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A trust is created when a person called the “Grantor” (1) transfers an asset; (2) to a person or institution called a “trustee”; (3) for the purpose of managing that property for a person called the “Beneficiary”.

The person who creates a trust is referred to as the “Grantor”, the “Trustor” or the “Settlor”. All are correct and have the same meaning, namely the person who creates a trust by transferring property to a trustee under certain terms and conditions (usually specified in the trust document) for the benefit of the Beneficiary (or Beneficiaries). We will use the term Grantor in the explanations that follow.

As the name implies a revocable living trust is fully revocable. This means the Grantor(s) can, at any time, revoke, alter, amend, or change any provision, revise any appointment of successor trustee or beneficiary; sell any asset held by the trust, add assets to the Trust and in general do the same things with the property in the trust as he or she did before establishing the trust.

Upon the death or incapacity of a Grantor that is also a trustee (the Grantor(s) of a revocable living trust is usually the initial trustee or co-trustees), the successor trustee steps in to manage the trust. The successor trustee can simply be the surviving co-trustee now acting alone or a person who was not previously acting as a trustee at all. In either event, all successor trustees have a fiduciary obligation to always act in the best interest of the beneficiaries.

Once a Grantor dies some or all of the trust may become irrevocable. This depends on whether or not the trust was created to simply avoid probate or to reduce or eliminate estate taxes. In some instances, a trust may also become irrevocable because of the circumstances of certain beneficiaries. What follows is an explanation of the most frequently used kinds of Revocable Living Trusts

NOTE: The following explanations are merely common examples of trusts to provide you an idea of how a living trust could work in different scenarios. Many times the specific facts of a situation dictate that the actual terms of your trust will be more complex and will vary from these examples.

A Probate Avoidance Trust may be used for a single individual, for a married individual who desires a separate property trust or for a married couple who have no need or desire to reduce estate taxes.

A Probate Avoidance Trust provides that any property remaining in, or transferred to the trust at the time of the Grantor’s death will either be distributed outright to the Grantor’s beneficiaries or held and managed according to instructions contained in the Trust.

If the Trust is for a married couple, when a spouse dies the Trust continues for the benefit of the surviving spouse. The surviving spouse retains full control over the Trust including the power to amend or revoke it.

A Probate Avoidance Trust functions just like a Simple Will and if properly funded eliminates the need for both a court supervised conservatorship while alive (in the event of the Grantor’s incapacity or disability) and a court supervised probate at death.

If you are familiar with your income taxes, you might recall that your tax bill begins with determining your gross income. In simple terms, once you have determined your gross income you are allowed certain deductions (either the standard deduction or itemized deductions), your tax is determined and then you may be allowed certain credits against the tax in calculating the tax payable.

The estate tax functions in a similar way. Every individual will have a gross estate when they pass away. Certain deductions are then taken and the tax is then determined. Once the tax is determined a credit is applied and the remaining amount is the tax payable.

The most important estate tax deduction the tax code allows an individual is the transfer of an unlimited amount of property to his or her spouse. The mechanism is a dollar-for-dollar deduction from a deceased spouse’s taxable estate for all amounts left to the surviving spouse. This is called the “Unlimited Marital Deduction”. As a result of the Unlimited Marital Deduction, if a deceased spouse leaves his or her entire estate to the surviving spouse (including all of the deceased spouse’s share of the trust assets), there are no estate taxes due upon the death of the first spouse.

Unfortunately, simply leaving everything to a surviving spouse will waste a very important estate tax credit. In addition to the Unlimited Marital Deduction, under current tax law every individual is allowed a nonrefundable estate tax credit that will completely shield a taxable estate of up to $1,500,000 (increasing to $2,000,000 in 2006) at death. Once an estate reaches the $1,500,000 limit, any property given away during at death is taxed at marginal rates that start at 37% and increase to 49%.[1]

An A-B Trust is often used when an estate is expected to exceed the available Credit Equivalent Amount. It makes it possible for a husband and wife to leave a joint estate of up to twice the Credit Equivalent Amount (that is, $3,000,000 in 2004 and 2005) to their heirs free of federal estate tax. The A-B Trust functions as a single joint revocable living trust until the first spouse passes away. At that time two trusts are created; an “A Trust” and a “B Trust”. In the following explanations we will call the “A Trust” the “Survivor’s Trust” and the “B Trust” the “Decedent’s Trust”.

The Decedent’s Trust is allocated an amount of property that is up to or equal in value to the amount that can be “sheltered” by the Credit Equivalent Amount (currently $1,500,000). If the deceased spouse’s share of the revocable living trust assets and other community property, as well as all of the deceased spouse’s separate property, is more than the Credit Equivalent Amount, the Decedent’s Trust wil1 only receive an amount of property that the deceased spouse owned that does not exceed the Credit Equivalent Amount. The amount allocated to the Decedent’s Trust is limited to the Credit Equivalent Amount because if any property beyond that amount were allocated to that trust, the excess would be subject to estate taxes.

NOTE: The Decedent’s Trust cannot be funded with any of the surviving spouse’s share of the trust assets or community property, nor any of the surviving spouse’s separate property.

The amount that is actually allocated to the Decedent’s Trust is usually calculated with reference to a formula that relates not to a specific dol1ar amount but to either the Credit Equivalent Amount, the Unlimited Marital Deduction” or an amount that is disclaimed by the surviving spouse (see example 3 below for an explanation of disclaimers). By using a formula clause, if the dollar amount of the Credit Equivalent Amount changes because of legislation or through other means, the amount allocated to the Decedent’s Trust is automatically adjusted to conform to any changes.

The Decedent’s Trust has two purposes. First, it is designed to provide for the surviving spouse while still alive. At the same time, the Decedent’s Trust also ensures that any property remaining in the Decedent’s Trust upon the surviving spouse’s death will go to your descendants free of Estate Tax.

NOTE: Because personal and household effects have very little chance of appreciating in value they should not be allocated to the Decedent’s Trust upon the death of the first spouse. An A-B Trust should also instruct the Trustee to first allocate any personal or household effects owned by the trust to the Survivor’s Trust. This prevents the Trustee from placing personal and household effects into the Decedent’s Trust. If the deceased spouse wanted certain items of personal property to go to a particular person, he or she would have made his or her wishes known using a Direction to the Trustee form. The Trustee, who in most cases will be the surviving spouse, could then give these items to the selected beneficiaries.

The Survivor’s Trust will consist of the surviving spouse’s separate property plus the surviving spouse’s share of any community or co-owned property held in the trust. The Survivor’s Trust will also receive the balance of the deceased spouse’s property (over $1,500,000, or the then existing Credit Equivalent Amount) which would then pass to the surviving spouse tax-free under the Unlimited Marital Deduction and be placed in the Survivor’s Trust.

The A-B Trust can be illustrated with the following example. Assume that a husband and wife create a Revocable Living Trust that includes A-B Trust terms. The Husband then passes away in 2005 when the Credit Equivalent Amount is $1,500,000 and the couple’s joint estate is worth $4,000,000. The following flow chart shows how the Revocable Living Trust would be distributed upon the Husband’s death.

The simplified estate tax computation for the Husband’s estate in the above example is as follows:

Note that this example refers only to the federal credit equivalent amount. As discussed at footnote 1 below, it is possible that in some states a state estate tax would be payable while no federal estate tax is due.

This variation is a combination of Example 1 and Example 2. It contains the same provisions as variation Example 1 - all of the property is allocated to the Survivor’s Trust - but it adds a very important estate planning option. If the surviving spouse disclaims (refuses) any of his or her interest in the deceased spouse’s property allocated to the Survivor’s Trust, the disclaimed property would go to a standby Decedent’s Trust (that is, the B trust in the A-B Trust of Example 2).

The purpose of the Family Disclaimer Trust is to provide the surviving spouse with more flexibility in the event that the estate was to grow to the point that using the deceased spouse’s estate tax credits (i.e., the Credit Equivalent Amount) would be advantageous.

NOTE: In light of the uncertainty surrounding the most recent enactment of the Federal Estate tax law that is due to expire after December 31, 2010, some variation of the Family Disclaimer Trust is now a preferred choice among many estate planners since it provides the most flexibility among the different options.

If no disclaimer is made, then the Decedent’s Trust will be dormant and the Trust will be administered as a simple Probate Avoidance Trust.

The Family Disclaimer Trust adds flexibility to an estate plan in that it gives the surviving spouse the ability to take various steps that may allow more property to pass to descendants free of estate tax. Notwithstanding the flexibility, a Family Disclaimer Trust is not appropriate in all situations. For example, if a spouse has children from a prior marriage and does not wish to leave a surviving spouse in complete control of all of the family assets or the spouse’s separate assets, a Family Disclaimer Trust would not be appropriate.

NOTE: A disclaimer must be made in writing, within nine months after the death of the first spouse. In that time the surviving spouse cannot use any of the funds disclaimed until after the disclaimer is made and the property is allocated to the Decedent’s Trust. The surviving spouse should consult with us or another qualified estate planner or tax specialist before making this decision.

A QTIP Trust is used when there is a desire to allow the surviving spouse to benefit from a deceased spouse’s estate or share of the revocable living trust, but to also make sure that the deceased spouse’s share of the estate will go to certain beneficiaries (such as the first deceased spouse’s own children) upon the death of the surviving spouse. QTIP trusts are also useful as a means of deferring estate taxes when the estate is expected to grow beyond the amount that can be sheltered by the Credit Equivalent Amount.

QTIP Trusts are also used to take advantage of various tax laws relating to the distribution of property to grandchildren.

In an estate plan that includes a QTIP trust, when the first spouse dies three trusts are created: an “A Trust”, a “B Trust” and a “C” Trust. In our documents we call the “A Trust” the “Survivor’s Trust”, the “B Trust” the “Decedent’s Trust” (exactly as above with the A-B Trust) and the “C Trust” the “QTIP” Trust.

The Survivor’s Trust will consist of the surviving spouse’s separate property, plus the surviving spouse’s share of any community or co-owned property held in the trust.

NOTE: Because personal and household effects have very little chance of appreciating in value they should not be allocated to the Decedent’s Trust. An A-B Trust should also instruct the Trustee to first allocate any personal or household effects owned by the trust to the Survivor’s Trust. This prevents the Trustee from placing personal and household effects into the Decedent’s Trust. If the deceased spouse wanted certain items of personal property to go to a particular person, he or she would have made his or her wishes known using a Direction to the Trustee form. The Trustee, who in most cases will be the surviving spouse, could then give these items to the selected beneficiaries.

As with the A-B Trust example, the Decedent’s Trust here is usually allocated an amount of property that is equal in value to the amount that can be “sheltered” by the Credit Equivalent Amount (currently $1,500,000). If the deceased spouse’s share of the trust is less than the amount that can be sheltered by the Credit Equivalent Amount, the Decedent’s Trust will only receive the property that the deceased spouse owned.

The balance of the deceased spouse’s property (above the Credit Equivalent Amount) would then be allocated to the QTIP Trust. This amount will not be included in the deceased spouse’s estate for tax purposes as the estate tax code provides that amounts distributed to a QTIP trust are allowed as Marital Deductions.

NOTE: Neither the AB Trust nor the QTIP Trust can be funded with any of the Surviving Spouse’s share of the trust.

The QTIP Trust is designed to provide for the surviving spouse’s needs while alive and at the same time ensure that any property remaining in the QTIP Trust upon the surviving spouse’s death will go to the beneficiaries of the first spouse to die. However because this Trust is funded with “marital deduction property” it will be subject to Estate Taxes at the time of the surviving spouse’s death. At that time, the amounts remaining in the QTIP Trust will be taxable as part of the surviving spouse’s estate

The following provisions are commonly included in a revocable living trust and related estate planning documents.

The Declarations and Recitals create the trust. They state that the Grantors are the initial beneficiaries, recite the name of the trust and declare who will be the original trustee. Usually the Grantors will be the original trustees. The Declarations and Recitals could also contain family information and other pertinent information.

This article states what the original “Trust Estate” will consist of and that property may be added to the Trust at any time and in any manner. Usually the assets consisting of the Trust Estate will be enumerated on a separate schedule at the end of the Revocable Living Trust document.

If the Trust is for a couple, it should include provisions that state that all property transferred to the trust will retain its character as community property, co-owned property, joint property or as the separate property of the Grantor who transferred it to the trust. The exact provision used depends on the laws of the state that the trust was created under. For example: if a trust was created in a community property state, the property will retain its community property characteristics. If created in a non-community property state, it will usually be treated as either co-owned or joint tenancy property.

This article deals with the selection and removal of a trustee. All of the provisions in this article relate specifically to the trustee. It names the original Trustee(s) and lists the succession of Trustees. It states that the Grantors have the right to remove any Trustee and to appoint a successor, and that a Trustee can resign at any time. It should also provide a means of naming further successor Trustees, such as allowing a successor trustee to appoint one or more Co-trustees to serve with him or her or allowing beneficiaries to name independent successor Trustees.

This Article gives the Grantors the right to remove property from the Trust and to change the provisions of the trust in any way, including the right to revoke the trust in its entirety.

If the trust is for a single individual this article provides that any property remaining in or transferred to the trust at the time of the Grantor’s death will either be distributed outright to the Grantor’s beneficiaries or held or managed according to instructions contained in the trust.

If the Trust is for a married couple, this article provides for the division and distribution of the trust upon the death of the first spouse. Depending on the type of Trust selected there are a variety of methods used to distribute the estate upon the death of the first spouse. Examine this provision closely to determine the type of trust you are dealing with. You may also refer to the examples above to assist you in determining the type of trust that you have.

This article provides for the removal of a Grantor / Trustee in the event that he or she is unable to manage the Trust.

This article can eliminate the need for the courts to get involved in the affairs of the trust should a Grantor become incapacitated (which would otherwise require a guardianship or conservancy proceeding).

This article details the powers that the trustee has over the property in the trust. It has provisions that enable a trustee to completely manage the property in the trust. It lists virtually anything that a person might do with property and states that the trustee has these powers.

These powers make the administration of the trust much more effective since under the laws of many states the powers of the trustee are limited, unless spelled out in the trust instrument.

This document is used to add another layer of effectiveness to your estate plan. Its purpose is to transfer any assets outside the Trust into the trust at your death. Keep in mind that titled assets must be transferred to the trust in order to avoid probate with respect to those assets.

For example: A law firm prepared a trust for a husband and wife. They met with the attorney to sign their documents, thereafter diligently transferring all of their assets to the trust. Several years later, the couple took a fishing trip out of state and decided to buy a riverfront summer cabin. They did not remember that they were supposed to take title to the real property in the name of their Revocable Living Trust. Unfortunately, the couple did not contact their attorney to schedule a regular periodic review of their estate plan (where ownership of the cabin would have probably been discovered), and they passed away continuing to own the property in their own names.

In this example, a probate proceeding would be required in order to transfer title to the cabin. The Pour-Over Wills direct that any assets still held in an individuals name are to be transferred to the trust and administered along with the other trust assets. The result is that all assets are now together for common administration. Without the Pour-Over Wills, the parties would be deemed to have passed away intestate (that is, without a will), and applicable statutes would direct to whom the property would be distributed (which would have been to surviving family members, not the trust).

This document is used to maintain your privacy when dealing with various financial institutions. When an asset is placed into or taken out of a trust, financial institutions will often require proof that a valid trust exists and will also ask for certain information such as the name of the trust, the date it was executed and the identity of the trustees and successor trustees.

Rather than giving the institution a copy of your trust you can provide them with this document. It provides the institution with the proof they need that you have a valid trust as well as the other information usually required, but it does not reveal other details about your estate plan. This way you are able to maintain complete privacy about how you want your trust distributed at your death.

Like your Pour-Over Will this document provides an additional layer of effectiveness to you estate plan. It is used to protect you from court involvement while you are still alive.

A Durable Power of Attorney allows someone to act on your behalf with respect to the matters described in the Power of Attorney. The individual named is called the “agent” or “attorney-in-fact”. The document can be immediately effective or effective only upon your incapacity. It can also define a narrow category of actions that the agent can take on your behalf, or it can give them complete authority over your property and financial affairs. We say the document is “durable” because it continues to be effective while you might be incapacitated. However, no power of attorney continues to be effective upon your death.

Some common powers granted to an agent under a Durable Power of Attorney include the authority to transfer assets to your revocable living trust, to file your tax returns, to administer your financial accounts and retirement plans, and to see to the administration of your real estate. In some situations, it may also be appropriate to allow the agent to make gifts of your property, to revise your estate planning documents. The range of authority that can be granted under your Durable Power of Attorney is very broad and should be carefully considered.

The benefits of having a Durable Power of Attorney along with your trust are too numerous to explain in this short report. In summary, the Durable Power of Attorney allows a person you choose to deal with assets not in your trust, to place assets into your trust and to act in a number of ways to protect your estate. A Revocable Living Trust combined with a well prepared Durable Power of Attorney is an unbeatable combination when it comes to providing your loved ones, rather than the courts, with complete control if you become incapacitated and are unable to manage your own affairs.

Like the Durable Power of Attorney, the Medical Power of Attorney allows a person that you designate to make certain decisions on your behalf. In this case, however, your agent is making decisions with respect to your medical care when you are, because of injury or illness, unable to make decisions for yourself.

Health Care Directives are also commonly called “Directives to Physicians” or “Living Wills”. The purpose of the Health Care Directive is to allow you to specify that if you are in a terminal state and declared to be permanently unconscious, you do not want administration of artificial nutrition or hydration.

Your physician should be given a copy of your Medical Power of Attorney and Health Care Directives so that he or she also knows your wishes and who to contact in the event that you cannot make your own health care decisions.

As you can see, a Revocable Living Trust estate plan contains the best estate planning documents available today. When properly established, maintained, updated and utilized you and your family can relax knowing that your estate will be efficiently managed and distributed by someone you have selected and trust, with no unnecessary costs, delays or court intervention. Please call our office for a free initial consultation.

[1] The credit that will shield a $1,500,000 taxable estate was formerly called the “Unified Credit” and we still often refer to it as such for the sake of simplicity. It is technically more correct to refer not to the credit itself at all, but to instead refer to the $1,500,000 amount as the “Credit Equivalent Amount”. The Credit Equivalent Amount for federal estate tax purposes is $1,500,000 in 2004 and 2005 and will increase to $2,000,000 in 2006. It will continue to increase until 2010 when it will be $3,500,000. In 2011 the federal estate tax will be repealed for one year. When it returns in 2012 it will be brought back as it existed in 2001, which will mean a Credit Equivalent Amount of $675,000. In many states, the Credit Equivalent Amount for state estate tax purposes is currently less generous. For example, in Washington, the Credit Equivalent Amount is $850,000. It will rise to $950,000 in 2005 and then reach $1,000,000 in 2006, where it will remain frozen absent further action by the Washington legislature. As a result of the disconnect between federal and state estate tax structures, in some cases a state estate tax may be due while no federal estate tax is due.

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NOTE: The information provided in these articles is for general dissemination and not intended as legal advice or for use in a particular situation. Please contact our office or other qualified attorney.