Which Assets go to Which Trusts

Which Assets Go To
Which Trusts Under Your Will:

Executors (or trustees of your revocable
living trust) have to make decisions as to which assets of your estate should
be transferred to which trusts (“funding”). The planning opportunities, traps
and complications are far greater than most executors, trustees and heirs
realize. Let’s take a look as just some of the questions that can come up in a
typical estate of a married couple, on the death of the first spouse. There are
likely to be at least two trusts (often many more) to which your will provides
for distributions:

1. A By Pass trust (also
called “credit shelter trust”) which can be funded with up to $2 million in
assets to protect the $2 million current federal exclusion (the amount you can
bequeath federal estate tax free). This amount is supposed to increase in
future years. The assets in the By Pass trust will be available to the
surviving spouse, but not taxed in his or her estate. In many instances a lower
amount may be transferred to the By Pass trust (if the will or post-mortem
planning permits) to avoid state estate taxes (many states don’t follow the
federal law and have lower exclusions).

2. A marital bequest which
can be out right to the surviving spouse, with no trust; to a marital trust
such as  Qualified
Terminal Interest Property Trust (“QTIP”); or a Qualified Domestic Trust (“QDOT”) if the
surviving spouse is a non-citizen. There are other options but the key is that
this bequest qualifies for a marital deduction to avoid estate tax on this
portion of the estate on the death of the first spouse. Let’s assume that the
entire amount is to be held in a QTIP – marital trust (trusts provide far more
planning flexibility and protection then an outright bequest to the surviving
spouse).

Which Document Controls:

If your will specifies that a
particular asset should be distributed to a designated trust, then that
decision probably controls. For example, if you have a family  business you want to retain in the
family line, you may bequeath it to a QTIP-Business trust with specially
selected trustees, principal invasion rights, and eventual distribution to your
named heirs. The rest of your assets may then be divided between a By Pass
trust and regular QTIP trust (i.e. a QTIP trust intended to hold all assets
other than the business). Other documents may be relevant. For example, if you
own stock in a close corporation, the shareholders’ agreement may govern where
your stock must be distributed.

Who Allocates Assets Between
the Trusts:

When there is a
choice, the decision as to which assets should be transferred to which trust should
be a team approach to address the many income tax, estate tax, legal, business
and other issues that can be affected. The team could include, depending on the
asset and issues: accountant, probate attorney, corporate counsel, pension
consultant, investment adviser, and others.  Don’t expect your probate attorney to be as sharp on income
tax issues as your accountant, and don’t expect your accountant to identify the
optimal mix of securities with the same skill as your wealth manager.

Factors to Consider:

There are a myriad of issues that can be relevant to making the decision as to
which assets are best to transfer to which trust under your will. The following
is only a partial listing:

o How is the funding of
the trust structured in the will. For example, if the By Pass trust is funded
under a pecuniary formula, and assets have
appreciated between the date of death and the funding, an income tax cost may
be incurred on funding.

o Who are the current
beneficiaries of the different trusts? For example, in some plans the  surviving spouse is the only current
beneficiary of both By Pass and QTIP trusts. In other plans, the surviving
spouse, children and others may all be beneficiaries of the By Pass trust. So,
for example, if the children are beneficiaries of the By Pass trust, and
certain assets should be made available to them or for their benefit, those
assets should be used to fund the By Pass trust. Another example, if the family
home is in the estate, it might be best to fund it to the QTIP trust to assure
that only the surviving spouse has access to it if other persons, especially
children from a prior marriage, are named beneficiaries of the By Pass trust.

o Who are the remainder beneficiaries of each trust? If different
people are intended to receive assets on the death of the second spouse, than
those assets should be distributed into the trust which will be appropriate for
them.

o Which assets are most
likely to appreciate? Since appreciation in assets in a By Pass trust will be
outside of the surviving spouse’s estate the assets with the greatest
appreciation potential could be funded to the By Pass trust. For marketable
securities a investment advisor should be consulted about this decision. The
solution may even be to acquire new investments for each trust,  in lieu of some of the current
investments held in the estate. Since the estate obtains a step up in basis on
your death, the executor may just choose to liquidate most marketable assets
and have the investment adviser create optimal portfolios in each trust after
funding them with cash.

o Who are the trustees of
each trust? If different trustees are named there may be an advantage to
transferring assets to the trusts so that the trustees best suited to manage
those assets have those assets in their trust. In light of recent court cases
the likelihood of a trust benefiting from a deduction of investment management
fees is looking bleak. If the trustees of one trust have the skills to
directly  manage investment assets
transferring marketable securities to that trust may have a better result than
transferring securities to a trust which will have to hire outside money
managers whose fees won’t be deductible.

o State income taxes may
be an issue. If, for example, your estate owns real estate or business assets
that will generate income taxable in a particular state, it might be possible
to segregate all of those assets in one trust, and manage the second trust in a
manner that avoids state taxation. For example, real estate in State A may be
put solely into the By Pass trust which will remain taxable in high tax State
A. Only securities may be transferred to the QTIP trust. The trustees of the QTIP
trust that reside in State A may resign so that there are no longer any
connections of the QTIP trust to high tax State A. The savings over time can be
significant.

o Discounts on ownership
interests in businesses (real estate, family business, investment LLC, etc.)
could be an important factor. If your estate owns 60% of a family business,
transferring 20% to the By Pass trust and 40% to the QTIP trust will assure
that on the death of your surviving spouse each of those interests will have a
greater likelihood of qualifying for a discount for
lack of control, lack of marketability,
etc. If instead the entire 60% is transferred to only the QTIP trust, there may
be a control premium actually increasing taxes on the second death.

There could be a myriad of other factors
to consider. So the best answer is involve all your professional advisers and
plan the decision carefully.