Revocable Living Trusts

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REVOCABLE LIVING TRUST (Revocable means that you can change it later.
You will also learn how to do this while we work on your documents and will not have to spend $ on attorneys for any future changes.)

Remember the probate nightmare described above? A revocable living trust (trust) eliminates all these problems. And, here’s the reason a trust solves all the Will – Probate problems. A trust is a contract between you and the successor trustee, i. e, the person(s) you designate while alive to handle your affairs upon your death. In other words, the state of California is not a party. Typical trust estate takes a few months to settle and the costs are very minimal. Did your attorney explain to you that he will make far less money from a trust than probate?

Typically you (or you and your spouse if married), name yourself as the trustor or settlor (the one who places the property in trust), the trustee (the one who distributes assets) and the beneficiary (the one who receives assets). Note that the ownership of the assets does not change. In other words, you still own everything and retain the right to sell, buy, mortgage, etc. You also name other beneficiaries upon the death of the last one of you to die. You may designate that the assets be distributed in one stage, or you may stagger this over a period of years. This is particularly useful if some of the beneficiaries are not financially responsible and you wish to delay asset transfer until later in their lives. Quite an incentive to shape up here! Remember that this is not possible with the Will where all assets must be passed at the age of 18 regardless of how financially irresponsible the recipient is (except for the legally incompetent individuals).

Upon the death of the last of you to die, the successor trustee takes over at that time and distributes assets. This is all done in private and without court involvement. If, while you’re still alive, you become unable to manage your assets, the successor trustee may take over and preserve the estate from predators. And best yet, each one of you gets to keep your own exemption from the estate tax because your spouse left you the assets in a trust rather than outright as in a will, for a total of two exemptions. This is “two for the price of one” referred to in the Wills section. Simply put, for 2005 you get to shelter $3,000,000 from the tax man by having a trust instead of $1,500,000 without a trust. So, it the entire estate is $3,000,000, the total estate tax would be zero. In case of a will, only one exemption would be applied and the estate tax the remaining $1,500,000 would be approximately $730,000. For a price of a living trust you can save lot of $$$.

You may also set up trusts within the revocable trust for minors or disabled persons. One example of this is a Special Needs Trust that may be utilized to take care of a disabled person while still benefiting from public assistance. This also avoids court appointed guardians or conservators (a tiresome, intrusive and an expensive process that should be avoided if at all possible).

Holding real property in trust instead of joint tenancy also offers significant income tax (capital gains) savings when the recipient sells the property. Typically, the cost basis (what you paid for property) gets stepped up (increased) to the market value at the time of first death. Suppose you’re married and paid $60,000 for the property ($30,000 each for cost basis calculation). At the time of the first death the house is worth $1,250,000 (not unusual for this part of the country). The cost basis is now stepped up to $1,250,000, in other words, because you held the property in the trust the price you paid for the house is now $1,250,000 If you choose to sell the property then, you get the entire gain from $60,000 to $1,250,000 ($1,190,000) tax free, i.e., $1,250,000 minus $1,250,000 = zero. So. No capital gains, no capital gains tax. Not bad! For the joint tenancy example (i.e., disaster) with the same facts see the section on Joint Tenancy.

The trust also avoids potential gift tax problems (about 50% of the gift over the $11,000 presently per recipient per year) that may arise due to placing property in joint tenancy.

Now, let’s spend a little time going over the trust mechanics. Typically (depending on what you’re trying to accomplish, the size of the estate, and similar), you would include the following in your documents:

1. Survivor Trust – useful for estates whose combined presently below $1,500,000. The survivor spouse controls ALL the assets and if the survivor spouse does not dispose of the assets they will be distributed to the descendants, typically equally to each of the spouse’s families. Need to be careful that the size of both spouses’ estates does not exceed the estate tax exemption, presently at $1,500,000. More commonly, the survivor trust holds only one half of the jointly held assets and separate assets of the survivor spouse.

2. Bypass Trust – the name probably means that it by-passes estate tax for the deceased spouse. Used primarily when the combined assets exceed $1.5 M (million), and it totally protects presently up to $3M. Note that the any subsequent increase (after the first spouse’ death) in the deceased spouse’s estate does not need to be reported. Possibly a BIG BREAK if the estate consists primarily of appreciating assets. Sadly, the capital gains tax may be lurking in the background….cannot get away from all the taxes completely. The terms of the Bypass Trust cannot be changed after the first spouse dies, i.e., the trust becomes irrevocable. The survivor may receive some or all of the income and some of the principle, subject to some standards (ascertainable standard…a legal jargon meaning “as long as its not too much”), i.e., for health, support, education and general maintenance. When the survivor dies the property in the Bypass Trust is distributed according to the wishes of the settlers’ at the time the trust was created.

A word on unlimited marital deduction. Spouses are allowed to transfer an unlimited amount of assets to each other during their lifetimes and at time of death. The transfer must be outright to the other spouse with no conditions attached to it whatsoever. Well, what if your spouse remarries and spends all the assets on new spouse instead of on your children, or, if this was a second marriage, say the spouse spends the assets on her children and not yours. If, on the other hand, you leave the gift in a trust to prevent this, the gift is not outright, and the survivor spouse has to pay estate taxes on everything above the estate tax exemption in effect at the time. So, to help with this situation, Uncle Sam, in 1981created QTIP Trust.

3. QTIP Trust (Qualified Terminal Interest Property Trust)
This trust comes into play when you want to control the ultimate distribution of your assets. Most commonly, you would use this to preserve the assets for your children from the first marriage (e.g., my late wife and I set up a QTIP trust to provide for the children so that I cannot just arbitrarily spend those assets on the new spouse). Like the Bypass Trust, this trust also becomes irrevocable after the death of the first spouse. It is good to include the QTIP trust in your papers as your situations may change and it may be warranted in the future. The beauty of it is that while the unlimited gift can be made to the spouse in the trust, the spouse must have the right to receive all the income from the trust assets, and upon the spouse’s death the trust assets pass to the children.

The assets in the QTIP trust are included in the surviving spouse’s estate at the time of second death.

TYPICAL STUATION: The following describes in more detail what happens in a typical revocable trust arrangement for a married couple including a QTIP trust, and the events that take place at the first and the second death:

The "trust estate" is all property subject to your living trust document, whether placed in your living trust now or later. The trustee is to hold, administer, and distribute the trust estate, including the property described in any schedules of property that are attached to the living trust document.

All property placed in this living trust, including all proceeds from the property, retains its original classification as either the community property of both of you or the separate or "quasi-community" property of the one of you who contributed it.

While both of you are alive, either of you may amend, revoke, or terminate your living trust as to your own separate or "quasi-community" property and either of you may revoke or terminate as to both of your community property in the living trust. While both of you are alive, you may only amend the living trust through joint action as to community property when rights or interests of either of you in that community property is affected.

On the death of the first of you to die, your living trust is divided into three parts: the Marital Deduction Share, the Nonmarital Share, and the Survivor's Share.

The surviving spouse may amend, revoke, or terminate the Survivor's Trust. All other trusts created by your living trust document are irrevocable and may not be amended.


The Survivor's Share consists of 1/2 of all community property, 1/2 of the "quasi-community" property of the first of you to die, and all of the separate and "quasi-community" property of the surviving spouse.


After the death of the first of you to die ("the deceased settlor"), the Nonmarital Share is placed in the Bypass Trust and the Marital Deduction Share passes to a QTIP Trust. As explained in more detail below, both of these shares should avoid federal estate tax on the death of the deceased settlor. (The Marital Deduction Share may be taxed on the death of the surviving settlor, in the survivor's estate.)

The amount of the Nonmarital Share is determined by means of a formula. The purpose of the formula is to reduce to the extent possible, or perhaps even eliminate, the federal estate tax that will be owed by the deceased settlor's estate at his or her death. For purposes of federal estate tax, a decedent's estate will usually include the property in a revocable living trust created for the decedent. The formula ensures reduction of the total federal estate tax by taking optimal advantage of the estate tax marital deduction and the applicable credit amount.

Note: Under the 2001 Tax Act, the federal estate tax is gradually phased out until the end of 2009, when it is scheduled to be repealed. However, for deaths occurring after the end of 2010, the law in effect as of 2001 is reinstated, unless further legislation is enacted. It is unknown whether Congress will allow this one-year repeal to remain and the subsequent return to higher estate taxes to become effective. Until Congress acts, it will be difficult to provide a meaningful numerical representation of how the formula will actually work for your estates. Nevertheless, the formula provided in your living trust document is designed to reduce your estate taxes to the extent possible regardless of the amount excluded from estate tax, and it will work even if there is no estate tax at all.

The estate tax marital deduction generally allows property that passes to a spouse at a person's death to avoid federal estate tax at that person's death. On the other hand, the applicable credit amount allows a certain amount of property to pass to any other beneficiary, while avoiding federal estate tax. At present, the maximum amount that can avoid estate tax because of the applicable credit amount is $1,500,000. This amount will gradually rise to $3,500,000 for deaths occurring in 2009, the year before the currently-scheduled repeal of the estate tax. However, the amount of estate tax that a particular decedent will be able to avoid also depends on a variety of other factors that might apply to your estates, such as whether you have made taxable lifetime gifts.

The formula allows all relevant factors to be determined on the deceased settlor's death and takes into consideration whether you each have made any gifts in your revocable living trust document, in your wills, or by other methods (e.g., life insurance) to persons other than your spouse (or other than to a charity).

The formula specifies that the Nonmarital Share is the portion of the trust estate that is excluded from federal estate tax because of the applicable credit amount, other than the Survivor's Share and any special gifts made by the deceased settlor. The Nonmarital Share passes to the Bypass Trust, pursuant to the provisions of your living trust document, and is in a form such that, to the extent possible, there should be no estate tax on that property in either of your estates. The balance of the trust estate (the total trust estate minus the Nonmarital Share minus the Survivor's Share minus any special gifts made by the deceased settlor) passes to the Marital Deduction Share. The Marital Deduction Share will avoid estate tax in the deceased settlor's estate because property passing to a QTIP Trust is in a form qualifying for the marital deduction.

You should be aware that the formula determines amounts (values) of property. The decisions regarding the specific property that goes to the Survivor's Share, to the Marital Deduction Share, or to the Nonmarital Share will be made by your trustee (or successor trustee) after the death of the deceased settlor (except for the surviving settlor's separate property, which automatically goes to the Survivor's Share). There could be income tax consequences to your trust, to your estates, or to certain beneficiaries under your living trust document, depending on the type of property involved and the decisions made by your trustee.


The surviving spouse has the right to decline taking property given to him or her by your living trust document. If the surviving spouse "disclaims" any property, that disclaimed property goes to a special trust, the Disclaimer Trust. The Disclaimer Trust is for the benefit of the surviving spouse for his or her lifetime. Note that the Disclaimer Trust only exists if the surviving spouse actually disclaims some property.

As part of tax planning after the death of the first of you to die, the surviving spouse may want to disclaim property in order to equalize as much as possible the values of your estates. The way the estate tax rates are set up, less total tax may be owed if there are two estates of approximate equal value, rather than if one estate is much larger than the other. The surviving spouse may also want to disclaim certain property, such as property that will very likely appreciate in value before his or her death, so that the estate tax is paid now on its current value rather than on the value at the surviving spouse's death. (Note that, for purposes of determining federal estate tax, the value of the estate of the first of you to die includes the value of one-half of all community property and the value of his or her separate or quasi-community property in your living trust.)

Of course, the surviving spouse may also have non-tax reasons for disclaiming property.


The assets of this trust, which is created on the death of the first of you to die, consist of the property placed in the Survivor's Share of your living trust document. The trustee for this trust makes monthly payments (or other periodic payments to which the surviving spouse and the trustee agree, but which payments must be at least annually) from the trust income to the surviving spouse (or for his or her benefit).

The trustee may, at the trustee's discretion, make payments of principal of this trust to the surviving spouse for his or her comfort, welfare, and happiness. The trustee is also to pay to the surviving spouse those amounts of the principal of this trust that he or she may request by a signed writing.

Power of Appointment: The surviving spouse has the right to specify, in another living trust document or in his or her will, how the remainder of the assets of the Survivor's Trust should be distributed after the surviving spouse's death. That right is termed a "power of appointment" over the trust assets. If the surviving spouse does not exercise the power of appointment, the property is to be distributed just like the default provisions of the Bypass Trust, as if the special power of appointment in that trust had not been exercised by the surviving spouse.


The assets of this trust, which is created on the death of the first of you to die, consist of the property placed in the Marital Deduction Share of your living trust document. The trustee is to pay the net income of this trust to the surviving spouse for his or her lifetime. The payments are to be made monthly or at any other convenient period agreed to by the surviving spouse and the trustee, but the payments are to be made at least annually. Additionally, the trustee may pay principal of this trust to the surviving spouse for his or her health, education, support, and maintenance.

On the surviving spouse's death, all net income of this QTIP Trust not paid out to the surviving spouse is to be paid to his or her estate. On request from the surviving spouse's estate, any federal taxes owed by that estate because of this trust are to be paid from this trust. The remaining QTIP Trust property is to be distributed just like the remainder of the Bypass Trust. This means that the remaining QTIP Trust property will also be subject to the special power of appointment referred to in the Bypass Trust remainder.


The assets of this trust, which is created on the death of the first of you to die, consist of the Nonmarital Share of your living trust document. The trustee of this trust is to pay principal and income of the trust to the surviving spouse to the extent that the trustee feels proper to pay the reasonable expenses for the surviving spouse's health, education, support, and maintenance. The payments are to be made monthly or to be made at any other convenient period agreed to by the surviving spouse and the trustee. However, the trustee is not to make payments of principal from the Bypass Trust to the surviving spouse unless the principal of both the Survivor's Trust and the QTIP Trust has been used up.

NOTE: While you’re avoiding probate, it is still important to go through the trust administration process. The following is the minimum that needs to be done:

1. All assets need to be distributed per the provisions of the trust instrument.
2. Proper appraisals need to be made.
3. Any estate debts and taxes need to be paid.
4. All beneficiaries need to be notified.
5. All creditors need to be notified.
6. Title to real property needs to be properly transferred.
7. An estate tax return may need to be filed.

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