A/B Trusts
An A/B Trust is any type of trust that splits into two separate and distinct trusts upon the death of the grantor. One of the separate and distinct trusts is a Credit Shelter Trust, which is designed to hold as much of the grantor's property as is sheltered from the federal estate tax by virtue of the unified credit; i.e., $2,000,000 for decedent's dying in years 2006, 2007, and 2008, and $3,500,000 for decedent's dying in the year 2009. The other separate and distinct trust is a Marital Trust, which is designed to hold the remainder of the decedent's property, which is sheltered from the federal estate tax by virtue of the unlimited marital deduction. These separate and distinct trusts are designed to eliminate or reduce the federal estate tax liability of a married couple over the deaths of both spouses. An A/B Trust arrangement can be created under a living trust or a testamentary trust, since these provisions do not take effect until after the grantor's death. See "Credit Shelter Trusts" and "Marital Trusts." See also "Family Trusts" and "By-Pass Trusts."
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Asset Protection Trusts
An "Asset Protection Trust" is a type of trust that is designed to protect assets from the claims of creditors. There are two types of Asset Protection Trusts - a Domestic Asset Protection Trust (also known as an "Onshore Trust" or "DAPT") and a Foreign Asset Protection Trust (also known as an "Offshore Trust"). Both types of trusts are also referred to as "Self-Settled Spendthrift Trusts." Asset Protection Trusts are always irrevocable living trusts.
Both types of Asset Protection Trusts have come under considerable scrutiny from federal and state governments of late, especially since the passage of the Bankruptcy Reform Act, as it is popularly called. Accordingly, the continued viability of Asset Protection Trusts is the subject of considerable debate. For further information on this subject, please see Quatloos' article on Domestic Asset Protection Trusts.
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By-Pass Trusts
A "By-Pass Trust" is another name for a Credit Shelter Trust. This type of trust is often called a "Credit Shelter Trust" because it shelter's property from federal estate taxation by virtue of the unified credit. For the amount of property that can be placed in this type of trust and sheltered from federal estate taxation by virtue of the unified credit, see "Applicable Exclusion Amount." Many people also refer to this type of trust as a "By-pass Trust" because the property placed in this trust is not subject to federal estate tax in the surviving spouse's estate. In other words, it "by-passes" the surviving spouse for federal estate tax purposes. The net result is that property placed in this type of trust (whether you call it a "Credit Shelter Trust" or a "By-Pass Trust" or a "Family Trust") is not subject to federal estate taxation in either spouse's estate.
A By-Pass Trust can be created under a living trust or a testamentary trust, since these provisions do not take effect until after the grantor's death. See "Credit Shelter Trusts" and "Family Trusts."
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Credit Shelter Trusts
A Credit Shelter Trust is a type of trust that is used by married couples with large estates in order to avoid federal estate taxes upon the death of the first spouse to die. This type of trust is structured so that, upon the death of the first spouse to die, the maximum amount of property sheltered from the federal estate tax (by virtue of the unified credit) is transferred to this trust. The trust is designed so that the assets in this trust will not be subject to the federal estate tax in the surviving spouse's estate upon his or her subsequent death. As a result, the assets placed in this trust upon the death of the first spouse to die will not be subject to federal estate taxes in either spouse's estate and will be transferred to other beneficiaries (normally the children) free of any estate taxes.
Even though the assets in a Credit Shelter Trust will not be taxed in the estate of the surviving spouse, the trust is designed in such a way that the surviving spouse can enjoy the benefits of the assets placed in this trust. For example, the surviving spouse can have the right to receive all the income of the trust during his or her lifetime. Although the surviving spouse cannot be given the right to demand any of the principal of the trust (an exception is the so-called "5 and 5 power"), the trustee can have the discretion to distribute principal to the surviving spouse for specified purposes.
This type of trust is also referred to as a "By-Pass Trust" because the assets placed in this trust effectively by-pass the surviving spouse for federal estate tax purposes. Some people also refer to this type of trust as a "Family Trust" in order to distinguish it from a "Marital Trust," which is established for the sole benefit of a surviving spouse.
A Credit Shelter Trust can be created under a living trust or a testamentary trust, since these provisions do not take effect until after the grantor's death.
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Charitable Trusts
A "Charitable Trust" is a type of trust that has one or more charitable beneficiaries. If properly established under federal tax laws, a charitable trust will entitle a grantor to deduct a portion of the amount contributed to the charitable trust as a current charitable income tax deduction. There are other tax benefits as well, depending upon the type of charitable trust established. For example, the amount passing to charity under a charitable remainder trust qualifies for a charitable estate tax deduction upon the death of the grantor. There are four types of charitable trusts; i.e., the charitable lead annuity trust (CLAT), the charitable lead unitrust (CLUT), the charitable remainder annuity trust (CRAT), and the charitable remainder unitrust (CRUT). In charitable lead trusts, one or more charities are paid a certain amount each year for a fixed number of years, with the remainder passing to non-charitable beneficiaries. In charitable remainder trusts, one or more non-charitable beneficiaries are paid a certain amount each year for a fixed number of years or for life, with the remainder passing to one or more charities.
A Charitable Trust can be created under a living trust or a testamentary trust; however, if any distributions are to be made during the grantor's lifetime, then the Charitable Trust must be an irrevocable living trust. See "split-interest trusts" below. See also "charitable lead trusts" and "charitable remainder trusts" above.
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Charitable Split-Interest Trusts
A "Charitable Split-Interest Trust" is a charitable trust that has both charitable and non-charitable beneficiaries. Since the interest of the charitable beneficiaries is separate from the interest of the non-charitable beneficiaries, these types of trusts are collectively referred to as a "Split-Interest Trust." In addition, there are different types of split-interest trusts, and each type is given a name that reflects the nature of the split interest. See, for example, Charitable Lead Trusts and Charitable Remainder Trusts. Charitable Split-Interest Trusts that meet the requirements of the federal tax laws are tax-exempt and irrevocable.
A Charitable Trust can be created under a living trust or a testamentary trust; however, if any distributions are to be made during the grantor's lifetime, then the Charitable Trust must be an irrevocable living trust. See "split-interest trusts" below. See also "charitable lead trusts" and "charitable remainder trusts" above.
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Charitable Lead Trusts
A "charitable lead trust" is a trust that provides for payments to one or more charities for a fixed number of years (lead interest). At the end of the charitable interest, the remainder of the trust assets pass to non-charitable beneficiaries (remainder interest). This is an example of a so-called "split-interest trust" whereby the present interest (lead interest) goes to one or more charities and the remainder interest goes to one or more non-charities. These trusts must comply with strict federal tax laws in order to receive favorable tax treatment (tax deductions for charitable contributions). However, a simple example of a charitable lead trust is as follows: Sam gives $10,000 to a charitable lead trust he established. The trust instrument provides that 8% of the value of the trust is to be given to the American Heart Association each year for 10 years. After the 10 years, the trust terminates and the trust assets (the remainder interest) pass to Sam’s children who are then living. See "split interest trusts" below.
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Complex Trusts
For federal income tax purposes, all trusts are classified as Simple Trusts or as Complex Trusts. A "Complex Trust" is any trust that is not classified as a Simple Trust. For the definition of a "Simple Trust," please see Simple Trusts below. For a copy of the IRS Instructions for Form 1041, please click here.
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Constructive Trusts
A "Constructive Trust" is a trust created by a court when no formal trust actually exists. For example, if a person has title to certain property and/or takes possession of certain property when the property rightfully belongs to another person, then the court may rule that the holder of the title is actually holding it as a constructive trustee for the benefit of the rightful owner. This can occur whenever a person acquires title to property through fraud, breach of faith, ignorance or inadvertence.
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Crummey Trusts
A "Crummey Trust" is a life insurance trust with certain provisions that allow gifts to the trust to qualify for the annual gift tax exclusion.
Initially, the IRS ruled that gifts of money to a Life Insurance Trust, which were used to pay premiums on life insurance policies held in the trust, did not qualify for the annual gift tax exclusion because the beneficiaries did not have a present interest in those gifts. The only interest they had was a future interest; i.e., when the insured died and the death proceeds were paid into the trust. Under the gift tax rules, the annual gift tax exclusion only applies to gifts of a present interest.
In order to get around this problem, a Mr. D. Clifford Crummey created a life insurance trust that prohibited the trustee from using any money gifted to the trust for at least 30 to 60 days after the gift was made. During that 30 to 60 day period, the beneficiaries were given the right to withdraw the money if they wished. If they didn't withdraw the money during the 30 to 60 day period, their withdrawal rights terminated and the money could then be used to pay the premiums that were due. Of course, the grantor never intended to have any of the money withdrawn from the trust during that 30 to 60 day period. That right was given to them solely to qualify the gift for the annual gift tax exclusion.
The IRS challenged these provisions in court, claiming that the right to withdraw the money was a sham because everyone knew that the money was needed for payment of the insurance premiums. Nonetheless, the IRS lost. The court stated that whether the beneficiaries actually withdrew the money or not, they had the right to do so - and that right is all that's needed to give the beneficiaries a present interest in the gift.
Today, an irrevocable life insurance trust that gives the beneficiaries the right to withdraw a gift for a pre-determined period of time in order to qualify it for the annual gift tax exclusion is called a "crummey trust."
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Grantor Trusts
A "Grantor Trust" is a trust under which the grantor or someone other than the grantor is treated as the "owner" for federal income tax purposes. As the owner of the trust for tax purposes, the grantor is required to report all income of the trust on his or her own income tax return each year and pay the income taxes on such income. A Grantor Trust does notfile its own income tax return (Form 1041).
A grantor (or someone other than the grantor) is treated as the "owner" of a trust for federal income tax purposes if he or she retains certain interests in the trust or retains certain powers over the trust fund, as set forth in Sections 671-679 of the Internal Revenue Code, including the following: The right to a reversionary interest in either the trust property or the income of the trust. The right to control the beneficial enjoyment of either the trust property or the income of the trust. The power to make decisions respecting the trust property, including the right to vote stock, etc. The power to amend or revoke the trust and take back the trust property.
Most revocable living trusts established for the purpose of avoiding probate or to provide for the management of assets in the event of incompetency are Grantor Trusts because the grantor generally retains the right to amend or revoke the trust. In addition, the grantor is often the sole trustee, which gives the grantor the right and power to make decisions respecting the trust property.
A Grantor Trust is most often a revocable living trust, but can be an irrevocable trust under some circumstances. It is never a testamentary trust.
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Grantor Retained Income Trusts ("GRITs")
A "Grantor Retained Income Trust" ("GRIT") is a Grantor Trust in which the grantor transfers property in trust, but retains the right to receive the trust income for life or for a term certain. There are three types of Grits in use today; the Qualified Personal Residence Trust ("QPRT"), the Grantor Retained Annuity Trust ("GRAT"), and the Grantor Retained Income Trust ("GRIT") .
All three are similar in that the objective behind them is to reduce the valuation of property for federal estate tax purposes upon the death of the grantor. In all three, the federal estate tax laws require only that the income interest retained by the grantor be included in the grantor's estate upon his or her death for federal estate tax purposes. This generally represents a substantial discount from the full value of the property.
Grits, Grats and Qprts are irrevocable trusts that are heavily regulated by the federal income tax laws.
A Grantor Retained Income Trust is always an irrevocable living trust.
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Life Insurance Trusts
A "Life Insurance Trust" is a type of irrevocable trust that is designed to hold life insurance on the life of the grantor or another person. The objective of a Life Insurance Trust is to exclude the life insurance proceeds payable on the death of the grantor from federal estate taxation. If a life insurance policy is owned by a grantor, the death benefits are included in the grantor's estate for federal estate tax purposes because the grantor has the power (among other things) to designate the beneficiary or beneficiaries to receive the death benefits under the policy upon his or her death. Life Insurance Trusts are attractive to individuals and couples with estates large enough to be concerned with federal estate taxes.
A Life Insurance Trust is always an irrevocable living trust.
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Qualified Personal Residence Trusts ("QPRTs")
A "Qualified Personal Residence Trust" or "QPRT" is a type of irrevocable living trust that is designed to reduce the value of a personal residence for federal estate tax purposes upon the death of the grantor. A QPRT allows a grantor to transfer his or her home to an irrevocable living trust and still continue living in the home, while reducing the value for federal estate tax purposes. A QPRT is a form of a Grantor Retained Income Trust ("GRIT"). See Grantor Retained Income Trust above.
A Qualified Personal Residence Trust ("QPRT") is always an irrevocable living trust.
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Qualified Terminable Interest Property Trusts ("QTIP Trusts")
A "Qualified Terminable Interest Property Trust" or "QTIP Trust" is a type of Marital Trust that is designed for use by a grantor when a second marriage is involved. It allows the grantor to transfer property in trust for his or her surviving spouse estate-tax free by virtue of the unlimited marital deduction, even though the surviving spouse is not given the right to determine the beneficiaries of the property upon his or her subsequent death. A QTIP Trust is an ideal vehicle to provide for a surviving spouse while insuring that the property is ultimately distributed to your children upon the surviving spouse's death.
A Qualified Terminable Interest Property Trust ("QTIP") can be created under a revocable or irrevocable living trust or a testamentary trust, since this type of trust does not become effective until the grantor's death. For a more detailed explanation of a QTIP Trust, pleaseclick here.
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Resulting Trusts
A "Resulting Trust" is a type of implied trust that is created through operation of law, where the actions of the parties involved and the nature of the transaction implies an intention to create a trust. A resulting trust and an express trust are similar in that both require an intent to create a trust. A resulting trust often occurs when someone fails to give up his or her beneficial interest in property, which can be intentional or simply by accident.
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Revocable Trusts
A "Revocable Trust" is a type of living trust in which the grantor retains the right, during his or her lifetime, to amend, change, revoke or terminate the trust within his or her sole discretion. A Revocable Trust is the type of living trust that is generally created when the objective is to avoid probate or to provide for continuity of management of one's assets in the event of incompetence.
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Simple Trusts
For federal income tax purposes, all trusts are classified as Simple Trusts or as Complex Trusts. To be classified as a "Simple Trust," the following requirements must be met: * The trust instrument must require that all income be distributed currently (i.e., in the tax year in which it is earned; * The trust instrument must provide that no amounts are to be paid, permanently set aside, or used for charitable purposes; and, * The trust must not distribute any amounts that are allocated to the corpus (principal) of the trust.
Both Living Trusts and Testamentary Trusts can qualify as Simple Trusts. For a copy of the IRS Instructions for Form 1041, please click here.
See also "Complex Trusts" above.
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Special Needs Trusts
A "Special Needs Trust" (also called a "Supplemental Needs Trust" or "SNT") is a trust that is established for a person who is receiving government benefits. The intent of a Special Needs Trust is to provide a source of funds for such person without disqualifying such person from such government benefits. Ordinarily when a person is receiving government benefits, an inheritance or a gift or even the receipt of a sum of money for damages in a personal injury law suit could reduce or eliminate the person's eligibility for such benefits. With a Special Needs Trust, a beneficiary can obtain certain luxuries and other benefits without defeating his or her eligibility for government benefits. Often a Special Needs Trust will include a provision that terminates the Trust if it makes the beneficiary ineligible for government benefits.
A Special Needs Trust may be created under a revocable or irrevocable living trust, or a testamentary trust.
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Spendthrift Trusts
A "Spendthrift Trust" is any kind of trust that includes certain language giving the trustee wide latitude to avoid making distributions to beneficiaries when the distribution would go to a creditor, or when the trustee fears that the distribution would be wasted by the beneficiary.
An example of a spendthrift provision is as follows:
"Spendthrift Provision. Except as otherwise provided by law, no power of appointment created hereunder shall be subject to involuntary exercise, and no interest of any beneficiary in the income or principal of any trust created hereunder shall be subject to assignment, alienation, pledge, attachment, or claims of creditors, including claims for alimony or support, until the same is distributed to such beneficiary or beneficiaries."
A Spendthrift Trust may be created under a revocable or irrevocable living trust, or a testamentary trust.
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Testamentary Trusts
A "Testamentary Trust" is a trust created under a Last Will and Testament. As such, a Testamentary Trust is amendable and revocable at any time during the testator's lifetime, but becomes irrevocable upon the testator's death. Unlike a Living Trust, a Testamentary Trust does not come into existence until the testator's death and, accordingly, cannot be used to avoid probate or to provide continuity of management of the testator's property in the event of his or her incapacity.
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Totten Trusts
A "Totten Trust" is an informal type of trust that is created during the lifetime of the grantor by depositing money into an account at a bank or other financial institution in the grantor's name as the Trustee for another person. Money deposited into this type of bank account is not considered a completed gift until the grantor's death, or the happening of some other event that unequivocally reflects the gift during the grantor's lifetime.
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