Living Trusts (Inter vivos trusts) 

In the United States, a living trust refers to a trust that may be revocable by the trust creator or settlor (known by the IRS as the Grantor). Living trusts are often used because they may allow assets to be passed to heirs without going through the process of probate. Avoiding probate will normally save substantial costs (the probate courts, in some states, charge a fee based on a percentage net worth of the deceased), time, and maintain privacy (the probate records are available to the public, while distribution through a trust is private). Both living trusts and wills can also be used to plan for unforeseen circumstances such as incapacity or disability, by giving discretionary powers to the trustee or executor of the will.

The grantor/settlor may also serve as a trustee or co-trustee. In the case where two or more co-trustees serve, the trust instrument may provide that either trustee may act alone on behalf of the trust or require both co-trustees to act/sign. The trust instrument may also provide that the other co-trustee shall act as sole trustee if the grantor becomes incompetent and is unable to continue administering the trust.

There are also some negative aspects to a living trust in the United States. Beneficiaries do not save on federal estate or state inheritance taxes. Setting up a trust may be expensive, and the expense is immediate, not delayed till after the grantor's death. The legal drafting of the trust instrument, which creates the trust, usually costs much more than the legal drafting of a will. Trust administration can be more expensive than the administration of a will in the long run, as most state laws allow a fee of 1% of the estate's gross assets to be paid to the trustee for every year the trust is in existence. The fees for probate estate administration under a will are usually from 1% of the gross estate (for very large estates) to 4% of the gross estate (for very small estates), but this is a one-time fee, not yearly. The same one-time fees apply when a person dies without a will or a trust (dies Intestate): State laws require that an intestate probate be opened at the local courthouse, that the decedent's closest relatives be identified, located and notified, and that the decedent's real and personal property be collected, accounted, and distributed to said relatives.

Important safeguards contained in the probate laws of most U.S. jurisdictions do not apply to trust administration. If the decedent leaves a will, his/her probate proceedings must be conducted under the auspices of the probate court. Unlike trusts, wills must be signed by two to three witnesses, the number depending on state law. Several safety provisions of probate law in the U.S. protect the decedent's assets from mismanagement, loss, and embezzlement, such as the requirement that the executor of the will be bonded, the real property insured, the executor’s sale of real estate monitored, and itemized accountings filed with the court during and at the end of probate administration. These procedures do not occur when a decedent's estate passes by trust. Trusts are conducted in private, unless a conflict develops and one of the parties seeks resolution by a court order.

Living trusts generally do not shelter assets from the U.S. Federal estate tax. A married couple having a trust can, however, effectively double the estate tax exemption amount (the amount of net worth above which an estate tax is levied) by setting up the trust with a formula clause. A formula clause takes advantage of the unlimited spousal deduction allowed under the internal revenue code. When the first married individual dies, the trust pays out to the beneficiaries an amount up to the total unified credit. The amount is set by the formula clause, not strict dollar amounts, because the unified credit increases over time. Without a formula clause, the unified credit could be wasted. The remaining amount of the estate (after the unified credit is exhausted) is paid to the spouse. Thus, when the first spouse dies, no estate tax is owed (just as if the individual died intestate). However, when the second spouse dies, the distribution to the trust beneficiaries is subject to that decedent's unified credit. The rest is subject to estate tax. If the married couple had died intestate, the first decedent's unified credit is lost because everything is transferred to the spouse upon his/her death. A formula clause is necessary only if the value of the estate is larger than the amount of the unified credit. Due to changes in Federal Estate Tax Laws that affect the year 2010 and later, using the Unified Credit formula may have some unintended consequences for persons who die during 2010 and later.

For a living trust, the grantor/settlor will often retain some level of relevance to the trust, usually by appointing him- or herself as the trustee and/or as the protector under the trust instrument (in jurisdictions where protectors are recognized). Living trusts also, in practical terms, tend to be driven to large extent by tax considerations. If a living trust fails, the property will usually be held for the grantor/settlor on resulting trusts, which in some notable cases, has had catastrophic tax consequences. A living trust is not under the control and supervision of the probate court, and property held by such a trust is not part of a decedent's probated estate.

Parties to the trust

There are three parties in a living trust, namely the founder, the trustees and the beneficiaries. The trust is managed by the trustees for the benefit of the beneficiaries. The beneficiaries can be any legal persons, including living people, other trusts, and registered businesses. Trustees may also be beneficiaries.

Establishing a living trust

The trust is created by drafting a trust deed (usually in cooperation with an attorney specializing in trust law) and registering the trust with the local High Court. The trust becomes effective as soon as it is registered.

Asset protection

The remaining advantage of a living trust is the protection of assets from creditors. In an ideal situation, since assets held by the trust aren't owned by the trustees or the beneficiaries, the creditors of trustees or beneficiaries can have no claim against the trust (there are exceptions). A common scenario of using living trusts for asset protection is a husband and wife acting as trustees along with a third unrelated trustee. The trust is granted a loan equal to the value of their assets, then the trust buys their assets using the loan, and finally the trust pays off the loan over time. When any of trustees die, the trust and any assets owned by it, remain unaffected.

Assets transferred into a living trust remain at risk from external creditors for 6 months if the previous owner of the assets is solvent at the time of transfer, or 24 months if he/she is insolvent at the time of transfer. After 24 months, creditors have no claim against assets in the trust, although they can attempt to attach the loan account, thereby forcing the trust to sell its assets.

Assets can be transferred into the living trust by selling it to the trust (through a loan granted to the trust) or donating cash to it (any person can donate R30 000 per year tax free; 20% donations tax applies to further donations within the year).

Tax considerations

In terms of tax law, living trusts are considered tax payers. Two types of tax apply to living trusts, namely income tax and capital gains tax (CGT). A trust pays income tax at a flat rate of 40% (individuals pay according to income scales, usually less than 20%). The trust's income can, however, be taxed in the hands of either the trust or the beneficiary. A trust pays CGT at the rate of 20% (individuals pay 10%). Trusts do not pay deceased estate tax (although trusts may be required to pay back outstanding loans to a deceased estate, in which the loan amounts are taxable with deceased estate tax).

The taxpayer whose residence has been "locked" in to a trust has now been given another opportunity to take advantage of special CGT exemptions. The Taxation Law Amendment Act was promulgated on 30 September 2009 and takes effect on 1 January 2010 allowing a window period of 2 (two) years from 1 January 2010 to 31 December 2011 for the opportunity of a natural person to take transfer of the residence with advantage of no transfer duty being payable or CGT consequences. Taxpayers can take advantage of this opening of a window of opportunity is not likely that it will ever become available thereafter.

If you are thinking: Saving taxes is commonly cited as an advantage of living trusts. That really is a myth. Living trusts do not inherently save taxes.

Living trusts can be used as a tool to save taxes, as can a testamentary trust. But, there is no unique tax advantage specific to a living trust.

There are principally three taxes to discuss when talking about living trust taxes. They are:

• Income Tax
• Capital gain Tax 
• Estate Tax

As discussed at What is a Living Trust?, the most common type of living trust is a revocable living trust.

If you have a revocable living trust, you can revoke it at any time. You can name yourself as the trustee and use the assets in the trust however you like. In fact, you could put your checking account in the revocable living trust and continue to pay your personal bills from that account as always.

So, you probably aren't surprised when I tell you that, for tax purposes, income earned by that revocable living trust is attributed to you as trustor of the trust.

You will pay income taxes on the income the trust earned just as if it was your income.

Your social security number will be the taxpayer identification number for the trust. [This is why you probably should not get a separate tax ID for the revocable living trust as that will only confuse matters.]

While you are trustee or co-trustee, no separate income tax returns are required to be filed for living trust. You will simply report the trust's income and deductions on your personal return.

Even if you are not the trustee of the revocable living trust – as long as you retain the power to revoke the trust, it is still considered yours for tax purposes. The trustee would file an information return with the IRS and any trust income would be attributed to you and reported on your personal return.

After your death, the IRS has a new problem. You are no longer "available" to pay taxes on the trust income.

No problem. At that point, the trust becomes a separate tax entity and pays its own income tax. [This is the same thing that would happen if the assets passed through a will (instead of a living trust) and earned income while in probate.]

What about living trusts and estate taxes?

Assets in your revocable living trust will be considered part of your estate and will be subject to estate tax. Whether estate tax will have to be paid will depend on whether your estate is valued above or below the estate tax exclusion amount at the time of your death.

So, as you can see, when it comes to living trust taxes – the tax laws actually make sense.

If you control the trust – you, or your estate, will pay income and/or estate taxes on the assets in the trust – just as if they were not in the trust.

There is simply no inherent tax advantage to placing assets in a normal, revocable living trust.

Living Trust Taxation Tips

Consumers all around the world all struggle with the issues of income and taxes. There are some countries where the tax rates are astronomical and people seek relief in any form possible. Due to those seeking tax relief, there have been rumors of using a living trust to avoid taxation. Many wonder is this true? Can you avoid living trust taxation by simply having a living trust and avoid paying income tax because your income is in the living trust?

The overall answer is that no you cannot avoid living trust taxation. Regardless of who the grantor of the trust is, there will still be taxes owed, and they must be paid by the appropriate person. Now the question rises, of who is the appropriate person. Typically, as long as the grantor is still alive, they claim the income from the living trust, minus any appropriate expenses as income on their own income taxes. This is only used as a taxation method if the grantor of the trust is still alive.

The process becomes a bit more drawn out if the grantor is not alive. First scenario is that the proceeds of the trust have not been distributed. The trust still has control over all proceeds, bank accounts, property, and anything else held in trust. If this occurs, the trustee must file for a tax identification number, and file income taxes for the living trust based upon taxable income. As you can see, there is no avoiding living trust taxation with this method.

Your other alternative, comes when the grantor has passed away, and the proceeds have already been distributed. This creates the need for the trustee to acquire a tax identification number for the living trust. Using the tax identification number an account would prepare the necessary tax papers required to show the proceeds of the trust being transferred to each beneficiary.

Once this is filed, each beneficiary would be required to claim their portion of the proceeds from the trust on their own individual income tax forms. As you can see, there is no legal way to avoid living trust taxation in some form. The taxes must be paid from somewhere, it is just a matter of where, depending upon the status of the trust, whether the grantor is still alive, and if the proceeds have been distributed or not. Remembering that there is no legal way to avoid living trust taxation is very helpful, do not believe sales people, or even lawyers who try to convince you that you will not have to pay taxes on the proceeds of a living trust as this information is grossly inaccurate.

The best way to ensure that all proceeds are properly accounted for, is to use an experienced accountant who has experience in living trust taxation issues. This is your best defense against inadvertently making a mistake that could be quite costly. While having your taxes prepared can be very costly, it will be much cheaper than any penalties, or fines that are imposed because of a mistake. In addition, ensure that the tax professional you select, offers an audit guarantee.

By insisting upon an audit guarantee, the accountant you select will be responsible for assisting you in an audit if they make a mistake that causes an audit. This helps protect you from living trust taxation fraud, and ensure that you are filing all of the correct paperwork as necessary for your particular situation. With a good accountant, you are sure to enjoy a good experience with your living trust, whether you are the grantor, or the beneficiary.

The Truth About Living Trusts

There are several ways to handle your estate. Intestacy -- dying without a will -- is an option for some people with relatively simple finances. For others, a will can be a useful tool to take care of giving away your goodies -- but it can open up the lengthy and complex processing, known as probate.

A simple will, a health-care proxy and durable power of attorney, and updated beneficiary designations are often all you need to carry out your final financial wishes with ease. However, a living trust -- a single document that combines the provisions of a will and a financial power of attorney -- can offer additional asset-management muscle both while you're alive and long after you're gone.

Before you add this document to your filing cabinet, read on.

Trust as a tax evasion? Not…