quarterly or annually? What date are they due? The anniversary date of the funding of the trust or year end? Charitable Remainder Trusts (“CRTs”), Grantor Retained Annuity Trusts (“GRATs”) require payments be made to you as grantor. If not made as required the trust will hit a flat note for tax purposes. Identify the amount and timing of the required payment and set up procedures to assure they’re sung in tune. If there is a unitrust payment, or inflation adjustment, be certain the calculations follow the trust terms. If an appraisal is necessary to calculate a payment, get the process going far enough in advance so that the trustee can make a timely payment. Have your CPA set up a chart of all payments and collect proof of payments now, so you’re ready when Uncle comes knockin’.

 Trust Permanent File: Every fiduciary and adviser should have a file of critical trust documents. Once this file is set up in an organized fashion, tailored to the specific trust involved, operating your trust becomes as simple as playing Choptstix. Consider: Trust agreement. This is the key to all operational decisions from investments to distributions. Be certain you have the entire trust and all ancillary documents, including: schedules listing assets transferred, amendments (if not irrevocable), etc. Fiduciary actions. The fiduciaries (trustees, investment advisors, distribution committee, someone holding a power to designate a charitable beneficiary, etc.) of a trust may have the authority to take certain actions that affect the trust. You need to maintain copies of all these actions. Sometimes it is essential to confirm that anyone holding a power has not exercised that power (e.g., if someone has a power to substitute assets whether or not they have done so is essential to confirming the assets of the trust). Periodic confirmations of actions not taken can be as important as copies o factual written actions taken. Beneficiaries. Current data on trust beneficiaries should be maintained: addresses, Social Security numbers, residency/domicile which may affect how the trust is taxed as well the marginal state/federal income tax rate to be considered in planning investments, etc. Crummey Powers: If gifts to the trust require notices of annual demand powers be issue to qualify for the annual gift tax exclusion records confirming that these notices were properly issued must be maintained in order to support favorable gift tax treatment. The trust CPA should consider whether a gift tax return can be filed reporting all gifts to toll the statute of limitations on an IRS audit. Too often, years after a trust has been established, notices are lost, not sent, or wind up being handled in a manner contrary to either the terms of the trust or the law. Even if you are sure that estate taxes will never matter (the exemption is still scheduled to plummet to $1M in 2013) failing to adhere to the terms of an irrevocable trust may still create liability for the trustee, demonstrate to a court that you have ignored the formalities of the trust in the event of a future suit or claim, etc. The trust permanent file should include copies of all Crummey notices since inception, and demonstrate that they were properly prepared and acknowledged.  Trust assets. Understanding trust assets is essential to a host of planning issues. Are the assets properly insured with the trustee properly covered? Too many people have residential real estate that is owned by a trust but insured as if owned by them personally. Will that suffice to protect the asset and trustee in the event of a casualty or suit? The assets may determine which fiduciary (e.g., investment advisers) has responsibility. Assets can impact state tax filing requirements. Assets should be consistent with the trust Investment Policy Statement (IPS). Should assets be supplemented by additional gifts be made to existing trusts to capture the new $5M gift exemption? The Obama budget proposal calls for a reduction to a $1M gift exemption.

Ancillary Transactions:  Ancillary transactions affect the necessary legal documentation, trust income tax return, and more. Split-dollar insurance. A split-dollar arrangement may have been used to pay for a portion of life insurance premiums.  Split-dollar loans require a statement to be filed with the trust and premium payor’s tax returns. If the trust involved is not an insurance trust, it might be the party advancing premiums for the policy owned by an insurance trust or family business. Split-dollar arrangements all need to be reassessed, and many unwound using the new $5M gift exemption. Guarantee. If the family engaged in any intra-family sales (e.g. a note sale to a grantor trust) a trust other than the purchasing trust may have guaranteed a portion of the payments. Are guarantee fees advisable? Were they in fact paid and reported appropriately? The $5M gift exemption gives leeway to make gifts to reduce or eliminate the need for guarantees. Loan Arrangements. With historically low interest rates many family entities have engaged in intra-family loans. Proper documentation, payment and reporting of interest, etc. is essential. Post tax season be certain you have all relevant documents that the interest rate charged is adequate, and that other formalities are adhered to. Personal use assets. If a trust purchases a house for a beneficiary, be certain that property tax and mortgage interest deductions are being properly handled both for the trust and those using the property. Clients often seek to deduct property taxes for a personal property that may be owned by a trust (e.g., the surviving spouse resides in the marital residence now owned by a bypass trust).

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