Arkansas Estate, Business, and Property Law

When Do You Need a Revocable Trust?

(Updated for 2011 and 2012)

                       You may have been told that you need to protect your assets by placing them into a “trust”.  While there are many types of trusts, it is the most common is a revocable trust, which is also sometimes referred to as a “living trust”.  In basic terms this trust is a tool pursuant to which a person, during their lifetime, may transfer assets into a trust which will then be distributed to his or her family or lawful heirs at the time of death.

Revocable trusts are powerful tools which may accomplish a variety of goals including reduction of the Estate Tax, avoidance of probate, and the protection of assets.  Determining whether the Estate Tax may apply involves an analysis of the applicable exemption provided by Congress.   For 2011 and 2012, the applicable exemption is approximately $5 million ($5,120,000  in 2012).  This means, generally, that anyone who dies in those years can declare up to $5 million in assets free from the Federal Estate Tax.  On January 1, 2013, the exemption will fall back to $1 million, subject of course to additional action by Congress.  Some experts predict that the exemption rate may eventually stabilize at $5 million, adjusted by the rate of inflation.  However, it is important to remain aware of the applicable exemption as your potential Estate continues to grow during your lifetime.

Any amount left in your estate (including proceedings from life insurance) minus the applicable exemption for the year of death, are potentially subject to the estate tax.  A trust does not avoid the estate tax, but does allow a married person to likely reduce the tax effect upon his or her spouse through proper use of a Bypass Trust (which generally allows both married parties to claim the exemption, separately).

Since the $5 million exemption presently excludes most estates from the tax, the more popular justification for forming a revocable trust is to avoid probate – the sometimes costly and lengthy legal process generally necessary to administer the estate of a person upon death.  Many probate lawyers will charge your family a percentage of the assets which pass through the Estate, regardless of the amount of work which may be necessary to complete the probate.  A typical Probate will take 6-12 months to complete, often limiting the ability to access assets during the completion of the proceedings.  If assets are property titled in name of a Trust, then upon death those assets avoid probate entirely.  Further, since probate records are available to the public a trust provides the additional benefit of privacy.

Trusts may also provide a limited measure of asset protection for the family or heirs of the deceased person.  By including a “spendthrift provision” in the trust, creditors of the beneficiaries may be prevented from reaching the assets placed in the trust.  This might also be used to prevent a younger heir from reaching the full amount of his or her inheritance, which can also be accomplished by placing an age limit on the date of distribution.

There are other benefits to creating a revocable trust, such as avoiding potential issues which may arise upon a future physical or mental disability and the benefit associated with allowing your family to retain control over your assets upon death.  The largest advantage, however, may be the peace of mind associated with knowing that your wishes upon death are specifically, properly organized and detailed in a manner causing the least amount of potential stress and difficulty upon your family or heirs.  For additional information on how a trust may benefit you and your family, please contact Cade Cox of Cox, Sterling & McClure at 501-954-8073 or at clcox@coxandsterling.com.

Believe it or not, as we enter 2010, there is no Estate Tax.   As discussed in other articles:  What is the Estate Tax? and When Does the Estate Tax Apply?, the estate tax (assessed upon death)  in prior years generally only affected persons with large estates.  For example, in 2009 the tax only affected estates with assets in excess of $3.5 million.  For this year, however, it will not affect anyone, no matter how large or small the estate.  Unless Congress acts quickly to stop this repeal, any large estates opened in 2010 will see significant tax advantages. 

There is another issue, however, that could offset this advantage and negatively affect many more estates.  In addition to the temporary repeal of the Estate Tax, there is also the repeal of a tool which generally helps most people who inherit an estate:  “step up basis”.  This comes into play for those who inherit assets through another person’s estate;  for example, when a family member leaves you stock, a business, or real estate upon their death.  

When you eventually attempt to sell  the property which has been left to you, a tax is implemented determined by your “basis” in the asset.  Under former law (which expired on December 31st), your basis was the value at the time of the transfer (at the time the person who gave it to you died).  So, if a family member left you stock valued at $50,000.00 at the time of death, and then you sold it later for $75,000.00, you would be taxed on the difference of $25,000.00 (since your basis would be established at $50,000.00 at the time your family member died).   This is called a “step up” in basis, since the law allowed you to “step up” the basis to the date of the transfer to you.

Compare this to a situation where no “step up” is allowed (as is the case under current law):  when you sell that same stock for $50,000.00 you will be charged with the basis of the person who transferred the asset to you (this is called ”carry over” basis”).  It is likely that the person who left you the stock upon her death paid significantly less for the asset.   The same $50,000.00 in stock left to you may have been bought by your family member for $10,000.00.  Therefore, when you sell the asset for $75,000.00, you would be taxed on $65,000.00 in gains.   

Even with the appeal, there remains an exemption amount of $1.3 million, total, which may be spread among all assets transferred in one estate.   Therefore, many smaller estates  will not be affected.  With the repeal of the estate tax and coinciding repeal of “step up” basis, this will be an interesting year for estate and property law.

You may have been told by an accountant, financial advisor, insurance agent, attorney, or other trusted advisor that you need to protect your assets by placing them into a “trust”.  While there are many types of trusts, it is likely that your advisor is referring to a revocable trust, which is also commonly referred to as a ”living trust” or a “loving trust”.  In basic terms this trust is a tool pursuant to which a person, during their lifetime, may transfer assets into a trust which will then be distributed to his or her family or lawful heirs at the time of death.

Revocable trusts are powerful tools which may accomplish a variety of goals including reduction of the estate tax, avoidance of probate, and the protection of assets.  Issues concerning the estate tax are discussed in more detail here and here.  Any amounts left in your estate (including proceedings from life insurance) minus the applicable exemption for the year of death ($1 million for 2011), are potentially subject to the estate tax.  A trust does not avoid the estate tax in full, but does allow a married person to delay payment at death and likely reduce the tax effect upon his or her spouse through proper use of a Bypass Trust.

A second major advantage provided by a revocable trust is the ability to avoid probate – the sometimes costly and lengthy legal process generally necessary to administer the estate of a person upon death.  Please see additional articles available on this blog concerning issues associated with probate.  Many probate lawyers will charge your family a percentage of the assets which pass through the Estate, regardless of the amount of work which may be necessary to complete the probate.  The legal costs, in addition to the wait associated with the Court system, make trusts an attractive alternative for many people.  Upon death all assets properly conveyed to a trust avoid probate entirely, and since probate records are available to the public a trust provides the additional benefit of privacy.

Finally, trusts may also provide a measure of asset protection for the family or heirs of the deceased person.  By including a “spendthrift provision” in the trust, creditors of the beneficiaries may be prevented from reaching the assets placed in the trust.  This might also be used to prevent a younger heir from reaching the full amount of his or her inheritance, which can also be accomplished by placing an age limit on the date of distribution.

There are other benefits to creating a revocable trust, such as avoiding potential issues which may arise upon a future physical or mental disability and the benefit associated with allowing your family to retain control over your assets upon death.  The largest advantage, however, may be the peace of mind associated with knowing that your wishes upon death are specifically, properly organized and detailed in a manner causing the least amount of potential stress and difficulty upon your family or heirs.  For additional information on how a trust may benefit you and your family, please contact Cox, Sterling & McClure at 501-954-8073 or via the Internet at coxandsterling.com.

When determining whether the Federal Estate Tax (“the Estate Tax”) may apply to you, the first step is to determine the amount which may be excluded under the Federal Tax Code.  For 2009, the exclusion is $3.5 million per person.  This means, for a person who dies in 2009, the first $3.5 million of their “taxable estate” is not subject to the Estate Tax.  The “taxable estate” is calculated from the “gross estate”, which is a broad spectrum including most assets owned by the party at the time of death, including any life insurance proceeds left to the person’s beneficiaries.  For a discussion of the taxable estate and recommended tools for reducing the estate, see “What is the Estate Tax.”

After 2009, the situation becomes significantly less clear.  Under current law, a person dying in 2010 will be subject to no estate tax.  Generally, this means that regardless of the value of the assets of the decedent, there will be absolutely no tax liability for purposes of the estate tax.  In 2011, the exclusion drops to $1 million, unless the present law is changed before that date by Congress.  In the event the law remains in effect, we will see a drastic increase in the number of estates subject to the death tax. 

Due to the fluidity of the tax laws and uncertainty regarding death, proper estate planning is necessary to protect your assets.  Under the present tax law, anyone who dies after 2010 will maintain only a $1 million exemption from the death tax, and the value of the primary residence, life insurance, and retirement savings alone will place many people in a position where the death tax will present a real problem for which adequate planning is necessary. 

The goal, of course, is to eliminate the death tax and ensure that all of the assets earned during your lifetime may be passed to your heirs.  Any amounts left subject to the estate tax are subject to the “tentative tax” rates allocated by the IRS.  Various articles on this blog will discuss tools which can be used to reduce your taxable estate, including:

• Revocable Trusts
• Gifts
• Business Ownership
• Life Insurance Trusts
• Bypass and Marital Trusts
• Charitable Gifts

Welcome to one of several introductory articles associated with the launch of our new blog, Arkansas Estate, Business, and Property Law, a blog addressing the protection of assets under Arkansas Law.  Today we will discuss an issue central to many of the articles featured on our blog:  “What is the Estate Tax,” and what do you need to know to ensure proper protection of your assets.

The Estate Tax, commonly referred to as “the Death Tax” in the media, is also known as the “inheritance tax.”  This tax is assessed on the estate of a deceased person.  In other words, when a person dies, and his or her property and assets are passed to heirs and descendants, the estate tax comes into play.  It does not matter if the person dies with a will (or trust), or whether they die intestate (without a will), the estate tax must nevertheless be taken into consideration (you know what they say about death and taxes).

For purposes of federal taxation, the estate tax is imposed upon the amount of “taxable estate” passed to the heirs or descendants of the person who has died.  When calculating the “taxable estate,” the law first takes into account the total “gross estate” of the decedent, which generally includes all property of the person at the time of death, including proceeds from life insurance. 

The key in estate planning is to limit the amount of your “gross estate” which will be included within your “taxable estate.”  By creating trusts and taking advantage of additional planning techniques, you are able to limit the amount of your estate which would be taxable, i.e. subject to the estate tax.  Various articles on this blog will discuss tools which may be used to reduce your taxable estate, including:

• Revocable Trusts
• Gifts
• Business Ownership
• Life Insurance Trusts
• Bypass and Marital Trusts
• Charitable Gifts

For additional information on this subject, please see “When does the Estate Tax apply?”