Our task is to avoid a probate at death. To avoid a probate at death, we cannot at death own any property titled in our name. The easiest way to avoid having property titled in our name at death is to have given it all away during life. The task, therefore, is to find some way of “giving it all away during life” while retaining all of its benefits for the rest of our life as well as the ability to control its disposition at death.
If we were thinking not so much about our personal assets but about forming a business, the solution would probably be intuitive: Form a corporation as the entity for our business. We would create a corporation and transfer our cash and other business assets to the corporation in exchange for its shares. As its only shareholder, we would elect our self as its chairman to run the corporation for the benefit of its sole shareholder, us. Furthermore, the corporation would take on a life of its own, in perpetuity. Upon our death, the shareholders, whoever they may be as the result of the disposition of our shares, would elect a new chairman, but the corporation itself would continue right along, without need for retitling its assets, dissolution, reincorporation, or whatever.
A corporation will work for our estate planning, and some people do use them primarily for estate planning, in which case they are called personal holding companies. But the fundamental problem is that corporations, while ideal as entities for business operations, are impractical for personal estate planning. The general idea works, but the execution fails.
We need to look for an entity that is more favorable than a corporation in its use for personal estate planning. That corporation-like entity exists, is called a Living Trust, and, in fact, has been serving people for almost 1000 years now.
If you are unfamiliar with Trusts, please use some “beginner’s mind.” When many people hear “a Trust,” they think of the Rockefellers, the Vanderbilts, Newport, Rhode Island, Palm Beach, Florida, Rolls Royces, and 5 o’clock tea at the Ritz. Granted, the Rockefellers, the Vanderbilts, and the wealthy in general have their Trusts. The point is: A Trust might work as well for you, too.
Compare the creation and the principal players of a corporation with that of a trust:
|Function or Status||Corporation||Living Trust|
|1. To set forth the terms and provisions for the operation of your entity:||You write Articles of Incorporation and By-laws for it||You write a Declaration of Trust (or Trust Agreement) for it|
|2. To create your entity:||You transfer property to the corporation in exchange for its benefits in the form of its shares (and file the Articles with the Secretary of State etc.)||You transfer property to your Living Trust in exchange for the right to:
|3. As the person who creates the entity and funds it, you are known as its:||Founder||Trustor (or Grantor or Settlor)|
|4. As the person who will receive the entity’s benefits, you are known as its:||Shareholder||Beneficiary|
|5. As the founder/shareholder or the Trustor/Beneficiary, you will elect or appoint yourself as its manager and be known as its:||Chairman/President||Trustee|
You’re now in business! And, as your first act in business, you, as Trustor, will transfer all your personal assets to and re-title them in the name of your Living Trust (technically, you will transfer them from yourself in your individual capacity to yourself in your capacity as Trustee of your Living Trust). Result:
Side-bar: Some nomenclature: Unless otherwise specified, the Trusts discussed on this website are known:
For income tax purposes, Grantor Trusts are ignored, and all of their tax attributes (income, expenses, tax credits, etc.) are attributed (ie, passed on) to the Grantor during his/her life and reported on the Grantor’s individual income tax return (Form 1040). At the Grantor’s death, Grantor Trust status stops, the Trust becomes a separate tax-paying entity, and its tax attributes are reported by its Trustee on a fiduciary income tax return (Form 1041).
Summary: For income tax purposes, Revocable Living Trusts are “transparent” during the life of the Grantor and take on a life of their own only upon the Grantor’s death, as would that person’s probate estate if he/she had chosen to use a Will, instead of a Living Trust, as his/her estate planning vehicle. As a corollary, Living Trusts cannot be used to obtain income tax savings during the Grantor’s life (a Living Trust and its living Grantor being identical in the eyes of the IRS). As will be discussed further on, the primary reasons for using a Living Trust are:
Bottom-line: This process was created by some of history’s first “estate and tax planners” in order to reduce the “property, income, and death taxes” imposed on the common folk of England upon their defeat by William the Conqueror in the Battle of Hastings in 1066. This process has continued successfully ever since. In its almost 1000 years of existence, its “bugs” have been worked out. You should not expect any “manufacturer’s recalls” except as a result of a future change in the law.
Furthermore, upon creating a Living Trust in the present, if there is any change in the law in the future: