Which Assets Go To Which Trusts Under Your Will:
Executors (or trustees of your revocable living trust) have to make decisions as to which assets of your estate should be transferred to which trusts ("funding"). The planning opportunities, traps and complications are far greater than most executors, trustees and heirs realize. Let's take a look as just some of the questions that can come up in a typical estate of a married couple, on the death of the first spouse. There are likely to be at least two trusts (often many more) to which your will provides for distributions:
1. A By Pass trust (also called "credit shelter trust") which can be funded with up to $2 million in assets to protect the $2 million current federal exclusion (the amount you can bequeath federal estate tax free). This amount is supposed to increase in future years. The assets in the By Pass trust will be available to the surviving spouse, but not taxed in his or her estate. In many instances a lower amount may be transferred to the By Pass trust (if the will or post-mortem planning permits) to avoid state estate taxes (many states don't follow the federal law and have lower exclusions).
2. A marital bequest which can be out right to the surviving spouse, with no trust; to a marital trust such as Qualified Terminal Interest Property Trust ("QTIP"); or a Qualified Domestic Trust ("QDOT") if the surviving spouse is a non-citizen. There are other options but the key is that this bequest qualifies for a marital deduction to avoid estate tax on this portion of the estate on the death of the first spouse. Let's assume that the entire amount is to be held in a QTIP - marital trust (trusts provide far more planning flexibility and protection then an outright bequest to the surviving spouse).
Which Document Controls:
If your will specifies that a particular asset should be distributed to a designated trust, then that decision probably controls. For example, if you have a family business you want to retain in the family line, you may bequeath it to a QTIP-Business trust with specially selected trustees, principal invasion rights, and eventual distribution to your named heirs. The rest of your assets may then be divided between a By Pass trust and regular QTIP trust (i.e. a QTIP trust intended to hold all assets other than the business). Other documents may be relevant. For example, if you own stock in a close corporation, the shareholders' agreement may govern where your stock must be distributed.
Who Allocates Assets Between the Trusts:
When there is a choice, the decision as to which assets should be transferred to which trust should be a team approach to address the many income tax, estate tax, legal, business and other issues that can be affected. The team could include, depending on the asset and issues: accountant, probate attorney, corporate counsel, pension consultant, investment adviser, and others. Don't expect your probate attorney to be as sharp on income tax issues as your accountant, and don't expect your accountant to identify the optimal mix of securities with the same skill as your wealth manager.
Factors to Consider:
There are a myriad of issues that can be relevant to making the decision as to which assets are best to transfer to which trust under your will. The following is only a partial listing:
o How is the funding of the trust structured in the will. For example, if the By Pass trust is funded under a pecuniary formula, and assets have appreciated between the date of death and the funding, an income tax cost may be incurred on funding.
o Who are the current beneficiaries of the different trusts? For example, in some plans the surviving spouse is the only current beneficiary of both By Pass and QTIP trusts. In other plans, the surviving spouse, children and others may all be beneficiaries of the By Pass trust. So, for example, if the children are beneficiaries of the By Pass trust, and certain assets should be made available to them or for their benefit, those assets should be used to fund the By Pass trust. Another example, if the family home is in the estate, it might be best to fund it to the QTIP trust to assure that only the surviving spouse has access to it if other persons, especially children from a prior marriage, are named beneficiaries of the By Pass trust.
o Who are the remainder beneficiaries of each trust? If different people are intended to receive assets on the death of the second spouse, than those assets should be distributed into the trust which will be appropriate for them.
o Which assets are most likely to appreciate? Since appreciation in assets in a By Pass trust will be outside of the surviving spouse's estate the assets with the greatest appreciation potential could be funded to the By Pass trust. For marketable securities a investment advisor should be consulted about this decision. The solution may even be to acquire new investments for each trust, in lieu of some of the current investments held in the estate. Since the estate obtains a step up in basis on your death, the executor may just choose to liquidate most marketable assets and have the investment adviser create optimal portfolios in each trust after funding them with cash.
o Who are the trustees of each trust? If different trustees are named there may be an advantage to transferring assets to the trusts so that the trustees best suited to manage those assets have those assets in their trust. In light of recent court cases the likelihood of a trust benefiting from a deduction of investment management fees is looking bleak. If the trustees of one trust have the skills to directly manage investment assets transferring marketable securities to that trust may have a better result than transferring securities to a trust which will have to hire outside money managers whose fees won't be deductible.
o State income taxes may be an issue. If, for example, your estate owns real estate or business assets that will generate income taxable in a particular state, it might be possible to segregate all of those assets in one trust, and manage the second trust in a manner that avoids state taxation. For example, real estate in State A may be put solely into the By Pass trust which will remain taxable in high tax State A. Only securities may be transferred to the QTIP trust. The trustees of the QTIP trust that reside in State A may resign so that there are no longer any connections of the QTIP trust to high tax State A. The savings over time can be significant.
o Discounts on ownership interests in businesses (real estate, family business, investment LLC, etc.) could be an important factor. If your estate owns 60% of a family business, transferring 20% to the By Pass trust and 40% to the QTIP trust will assure that on the death of your surviving spouse each of those interests will have a greater likelihood of qualifying for a discount for lack of control, lack of marketability, etc. If instead the entire 60% is transferred to only the QTIP trust, there may be a control premium actually increasing taxes on the second death.
There could be a myriad of other factors to consider. So the best answer is involve all your professional advisers and plan the decision carefully.
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