What is a Living Trust?
A living trust is a trust arrangement that someone establishes during their lifetime for their own benefit and for the benefit of a spouse and designated people after their death. When a living trust is revocable it can be amended or revoked during the lifetime of the grantor (or trustmaker). A Florida living trust, like any other trust, is an agreement between three parties: the grantor (or grantor, or trustmaker), the trustee (including successor trustees), and the beneficiaries who get the benefit of trust income and assets. The grantor is the individual who forms the trust and creates the trust agreement. The grantor typically contributes to the trust most of the trust property. The trustee is the individual or entity that administers the trust for the benefit of the trust’s named beneficiaries. The trustee has a fiduciary duty to the grantor and the beneficiaries to carry out the grantor’s intentions in a fair and reasonable manner. In a typical revocable living trust, the grantor can add or withdraw assets from the trust as he pleases at any time until his death. Because the grantor is also the trustee during his lifetime, he has complete control over management of trust assets. For tax purposes, all taxable income or tax losses generated by trust assets flow through to the grantor while he is alive. This typical living trust has negligible effect over a trustmaker’s management and enjoyment of his property during his lifetime. When the grantor dies the living trust becomes irrevocable and the trust beneficiaries and successor trustees may not alter any of the trust provisions.
The terms of a living trust are set forth in a written document known as a trust agreement. The trust agreement does not have to be recorded in the public records and does not have to be filed with any government agency. It is, therefore, a relatively private document between the parties. A revocable living trust does not need its own tax identification number so long as the grantor is alive and either the grantor or his/her spouse serve as the Trustee. To be given full legal effect upon the death of the grantor, the trust document must be properly executed with the same formalities as a will.
Florida recognizes the validity of a living trust created in another state so long as the trust has been properly executed under the laws of the state of formation. Therefore, people moving to Florida do not necessarily have to redo their living trust for it to be enforceable under Florida law.
Benefits of a Florida Living Trust
The two most often cited advantages of a living trust are:
- avoiding court administered guardianship in the event of the grantor’s incapacity and
- the avoidance of probate upon the grantor’s death.
The living trust agreement typically provides that in the event of the grantor’s incapacity a successor beneficiary takes over the administration of trust property for the grantor’s benefit. Incapacity is a defined term within the trust document, and specific procedures for determining the grantor’s incapacity are also set forth in the trust. The incapacity provisions of a living trust permit the grantor and his family to avoid a public guardianship in the event that the grantor becomes unable to manage trust property he contributed to his trust.
The other primary attraction of a living trust is avoidance of probate upon the grantor’s death. Probate is avoided because living trust property is not titled in the name of grantor at the time of death and therefore the property is not part of a probate estate. As long as property is properly titled in the name of the living trust, the successor trustee may administer the trust property and transfer the property to trust beneficiaries without probate. The mere creation of a living trust document provides no benefit to the grantor unless the trust is properly funded with the grantor’s assets. Only those assets whose title is transferred to the trust are protected in the event of incapacity or death.
In addition to provisions for incapacity and avoidance of probate, living trusts have other estate planning benefits. For clients with property located in multiple states, a living trust owning all of the client’s property avoids multiple probate proceedings in the states where each property is located. The administration of a client’s real property is consolidated through the use of a single trust document.
Asset Protection and Living Trusts
Some people mistakenly believe that living trusts provide asset protection for the trustmaker. In fact, a living trust provides the trustmaker no asset protection of assets the trustmaker conveys to his own living trust. It makes no difference that the living trust has a spendthrift clause which states that creditors cannot reach the interests of a trust beneficiary. The reason a living trust is not effective asset protection is that a living trust is a“self-settled” trust. A self-settled trust is one where the person who creates and funds the trust is also a trust beneficiary. Florida law unequivocally provides that the beneficiary of a trust created for the beneficiary’s own benefit is not protected from the beneficiary/trustmaker’s creditors even if the trust has a protective spendthrift provision.
A living trust may have substantial asset protection benefits for future trust beneficiaries. If a living trust provides that upon the trustmaker’s death the remaining trust property is retained in the living trust, or in separate sub trusts, for the benefit of the trustmaker’s spouse, children, or other beneficiaries, the money is protected from these beneficiaries’ creditors if the trust document has a properly drafted spendthrift clause. An interest of a beneficiary other than the trustmaker is protected even if there is not a proper spendthrift clause if the trust is a “discretionary trust.” A discretionary trust is one where the trustee has complete discretion over the amount and timing of distributions of income and trust principal to the beneficiaries.
Taxation Issues in Living Trust Administration
Living trust planning changed in 2013 when the American Taxpayer Relief Act of 2012 went into effect. Under prior law, typically married couples drafted their living trusts to provide that the assets of the first spouse to die were left in what was called a “unified credit trust” for the surviving spouse up to the amount of the then-effective unified estate planning credit of approximately $3.5 million. Today, the credit is approximately $5.4 million per person. The goal was to make sure the deceased spouse could apply their full estate planning credit, because if the assets passed to the surviving spouse the assets would escape tax by virtue of the marital deduction rather than the unified credit. If the decedent’s unified credit was not applied to assets the credit would be lost. These assets would be held in the unified credit trust for the benefit of the surviving spouse, and perhaps even the children or other heirs. Regardless of the increase in value, these trust assets would not be subject to federal estate tax at the death of the second spouse to die. Any assets in excess of the unified credit would be held in a separate trust for the surviving spouse, called a “marital exemption trust”, and that trust could avoid estate taxation by applying an unlimited marital exemption against estate tax.
The 2012 estate tax law added concept of portability, which allows the surviving spouse to elect to get the unused exemption of the first spouse to die. In 2017, a married couple has a combined inflation unified credit of $10.8 million. With the larger federal estate tax exemption and portability, most couples are not concerned about federal estate tax. Because of portability, many married couples may chose a simple plan that leaves all assets outright to their spouse or in a trust using the marital deduction rather than the unified credit.
This type of planning, although seemingly simple. The first issue is an asset protection issue. If assets are left directly to a surviving spouse, the assets are vulnerable to the surviving spouse’s judgment creditors. Even assets held in a marital trust that uses the marital deduction, rather than the unified credit trust were not protected; tax law requires the marital trust to distribute all income to the surviving spouse, and that spouses creditors can garnish the income and even compel distribution. The unified credit trust does not require any distributions to the surviving spouse that would be exposed to creditors. A unified credit trust, even if unnecessary for estate tax planning, is still a preferred asset protection tool.
The second issue involves income tax rather than estate tax. There is an income tax advantage of using either an outright bequest to a surviving spouse or a marital exemption trust. The income tax advantage is the “double step up in basis.”
The Internal Revenue Code provides that any appreciated assets receive a new basis, or stepped-up basis, to their tax cost equal to the fair market value of the property at the date of the decedent’s death. For example, if your parent bought stock for $10 per share and dies when it’s worth $50 per share, you get to inherit the stock with a new basis equal to that $50 date-of-death value. If you later sell the stock for $60, your capital gain, is taxed. Your capital gain would be the difference between your $60 sale price and the $50 value on the date of your parent’s death rather than your parent’s original cost of $10. This “step up in basis” rule applies to all investmet assets such as stock, real estate, and business entities.
The approach of transferring assets to the credit shelter trust at the first marital death for asset protection benefits ignores “step up in basis.” When assets are left to a spouse in an asset-protected credit shelter trust there’s a “step up in basis” at the death of the first spouse to die, but there’s no “step up in basis” for the children after the surviving spouse’s death.
It would seem that couples not concerned with asset protection would draft a living trust that leaves all assets to the surviving spouse outright or in a marital exemption trust. This works for small and medium size family estates. But if the surviving spouse’s estate, which includes the marital trust, later exceeds the applicable federal estate tax exemption of the surviving spouse and the amount that ported over to the survivor from the first spouse the excess will be subject to an estate tax of approximately 40%. Also, if the assets decline in value after the death of the first spouse, they would have retained the higher basis they obtained at the death of the first spouse to die if they were in the credit shelter trust, and the surviving spouse would be able to deduct more losses.
A living trust can be drafted to permit the surviving spouse to make the decision whether the deceased spouse’s assets are left in a unified credit trust or a marital trust. This way, the surviving spouse may consult with legal and tax professionals, examine the value of assets at the time of transfer, and make the decision that best servers the family’s legal and tax goals.
Do You Need Attorney To Prepare Living Trust?
There are inexpensive, boiler plate trust agreements available on the internet and at office supply stores. Many people try to save money by using a do-it-yourself living trust. However, the above discussion shows that living trusts are complicated legal documents. There are many choices in drafting a living trust agreement, and there are serious tax issues in trust design and trust administration that have significant tax consequences for the trustmakers and their children. A living trust should be drafted by an experienced attorney. In fact, the Florida Supreme Court has held that preparation of a living trust by anyone other than a licensed lawyer constitutes the unauthorized practice of law. You should consult with a Florida estate planning attorney to learn if and how a living trust can fits in your family’s overall estate and asset protection plan.