A revocable living trust is an agreement between a grantor and a trustee so that a trustee can manage assets on the grantor’s behalf. Generally, a revocable living trust is created and expanded during the grantor’s lifetime and often initially the trust provides that the assets of the trust are to be used for the grantor’s benefit. The grantor is often entitled to distributions of income and principle.
Frequently in a revocable living trust, a grantor retains the right to amend, revoke in full or in part, fund or defund, or make any changes to the trust that they wish. However, as of the grantor’s death or in the event that the grantor loses capacity, the trust becomes irrevocable. These trusts certainly have benefits, but they are not necessarily an ideal choice for everyone who considers them. it is important to consult with a DC trusts lawyer about the costs and benefits before creating a revocable living trust.
Misunderstandings About Revocable Living Trusts
The common misunderstanding is that a revocable living trust avoids taxes—that is not the case. A revocable living trust is a tax neutral document. During the grantor’s lifetime, the assets of the revocable living trust continue to use the grantor’s personal social security number and any income on trust assets are reported on the grantor’s personal income tax return. After the grantor’s death, the trust is assigned a new tax identification number and any income for trust assets are reported on a fiduciary income tax return.
In addition to income tax, in a revocable living trust, the assets of a revocable living trust are also considered part of the initial grantor’s gross taxable estate for estate tax purposes in the event that either a Federal or District of Columbia estate tax return would be due. That means all of the assets that have been prefunded in the trust are valued as of the date of the grantor’s death and if the amount of the trust exceeds the Federal or DC filing threshold, then a tax return will be filed.
Another common misunderstanding of a revocable living trust is that the creation of the trust alone governs all of the grantor’s assets. That is not the case. A revocable living trust governs only those assets that have been retitled or re-deeded into the trust. For example, real estate would have to be re-deeded and a new deed would have to be prepared for the trust to control or govern that asset.
Clients a Revocable Trust Will Not Work Well For
A revocable living trust is part of an overall comprehensive estate plan. A trust attorney will review the needs, desires, and capabilities of a client to determine whether a revocable living trust would be a good fit. Sometimes revocable living trusts are not a good fit for clients who are concerned about the initial startup costs of administering the trust or the additional administrative burden of creating a revocable living trust during their lifetime.
In addition, there are other issues that need to be considered specifically with regards to real estate. For example, real property transfers require special attention and it may be prudent to check with the mortgage holder to determine whether or not transfer of the real estate will trigger a due-on-sale clause in the mortgage and then also to ensure that the title insurer will continue to ensure the property after the transfer has incurred.
In addition, revocable living trust concepts are very complicated and complex and may be difficult for clients to understand. In the event that this is the case, the vehicle of a revocable living trust may not be a good fit for a client.
Death Tax Savings and Revocable Trusts in DC
The death tax is the common name for the District of Columbia or the Federal estate tax. Estate tax is a tax on the right to distribute property at death. The current DC estate tax filing threshold or exemption is at $1 Million. There has been movement to increase the DC estate tax exemption to $2 Million but that is not anticipated to take effect until the 2017 tax year at the earliest. That will be applicable for decedents dying in the 2017 tax year.
If an estate exceeds the DC estate tax filing threshold, then taxes are generally assessed up to a 16% tax rate. The Federal estate tax differs from the DC estate tax; the Federal estate tax currently provides protection for estates that are $5,450,000.00 for decedents dying in 2016. The Federal exemption continues to be indexed for inflation, so it typically changes every year and increases. The Federal estate tax rate is much higher than the DC estate tax rate, and the maximum rate is 40% rather than 16%.
A common misunderstanding about revocable trusts is that they avoid estate taxes and that using the instrument itself provides death tax savings. That is not necessarily true. Revocable living trusts are tax neutral documents and the document alone does not save estate taxes or income taxes. There are certain provisions that can be included in revocable trusts, some of which are also available to be included in a last will and testament as well, that could help maximize each spouse’s exemption, and possibly reduce a married couple’s overall exposure to estate tax liability.