Trusts 101

Slide1A trust is a fiduciary relationship between a trustee and beneficiaries of the trust. Trusts can be implied and express. Implied trusts are court created in order to prevent unjust enrichment (a constructive trust) or to carry out what the parties intended, but failed to do properly.

In estate planning, we concerned almost entirely with express trusts, trusts set up intentionally to achieve some goal or purpose, to avoid taxes or direct money to a charity, for example. To set up such a trust, a person–the settlor–must have the intent to do so and then must comply with three formalities:

1. There must be a res or property, a bank account, a piece of real estate, a life insurance policy, or some such.

2. The trust must have ascertainable beneficiaries. Why have a trust if there are no beneficiaries, right?

3. Finally, the trusts must have a trustee, though a court can appoint the trustee if the trust document doesn’t name one.

Express trusts are almost always laid out in a trust document that names the res, the beneficiaries, and the trust. Those documents also explain the trust’s purpose, list the trustee’s powers, and the like.

Express trusts can be testamentary, that is they come into existence upon death. Such trusts are generally established in a will and must always comply with the formal requirements of a will, In Wyoming that means the testator or maker of the will must sign the written/typewritten document and that at least two disinterested people must witness the testator’s signature. Though testamentary trusts are irrevocable upon death, the testator can change the terms of the trust while he is still alive.

Express trusts can also be established during the settlor’s lifetime. They are called inter-vivo trusts. People often set up revocable inter-vivos trusts, so they can test drive them before they die. Revocable trusts are not separate taxable entities. Thus, if you have a revocable trust with an investment account as part of the trust property, you will have to report the trust’s taxable income on your 1040 form. Upon the settlor’s death, that revocable trust become irrevocable.

Intervivos trusts can also be irrevocable from the beginning, but by doing so, you may also create a taxable event because, remember, the trust has to have a res, and if that res is large enough, you will have to transfer that property from your pocket to the trust’s pocket, if you will. We call that a gift, and a large enough gift will be subject to the federal gift tax system. Why? Because a revocable trust is a separate taxable entity, a separate person. But that’s enough on that subject for now.

Though the wealthy often use trusts to save estate taxes, they can also be a valuable estate planning tool for the middle class. But more on that later, in another place on this site.

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