Ode to the Trust – 1st Sonata

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Type of Trust:  Understand the
nature or type of trust involved. This will help you identify many other issues
you will have to address to properly operate your trust: tax filing
requirements (grantor trust, split-dollar loan statement, gift tax return,
etc.). The tune of your trust can be classified in a myriad of ways: ♫ Revocable versus irrevocable (can’t
change); ♫
Grantor
(person establishing the trust is taxed on the trust) versus non-grantor (trust
pays its tax, subject to the complex “DNI” rules on when distributions carry
income out to beneficiaries); ♫
Testamentary (formed at death) or inter-vivos (formed while you’re alive); etc.
♫ The type of
assets held by a trust can have a significant impact on the terms of the trust
and required operational steps: life insurance, S corporation stock, etc. ♫Each note has importance to operational
steps: ♫
Life Insurance Trust: In most instances, Irrevocable Life Insurance Trusts
(“ILITs”) are grantor trusts. This means that income (which is usually
negligible) is taxed to the grantor/insured. It also can have benefits to
minimizing tax rules when transferring or selling policies. ILITs are typically
set up to assure that the proceeds are excluded from the grantor/insured’s
estate and not reachable by creditors or ex-spouses. These latter benefits will
remain vital whatever the tax finale Congress sings. There are many variations
on this type of planning and the types of trusts that might own insurance.
Evaluate transferring new policies to the ILIT in light of the large $5M
exemption, or unwinding split dollar loans. ♫ Dynasty/GST Trusts: These perpetual trusts are typically
(2010 remains an oddity) intended to continue for a loooong time, often in
perpetuity, without triggering estate or GST tax at generational levels. This
may require an allocation of GST exemption on a gift tax return unless it is
confirmed that the GST automatic allocation rules apply. Plan now, the Obama
budget has proposed limitations on these trusts. ♫Child’s Trust: Confirm
whether Crummey powers are used, whether the trust fulfills a parent’s
obligation to support income may be reported to the parent. Alternatively, the
trust may have intentionally been structured as a grantor trust so that the
parent/grantor’s payment of income tax leverages greater asset growth in the
child’s trust.

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Payments to Be Made: ♫
Many
trusts require exacting payment schedules. ♫Are they monthly, quarterly or annually? What date are
they due? The anniversary date of the funding of the trust or year end? ♫Charitable Remainder Trusts (“CRTs”),
Grantor Retained Annuity Trusts (“GRATs”) require payments be made to you as
grantor. If not made as required the trust will hit a flat note for tax
purposes. Identify the amount and timing of the required payment and set up
procedures to assure they’re sung in tune. ♫If there is a unitrust payment, or inflation
adjustment, be certain the calculations follow the trust terms. ♫If an appraisal is necessary to
calculate a payment, get the process going far enough in advance so that the
trustee can make a timely payment. ♫ Have your CPA set up a chart of all payments and
collect proof of payments now, so you’re ready when Uncle comes knockin’.

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Trust Permanent File: Every fiduciary and adviser should have a file of
critical trust documents. Once this file is set up in an organized fashion,
tailored to the specific trust involved, operating your trust becomes as simple
as playing Choptstix. Consider: ♫Trust
agreement. This is the key to all operational decisions from
investments to distributions. Be certain you have the entire trust and all
ancillary documents, including: schedules listing assets transferred,
amendments (if not irrevocable), etc. ♫ Fiduciary actions. The fiduciaries (trustees, investment
advisors, distribution committee, someone holding a power to designate a
charitable beneficiary, etc.) of a trust may have the authority to take certain
actions that affect the trust. You need to maintain copies of all these
actions. Sometimes it is essential to confirm that anyone holding a power has
not exercised that power (e.g., if someone has a power to substitute assets
whether or not they have done so is essential to confirming the assets of the
trust). Periodic confirmations of actions not taken can be as important as
copies o factual written actions taken. ♫ Beneficiaries. Current data on trust beneficiaries
should be maintained: addresses, Social Security numbers, residency/domicile
which may affect how the trust is taxed as well the marginal state/federal
income tax rate to be considered in planning investments, etc. ♫ Crummey Powers: If gifts
to the trust require notices of annual demand powers be issue to qualify for
the annual gift tax exclusion records confirming that these notices were
properly issued must be maintained in order to support favorable gift tax
treatment. The trust CPA should consider whether a gift tax return can be filed
reporting all gifts to toll the statute of limitations on an IRS audit. Too
often, years after a trust has been established, notices are lost, not sent, or
wind up being handled in a manner contrary to either the terms of the trust or
the law. Even if you are sure that estate taxes will never matter (the
exemption is still scheduled to plummet to $1M in 2013) failing to adhere to
the terms of an irrevocable trust may still create liability for the trustee,
demonstrate to a court that you have ignored the formalities of the trust in
the event of a future suit or claim, etc. The trust permanent file should
include copies of all Crummey notices since inception, and demonstrate that
they were properly prepared and acknowledged.  ♫ Trust assets. Understanding trust assets is
essential to a host of planning issues. Are the assets properly insured with
the trustee properly covered? Too many people have residential real estate that
is owned by a trust but insured as if owned by them personally. Will that
suffice to protect the asset and trustee in the event of a casualty or suit?
The assets may determine which fiduciary (e.g., investment advisers) has
responsibility. Assets can impact state tax filing requirements. Assets should
be consistent with the trust Investment Policy Statement (IPS). Should assets
be supplemented by additional gifts be made to existing trusts to capture the
new $5M gift exemption? The Obama budget proposal calls for a reduction to a
$1M gift exemption.

♪ Ancillary Transactions:  Ancillary
transactions affect the necessary legal documentation, trust income tax return,
and more. ♫ Split-dollar insurance. A split-dollar arrangement may have been used to pay
for a portion of life insurance premiums.  Split-dollar loans require a statement to be
filed with the trust and premium payor’s tax returns. If the trust involved is
not an insurance trust, it might be the party advancing premiums for the policy
owned by an insurance trust or family business. Split-dollar arrangements all
need to be reassessed, and many unwound using the new $5M gift exemption. ♫ Guarantee.
If the family engaged in any intra-family sales (e.g. a note sale to a grantor
trust) a trust other than the purchasing trust may have guaranteed a portion of
the payments. Are guarantee fees advisable? Were they in fact paid and reported
appropriately? The $5M gift exemption gives leeway to make gifts to reduce or
eliminate the need for guarantees. ♫ Loan Arrangements.
With historically low interest rates many family entities have engaged in
intra-family loans. Proper documentation, payment and reporting of interest,
etc. is essential. Post tax season be certain you have all relevant documents
that the interest rate charged is adequate, and that other formalities are
adhered to. ♫ Personal use assets. If a trust purchases a
house for a beneficiary, be certain that property tax and mortgage interest
deductions are being properly handled both for the trust and those using the
property. Clients often seek to deduct property taxes for a personal property
that may be owned by a trust (e.g., the surviving spouse resides in the marital
residence now owned by a bypass trust).