Trusts play an important role in estate and tax planning. A trust is a fiduciary arrangement that allows a trustee to hold legal title to assets for the benefit of a beneficiary. The beneficiary is, in turn, said to maintain beneficial ownership over the property.
The law of trusts can be traced back to Roman and Greek law, though it was further developed in medieval England during the time of the Crusades. Although Roman law did not recognize a trust in precisely the same sense that we do today, the Roman concept of a Fiducia and fideicommissum served a similar function, as did the salman or treuhand of Germanic law. Modern conceptions of trust law find their roots in twelfth century English law, as well as feudal land conveyances circumventing Henry VIII’s “Statute of Uses” in the sixteenth century.
Trusts are commonly used for estate planning, charitable purposes, and managing assets for beneficiaries, as well as for asset-protection purposes. And there are a wide variety of trust structures.
What is a Trust?
The Restatement (Second) of Trusts defines a trust as “a fiduciary relationship with respect to property.” A trust is essentially a three-party arrangement: A founder of the trust, generally known as a “settlor,” transfers legal title of trust property (known as the trust “res”) to a trustee to hold and administer the property for the benefit of the trust’s beneficiaries. The beneficiary is said to hold “beneficial” title to the trust property.
Thus, the primary parties are the (i) grantor or settlor, (ii) trustee, and (iii) the beneficiary.
What is the Purpose of a Trust?
By definition, a trust is a legal relationship with respect to property. Thus, the common-law rule is that a trust does not exist without a res—that is, it fails without property. Nonetheless, the res may be sufficient even if it has only a nominal value.
Generally, a promise to transfer property to the trustee does not create a trust unless the promise is enforceable as a contract.
What are the Requirements to Create a Valid Trust?
In order to create a valid trust in Texas, a settlor must have capacity and must manifest an intent to create a trust. The beneficiary must be identified and there must be trust property. The trust must be created for a legal purpose. In addition, the same person may not serve as the sole trustee and the sole beneficiary.
Is a “Trust” Always a Trust for Tax Law Purposes?
No. An arrangement may be characterized as a “trust” for state law purposes, but may nonetheless be characterized as something else for federal tax law purposes. For example, under Treasury regulations, a trust for State law purposes may be treated as a corporation or partnership for federal tax purposes under some circumstances.
IRS Treasury Regulations define a trust as follows:
an arrangement created either by will or inter vivos declaration whereby trustees take title to property for the purpose of protecting and conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts . . . . Generally speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.
What is a “Testamentary” Trust?
A testamentary trust is simply a trust that takes effect at a settlor’s death—generally, through a will or trust document.
What is an Inter Vivos Trust?
An inter vivos trust, also known as a “living” or “lifetime” trust, becomes operative while the grantor is alive. An inter vivos trust is often employed to avoid the probate process, which can entail publicity, expense, and delay.
What is a Grantor?
A grantor may also be called a creator, donor, founder, settlor, or trustor. Every express trust has one or more grantors who contribute the property to the trustee and state the terms of the trust.
What is a Trustee?
The trustee or trustees receive the property and hold it for the benefit of one or more beneficiaries. The trustee is the legal owner of the property but must use it for the benefit of the beneficiaries.
In general, a trustee has a fiduciary duty to the trust and its beneficiaries. As a result, the trustee is held to a high standard of conduct with respect to the administration of the trust. A trustee is under a duty to the beneficiaries of the trust to administer the trust solely in the interest of the beneficiaries. The trustee must act fairly, justly, honestly, in the utmost good faith, and with sound judgment and prudence. A trustee owes the beneficiaries duties of loyalty and care.
What is a Beneficiary?
The beneficiary, also known as the cestui que trust, is the beneficial or equitable owner of the trust property.
Express vs. Implied Trusts.
An “express” trust, also known as a “direct,” “technical,” or “voluntary” trust, is declared in express terms (either oral or written) by the grantor.
“Implied” trusts (including “constructive” or “involuntary” trusts and “resulting” trusts) are equitable remedies imposed by courts to prevent unjust enrichment.
A court may impose a “constructive” trust upon the holder of property acquired through fraud, mistake, or undue influence.
How does a Beneficiary’s Income Interest Differ from a Remainder Interest?
The income beneficiary typically has a right to the trust income (or a fixed percentage of the assets) for the period of his interest. The trust may provide the trustee with discretion to transfer principal to the income beneficiary as well.
The interest of an income beneficiary runs for a stated period, typically the life of the beneficiary (such interest is known as a “life estate,” and the beneficiary as a “life tenant”). The remainder beneficiary is entitled to the remaining property at the end of the income beneficiary’s interest.
The income beneficiary is said to have a “present interest” in the trust during the period of his interest, and the remainder beneficiary a “future interest” during such period.
If the future interest is fixed, it is “vested”; if it depends on some preceding condition (other than the passage of time or death of the income beneficiary), it is “contingent.”
Types of Trusts
The following is a non-exclusive list of common trusts:
Revocable Trusts: A revocable trust is any trust with respect to which the settlor can revoke the trust and re-assert ownership of the assets for themselves.
Irrevocable Trusts: An irrevocable trust is a trust with respect to which the settler cannot revoke and reclaim the assets.
Living Trusts: A living trust is a trust created during the decedent’s lifetime. Typically, it is a form of grantor trust in which the grantor retains the right to the use of income from all of the assets. When the grantor dies, the assets go to designated remainder beneficiaries.
Grantor Trusts: Grantor trust is a term used in the Internal Revenue Code to describe any trust over which the grantor or other owner retains the power to control or direct the trust’s income or assets. If a grantor retains certain powers over or benefits in a trust, the income of the trust will be taxed to the grantor, rather than to the trust. (Examples include the power to decide who receives income, the power to vote or to direct the vote of the stock held by the trust or to control the investment of the trust funds, the power to revoke the trust, etc.) All “revocable trusts ” are by definition grantor trusts. An “irrevocable trust ” can be treated as a grantor trust if any of the grantor trust definitions contained in Internal Code Sections 671, 673, 674, 675, 676, or 677 are met.
Grantor Retained Annuity Trusts (GRAT): In a grantor retained annuity trust, the grantor creates an irrevocable trust and retains the right to receive, for a specified term, an annuity based on specified sum or fixed percentage of the value of the assets transferred to the trust. A grantor retained annuity trust is specifically authorized by Internal Revenue Code Section 2702(a) (2) (B) and 2702(b). For federal income tax purposes, this trust is treated as a grantor trust.
Grantor Retained Income Trusts (GRIT): In a grantor retained income trust, the grantor creates an irrevocable trust and retains the right to all trust income for the earlier of a specified term or the death of the grantor. If the grantor survives the specified term, the trust principal passes to others according to the terms and provisions of the trust instrument. For federal income tax purposes, such a trust is treated as a grantor trust.
Grantor Retained Unitrusts (GRUT): A grantor retained unitrust is similar to a grantor retained annuity trust. However, in a grantor retained unitrust, the grantor creates an irrevocable trust and retains, for a specified term, an annual right to receive a fixed percentage of the annually determined net fair market value of the trust assets (Treasury Regulation Section 25.2702-(c)(1)). For federal income tax purposes, such a trust is treated as a grantor trust.
Personal Residence Trust (PRT): A personal residence trust involves the transfer of a personal residence to a trust with the grantor retaining the right to live in the residence for a fixed term of years. Upon the earlier of the grantor’s death or the expiration of the term of years, title to the residence passes to beneficiaries of the trust. This is an irrevocable trust with gift tax implications.
Qualified Personal Residence Trust (QPRT): A qualified personal residence trust involves the transfer of a personal residence to a trust with the grantor retaining a qualified term interest. If the grantor dies before the end of the qualified term interest, the value of the residence is included in the grantor’s estate. If the grantor survives to the end of the qualified term interest, the residence passes to beneficiaries of the trust. A QPRT is a grantor trust, with special valuation rules for estate and gift tax purposes, governed under IRC 2702.
Intentionally Defective Grantor Trust (IDGT): An intentionally defective grantor trust (IDGT) is a complete transfer to a trust for estate tax purposes but an incomplete, or “defective ” , transfer for income tax purposes. Because the trust is irrevocable for estate and gift tax purposes and the grantor has not retained any powers that would cause estate tax inclusion, the future value of the assets transferred is removed from the grantor’s gross estate on the date of the trust’s funding. However, because the grantor retains certain other powers, the trust is treated as a grantor trust for income tax purposes. As a result, the grantor is taxed on all the trust’s income, even though he or she is not entitled to any trust distributions. If structured properly, the IDGT will receive the gross income generated from the trust’s income-producing assets, which will accrue to the benefit of the trust’s beneficiaries. The trust also allows the grantor the opportunity to remove future appreciation from the grantor’s estate while maintaining control over the assets.
Charitable Remainder Annuity Trusts (CRAT): A CRAT is a trust that is to pay its income beneficiaries a specified sum each year that cannot be less than 5% of the initial net fair market value of all property placed in trust. Other amounts may be paid to a charity.
Charitable Remainder Unitrusts (CRUT): A CRUT is a trust which is to pay the income beneficiaries a fixed percentage each year, not less than 5% of the net fair market value of its assets, as valued annually.
Charitable Lead Annuity Trusts (CLAT): A charitable lead annuity trust is a charitable lead trust paying a fixed percentage of the initial value of the trust assets to the charity for the charitable term.
Charitable Lead Unitrust (CLT): A charitable lead unitrust is a charitable lead trust paying a percentage of the value of its assets, determined annually, to a charity for the charitable term.
Split Interest Trust. A split-interest trust is essentially a trust with both charitable and non- charitable beneficiaries. The term is a term of art in the Code and regulations referring to certain trusts described in IRC 4947(a)(2) that have both (1) assets for which a charitable deduction was allowed for income, estate, or gift tax purposes and (2) unexpired noncharitable interests.
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