I. What is a living trust?
Basically, a Living Trust (also known as revocable trust, declaration of trust, grantor trust, and many other names) is a trust in which the same individual is simultaneously the creator, or “settlor”, of the trust, the initial trustee and the initial beneficiary. Such “one party” trusts are valid in Illinois and most other states.
To create a valid Living Trust, your intention to establish the trust must be clear and unequivocal, there must be a transfer of property, although nominal, to the trust, and there must be an ascertainable trust beneficiary. As discussed in more detail below, to be fully effective, the provisions of the Living Trust should encompass not only the period of time during which you, as settlor, are acting as trustee, but, in addition, any period of time in which you are not acting as trustee due to incapacity, illness or death (i.e., incapacitated).
Stated very broadly, a well-prepared Living Trust should contain provisions dealing with the disposition of trust assets both during your lifetime and after your death, as well as with the trustee’s powers to make distributions and investments both during your own trusteeship and during the trusteeship of any successor trustee.
In funding your Living Trust, title to your assets is transferred by you individually to you as trustee and thereafter you own the trust assets in that capacity. At your death, a probate proceeding is necessary to transfer only those assets registered in your name individually and therefore no probate would be required as to assets registered in your name as trustee or as to assets passing by joint tenancy or by beneficiary designation (such as proceeds from life insurance policies and retirement plans). Creating and funding the trust has no gift tax effects and, apart from reporting requirements, no income tax effects (essentially, nothing changes as to the ownership, the Living Trust is only a titling mechanism).
Finally, in order that your basic estate planning objectives and tax minimization goals can be achieved, it is essential that your Living Trust be coordinated with a “pour-over” will. Such a will is designed both to add the balance of your assets to your Living Trust at your death and to specify the source of payment of debts, taxes and administration expenses in a manner coordinated and consistent with the provisions for payment of these items under the terms of the Living Trust. Without such coordination, probate assets passing outside your Living Trust may be distributed in a manner that you did not intend, and death tax minimization may be jeopardized by conflicting or ambiguous tax payment clauses in the two instruments.
II. What are the advantages of a living trust?
A. General Advantages.
As noted above, the Living Trust contemplates that you will be initial trustee with full powers to manage, invest and dispose of your assets placed in your trust to the same extent as if you continued to own those assets outright in your individual name. Such an arrangement means that corporate trustee fees and other charges are avoided during the period that you are acting as trustee. Furthermore, since you are both trustee and initial beneficiary, complete privacy and confidentiality as to the nature and extent of the assets held in your trust are guaranteed.
B. Provisions for the Event of Your Disability.
Another advantage of a Living Trust is that if you become ill, incompetent or otherwise unwilling or unable to continue to handle the trust affairs, the person or corporation named as successor trustee can automatically step in, manage the trust assets, and make distributions of income and principal to you or for your benefit as required for your support, maintenance, health or other needs and the needs of your dependents. The need for a court-appointed conservator/guardian to manage your financial affairs and the public nature of a court proceeding to determine the issue of your competency are thus eliminated, since the properly drawn Living Trust contemplates automatic succession of the new trustee in the event of your disability. The instrument should also provide for the determination of the competency of any individual acting as trustee without a court proceeding. For example, the instrument may provide that such determination is to be made by a doctor whom that person has regularly consulted. The privacy ensured by this method, as well as the ability to designate the person who is to make the determination, are clearly preferable to a public court procedure on the matter.
C. Joint Tenancy Holding.
Since a trust is not a natural person, it cannot hold title to assets in the form of joint tenancy. Joint tenancy holdings are often created to enable one person to have access to property for the benefit of the other joint tenant. The same type of “convenience” access can be accomplished, however, through a properly drafted trust instrument which authorizes the trustee to appoint “attorneys-in-fact” under a power of attorney.
D. Avoidance of a Probate Proceeding at Your Death.
Depending on the extent to which the Living Trust is funded, it may be possible to reduce the total value of assets subject to probate at your death or even to eliminate completely the need for a formal probate proceeding. Under current Illinois law, no probate proceeding is required if the total value of assets held in your individual name is less than $100,000.00. Reduced attorney’s and executor’s fees attributable to probate assets may also result from a reduced probate estate, and delays incident to the probate proceeding may be substantially lessened or eliminated.
If you own real estate assets located outside the state of your domicile, the Living Trust may also be utilized to avoid probate (known as “ancillary proceedings”) in the state in which the realty is located. The placing of title to real estate, oil, gas, and mineral interests and other interests considered to be real estate in your trust should be effective to convey these assets at your death without the expense and delay of an ancillary proceeding.
E. Payment of Death Taxes.
As noted above, coordinated tax clauses in the Living Trust and “pour-over” will permit payment of death taxes from the most convenient “pocket” while ensuring that the tax exempt status of insurance and qualified employee benefit plan proceeds will not inadvertently be jeopardized by use in payment of death taxes.
III. What are the disadvantages of a living trust (if any)?
A. Necessity for Funding of the Trust.
Assuming that your goals in establishing the Living Trust include avoiding (as opposed to reducing) probate at your death and achieving automatic succession of the designated successor trustee to manage all your assets in the event of your disability, it is very important that you transfer all, or substantially all, of your assets to your trust. This means that bank accounts, shares of stock, notes, bonds, and title to all real estate must be registered in your name as trustee of your Living Trust. In addition, you should change the registration of your safe deposit box to your trustee name along. Assets such as partnership interests, condominiums and oil and gas interest pose special problems and will probably require the assistance of an attorney. Of course, it is possible to have us handle the transfer of all your assets, but this will entail an additional expense to you since the transfer of all your assets may require many hours of attorney time.
B. Proper Filing of Income Tax Returns.
(ONLY IF A 3RD PARTY TRUSTEE IS ACTING (i.e., not the grator/settlor) Because the Living Trust, when funded, becomes a separate entity, a 3rd party trustee will be required to file an annual fiduciary income tax return (Form 1041). This return is merely a reporting device on which is set forth the trust income, deductions, and credits on a separate statement attached to this return. Because such a trust is a “grantor trust”, you will include all the trust income, deductions and credits on your own personal income tax return (Form 1040), and pay tax thereon. Thus, although the trust itself pays no tax and the return is not difficult, it is a nuisance and can be an irksome job for the 3rd party trustee. Of course, it is possible to have our firm or an accountant prepare the return for you, but this entails an additional expense to you. As long as you are acting as a trustee of the Living Trust, no separate tax reporting is necessary. All income is reported on your personal income tax returns. However, if you stop acting as trustee, then a separate tax number will be required for the Living Trust and separate trust tax returns will be required. These separate trust tax returns are for reporting purposes only and no
income taxes are payable by the trust. You will continue to include all the trust income and pay income taxes related thereto on your own personal income tax returns.
C. Maintenance of Separate Trustee Accounts and Records.
You, as trustee, should open a trust checking account and process all receipts and disbursements through it, including all distributions of income and principal to yourself. It is also important to retain clear records regarding which assets are registered in the trust name and which, if any, are still held in your name. If there is confusion as to registration, the job of your successor trustee will be unnecessarily complicated, and he/she may be forced to undertake a court proceeding at your death to transfer assets held in your individual name into the trust. If trust assets are sold, any new assets acquired with the proceeds of sale must be registered in the trust name, not your name.
D. Changing Your Domicile.
If you are contemplating establishing a permanent home out of Illinois, it is important that you notify us so that we can check whether that state recognizes Living Trust (which most states do) or has requirements for execution of such trusts which are at a variance with Illinois requirements. Similarly, if you are considering acquiring real estate interests outside of Illinois, you should notify us so that we can determine whether local state law permits title to be recorded in the trust name or whether some other approach will be necessary. Some states require rather detailed disclosure of information regarding trust beneficiaries, trust assets and other matters, and you should be apprised of those requirements before purchasing real estate in those states.
E. Prohibited Assets.
A few assets may be inappropriate for transfer to the Living Trust. Severe and unfortunate tax problems may result from transfer of these assets. They may require probate. An attorney should review the types of assets proposed to be placed in the Living Trust.
F. Loss of Estate as Separate Tax-Paying Entity.
In some circumstances, it may be preferable deliberately to retain a certain amount of assets in your name so that the probate estate may be used as a separate income tax-paying entity at your death. There may be some tax deferral structures that may often be used to the extent the estate’s effective income tax bracket is lower than that of the estate’s various distributees. Thus, overall income tax liability may be spread over two entities, your estate and your Living Trust, rather than one entity, your Living Trust. Consequently, in some instances a fully funded Living Trust may result in the payment of more income taxes than would have resulted if a probate estate had been in existence.
Finally, it is important that you understand that a Living Trust does not (1) remove property from your estate so that your estate will be taxed at a lower level; or (2) avoid any estate or gift taxes; or (3) create a shelter from creditor and other claims. Generally speaking a Living Trust is tax-neutral for all purposes.
The above constitutes merely a summary of the more important consideration involved in a LIVING TRUST, and you will probably have additional concerns which you will want to discuss.
If you have any questions about living trusts, or if you would like to explore your option with regards to creating one, please call our office at (815) 726-4311. Our team of wills, trusts, and estates lawyers are ready and willing to help you through any eventuality.