Estate planning is an in-depth process that requires careful arranging to ensure that you’re able to maximize the use of your assets while alive, and that your assets are distributed appropriately after your passing or other set terms. A trust is commonly used in estate planning due to its ability to enforce the owner’s intentions. A revocable or irrevocable trust is set up by the trustor or grantor (original owner) to give legal ownership of the assets to the trustee upon terms set by the trustor. A trust allows your trustees to inherit and disburse the assets without the hassle of dealing with probate court or other obstacles that might occur when the state becomes involved. Consulting with an experienced accountant can help you make the right decision between a revocable or irrevocable trust to allow you to optimize your benefits.

Revocable Trusts

A revocable trust is as the name implies; a trust that may be revoked or amended at any point while the original owner is capable of making sound decisions and alive. However, once the trustor passes away, the trust becomes irrevocable. Establishing a revocable trust is an easy way for people to retitle their assets to the beneficiary without having the court systems involved.

When the trust is created, property and money generate the principle of the trust; however, the value of the trust may change due to the financial market – for instance, how a house may increase/decrease in value. A successor will be provided by the trustor to manage the trust once the owner passes away or becomes incapacitated. This ensures that the transfer of assets happens seamlessly without the hassle of any legal processes that may be costly and time consuming. The successor uses the established trust in conjunction with other legal documents, such as a will, to carry out the trustor’s wishes.

A key difference between the two types of trust is that with a revocable trust, ownership of the asset remains in the name of the trustor. This is important when considering taxes and income; for example, with government aid such as Medicaid. Since ownership of the asset remains in the trustor’s name, it is not tax exempt, does not require a separate tax return, and is counted as part of the owner’s assets. Additionally, any income derived from the assets is still distributed to the trustor, is counted as income, and is not accessible to the trustee. It also does not allow for any protection from creditors or lawsuits that may seek compensation.

Irrevocable Trusts

An irrevocable trust is the opposite of a revocable trust. Once it is established, it cannot be changed directly by the trustor without the permission of the beneficiary/beneficiaries. This includes the assets included in the trust, but aspects of the included assets as well. (Assets can include a business, insurance policies with listed beneficiaries, and financials.) This is due to the fact that these assets are no longer owned by the trustor. Once the trust is established, ownership of the asset is transferred to the trustee, although, the trustor still has access to use the asset.

The irrevocable trust is most commonly used for Medicaid purposes and for providing lawsuit protection. Since the assets are no longer in the trustor’s name, they’re not included as a part of the original owner’s income or taxes. This helps lower people into an eligibility bracket for Medicaid payouts and prevents Medicaid from accessing the assets. And, since it is no longer in their name, creditors and lawsuits cannot seek compensation through the assets in the trust.

Another benefit utilized from an irrevocable trust are the tax saving benefits. As previously mentioned, since the assets aren’t owned by the trustor anymore, they are not included as a part of the trustor’s taxes and become their own entity. Furthermore, taxes are not paid on generated income. Taxes are only collected from the beneficiary upon distribution. Since assets are a part of an irrevocable trust, they are no longer a part of the trustor’s taxable estate; so, when the trustor passes away, estate taxes do not have to be paid. It’s imperative to consult your accountant to ensure that you are filed under the appropriate category. Otherwise, taxes may have to be paid at a much higher rate than what is typically expected.

For tax purposes, an irrevocable trust can be treated as a grantor trust, simple non-grantor trust, or complex non-grantor trust.

• Grantor Trust – As previously mentioned, the assets will be labeled as a disregarded entity and a separate tax return will have to be filed and paid for.
• Simple Non-grantor Trust – A simple trust makes annual distributions of income earned to the beneficiaries as long as it doesn’t exceed the principle of the trust or go to a charitable organization. It allows for a $300 exemption. A simple trust may be converted to a complex trust.
• Complex Non-grantor Trust – A complex trust is labeled as a separate entity that income taxes must be paid on. The tax rate is much higher than an individual’s tax rate. However, expenses may be deducted. A big difference between a simple and a complex trust is seen when you note that they may retain some of their income, the principal balance may be distributed, and some of the funding may be distributed to a charitable organization. The complex trust is allowed a $100 exemption.

Picking the Trust Right for You

Picking the right trust for your estate needs to be carefully thought out. Are you looking for protection? What is the value of your estate? Do you want full, unrestricted access to your assets? Answering these questions is just the start of making the right choice.

Planning your future and what will happen to your life’s work can be daunting. You always want to pick the plan that will work best for you now and your beneficiaries in the future. Consulting with Kislay Shah CPA can help you pick the best plan that makes everyone feel more in control and comfortable. You can reach Shah at kislay@shahcpaus.com or call at 646-328-1326.