Living Trusts – Who Can Get a Copy of My Trust?

Who’s Entitled to See Your Living Trust?

As a California attorney for 30 years, I’m often asked the question:

Is anyone entitled to receive a copy, for example, of my parent’s living trust before one, or both, have passed away?

The answer depends upon whether their trust is revocable or irrevocable.

If the trust is irrevocable, then the answer is generally yes. Irrevocable trusts mean just that – they can’t be changed or amended. However, there are some exceptions where, for example, the trustor (the person who creates the trust), trustee (person who carries out the terms of the trust) and all beneficiaries agree in writing to a change or amendment. Sometimes this would require court review and approval.

Since the general rule is that an irrevocable trust is “etched in stone”, the law recognizes the named beneficiaries as having certain rights, including the right to receive a copy of the trust.

Conversely, revocable trusts may be amended or revoked by the person who created the trust (the trustor) and the beneficiaries therefore have no assurance that the trustor won’t later change his or her mind and remove one or more persons as beneficiaries. Since their interest is not “vested”, they have no right to receive a copy of the trust.

However, a revocable trust will become irrevocable when the trustor passes away. Only the trustor (not the “trustee”) has authority to make changes to a revocable trust. When the trustor dies, then the trust becomes “etched in stone”.

A revocable trust may also become irrevocable if the trustor becomes mentally incapacitated and no longer able to understand what a trust is, what assets she or he (and the trust) owns, or who the beneficiaries are (or could be). At this point, a beneficiary could argue that the trustor’s diminished mental capacity will not be reversed and will only progressively get worse, and therefore the trust has become irrevocable and the beneficiary is entitled to receive a copy of the trust.

In rare cases, this is an example of why a trust doesn’t always “avoid probate” or, more accurately, avoid the probate court. A beneficiary desiring to see the trust might petition the court for that right, but may meet strenuous objection from the trustee who doesn’t feel that it’s proper to disclose the terms of the trust. The trustee will argue that the trustor’s diminished mental capacity is not substantial and that future medical treatment and proper medications will improve his/her capacity.

You can see how litigious this can become, with both sides presenting expert medical testimony to convince the judge of the trustor’s capacity (or lack thereof). If a trust has become irrevocable (either because of death or mental incapacity), then a beneficiary who wants to see the trust can simply make a written request to the trustee. If the trustee refuses, then a petition can be filed with the court asking that the judge order the trustee to provide a complete copy of the trust.

The vast majority of revocable living trusts run smoothly, and don’t require any court intervention.

Whether you actually need a trust, or need an attorney to help create one, are topics discussed throughout my Living Trust Advocate website. After reading (and studying) the information provided on that site, you may find that you don’t need a trust. Or, you may decide that you’re one of the millions who could benefit from having a simple living trust. But you’ll find that the content on that site provides you with probably much more information than a private attorney will reveal to you (or even know).


Holding Investment Real Estate – LLC, Trust, Or Both?

The Issue: How to Hold Property in California?

Countless individuals invest in real estate every day. Some dream of becoming the next real estate mogul, while others simply wish to supplement their salary with additional income. Whatever your motivations, owning investment properties can produce big rewards, but also big problems. This is why it is important to hold title to your property in the most beneficial way. The internet is saturated with various posts and articles touting the most effective techniques to manage your property. It can often be a daunting task weeding through the mass of information in an attempt to discern what advice is reliable and what advice can get you into trouble. Our goal here is to provide a succinct and clear summary of the safest and most important strategies for holding investment property in California. We hope the result will be a valuable starting point in considering the best ways to both protect you as the owner/landlord from liability and also guarantee the best treatment of your assets.

The Risks of Owning Real Estate

As stated above, while property can be a valuable investment, there are also significant risks. One of the biggest risks is lawsuits. From common slip and falls, to environmental contamination, landlords and owners are easily exposed to legal judgments. Landlords have also been successfully sued by victims of crimes — such as robberies, rape, and even murder — that occur on their property on the theory that the landlord provided inadequate security.

Options for Holding Real Estate

Faced with the risk of lawsuits, it is crucial that you do not own investment real property in your own name. (The only real property you should hold in your own name is your primary residence.) Thankfully, there are several ways in which an individual can hold property other than in his/her own name. These include as a corporation, limited partnership, limited liability company (“LLC”), trust, and many others. While there are many options, when it comes to real estate investment, LLCs are the preferred entity by most investors, attorneys and accountants.

For many reasons, few investors hold investment real estate in C corporations. A corporation protects the shareholders from personal liability, but the double taxation of dividends and the inability to have “paper losses” from depreciation flow through to owners make a C corporation inappropriate for real estate investments.

In the past, partnerships and limited partnerships were the entities of choice for real estate investors. Limited partners were protected from personal liability while also being able to take passed through tax losses (subject to IRS rules–you’ll need an accountant or attorney to sort out the issues of at-risk limitations and so on) from the property. However, the biggest downfall with limited partnerships was that someone had to be the general partner and expose himself to unlimited personal liability.

Many small real estate investors also hold property in a trust. While a living trust is important for protecting the owner’s privacy and provides valuable estate planning treatment, the trust provides nothing in the area of protection from liability. However, although a trust provides no liability protection, it should not be overlooked, as it can easily be paired with an LLC.

1. Benefits of a LLC

LLCs appear to be the best of all worlds for holding investment real estate. Unlike limited partnerships, LLCs do not require a general partner who is exposed to liability. Instead, all LLC owners — called members — have complete limited liability protection. LLCs are also superior to C corporations because LLCs avoid the double taxation of corporations, yet retain complete limited liability for all members. Furthermore, LLC’s are rather cheap and easy to form.

A. One LLC or Multiple LLCs?

For owners of multiple properties, the question arises whether to hold all properties under one LLC, or to create a new LLC for each additional property. For several reasons, it is generally advisable to have one LLC for each property.

First, having a separate LLC own each separate property prevents “spillover” liability from one property to another. Suppose you have two properties worth $500,000 and they’re held in the same LLC. If a tenant is injured at property 1, and wins a $750,000 judgment, he will be able to put a lien on both properties for the entire $750,000 even though property 2 had nothing to do with the plaintiff’s injury.

On the other hand, if each property had its own LLC, then the creditor could only put a lien on the property where the plaintiff was injured (assuming that they cannot pierce the corporate veil).

Additionally, many banks and lenders require separate LLCs for each property. They want the property they’re lending against to be “bankruptcy remote”. This means that the lender doesn’t want a problem at a separate property to jeopardize their security interest in the property that they’re lending on.

2. Benefits of a Trust

As stated above, an LLC may be used concurrently with a trust to provide the best protection and estate treatment for your property. There are many types of trusts, but the revocable living trust is probably the most common and useful for holding title to real estate. The major benefit from holding property in a trust is that the property avoids probate after your death. As many are aware, probate is a court-supervised process for transferring assets to the beneficiaries listed in one’s will. The advantages of avoiding probate are numerous. Distribution of property held in a living trust can be much faster than probate, assets in a living trust can be more easily accessible to the beneficiaries of the trust, and the cost of distributing assets held in a living trust is often less than going through probate. [Note: One should also be aware of other ways to avoid probate. For instance, property held in joint tenancy with a right of survivorship automatically avoids probate whether or not the property is in the living trust. Consult an estate planning attorney for more advice regarding probate matters.]

3. Use Both an LLC and a Trust

Because an LLC and a trust both provide significant benefits to the owner of real property, a smart investor should consider using both a LLC and a trust to adequately protect himself and his property. Utilizing both a trust and a LLC creates the best combination of liability protection and favorable estate planning. To accomplish this, the owner should hold the investment property in a single member LLC, with the living trust as the sole member of the LLC. Here, the trust is the owner of the company and holds all of the interests of the LLC. This form of ownership gives you an added layer of protection from the LLC as well as the additional estate planning benefits of a trust.

A. Costs

For the most part, the costs of forming and maintaining an LLC and trust are rather minimal. For an average LLC, the costs are simply nominal filing fees and an $800 per/yr fee to the state of CA. While simple incorporations may be done on your own, it is strongly advised that you seek the advice of a knowledgeable attorney so that no mistakes are made. The same may be said for forming a trust. A little money now is worth the price of avoiding big problems in the future.

B. The CA LLC Fee

While the costs of forming a LLC are generally small, there are additional fees that may be imposed on LLCs in California depending on gross profits. The California Revenue and Taxation Code Section 17942(a) includes an additional fee on LLCs if total gross income (i.e. rent) exceeds $250,000. “Total gross income” refers to gross revenues (not profits). Under this Tax Code Section, the amount of the fee is determined as follows:

1. $0 for LLCs with total gross income of less than $250,000;

2. $900 for LLCs with total gross income of at least $250,000 but less than $500,000;

3. $2,500 for LLCs with total gross income of at least $500,000 but less than $1,000,000;

4. $6,000 for LLCs with total gross income of at least $1,000,000 but less than $5,000,000; and

5. $11,790 for LLCs with total gross income of $5,000,000 or more.

Although the fee is relatively small, one must consider that the fee is assessed against gross revenues, not profits. This means that the fee is due whether or not your property is profitable. For a property with high revenues but narrow profit margins, the fee would reflect a higher portion of the property’s profitability than it would on a property that is highly profitable. For example, a company that owns an office building with revenues from rent totaling $1 million, but a mortgage of $995,000, would actually operate at a loss after the $6,000 fee was imposed. Furthermore, the fee would be particularly irksome for those companies that foresee incurring losses in their early stages of development.

4. Limited Partnership: a Possible Strategy if Gross Receipts Exceed $250,000

For the vast majority of investors, the CA LLC fee should not dissuade you from forming an LLC. If, however, the impact is severely detrimental, there are several potential solutions that may be explored. A competent attorney or accountant may be able to work with you to avoid this fee. One method may be to form a Limited Partnership. The partnership should be set up with an LLC as the General Partner (assuming liability) and the owner(s) of the property as the limited partner(s). By forming a limited partnership with an LLC acting as the general partner, the landlord can likely avoid the higher fee imposed on an LLC while still protecting his/her personal liability. While this may be a possible solution, it is strongly recommended that you consult with an attorney or accountant regarding the best course of action.

While there are risks associated with real estate, with intelligent decision-making and thoughtful preparation, real property can be a valuable investment. The first step though, is to make sure that you have adequately protected yourself and your property. We hope that this article helps property owners begin to discover the various ways in which one may hold investment property, as well as the protections and benefits provided by such ownership.


What Is the Cost of a Living Trust in California?

Different Living Trust Costs and Options

There are a variety of options when completing a California living trust. After some extensive research to determine the cost of a living trust in California, I’ve summarized my results into 2 categories:

* In-Office Consultation

* Online Living Trusts

In-Office Consultation

The In-Office Consultation is your traditional office visit with an attorney. You see these a lot of these listed in the yellow pages. They offer you a free one-hour consultation in the hopes of earning your business.

The typical charge is $2,500. The services provided will be a complete estate plan, which includes a living trust.

Lawyers in California are required to have you sign a fee agreement. This fee agreement will dictate the terms of payment, document delivery, etc. You will typically need to pay the $2,500 up front. This $2,500 will be deposited into the attorney’s trust account.

These types of contracts typically take 3-4 weeks to complete.

After interviewing several law firms, I found they typically include the following documents in their California estate plan:

* California Living Trust

* California Advance Health Care Directive (Living Will)

* California Power of Attorney for Finance

* California Pour-Over Will

The Advance Health Care Directive is important in case you are incapacitated because it allows you to appoint a health care agent who has the authority to make decisions based on your current wishes.

The Power of Attorney for Finance is needed in case you are incapacitated and need someone to take care of your finances (e.g. file your personal tax returns, etc.).

The Pour-Over Will essentially transfers everything to your living trust that was not formally transferred. Basically, you are naming your California living trust as the sole beneficiary of your property.

However, these $2,500 plans did not include some key elements:

* California Notary Fees

* California Transfer Grant Deeds

California Notary Fees

Notary fees in California run a maximum of $10 per signature (that’s the law). If you are single, there are four signatures or $40. Married couples will pay $80. If you use a mobile notary, their travel fees are excessive. Many banks offer a notary service for free.

California Transfer Grant Deeds

After you complete your living trust in California, you will need to transfer your home (and any rental properties) to your living trust. Essentially, you prepare a transfer grant deed to title the property in the name of your trust.

If you don’t complete these transfer grant deeds, the living trust is invalid.

It’s much simpler on your 401k and life insurance because it’s a simple matter of naming your trust as the beneficiary. However, you cannot name a beneficiary on real estate in California. The only way to name a beneficiary on real estate in California is to use a living trust.

After you notarize the trust and prepare your transfer grant deeds (each parcel requires a separate grant deed), you will need to record them. Each transfer grant deed is recorded at the County where the parcel is located. That transfer grant deed is also accompanied by a county change of ownership report. This county change of ownership report is a document required by all 58 California Counties and is used by the County Assessor to see if the property should be:

* Re-assessed

* Documentary transfer tax be applied

Since a living trust is EXEMPT from both of these taxes, you must be careful to complete that form properly.

Now that I’ve discussed in-office consultations, let’s examine online offerings.

Online Living Trusts

There were many options for online trusts as well, as this option was gaining popularity. The price for an online living trust ranges anywhere from $297 to $997, so it’s an avenue where you can save a lot of money.

We found, just like in the in-office version, that many did not include the transfer grant deed. In fact, one provider charged an additional $249 per transfer grant deed (if you owned four properties you would pay $249 x 4 or $996).

We also found there were extra hidden fees for other documents. For example, one provider charged another $40 each for both the advance health care directive AND power of attorney (x2 if you are married or domestic partners because separate ones are required for each or $160). Make sure you pay attention to the fine print.

In the in-office consultation, you pick your trust package up in person, but the online version is shipped, so be sure to verify if the shipping charge is included.


If you have a complicated estate needs, you’re probably best meeting with a local provider in their office. Whether you are using an online provider or in-office consultation, be sure to take this list with you and ask to ensure ALL of the documents are provided.

If you have more than one piece of real estate, make sure the transfer grant deeds are completed for ALL of the properties. Also make sure they include each preliminary change of ownership report and the recording instructions (separate ones required for each deed).

Lastly, make sure the notary fees are included because they will cost you another $40 (single) and $80 (married). You will also pay another $10 for each transfer grant deed ($20 each if married).


Asset Protection Trust

What’s an asset protection trust? What’s a Trust?

A “TRUST” is nothing more than a “CONTRACT” between the person who wishes to protect his assets (the Grantor) the person who will manage the assets (the Trustee) for the benefit of all Beneficiaries which may include the Grantor, his spouse, children and grandchildren.

The Trust Contract requires the transfer of assets from the original owner (Grantor) to a legal entity for the purpose for which the Trust Contract was created.

What type of trust, Grantor, or Non Grantor? What’s the distinction? A Grantor Trust take a special place within the tax code. A “Grantor-Type Trust” for tax purposes is treated as a disregarded legal entity. The disregarded entity is “Income Tax Neutral” meaning that the original Grantor retained strings attached so that for purposes of the IRS he retains the assets in his complete control, thus he did nothing for the purpose of asset protection.

Income tax benefits and income tax expenses are retained by the Grantor, thus he pays income taxes on the income of the trust. The Trust is a “pass-through” to his form 1040 i.e. real estate tax deduction and mortgage interest deduction on his person income tax return.

Revocable, irrevocable trust, what’s that mean? Revocable is when the original person with the assets transfers (repositions) the assets to a trust with strings attached. The Grantor, the Trustee, and the beneficiary are the same person. Effectively you have kissed yourself on the hand and blessed yourself as the Pope. A revocable trust does absolutely nothing for asset protection. Many lawyers recommend revocable trusts for avoiding probate, recognizing that the trust is not worth the paper it’s written on for protecting assets against frivolous lawsuits and the avoidance of estate taxes.

An irrevocable trust is when the Grantor (the person with the assets) gives-up complete control to an independent Trustee who in turn will use his judgment as Trustee to manage the assets for the beneficiaries of the trust. The fiduciary relationship of the Trustee is to the protection of the assets at any cost. The Trustee must protect and must diligently invest under the prudent man rules, he cannot ever deal for himself.

The courts do not look favorably on dereliction of duties while serving as Trustee. An irrevocable trust is the only significant asset protection device for avoiding frivolous lawsuits, avoiding the probate process, avoiding estate taxes, and is the only device for avoiding the mandatory spend-down provisions for qualifying into a nursing home.

An irrevocable asset protection trust when combined with a Limited Liability Company is an asset protection fortress, short of a foreign asset protection trust. A foreign asset protection trust is the Rolls Royce of asset protection, the irrevocable trust with an LLC is the Cadillac.


Who Should You Trust? – Advantages & Disadvantages of Engaging in Land Trust Agreements

If you have done any research in reference to real estate lately, chances are that you have probably come across the information on land trust agreements. An agreement of this type is relatively new and often underestimated. Opting to close a deal through the incorporation of a land trust agreement is a simple and inexpensive way of handing the ownership of real estate, especially if who holds the actual title of the property is an issue for the buyer.

A land trust agreement is basically an arrangement between two parties where the recorded title of the real estate property is held by a trustee instead of the actual buyer. Creating a land trust agreement involves signing a short term trust agreement at the time real estate is purchased that is made between the beneficiary/owner and the trustee/title holder. The beneficiary directs any actions taken in relation to the property and the trustee abides. The beneficiary, which is the buyer, retains the use and operation of the property, and any income that it generates. The trustee, on the other hand, which can be an attorney, law firm, bank, trust company, or other investor holds title and acts according to the direction of the new owner.

As to who can take part in such an agreement, there really are not any set limitations. Anyone who is willing and able to enter into a contract with an investor, whether as a trustee or a beneficiary, can do so. Also, the agreement does not have to be specifically between two individuals. An agreement can be with business associates, syndicates, as a joint venture or partnership, or with other groups that have a general interest in getting involved in a potential deal.

So you may be wondering, just what is in it for the buyer and what does he/she have to gain if the title of the property is not under his/her name, upon sealing the deal. This is where this type of an agreement gets creative. Even though, the title of the home or property if officially under the name of the trustee, the buyer as the beneficiary is the actual owner of the physical property. As its owner, all rights, conveniences, responsibilities, and duties that are attached to claiming ownership of the property are subject to the beneficiary or beneficial owner. Even though his/her interest in the property is typically not disclosed, assumption of all liabilities and accountability for all occurrences that may ensue are stated and confirmed within the agreement.

So, in a nutshell, the beneficiary owns the property and acts as the record title owner but it is the trustee who officially holds the title. The beneficiary buys and claims ownership of personal property and maintains the complete management and control of it. Being the beneficiary also offers the advantage of not having to deal with any legal responsibilities, characteristics, and proceeds involved with the property.

The responsibilities of the trustee, in addition to lending their name to the title of the property, include dealing with all legal obligations, such as the execution of deeds and mortgages. But even in this area, the trustee is not left to his/her own devices. He/she usually must act under the direction and authority of the beneficiary, who is ultimately in control of the real estate.

Advantages to becoming the beneficiary of a piece of real estate are many. For example, because, they control the ownership of the property, beneficiaries have the right to the selling, assigning, or pledging of their interest in the property at their discretion. Also, if this is what they decide to do, these processes tend to be much easier to do than the more traditional and conventional methods, chiefly because they officially control the ownership of the property. Deeds are typically not needed to transfer interest in the property and it is often done by assignment.

Another advantage is anonymity. A land trust agreement can be viewed as kind of a like a vehicle that allows someone to hold title to real estate that is exempt from probate. As the ownership is not officially disclosed to the public, the owner is protected. At times the beneficial ownership may fall under legal scrutiny, but in general, basic identification information of the beneficiary is not typically questioned.

This type of an agreement is very attractive to those who wish to protect their privacy and identity in relation to the real estate in question. Since actual ownership of property is disguised, it is an optimal agreement for real estate investors that may be targets of litigation may have been sued in the past and wish to avoid a similar scenario from occurring in the future.

Succession of ownership is yet another advantage. On behalf of the beneficiary, who receives ownership of the property, financial status is not compromised if any negative circumstances were to arise. There is also a greater sense of security for benefactors involved. Partners or co-benefactors also do not have the ability to opt out of the agreement, but ownership of the property can be transferred. Another positive aspect is that there are no adverse tax consequences involved if the property ownership is transferred into a revocable trust because the owner, or grantor, controls the property where tax purposes are concerned.

The owner is also protected on another level, especially if there is more than one beneficiary that can claim and control ownership. The ease of multiple ownership is even more magnified, considering that all necessary documents must be signed, notarized, and recorded by the trustee and not the beneficiaries involved, however many of them there are.

Also, in such cases where death, divorce, disability, or other legal judgments and litigations may become an issue that involve one of the owners and not the other, a land trust agreement protects all owners individually. For example, a possible judgment or lien that could be placed on the financial holdings of one owner of a specific property, the financial situations of other owner(s) involved would not consequently be affected.

In addition, because the title is still in the name of the trustee, the title of the property is not affected even if beneficiaries are negatively dealing with claims and creditors. On the other hand, even though claims against benefactors do not directly affect the ownership of the property, the income generated from the property that belong to the benefactor does have the potential to be affected by any legal proceedings that may occur.

Another possible negative situation that may occur is the possibility that a creditor may force a beneficiary into signing over his/her beneficial interest as a resolution to a legal matter. For such reasons as the previously mentioned, it is very important to make sure that both irrevocable domestic trusts and foreign asset protection trusts that are prepared include sections that ensure that the rights of all beneficiaries involved are not compromised and a creditor can not attain the power of ownership for the real estate property in question.

As with any other agreement, it is imperative to investigate the rules and regulations that are applicable within each state. Although land trust agreements are legal and commonly used in states such as Illinois and Florida, they are illegal in others. There may also be laws that could be associated that may require the administration of the land trust agreements are executed by commercial trustees, such as banks or trust companies. Seeking the legal counsel of an attorney regarding all necessary documents and proceedings is also highly advisable.

Wealth Building

Estate Planning: Why Do I Need a Will If I Have a Trust?

If you've spent any time at all talking about estate planning, you've probably wondered why you would need a Will if you have a Trust. That is a common question. Before we explore the answer, let's review some basic differences between the two.

Most people are familiar with a Will (or "Last Will and Testament" to be fully formal), but many do not really know what a "Trust" is. Think of a Trust as being a special box into which you place your assets (bank accounts, stocks, your home, rental properties, etc.) The person you appoint to take care of the box is called the "Trustee". This person is NOT the "Executor". An Executor is appointed in a Will, approved by a court, and only has authority after you die. A Trustee generally does not need court approval, and can handle things during your lifetime and after your death. This is why it is sometimes called a "living" Trust.

There are many differences between a Will and a Trust, but the most basic differences are:

  • A Will only takes effect when you die, but a Trust can be operative both during your lifetime and after your death.
  • Property given to someone under a Will must be distributed to them outright, with no strings attached. Property given under a Trust can be given outright, or it can remain in Trust and be supervised by the Trustee. It is possible to setup a Trust through a Will, but the result is still a Trust.
  • There is more potential to reduce your estate taxes if you use a Trust rather than a Will.
  • A Trust allows you to better protect your heirs from creditors, divorce, and other relatives (or step-relatives).
  • Property given under a Will must go through the Probate Court. That process is very expensive in California, it is time consuming, and it is very public. A Trust does not have to go through the Probate Court, can remain a private matter, the expenses of probate can be avoided, and the decedent's final affairs can be handled quickly.

For most people, having a Trust is well worth the expense of setting one up – a cost which is, by the way, generally far less expensive than a probate. It is customary (though not required) to name the same person as Trustee and as Executor, so that control of both Trust and non-Trust assets are centralized in one person.

So, why do you need both? Having a Will even if you have a Trust is like having a safety net. It is very common for people to accidentally leave something out of their Trust. The family home is a good example. People buy a new home, or refinance the existing one, and forget to title the property back to their Trust when they are finished. When the person dies, the house is not part of the Trust, so "who gets it" is decided by the Will. Ideally, the Will states that all assets pass to the Trust. This way, final distribution of assets still follows the plan laid out in the Trust. Without a Will, the State will decide who gets any assets that are not in the Trust. That may or may not be the people you wanted to have that property.

A good estate plan will always include a Will, even if it has a Trust. Regardless whether you decide to have one or both, you should always get help from a lawyer. In the long run, do it yourself estate planning usually results in more expense and unintended consequences.

Wealth Building

The ABC Trust Structure Would Have Worked for Cinderella

Trusts, as we know them, have been around for hundreds of years and started under English law before America existed. However, trusts have only become popular with the American middle class for a couple of decades. Traditional structures don't always fit today's families.

An ABC trust is a very traditional trust structure that is used when a married couple wants to make sure that the children of the marriage or a prior marriage cannot be disinherited following his / her death. For example, if Cinderella's father had created an ABC trust, Cinderella would have been entitled to more rights and benefits of her father's inheritance, and the cruel stepmother could not have disinherited her.

The ABC stands for the three trusts that come into being at the first death: one is called "A", one is called "B" and one is called "C." The A Trust represents the surviving spouse's assets. The B trust represents the deceased spouse's assets and will pass estate tax free at the time of the surviving spouse's death. The C trust saves no taxes, but only exists for purposes of protecting the childrens' future inheritance. The B and C Trusts cannot be rewritten to disinherit anyone after the first spouse dies. The surviving spouse can usually use the assets of all three trusts during his / her lifetime, but cannot lose the assets of the B and C trusts to creditors or remarriage events.

However, in families that are not concerned about children from prior marriages or a spouse who cannot be trusted to protect the family assets, the ABC trust structure can backfire in a couple of ways:

1) Inconvenience . Imagine you have just lost your spouse and you go to the attorney to find out what you should do about the trust. The attorney tells you that you must divide the assets into two parts, your spouse's half and your half. You can do whatever you want with your half of the money, but you are limited to what you can do with your spouse's money for the rest of your life. Additionally, you must now file tax returns for two or three trusts instead of just one. Finally, you must answer to your children about how you are investing and spending their future inheritance. They can sue you if you break the rules.

2) Capital Gains Tax. Upon the death of the Surviving Spouse, the "A" and "C" Trusts enjoy a full step-up in cost basis which means that no one has to pay capital gains tax on the increase in value of the assets when they are sold. The "B" Trust does not get this step-up, so it may be exposed to capital gains tax upon the sale of the assets.

3) Irrevocable. The "B" and "C" Trusts are irrevocable. That means they cannot be changed without consent of all beneficiaries and a court order. If circumstances change, this could feel restrictive.

So what is the alternative? More and more married couples are using a more flexible approach. It is called a Disclaimer Trust . Disclaimer Trusts allow the surviving spouse to choose whether or not it makes sense to fill up the "B" Trust to avoid estate tax at the second death rather than being forced to do so. If we make that decision today instead of at the time of the first death, we do not have all the information we need. We don't know what the tax law will be or how much money we may have by then or even if we want to change the plan. This Disclaimer Trust requires the trustee to be responsible enough to make this important tax-driven decision within 9 months of the first spouse's death. It is not a great structure if the surviving spouse has gambling addictions or can't be trusted to handle money.

Wealth Building

Offshore Private Placement Life Insurance Dynasty Trust – Funding Through Multiple Grantors

Private placement life insurance (PPLI) typically requires a minimum premium commitment of $ 1 million or more. By pooling their available assets, two or more grantors of (ie, contributors to) an irrevocable life insurance trust (ILIT) can reach the minimum premium commitment of a PPLI policy. The insured may be one of the grantors, but need not be.

Through creative drafting of the trust document, an ILIT (also known as a dynasty trust) can provide for multiple grantors (contributors) and various beneficiaries. Each of the grantors allocates part of his lifetime gift and estate tax exemption and generation-skipping transfer tax (GSTT) exemption to cover his contribution to the trust.

A tax-efficient method of building wealth in a dynasty trust is the purchase of a private placement life insurance (PPLI) policy that serves as an "insurance wrapper" around investments. As a result, investments grow tax-free during the life of the insured, and upon death of the insured, proceeds are paid to the trust free of estate taxes. PPLI is especially useful for holding tax-inefficient short-term investments, such as hedge funds, as well as long-term high-growth investments, such as venture capital and start-up businesses.

Domestic insurance companies offering PPLI in the US typically require a minimum insurance premium commitment of $ 10 million to $ 50 million. Offshore insurance carriers are more flexible, but still seek a minimum premium commitment of about $ 1 million. This means that many potentially interested individuals or married couples from the economic middle class simply cannot enjoy the same investment and tax advantages as rich people.

In a typical PPLI-dynasty-trust scenario, an individual wealthy grantor contributes several million dollars cash or property to an offshore asset protection dynasty trust, and the trust purchases PPLI on the grantor's life. If the grantor cannot afford at least one million dollars, however, PPLI cannot be purchased.

In contrast, when multiple grantors contribute assets to a single dynasty trust, the trust is more likely to have sufficient funds for purchasing an offshore PPLI policy. For example, three hypothetical grantors might each contribute $ 400,000 worth of assets to a dynasty trust. With $ 1.2 million of assets, the dynasty trust could purchase an offshore PPLI policy, insuring the life of a suitable individual. Assets within the PPLI wrapper grow free of income and capital gains taxes. When the insured dies, the trust receives the policy proceeds free of income and estate taxes, and beneficiaries receive trust benefits free of estate and GSST taxes perpetually.

The greater investment flexibility of PPLI compared with conventional life-insurance is the ability to invest policy funds in high-return assets, such as hedge funds or start-up companies. Another important advantage of offshore PPLI is the ability of the insurance purchaser to make in-kind premium payments. For example, if one or several grantors contribute stocks, bonds, or business interests to the trust, then the trust can fund the PPLI policy with in-kind assets instead of cash.

In some circumstances, each of several grantors (contributors) will have his own ideas about how to design an irrevocable, discretionary, asset protection dynasty trust and will bring his own list of beneficiaries. Accordingly, the design and implementation of a multi-grantor trust function well when the grantors have common interests and common goals, as might exist among family members. Presumably, the number of beneficiaries increases with the number of grantors, so that trust benefits might become diluted. On the other hand, since more grantors mean more initial contributions and greater trust assets, these factors should balance. In any case, since the trustee (s) of a dynasty trust must possess substantial discretionary authority in order to achieve asset protection, a rigid allocation of benefits among beneficiaries is usually not desirable.

Grantors (contributors) of an irrevocable, discretionary PPLI dynasty trust may benefit (at the discretion of the trustee) from trust assets. As investments in the PPLI wrapper grow tax-free, beneficiaries (including grantors) may benefit from tax free loans of the PPLI policy to the trust. Upon death of the insured, insurance benefits are received tax-free by the trust. The trust could then purchase another PPLI policy to continue tax-free investment growth.

By contributing to a multi-grantor dynasty trust that then purchases and owns offshore PPLI, individuals from the economic middle class are now able to utilize a tax saving, wealth building, asset protection technique generally available only to the rich.

Warning & Disclaimer: This is not legal or tax advice.

Copyright 2010 – Thomas Swenson

Wealth Building

Save Taxes – Basics of an Irrevocable Life Insurance Dynasty Trust

For US persons, an irrevocable life insurance trust (ILIT) is arguably the most efficient structure for integrating tax-free investment growth, wealth transfer and asset protection. An ILIT comprises two main parts: (1) an irrevocable trust; and (2) a life insurance policy owned by the trust. An international (or offshore) ILIT is a trust governed by the law of a foreign jurisdiction that owns foreign-based life insurance. An offshore ILIT is better than a domestic ILIT because it is more flexible and less expensive. Regarding US tax laws, a properly designed international ILIT is treated virtually the same as a domestic ILIT.

An ILIT becomes a dynasty trust (or GST trust) when the trust’s settlor (or grantor, the person who establishes and funds the trust) applies his lifetime exemption for the generation skipping transfer tax (GSTT) to trust contributions. Once a dynasty trust is properly funded by applying the settlor’s lifetime exemptions for gift, estate and GST taxes, all distributions to beneficiaries will be free of gift and estate taxes for the duration of the trust, even perpetually. The individual unified gift and estate tax exemption and the GSTT exemption are both $5 million ($10 million for a married couple) during 2011 and 2012, which are the highest amounts in decades.

Under the US tax code, no income or capital gains taxes are due on life insurance investment growth, and no income tax is due when policy proceeds are paid to an insurance beneficiary upon death of the insured. When a dynasty trust purchases and owns the life insurance policy and is named as the insurance beneficiary, no estate tax or generation skipping transfer taxes are due. In other words, assets can grow and be enjoyed by trust beneficiaries completely tax-free forever. Depending on how a trust is designed, a portion of trust assets can be invested in a new life insurance policy each generation to continue the cycle.

Private placement life insurance (PPLI) is privately negotiated between an insurance carrier and the insurance purchaser (e.g., a dynasty ILIT). Private placement life insurance is also known as variable universal life insurance. The policy funds are invested in a separately managed account, separate from the general funds of the insurance company, and may include stocks, hedge funds, and other high-growth and/or tax-inefficient investment vehicles. Offshore (foreign) private placement life insurance has several advantages over domestic life insurance. In-kind premium payments (e.g., stock shares) are allowed, whereas domestic policies require cash. There are few restrictions on policy investments, while state regulations restrict a domestic policy’s investments. The minimum premium commitment of foreign policies typically is US$1 million. Domestic carriers demand a minimum commitment of $5 million to $20 million. Also, offshore carriers allow policy investments to be managed by an independent investment advisor suggested by the policy owner. Finally, offshore policy costs are lower than domestic costs. An election under IRC § 953(d) by a foreign insurance carrier avoids imposition of US withholding tax on insurance policy income and gains.

Whether domestic or offshore, PPLI must satisfy the definition of life insurance according to IRC § 7702 to qualify for the tax benefits. Also, key investment control (IRC § 817(g)) and diversification (IRC § 851(b)) rules must be observed. When policy premiums are paid in over four or five years as provided in IRC § 7702A(b), the policy is a non-MEC policy from which policy loans can be made. If policy loans are not important during the term of the policy, then a single up-front premium payment into a MEC policy is preferable because of tax-free compounding.

An offshore ILIT provides much greater protection of trust assets against creditors of both settlor and beneficiaries. Courts in the US have no jurisdiction outside of the US, and enforcement of US court judgments against offshore trust assets is virtually impossible. Although all offshore jurisdictions have laws against fraudulent transfers, they are more limited than in the United States. In any case, an offshore ILIT is necessary to purchase offshore life insurance because foreign life insurance companies are not allowed to market and sell policies directly to US residents. An international trust, however, is a non-resident and is eligible to purchase life insurance from an offshore insurance carrier.

An international ILIT may be self-settled, that is, the settlor of the trust may be a beneficiary without exposing trust assets to the settlor’s creditors. In contrast, in the United States, the general rule is that self-settled trusts are not honored for asset protection purposes.

In Private Letter Ruling (PLR) 200944002, the IRS ruled that assets in a discretionary asset protection trust were not includable in the grantor’s (settlor’s) gross estate even though the grantor was a beneficiary of the trust. The trustee of a discretionary trust uses his discretion in making distributions to beneficiaries consistent with trust provisions. Previously, it was questionable whether a settlor could be beneficiary of an ILIT without jeopardizing favorable tax treatment upon his death. The new ruling gives some assurance to a US taxpayer who wants to be a beneficiary of a self-settled, irrevocable, discretionary asset-protection trust that is not subject to estate and GST tax. As a result, the trustee can (at the trustee’s discretion) withdraw principal from the PPLI or take a tax-free loan from the policy’s cash value and distribute it tax-free to the settlor, as well as to other beneficiaries. In other words, a settlor need not sacrifice all enjoyment of ILIT benefits in order to achieve preferred tax treatment.

An offshore ILIT is designed to qualify under IRS rules as a domestic trust during normal times and as a foreign trust in case of domestic legal threats to its assets. The offshore ILIT is formally governed by the laws of a foreign jurisdiction and has at least one resident foreign trustee there. As a “domestic” trust under IRS rules, the trust also has a domestic trustee who controls the trust during normal times. If a domestic legal threat arises, control of the trust shifts to the foreign trustee, outside the jurisdiction of US courts, and the trust becomes a “foreign” trust for tax purposes. A domestic trust “protector” having negative (or veto) powers may be appointed to provide limited control over trustee decisions. An international ILIT protects trust assets against unforeseen lawsuits, bankruptcy and divorce.

The objective of PPLI is to minimize life insurance costs and to maximize investment growth. The life insurance policy acts as a “wrapper” around investments so that they qualify for favorable tax treatment. Nevertheless, PPLI still provides a valuable life insurance benefit in case of an unexpected early death of the insured.

Initial costs of setting up an ILIT are high, but are recouped after a few years of tax-free investment growth. Initial legal and accounting fees are typically in a range of $25,000 to $50,000. Premium “loading” charges are in a range of about 3% to 5% of premiums paid into offshore PPLI (compared to 8 – 10% in domestic PPLI). Annually recurring charges depend on policy value and vary widely among PPLI carriers, so careful comparison shopping is advised. For example, annual asset charges should be in a range of about 40 to 150 basis points (0.4% to 1.5%) of the policy’s cash value. The annual cost of insurance is not substantial and declines over time. Annual costs for maintaining an offshore trust are several thousand dollars. Finally, investment manager fees are paid regularly out of policy funds.

Cash may be contributed to the ILIT, which then purchases PPLI. If asset protection of vulnerable fixed assets in the US is a concern, then equity stripping can be used to generate cash, which is then contributed to the offshore ILIT. Of course, stocks and bonds and other assets may also be contributed to the ILIT and used for investing in PPLI. Various value-freezing and valuation discounting techniques can be used to leverage the GSTT exemption.

An offshore “frozen cash value” policy is a variation of PPLI governed by IRC § 7702(g). The minimum premium commitment is about $250,000. During the life of the insured, the cash surrender value is fixed at the sum of the premiums paid. Withdrawals up to the amount of the paid-in premiums are tax-free, but cash value in excess of the premium amounts is inaccessible until after death of the insured.

Another alternative investment for an ILIT is a deferred variable annuity (DVA). There is no cost of insurance, so investment growth is faster. Tax on appreciation is deferred, but DVA distributions are taxed as income.

Generally, for public policy reasons and because the insurance industry possesses strong political influence, life insurance has long enjoyed favorable tax treatment. Over the past two decades, numerous IRS rulings have clarified the tax treatment of PPLI and irrevocable discretionary trusts. At the same time, strong, new asset protection laws and reliable service providers in numerous foreign jurisdictions have enabled safe, efficient and flexible management of international trusts and insurance products. As a result, an international irrevocable, discretionary trust owning PPLI can provide tax-free growth of a global, variable investment portfolio managed by a trusted financial adviser in full compliance with US tax laws. At the discretion of the trustee, trust assets (including tax-free insurance policy loans and withdrawals) are available to the settlor during his lifetime. Upon death of the insured, policy proceeds are paid tax-free to the trust. Thus, a well-managed life insurance dynasty trust perpetually secures the financial well being of settlor, spouse, children and their descendants.

Warning & Disclaimer: This is not legal advice.

Copyright 2011 – Thomas Swenson

Wealth Building

Winding Up a Qualified Personal Resident Trust

The Qualified Personal Residence Trust, or QPRT, became popular a couple of decades ago as a way to save gift and estate taxes. Now that many of the earlier trusts are expiring, families have to proceed carefully to protect their tax benefits.

Let’s take, for example, the case of a man called Brian. In August 1997, Brian met with his estate planning attorney. Because he was a widower with a net worth of $3 million at that time, and only a $600,000 federal unified gift and estate tax exemption, the attorney convinced him to transfer his $1 million home into an irrevocable trust (a QPRT) with a 15-year term. During the next 15 years, Brian continued to live in his home rent-free, and assuming he was still living at the end of the term, ownership of the house would then transfer to his children.

Since Brian gifted a future interest in the property to his children, the Internal Revenue Service granted him a valuation discount for the value of the interest he retained in the home. If he had died before the end of the QPRT term, the home and any other assets in the trust would have reverted back to his estate, essentially canceling the trust without realizing any tax savings. The IRS also granted Brian an additional valuation discount for the possibility of this reversion. These valuation discounts were calculated based on Brian’s age, the IRS-approved Section 7520 applicable federal rate of interest at the time he created the trust, and the length of the QPRT term.

Due to these valuation discounts, the value of Brian’s gift was only about $460,000 for federal gift tax purposes, even though his home was worth $1 million. Because the value of the gift was below Brian’s $600,000 lifetime exemption, he owed no gift tax upon creating and funding the QPRT. Thus, the QPRT provided the potential for significant gift and estate tax savings, not only on the value of the house at the trust’s creation but also on any future home appreciation thereafter.

Fast-forward almost 15 years – 14 years and eight months, to be exact. Within four months, the QPRT term will end. Brian is currently in good health; his home has a current fair market value of $2 million; and his net worth excluding the value of the home is now $4.65 million. With a current federal unified gift and estate tax exemption of $5.12 million, if Brian passed away after August, he would have shielded over $1.5 million from federal estate taxes. Establishing the QPRT was a great decision.

However, he wants to continue living in the house after the trust term ends, so he visits his estate planning attorney to consider his options.

The attorney informs Brian that in August, at the end of the QPRT term, his children will replace him as trustees. At that time, his children will most likely dissolve the trust and transfer title of the property into their individual names or into an entity, such as a limited liability company, that they own equally. If Brian continues to live in the house at that time, he will need to start paying his children fair market rent. Otherwise the IRS will contend that there was an understanding between Brian and his children that, at the time they took ownership of the home, he would retain use of the property rent-free for the rest of his life. Such an arrangement would result in the residence being included in Brian’s gross estate at his death, and all that great estate planning would go to waste.

Further, the attorney mentions the possibility that Congress will allow the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act (“TRA 2010”), which President Obama signed into law in 2010, to sunset on January 1, 2013, causing the estate tax exemption and top estate tax rate to return to $1 million and 55 percent respectively, resulting in a much higher estate tax bill if the house is included in Brian’s estate.

Because of his net worth and the possible sunset of TRA 2010, Brian decides that he has no qualms about paying his children fair market rent. Not only will he avoid undoing his estate plan, he will also benefit from transferring additional wealth to his heirs, in the form of rent, without incurring gift tax. However, depending on the amount of deductions related to the property (such as real estate taxes, insurance, repairs, maintenance, and depreciation), the rental income may generate additional income tax liability for Brian’s children.

To ensure that Brian receives the benefits of the QPRT, he will need to take the following steps.

  • If he has not already done so, Brian should inform his children that the QPRT exists, and that they will become the owners of his home when it ends.
  • Before the trust term ends, Brian will need to enter a lease agreementwith his children. (This will demonstrate to the IRS that there was no implied agreement between Brian and his children that he would continue to reside in the home rent-free at the end of the trust term, and further, that Brian’s children have sole right to possession of the home.)
  • After the deeds have been signed and recorded with the county, Brian will want to contact his insurance company to cancel his homeowner’s insurance and obtain a renter’s policy.

Brian should also make sure his children know to take some steps of their own to ensure the transfer goes smoothly. They should:

  • Either obtain a letter stating the fair market rent from a local real estate broker or pay for a fair market rent appraisal. (The payment of fair market rent will help avoid an IRS challenge that Brian continued control and enjoyment of the home, so as not to bring the home back into his estate.)
  • Hire a real estate attorney to draft the formal lease agreement. The agreement should be for at least one year and provide for automatic renewals unless canceled by either party. Further, the rental amount should be revisited at the end of each lease term to ensure that Brian continues to pay fair market rent.
  • Have the real estate attorney draft the necessary legal documents to allow the children to accept trusteeship after the QPRT term ends, and to transfer title of the property from the trust to either their individual names or to the entity they establish to hold the property.
  • If the children plan to hold the property in an LLC, to limit their liability against a lawsuit from someone that gets injured on the property, they should also have the attorney draft the LLC formation documents.
  • Obtain an appraisal to determine the home’s fair market value, since they will be converting the property to a rental home. They will need the market value in order to claim a depreciation deduction against rental income.
  • Obtain new title insurance on the property once they become the owners.
  • Once they own the house, they should also obtain homeowner’s insurance and inform the insurer that the home will be used as a rental property. This may increase the cost of insuring the property. However, the children should also mention that they will be renting it to their parent, the previous owner, and not some unrelated third-party, as this may result in either minimal or no increase in premium.

A well-managed QPRT can provide substantial estate tax savings. However, if you do not take the necessary steps to wind it up properly, Uncle Sam may still get a stake in the house.