Basic Trust Information
A trust (revocable or irrevocable) is created by a written document typically called a “Trust Agreement.” The person establishing the trust is called a “settlor” or “trustor.” The “Trustee” can be an individual (including you), a corporation or other entity such as a bank trust department. Trustees who accept the obligation to serve hold the “legal title” to all assets transferred to the trust. Property owned by the trusts is called “trust corpus” or “trust res.” Trustees are obligated to handle all assets under a “fiduciary duty” to maximize the interests of the persons who are entitled to the benefits produced by the assets – the “beneficiaries.” Under the law, the trustee is obligated to never do anything that injures or diminishes the interests of the beneficiaries. It is critically important for the trust agreement to fully and clearly express all of the rights, responsibilities, powers, and duties of the settlor, trustee and beneficiaries.
“Intervivos” trusts are established by the settlor during life. A “testamentary trust” is established at death, usually by including trust provisions in the decedent’s Last Will and Testament. Trusts created during the settlor’s life can be “revocable” – that means the entire arrangement can be terminated by the settlor. If a trust is expressly made to be “irrevocable” then it cannot be terminated at the election of the settlor or any other person. One important distinction between revocable and irrevocable trusts is shown by the federal gift tax law. Federal gift tax is applied to gratuitous transfers that are completed. A “completed gift” is made when the donor has so parted with dominion and control (in an interest in property) as to leave him no power to change its disposition, whether for his own benefit or for the benefit of another. Hence, when the settlor reserves the power to revoke the trust and/or cut off the beneficiary’s interest in the trust, the transfer of property to the trust is not subject to federal gift tax. The settlor kept the power to change the disposition of trust property so the transfer is not “completed” when the trust is initially established. Thus, the gift tax would not be applicable to the “incomplete gift.”
Trusts are enormously flexible. Settlors are at liberty to establish almost any kind of scheme of disposition imaginable so long as the requirements of the law are met. A trust can provide for payment of income (or shares) to beneficiaries at defined intervals. It can either require or forbid distribution of trust property. It can require distribution of income to charities – a “charitable trust.” Charitable “lead trusts” require distribution of income to a charitable organization for a defined period. At the end of that period the income is typically to be distributed to individuals. Federal tax law allows taxpayers a charitable deduction on their income tax return for the value of the interest distributable to the charity. Likewise, a charitable deduction is allowed for charitable “remainder trusts.” A remainder trust reverses the order of the required distributions – first to individuals (for a term or for life) after which distributions are made to the charitable organization.
Trustees can be given power to determine which of the various named beneficiaries should receive distributions. This is called “sprinkling power.” Typically, the power is to be used to make distributions after the needs, requirements, and circumstances of the various potential beneficiaries are considered by the trustee. There is also a way to give the trustee power to withhold all distributions from individuals who tend to make imprudent financial decisions. These are known as “spendthrift” provisions.
Some of the other uses of trusts include these: (1) Probate – it is possible to exclude property from probate, (2) Guardianships – property held in trust can be excluded from public disclosure and description in guardianship situations, (3) Asset Protection – judgment creditors can be blocked from levy on trust property depending upon the persons who hold interests in the trusts and the kind of interest they hold, (4) Tax Reduction – trusts can have the lawful effect of reducing federal taxes in a variety of situations. Information about how trusts avoid making detailed public disclosures of your assets is available at Trusts: Avoid Public Disclosure of Assets.
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