Living Trusts (specifically, Revocable Living Trusts)

  1. The Task: Avoiding a Probate at Death
  2. A Possible Solution: A Corporation
  3. The Solution: A Living Trust
  4. Its Proof: A Living Trust Works

The Task: Avoiding a Probate at Death

Our task is to avoid a probate at death. To avoid a probate at death, we cannot at death own any property titled in our name. The easiest way to avoid having property titled in our name at death is to have given it all away during life. The task, therefore, is to find some way of “giving it all away during life” while retaining all of its benefits for the rest of our life as well as the ability to control its disposition at death.

A Possible Solution: A Corporation

If we were thinking not so much about our personal assets but about forming a business, the solution would probably be intuitive: Form a corporation as the entity for our business. We would create a corporation and transfer our cash and other business assets to the corporation in exchange for its shares. As its only shareholder, we would elect our self as its chairman to run the corporation for the benefit of its sole shareholder, us. Furthermore, the corporation would take on a life of its own, in perpetuity. Upon our death, the shareholders, whoever they may be as the result of the disposition of our shares, would elect a new chairman, but the corporation itself would continue right along, without need for retitling its assets, dissolution, reincorporation, or whatever.

A corporation will work for our estate planning, and some people do use them primarily for estate planning, in which case they are called personal holding companies. But the fundamental problem is that corporations, while ideal as entities for business operations, are impractical for personal estate planning. The general idea works, but the execution fails.

The Solution: A Living Trust

We need to look for an entity that is more favorable than a corporation in its use for personal estate planning. That corporation-like entity exists, is called a Living Trust, and, in fact, has been serving people for almost 1000 years now.

If you are unfamiliar with Trusts, please use some “beginner’s mind.” When many people hear “a Trust,” they think of the Rockefellers, the Vanderbilts, Newport, Rhode Island, Palm Beach, Florida, Rolls Royces, and 5 o’clock tea at the Ritz. Granted, the Rockefellers, the Vanderbilts, and the wealthy in general have their Trusts. The point is: A Trust might work as well for you, too.

Compare the creation and the principal players of a corporation with that of a trust:

Function or Status Corporation Living Trust
1. To set forth the terms and provisions for the operation of your entity: You write Articles of Incorporation and By-laws for it You write a Declaration of Trust (or Trust Agreement) for it
2. To create your entity: You transfer property to the corporation in exchange for its benefits in the form of its shares (and file the Articles with the Secretary of State etc.) You transfer property to your Living Trust in exchange for the right to:

  • Receive its benefits for the rest of your life,
  • Direct its benefits at your death, and
  • Change or revoke it during your life as you see fit.
3. As the person who creates the entity and funds it, you are known as its: Founder Trustor (or Grantor or Settlor)
4. As the person who will receive the entity’s benefits, you are known as its: Shareholder Beneficiary
5. As the founder/shareholder or the Trustor/Beneficiary, you will elect or appoint yourself as its manager and be known as its: Chairman/President Trustee

Proof: A Living Trust Works

You’re now in business! And, as your first act in business, you, as Trustor, will transfer all your personal assets to and re-title them in the name of your Living Trust (technically, you will transfer them from yourself in your individual capacity to yourself in your capacity as Trustee of your Living Trust). Result:

  • Immediately before the transfer:
    • All of your assets were titled in your name as an individual.
    • Had you then died, owning all those assets titled in your name, they would have been required to be probated in order to take your name off their title and transfer them to and re-title them in the name of your transferees, for example, the beneficiaries under your Will.
  • Immediately after the transfer:
    • All of your assets are now titled in the name of your Living Trust, as an entity that will live for as long as your have provided in your Declaration of Trust, for example, in a typical marital situation, upon the later of:
      • Your death,
      • Your spouse’s death, and
      • Your youngest child attaining an age that you have selected, such as 35.
    • Had you then died, all those assets would continue to be held and managed by your Living Trust, although now for the benefit of others (eg, in a typical marital situation, your surviving spouse and children) as your beneficiaries, as you have provided in your Declaration of Trust.
    • As there is no need upon your death to re-title the assets held by your Living Trust, there is no need for those assets to be probated. You have avoided a probate at your death to the extent that “your” assets are now held by your Living Trust, over which you, as Trustee, have complete control.

Side-bar: Some nomenclature: Unless otherwise specified, the Trusts discussed on this website are known:

  • For property law purposes as:
    • Revocable Trusts, meaning that the person who creates the Trust (ie, the Trustor) may revoke or modify it at anytime during his/her life for no reason at all (as opposed to an Irrevocable Trust, which cannot be revoked once it has been created); and
    • Living Trusts (also known as Inter Vivos Trusts), meaning that the Trust is not only created but also comes into being during the Trustor’s life (as opposed to a Testamentary Trust, which although created by a Testator in his/her Will during his/her life, comes into being only following the Testator’s death, upon the closing of probate and the distribution of its assets, here, from the Testator/Decedent’s Personal Representative to his/her Testamentary Trustee).
  • For tax law purposes as:
    • Grantor Trusts, meaning that the the person who creates the Trust retains for his/her life any one or more (and usually all) of a number of different rights to the Trust, for example:
      • To revoke it,
      • To receive any of its income or to have it used to pay premiums on insurance policies on that person’s life,
      • To obtain any of its assets other than by purchase at fair market value,
      • To borrow any of its assets without adequate interest and security, or
      • To receive any of its assets at a later date.

      For income tax purposes, Grantor Trusts are ignored, and all of their tax attributes (income, expenses, tax credits, etc.) are attributed (ie, passed on) to the Grantor during his/her life and reported on the Grantor’s individual income tax return (Form 1040). At the Grantor’s death, Grantor Trust status stops, the Trust becomes a separate tax-paying entity, and its tax attributes are reported by its Trustee on a fiduciary income tax return (Form 1041).

      Summary: For income tax purposes, Revocable Living Trusts are “transparent” during the life of the Grantor and take on a life of their own only upon the Grantor’s death, as would that person’s probate estate if he/she had chosen to use a Will, instead of a Living Trust, as his/her estate planning vehicle. As a corollary, Living Trusts cannot be used to obtain income tax savings during the Grantor’s life (a Living Trust and its living Grantor being identical in the eyes of the IRS). As will be discussed further on, the primary reasons for using a Living Trust are:

      • To avoid probate at death and possibly
      • To ease financial management upon disability —
      • Not to effect either income or estate tax savings or avoidance, either during life or at death.

Bottom-line: This process was created by some of history’s first “estate and tax planners” in order to reduce the “property, income, and death taxes” imposed on the common folk of England upon their defeat by William the Conqueror in the Battle of Hastings in 1066. This process has continued successfully ever since. In its almost 1000 years of existence, its “bugs” have been worked out. You should not expect any “manufacturer’s recalls” except as a result of a future change in the law.

Furthermore, upon creating a Living Trust in the present, if there is any change in the law in the future:

  • During your life: You should be able to respond to it, if you desire to do so, by changing your Living Trust to take advantage of (or protect yourself against) those legal changes, because your Living Trust remains fully revocable and amendable.
  • Following your death: Your Living Trust should not become burdened by any change in the law, because by then your Living Trust will have become irrevocable and unamendable, and for our purposes, the due process clause of our Constitution provides in effect that a current change in the law cannot negatively affect a then valid irrevocable Trust or take effect retroactively (eg, when your Living Trust was revocable and amendable).