Planning Your Estate in Connecticut- Part 3

10. Trusts

    i. Introduction

    Many complex, and even simple estate plans now include some type of trust. A trust is an extremely flexible estate planning instrument that can be used for a variety of purposes. It has been said that “the purposes for which trusts can be created are as unlimited as the imagination of lawyers.” 4.01 Frachter, Scott on Trusts, at 2 (4th ed. Little, Brown 1987). For instance, there are marital trusts, tax-avoidance trusts, minor trusts, charitable trusts and even pet trusts in some jurisdictions. 
    While many people have heard of a trust, not many fully understand the concept and requirements of a trust. For example, most people mistakenly believe that all types of tax can be avoided by placing assets into a trust. Although trusts can be structured in a way to lower or avoid taxes, simply placing property into one does not eliminate taxes entirely. Besides tax incentives, the real advantage of a trust is the ability for the donor to impose restrictions on the use of property while still keeping that property out of the donor’s estate for privacy and estate tax purposes.
    Essentially, a trust is a device for holding property in which ownership is divided between a trustee and a beneficiary. Madoff, § 4.02.The trustee holds legal title to the property contained in the trust and has both the right and duty to manage the property for the benefit of the beneficiary. Any named beneficiary of the trust has an equitable interest in the property because of a right to the economic benefit of the property. Id. This interest is also a property interest that is capable of being transferred by the beneficiary, or attached by the beneficiary’s creditors unless there is a spendthrift provision (something that will be discussed later in this chapter). Id.
    A trust is created when a person transfers property to another person with the intent that the recipient holds the property for the benefit of someone else. The trust instrument, a written document, will provide the trustee with instructions on how to manage and distribute the transferred property. This is an important responsibility, and the law imposes various duties on trustees to ensure proper performance. If a trustee breaches his duties, the law provides various remedies for the beneficiary.  

    ii. Parties to a Trust

    There are typically three separate parties to a trust: a settlor, a trustee, and a beneficiary. The settlor is the person who creates a trust and is also known as the donor or the grantor. Ultimately, the intent of the settlor determines if a trust has been created. Madoff, § 4.03. If the settlor transfers property to an individual with the intent that the recipient use that property for the benefit of another, a trust has been created. If instead, the settlor transfers property to an individual for that recipient to use for their own benefit, no trust has been created. 
    The trustee is the person who receives the property from the grantor and accepts the obligation to hold such property for the benefit of the beneficiary. A trustee can be an individual, multiple individuals, or an institution. Many legally enforceable duties come with the title of trustee. In particular, once someone has accepted the role of trustee they must:
1. Use prudence in investing the trust assets;
2. Follow the terms of the trust;
3. Be loyal to the trust, its assets, and its beneficiaries;
4. Pay attention to trust assets and beneficiaries; and
5. Provide regular accounting to the beneficiaries.
    Due to the many duties of being a trustee, an individual named as trustee must formally accept the position. The individual, or corporation named is also allowed to decline the position. If declined by the primary trustee and there is no other accepting trustee, the court will appoint one. In Connecticut, the appointed or accepted trustee will be paid a reasonable fee for their duties. What is reasonable has not been defined by statue in this state but is usually anywhere from 2-4% of the estate’s total worth.
    Of course, there must be a beneficiary or beneficiaries of a trust. This is the individual, or group of individuals set to receive benefits from the trust. In order for a trust to be valid, there must be at least one beneficiary. A trust cannot have one beneficiary that is also the settlor and trustee. When naming beneficiaries, they must be described with sufficient detail if they are separate individuals, or a class of beneficiaries can be named (such as grandchildren or children). If the description of beneficiaries is too vague, the trust will fail. Madoff, § 4.04.
    Finally, in order for a trust to be formed, it must contain property. Trust property is known as the trust corpus or the body of the trust and is transferred by the settlor to the trustee for the benefit of the trust beneficiaries.

    iii. Forms of Trusts

a. Inter Vivos and Testamentary

    While there are a variety of forms of trust, discussed below are some of the most common forms, as well as the elements that are common to all trusts, regardless of form.
    All trusts in estate planning can be categorized as inter vivos or testamentary trusts. A trust created during the life of the settlor is called an inter vivos trust. A trust created at his or her death is called a testamentary trust. Any property contained in an inter vivos trust is not part of the settlor’s probate estate and will pass directly to the beneficiary when the settlor dies. Madoff, § 4.05(b)(1). An inter vivos trust is most popular with settlors who wish to take advantage of the annual gift tax exclusion of $14,000 by making gifts of that amount, for one or more beneficiaries, to the trust each year. A testamentary trust on the other hand is created at death by the settlor’s will. Since this is a part of a will, the terms of the trust will be made public during the probate process. This type of trust lacks the privacy many settlors look for because it is subject to the continuing jurisdiction of the probate court, and because the trustee must file a public inventory of the initial assets the trust was funded with. Id. 

b. Revocable or Irrevocable

    Additionally, trusts are either revocable or irrevocable. As their names suggest, a revocable trust may be revoked by the settlor, and an irrevocable trust may not be revoked. Revocable trusts have the benefit of allowing the settlor to retain control of the assets in the trust, to revoke the trust, and to change the terms of the trust at any time. These trusts are also known as living trusts, and allow for assets to be protected during life and at death. Typically, a simple pour-over will (discussed below) ensures that the rest of a settlor’s assets are transferred into an already created revocable trust at death. 
    With an irrevocable trust, the assets no longer belong to the settlor, they belong to the trust. Typically, trust terms cannot be changed without consent of the beneficiaries and the trustee. The main reasons for creating an irrevocable trust are to reduce taxes and to protect property. This type of trust is most often created at death through a will or otherwise. After death, any living revocable trust will transform into an irrevocable trust.

    iv. Types of Trusts

    The various types of trusts are surely endless, but the following are the most common trusts that are drafted today.

a. Pour-Over Trust

    A pour-over trust is a revocable living trust that is structured to receive and dispose of assets at the settlor’s death. This is usually done through the settlor’s will, normally called a pour-over will. This type of trust is separate, and not contained in the will itself, which distinguishes it from a testamentary trust. This difference provides numerous advantages. For instance, a pour-over trust is administered without court supervision, the instrument itself is not a public record, it can provide for disposal of all assets (both probate and non-probate), and can be merged with other trusts to provide one unified plan. Madoff, § 4.05(B)(3).  

b. A-B Trust / Marital Deduction Plan

    One estate plan that has become very common for married couples with wealth that exceeds the lifetime exemption amount is the optimal marital deduction plan. This plan ensures full use of both spouses’ lifetime exemptions and postpones any estate taxes until the second death. This is often accomplished by the couple having reciprocal wills that, upon the first death, divide the first estate into two trusts, an “A” trust (also called the marital share), and a “B” trust (also called the bypass or credit share). When the first spouse dies, an amount equal to their lifetime exemption gets placed in the “B” or bypass trust, with the residue of the estate funding the “A” or marital trust. Each trust will be irrevocable and benefit the surviving spouse for life.
    This plan saves the most in estate taxes because the bypass trust uses the first spouse’s full lifetime exemption and then keeps that property out of the second spouse’s estate by placing it in a trust for the benefit of any children and the surviving spouse. It remains outside of the surviving spouse’s estate because they only have a discretionary income interest (discretion lies in the hands of the trustee to make distributions) in the trust. As for the marital share, that passes to the surviving spouse free of estate tax on the first spouse’s death because of the unlimited marital deduction. The surviving spouse will continue to benefit from the property as a beneficiary of the trust, usually a QTIP (discussed below), and the property will be included in the surviving spouse’s estate. More often than not, individuals like to place the marital share in a trust instead of giving it to the surviving spouse outright so they have some control over the disposition of the property and protection from creditors. This “A-B” plan has become extremely popular with married couples who have estates that may owe federal estate taxes (i.e. estates over $5.34 million). 
    One key factor in ensuring the trust’s success is dividing the marital assets appropriately between the two spouses. If the first spouse to die does not have enough assets in their estate to take full advantage of the estate tax exemption and the second to die has too many, the intended purpose of the plan would be defeated. Therefore, it is important to properly sever assets and convert jointly held assets into assets held by only one spouse. Jointly held assets would pass to the surviving owner at death and not qualify for the credit shelter trust (“B” trust).
    Once assets are placed into the credit shelter trust, they are free from estate tax, even upon growth of the assets. The surviving spouse can use and receive income for life from the trust property but will never own the property. Because the surviving spouse never owns the property, the property in the credit shelter trust will remain outside of their estate at death and pass to the trust’s remainderman, usually a child. Thus, this trust plan takes advantage of both estate tax exemptions, allows for the surviving spouse to receive a benefit from the first spouse’s property during life, and remains free of any estate tax.
    For an example of how much couples can save using this type of trust, compare what happens in the following two scenarios. In scenario one, there is no credit shelter provision in either will, and each spouse owns $5 million in assets. Each will provides that the surviving spouse receives all the property outright. When the first spouse dies, all property will go to the spouse tax free because of the unlimited 43 Maya Murphy, P.C. | Mayalaw.com marital deduction. Assuming the property has not grown, when the second spouse dies their estate will be valued at $10 million. After using the full estate tax exemption (we will use $5 million for ease of math), the second spouse’s remaining estate of $5 million will be taxed at a 40% rate. This would result in federal estate taxes of $2 million (ignoring any other deductions or credits).
    Alternatively, if the couple had provisions for credit shelter trusts in their wills, when the first spouse died, their $5 million would go into a credit shelter trust and be exempt from any federal estate tax due to the $5 million lifetime exemption. The income from the $5 million would be given to the surviving spouse for life. When the second spouse died, their $5 million estate would be free of estate taxes because of the lifetime exemption. Also, the income they received from the credit shelter trust would have no effect on their estate, and the $5 million in the credit shelter trust would remain outside of the second spouse’s estate. At the second spouse’s death the estate would owe no taxes whatsoever. Accordingly, by establishing this trust, the federal tax savings are $2 million.

c. QTIP Trust

    Another trust frequently used by married couples is the qualifying terminable interest property trust, or QTIP trust. This trust is used in estate planning for U.S. citizens to postpone the payment of estate taxes until the second spouse’s death. Often, this trust is preferred in families that have divorces, remarriages, and stepchildren because the grantor can provide his current spouse with income for life while also ensuring the trust assets ultimately pass to his or her children of a first marriage, or other named beneficiaries. 
    This trust can qualify for the marital deduction on the first spouse’s death but needs to meet strict guidelines to do so. First, the surviving spouse must be entitled to receive all income from the trust, at least annually, during life. During the surviving spouse’s lifetime, they cannot decide on the ultimate disposition of the trust assets and cannot withdraw any principal from the trust. Finally, the executor of the first spouse to die must elect QTIP treatment of their property on the estate tax return in order for it to qualify for the beneficial tax treatment.
    When the second spouse dies, the assets in the QTIP will be distributed according to the first spouse’s specifications, and the property will be included in the second spouse’s estate. Therefore, there is no estate tax until the second death. However, any increase in estate taxes on the second spouse’s estate as a result of the trust is usually paid using the QTIP’s remaining trust assets.
    There are two main benefits of this trust-- flexibility for the executor and control for the settlor. First, a QTIP does not become a QTIP until the estate’s executor makes the election. So, if it is unclear what a testator’s estate tax situation will be at the time of death, it may be prudent to provide flexibility for an executor to elect between either claiming a marital deduction for the amounts transferred into the QTIP, or foregoing that deduction. This will allow the executor to make a calculation and determine which option will minimize the total estate taxes paid by the testator and their spouse.
    Second, and often a more compelling reason for some, is that a settlor may want to utilize the marital deduction for transfers into a QTIP but also limit the power and ownership rights their surviving spouse has over the trust assets. As mentioned before, this trust is very helpful in divorced families and with remarried individuals. If a settlor is concerned that his current spouse may not provide for his children from a previous marriage, this trust can be used to limit the current spouse’s interest and ensure the children are provided for.

d. QDOT 

    A qualifying domestic trust, or a QDOT, is a trust established for the benefit of a spouse who is not a U.S. citizen and therefore does not qualify to receive assets tax free from the federal unlimited marital deduction. Individuals who still want to pass property to their non-citizen spouse tax-free must transfer the property to this type of trust. In order for this trust to qualify for beneficial tax treatment, at least one trustee must be a U.S. citizen or domestic corporation, and the trust can provide no distributions, other than income, to the surviving non-citizen spouse unless the trustee has the right to withhold special estate taxes. The reason for these more stringent rules is to ensure property passing tax-free to a non-citizen spouse will not evade ultimate taxation by the IRS if the non-citizen decides to return to their home country.
    
e. Life Insurance Trust

    An irrevocable life insurance trust, or an ILIT, will remove life insurance policies from the estate, can help pay estate costs, and help provide heirs with a large amount of cash. This trust is created during life and the beneficiaries are often the grantor’s spouse, children, or grandchildren. Instead of the grantor owning the policy, the ILIT would buy a policy on the testator’s life with assets they transferred into it. Alternatively, a testator may choose to transfer ownership of a current policy to an ILIT. The grantor of such a trust must completely give up all rights to the policy transferred and retain no right to revoke or alter the trust. 
    Additionally, this trust can be formed as a “Crummey” trust so the grantor can provide gifts in the amount of the annual gift tax exclusion (currently $14,000) each year to pay for the insurance premiums. For example, if there are four beneficiaries, the grantor can transfer up to $56,000 to the trust, per year, to pay insurance premiums without having to pay any gift tax on the transfer. If a grantor does not want to choose this option, they can fund the trust initially with a large amount of money to pay for the future insurance costs.
    The use of this trust will keep the insurance policy proceeds out of the taxable estate of the decedent as long as: (i) the trust is irrevocable; (ii) the grantor is not the trustee; (iii) the grantor has no incidents of ownership; (iv) the insurance proceeds do not directly benefit the grantor’s estate; (v) and the insured grantor lives for at least three years after funding the trust if the trust is funded with an existing life insurance policy.
    Also, and as an added benefit, the Crummey trust can be used to provide liquidity to the grantor’s estate even though the estate cannot directly benefit from the trust. This can be accomplished by authorizing the trustee to purchase non-liquid assets from the estate upon the grantor’s death with the insurance policy proceeds, or by authorizing the trustee to give loans to the estate to pay taxes and fees. In either scenario, cash can flow to the estate if needed. As long as this is in the trustee’s discretion, not mandatory, the proceeds will remain outside of the grantor’s estate while also providing some insurance for the estate upon death.

f. Spendthrift Trust

    When transferring property to a beneficiary, many individuals worry that the assets given may be confiscated by creditors or spent frivolously. Spendthrift trusts are designed to relieve both of those worries by preventing creditors from attaching the beneficiary’s interest in the trust and/or limiting a beneficiary’s ability to transfer assets in the trust. Basically, the beneficiary is prohibited from assigning his present or future income from the trust and from selling his or her rights to creditors.  
    The trust must be irrevocable and should be funded with income producing assets. When appointing a trustee, the trust provisions must give the trustee broad discretion regarding distributions. Additionally, to afford greater protection from creditors, the trustee should not be the beneficiary. Further, due to the fraud of a grantor attempting to evade creditors, most states, including Connecticut, do not allow a grantor to establish a spendthrift trust for their own benefit. Because a spendthrift trust enables a donor to provide for a beneficiary while also protecting that beneficiary against their own impudence, they have become very popular estate planning tools. However, they have also become very controversial because the beneficiary’s property interest is immune from creditors and allows the beneficiary to enjoy the wealth without bearing its responsibilities.
    It is prudent to note that spouses and children that have claims against a beneficiary of a spendthrift trust for alimony or child support have generally been able to obtain that beneficiary’s interest in the trust despite the spendthrift provisions. This has held true more for child support than alimony because child support is a common law duty while alimony merely represents a court imposed adjustment of economic interest. Madoff, § 4.05(C)(4).

g. QPRT Trust

    An irrevocable qualified personal residence trust, or a QPRT, is a trust that allows the settlor to gift their personal residence or a vacation home into trust for the benefit of children and potentially remove it from their taxable estate. In addition, thanks to favorable IRS regulations, the residence can be gifted to the trust at a discounted value. This trust is most commonly used when a settlor wishes to transfer a personal residence to family members at some time in the future, desires to still reside in the residence, and wants to save on estate and gift taxes of the transfer.  
    Ultimately, a QPRT is a lifetime transfer of a personal residence in exchange for continued rentfree use of the residence during the trust term. Often, a QPRT also provides that if a settlor outlives a trust term, the property can be rented back to the settlor at the fair market value. When the term of the trust ends, the residence passes outright to the beneficiaries or remains in trust for their benefit.
    The real benefit from the use of this trust comes in the federal tax savings. These tax savings rely upon the current rate set by the IRS in the month of the transfer. For instance, when transferring the property to the trust, there will be a gift tax on the gift of the remainder interest to the beneficiaries. The amount of gift tax will be determined by taking the fair market value of the property and subtracting the value of the retained interest of the settlor. The retained interest is calculated using the tables published by the IRS and consists of the length of the trust term along with the applicable federal rate as shown in I.R.C. § 7520. Generally speaking, the longer the term of the trust, the larger the value of the retained interest by the settlor, which results in a smaller value of the remainder to the beneficiaries and thus a smaller taxable gift. In most instances, the gift taxes will be offset by using some of the settlor's lifetime exemption.
    A QPRT can remove property from an estate and increase tax savings, but it is not without some risk. If the settlor dies before the trust term is over, the residence is included in their estate and taxes will be due. This is because the settlor had retained use of the property in a period that did not end before their death, i.e. the purpose of the trust is defeated. Alternatively, if the settlor dies after the term, the property is distributed to the beneficiaries free of any further transfer tax. Setting the term of the trust becomes extremely important and depends on various factors. Essentially, the trust term is a bet against the settlor’s life expectancy.
    The true potential benefits of a QPRT are best shown in an example. Take Bob, aged 50 and in good health. He decides to transfer his $1 million home in Miami to a QPRT for the benefit of his two children Karen and Thomas. In the trust, he retains a right to use the home as his residence for a term of 20 years. That means the trust will terminate, and the property will transfer to his children when he is 70 years old. If the tax rate in effect was just 1% when he made the transfer, his initial gift after doing the calculation would be $475,000. If he had made no previous gifts, $475,000 would be counted against his $5.34 million lifetime exemption. If he outlives the 20 year term, the property will transfer to his children, and be removed from his estate. If the home increases in value to $2 million over that 20 year term, Bob would have transferred a $2 million property to his children at zero cost (besides a reduction in his lifetime exemption) and removed $2 million from his estate. Effectively, both children received a $1 million gift while Bob continued to live in his house for 20 years. 
    If however Bob died during that 20 year time period, he would have used $475,000 of his lifetime exemption and the property would have been brought back into his estate for tax purposes. Thus, the purpose of the QPRT would be defeated.

h. Family Pot

    A family pot or family trust is a type of trust designed to hold assets for minor children of a married couple in case the parents meet untimely deaths. Usually, this trust will give the trustee discretion to distribute income and principal to the children according to their appropriate needs, and will terminate when the youngest child reaches majority, normally 18 to 25 years of age. When the trust terminates, the remaining property is usually divided into separate shares for each child and can be placed into new trusts, or given outright. 

i. Minor’s Trust

    This is a type of trust established for the benefit of a minor that will qualify for the annual federal gift tax exclusion and the federal exclusion for generation-skipping transfer tax. This is also called a Section 2503(c) trust after the Internal Revenue Code section that provides for its tax savings.
    To achieve the above stated benefits, the trust must provide the trustee with no restrictions on distributing income and principal to the minor beneficiary until they reach age 21. When the beneficiary is of age, all trust property must be paid to him or her. During the trust term, the beneficiary must have a general power of appointment by will, or the trust property must pass to the beneficiary’s estate if they die before 21. 
    Additionally, Connecticut has adopted the Uniform Transfers to Minors Act (UTMA). This provides that transfer of property to a child under the UTMA takes the form of an irrevocable gift to a custodian for the child. A UTMA account can be opened at most major banks, and is an advantageous way to save money for a child, and to save on taxes as well. A UTMA account is basically an investment account that allows a parent to invest money in the names of their children and for the benefit of their children.
    The parents of the child may be the custodians of the property, or someone else may be appointed. Once the property is transferred to the account, it becomes the property of the child and must be used for that child’s benefit. The custodian has powers over the property and duties to the child much like those of a trustee. If a custodian was to misuse the funds, they would be held accountable for breach of fiduciary duty
    As for the tax savings of a UTMA account, currently the first $1,000 of unearned income is tax exempt, the next $1,000 of unearned income is taxed at the child’s tax rate, and unearned income over $2,000 is generally taxed at the parent’s tax rate if the child is under the age of 19 or is a full time student under the age of 24. There are no maximum contribution amounts, and parents can transfer up to $14,000 each, or $28,000 together, to the UTMA account each year free of federal gift tax. Contributions must be made before the minor’s statutory vesting age (between 18 and 25) and, as discussed above, the custodian must turn over the balance of the UTMA account at the appropriate vesting age of the child.
    Finally, there are also accounts for minors known as 529 plans. A 529 plan is a higher education trust, known as a CHET account in Connecticut. This account allows for a maximum contribution of $300,000. The contribution amount must be used to pay for the child’s higher education expenses. Run by Connecticut, CHET is an investment account that deals mostly in mutual funds. Contributions of up to $5,000 per year by an individual, and up to $10,000 per year by a married couple, are deductible in computing Connecticut taxable income.
    Additionally, qualified distributions for higher education expenses such as tuition, fees, books, supplies and equipment are exempt from state taxes. Non-qualified distributions to the beneficiary are also exempt from Connecticut state tax. As for federal taxes, individuals may gift $14,000 to the account each year or $28,000 if gifted as a couple. The withdrawn earnings are excluded from income if used for qualified high education expenses and non-qualified withdrawals are subject to tax and a 10% federal penalty. There are no age or time restrictions on the account beneficiary and the beneficiary can be changed at any time to another member of the beneficiary’s family.

j. Pet Trust

    In Connecticut, as of 2009, a trust for the benefit of a family pet is valid. This is also true for 40 other states. According to C.G.S. § 45a-489a, a testamentary or inter vivos trust may be created to care for a pet. The appointed trustee is called a trust protector and their “sole duty shall be to act on behalf of the animal or animals.” Id. This type of trust terminates when the last surviving animal named in the trust dies. If a settlor wants the trust to continue for all pets, they can achieve that goal by naming a class of pets such as “dogs I own” or “pets I own.”  
    Sometimes there are limits to the amount of assets that can be placed in a pet trust. For example, in New York, hotel mogul Leona Helmsley attempted to leave $12 million to care for her small dog “Trouble.” The Surrogates Court found this excessive, and returned the excess millions to her estate to be distributed amongst her heirs. A Connecticut Probate Court has the same authority, but this issue can be addressed by designating in the trust who will receive any excessive funds. 

k. GRATs

    A grantor retained annuity trust, or a GRAT, is an irrevocable trust in which a grantor retains an annuity payable for a term of years. At the end of the trust term, anywhere from 5-15 years, the trust property will go to the beneficiaries (either outright or in trust). The initial transfer of property to the trust constitutes a gift for tax purposes that will be counted against the grantor’s federal lifetime exemption. The value of this gift is calculated based upon actuarial tables provided by the IRS that are based upon the life of the grantor and the current I.R.C. § 7520 rate (also known as the "hurdle rate"). Because of this valuation, if assets transferred in the trust appreciate at a rate faster than the hurdle rate (which recently has been historically low and easy to beat), the grantor can transfer all excess appreciation free of gift tax to his heirs. One downside of a GRAT is that a grantor must outlive the term of the trust. If not, all trust assets are included in the grantor's estate, thereby defeating the purpose of the GRAT.
    A fairly common strategy used by individuals with significant wealth is a “rolling GRAT.” The rolling GRAT involves creating a series of consecutive short-term GRATs (typically two to three years) with each successive GRAT funded by the previous GRATs annuity payments. Rolling GRATs minimize the risk of grantor mortality due to their short terms, and increase the success of transferring wealth tax-free by capturing rapid appreciation. A two year term for a rolling GRAT is the shortest allowable by the IRS according to recent revenue rulings. These short-term GRATs can take advantage of asset volatility by capturing rapid appreciation and transferring it free of additional tax.
    For example, rolling GRATs are often utilized with U.S. stocks that have the possibility of rapid appreciation. Take Tesla’s stock performance over the 2013/2014 time period for example. The company saw its stock price grow over 200% in a little over a year. If someone had placed Tesla shares into a two year GRAT, they would be able to transfer that rapid appreciation free of tax on the gains.
    If the short-term GRAT strategy is effective (i.e. assets appreciate faster than the I.R.C. § 7520 rate within the trust term), wealth is removed from the taxable estate and transferred to beneficiaries at little cost. If the strategy is not effective (i.e. assets do not outperform the I.R.C. § 7520 rate), all of the assets would go back to the grantor by way of the annuity payments and none of the lifetime gift tax exemption would be wasted. Thus, there is almost no risk and potential for a very high reward in using a GRAT as an estate planning vehicle. The only real disadvantage of a short-term GRAT is that a particularly low Section 7520 rate will not be locked in long-term.
    Rolling GRATs also offer the advantage of flexibility. The grantor can stop the rolling process at any time and for any reason. For example, the grantor may wish to stop funding these rolling GRATs if he or she needs the income from the trust assets, no longer has an estate tax concern, wants to transfer wealth to the beneficiaries sooner, the assets’ growth rates drop too low, or his or her health has deteriorated and is not expected to live for another two or three years.
    While rolling GRATs offer advantages for liquid assets, such as publicly traded stock, non-liquid or hard-to-value assets are better suited for long-term GRATs. In particular, non-liquid assets would require frequent valuations that may be subjective, cumbersome and costly.
    It is important to note that a provision in President Obama’s 2014 budget seeks to eliminate the use of short-term GRATs. The proposal would require that any new GRAT have a minimum ten year term, and that the remainder interest retained by the grantor have a value greater than zero at the time of creation. This minimum ten year term would not eliminate the use of GRATs, but it would increase the risk that the grantor would fail to outlive the GRAT term and lose the anticipated transfer tax benefit. Effectively, this would eliminate the short-term rolling GRAT strategy. 

l. Charitable trusts

    Charitable trusts are established for a recognized charitable purpose. Due to their beneficial societal impact, the IRS has made qualifying charitable trusts tax exempt and eligible to receive tax deductible contributions. Additionally, and unlike most other trusts, charitable trusts can last forever. For those with a desire to give to charity, or simply to save on taxes, charitable trusts are a great way to take advantage of a rare double-benefit, income tax deduction during life and estate tax reduction at death. 
    A common way for individuals to give large amounts to charity is by establishing a charitable remainder trust. A charitable remainder trust is one in which a non-charitable beneficiary is given an income interest in the trust, and a charity is given the remainder interest in the trust property. Madoff, § 4.05(L)(2)(b). These trusts, like GRATs, come in unitrust and annuity trust form. These are most popular with high wealth individuals who utilize the tax savings while also continuing to benefit from the property for a term of years.
    A charitable remainder unitrust, or a CRUT, is a trust where the non-charitable beneficiary receives an annual distribution of a fixed percentage (at least 5%) of the trust property for a term of years (not to exceed 20) for the life of one or more individuals. I.R.C. § 664(d)(2). When that term ends, the remaining property will pass to the selected charity. For tax purposes, the donor of the trust is treated as having made a charitable contribution equal to the value of the trust property minus the value of the interest passing to the non-charitable beneficiary. I.R.C. § 664. The primary advantage of a 55 Maya Murphy, P.C. | Mayalaw.com CRUT over a CRAT (see below) is that the distribution is more likely to keep pace with inflation since the amount of the annual distributions from the CRUT will rise and fall with the value of the assets in the trust. Madoff, § 10.06(B)(3)(b).
    A charitable remainder annuity trust, or a CRAT, is a trust where the non-charitable beneficiary receives an annual distribution of a fixed dollar amount (at least 5% of the initial value of the trust property) for a term of years (not to exceed 20) for the life of one or more individuals. I.R.C. § 664(d)(1). At the end of the term, the property transfers to the selected charity. The value of the charitable contribution is valued in the same manner as the CRUT (see above). The primary advantages of a CRAT over a CRUT is that the donor will receive a fixed annuity regardless of the performance of the trust, and they can avoid the expense of revaluing the trust property each year.
    When choosing how to fund a charitable remainder trust, most estate planners recommend using greatly appreciated property such as a stock with a very low basis i.e., basis is what was paid for the stock and is compared to the stock’s current worth. The reason for this recommendation is to avoid capital gains taxes. For example, Bob owns 100 shares of Google common stock that are worth $100.00 a share. He purchased those shares at just $10.00 a share and wants to avoid capital gains taxes on the $90.00 of appreciation per share. If Bob simply sold the stock, he would owe capital gains taxes on the $90.00 of appreciation. If instead he gives the shares to a charitable remainder trust which then sells them, there would be no immediate capital gains taxes. Rather, the beneficiary of the trust would be taxed over time as distributions were made. I.R.C. § 644(c).

Trusts Conclusion

    The previously discussed information involving trusts, how to establish a valid trust, and various trust forms is meant to provide a brief overview of the subject and give you some insight into understanding their format, usefulness and complexity. While we have discussed many of the most important aspects of trusts and the laws that shape them both federally, and in Connecticut, this is by no means an exhaustive explanation. There are various complex techniques dependent on each client’s unique circumstances that are outside of the general scope of this publication. For more information, or for a consultation about establishing a trust, one of the experienced estate planning attorneys of Maya Murphy, P.C., can be reached at 203-221-3100 or by emailing ask@mayalaw.com.