What better way to show one cares for their family’s financial security than to create and fund a discretionary trust that directs that assets may be used for the lesser wealthy “donee-spouse” and the children and/or other family members. Certain trusts can be designed to maximize the avoidance of gifts taxes, estate taxes, income taxes, and at the same time, better ensure that the trust assets will be available to only the desired family members as opposed to being exposed to creditors, bankruptcies and divorces (alimony, maintenance, support, and property settlements) of the beneficiaries.
The vehicle of favor is technically known as an “inter vivos QTIP” trust. The trust can be created by the “donor-spouse” for the donee-spouse (i.e., the person to whom the donor-spouse is married, as determined at the time or times distributions may be made) and other family members, all for their entire lifetimes and the lifetimes of future generations. This way, the family is better assured that the gift will always be there for use in only appropriate ways and times.
The trust can be funded gift-tax-free because the trust is designed to qualify for the unlimited marital gift tax deduction. The trust is also removed from the donor-spouse’s taxable estate. It should be noted though that the trust will be included in the donee-spouse’s taxable estate. That being said however, the donee-spouse can apply (under current law) huge exemptions toward any such taxable estate. In fact, at the time of the donee-spouse’s death, the donee-spouse may also be able to use his or her own marital deduction to the extent the trust exceeds the then-available estate tax exemption, if the trust then reverts to a discretionary trust for the surviving donor-spouse. Such reversion can allow for an interim step up in basis if the donee-spouse lives for at least a year after the trust is created and funded by the donor-spouse. Certain strategies can also be implemented if there is concern that the donee-spouse might not live for at least a year.
For trusts in excess of the estate tax exemption amount (assuming the donor-spouse outlives the donee-spouse), the trust (upon the donee-spouse’s death) can be bifurcated into a marital and a bypass trust, which can allow for further estate tax reduction techniques (such as the marital trust selling appreciating assets on an installment sale basis to the bypass trust that is not included in either spouse’s taxable estate). The reverted trusts can also be treated as “grantor trusts” to the donor-spouse so that the trusts are not burdened with income taxes. Furthermore, as intimated above, the reverted bypass trust avoids estate tax inclusion in the donor-spouse’s estate. See Treas. Reg. 25.2523(f)-1(d) and d (f) examples 9, 10 and 11.
As opposed to an automatic reversion, it can be better from a protective standpoint if the donee-spouse appoints the assets at death to a trust for the donor-spouse or other family members. Assets can then be distributed, or better yet, used for the benefit of, the donee-spouse’s family members.
If the donee-spouse predeceases the donor-spouse, the trust can continue for the donor-spouse’s family in a well-designed and flexible trust environment. Having a “protector” designated can further allow for added pliability of the trust in the event of unforeseen changing circumstances.
The trust can be funded with low-tax basis assets. This way, if the donee-spouse dies before the donor-spouse’s death, all the assets get a step-up in tax basis to any appreciated assets’ then-current values, possibly allowing those assets to be sold during the donor-spouse’s lifetime tax-free.
All fifty states recognize laws that impose spendthrift restrictions that dictate that when trusts are created for someone other than the trust creator, spendthrift clauses are generally applied to preserve the assets from the reach of creditors, even in the event of voluntary or involuntary bankruptcies. Such spendthrift clauses also prevent the beneficiaries from unilaterally pledging trust assets for bank loans to the beneficiaries.
In designing these trusts, choice of governing law and trust situs is very important, and can be affected by where the donor-spouse resides. For example, in Florida, an inter vivos QTIP trust that reverts to the donor-spouse is considered as a third party trust that Florida law favors (for spendthrift protection effectiveness) as opposed to a self-settled trust, which Florida law’s public policy discourages. This being said, self-settled trusts remain common designs for those who want to remain a beneficiary for any period of time. Regardless of the design of any trust, it should be noted that no plan is “bullet-proof.” That is, proper planning and attention being given to the ongoing administration of the trust and following all trust formalities is paramount, and any change in circumstances for any individual warrants revisiting any plan, since each individual’s situation is unique. Any benefit or controls that an individual desires to retain over trust assets can be a trade-off for the level of protection that can otherwise be achieved.
This blog is for your general information. The discussion of any asset protection and/or estate planning strategies, alternatives, and other observations herein are not intended as legal or tax advice and does not consider the asset protection goals, estate planning objectives, financial situations, or needs of individual clients. This blog is based upon information obtained from various sources that the author believes to be reliable, but the author makes no representation or warranty with respect to the accuracy or completeness of such information. Views expressed herein are current opinions only as of the date written, and are subject to change without notice. Suggested outcomes may not be realized due to a variety of factors, including changes in law or regulations.