by Karla McAlister
Historically, tax planning was one of the suggested reasons for using trusts in estate planning. In 2000 the federal estate tax exemption was $675,00.00. So, after considering the value of a home, vehicles, life insurance and retirement benefits (all of which are typically subject to estate tax), many Oklahomans were surprised to learn they had an estate tax problem. There have been many adjustments to the estate tax exemption in the last 18 years and now we are at an historic high. In the past when the exemption was lower, it was critical to try to avoid the estate tax because of the very high tax rates; the federal estate tax topped out at 55% and the Oklahoma estate tax at 15% for collateral heirs.
With the federal estate exemption at $11,180,000.00 per person in 2018, thanks to the Tax Cuts and Jobs Act passed in late 2017, and scheduled to increase to $11,400,000.00 in 2019, does anyone need a trust in their estate planning? 99% of Americans have estates less than this exemption.
This law is scheduled to sunset in 2026, such that the exemption (basic exclusion amount for federal estate tax) will revert to its pre-2018 level ($5,490,000 adjusted for inflation) in 2026. So, we are not guaranteed the higher exemption is permanent. However, at present, given the large federal estate tax exemption and the repeal of the Oklahoma estate tax for persons dying after January 1, 2010, the vast majority of Oklahomans no longer have an estate tax problem.
However, before one assumes they do not have any concern about estate taxes, present or future, it is important to take into account everything considered as part of your gross estate for estate tax purposes. Very generally, anything of economic value which you own or control is taxable at your death. And, this might also include economic value you have transferred to others during your lifetime. Your estate tax is then calculated on the value of your taxable estate - what is left after mortgages, other debts, and the administrative costs of settling your estate are paid. You can also deduct money or property given to charities (charitable deduction) and the value of the property that goes to your spouse (marital deduction) because those gifts are not subject to estate tax. Assets that pass directly to a named beneficiary such as life insurance or payable on death bank accounts and retirement funds are part of your estate for estate tax purposes even though they are not a part of a probate estate for purposes of court administration.
Without estate tax incentives to use trusts in their estate planning, should people still consider the utility of trusts in their planning for their surviving spouses, children and grandchildren, other dependent family or friends, and charities?
Advantages of trusts for beneficiaries
a. Control and benefit. One of the main advantages of retaining assets in a trust after a client dies is that the trust provisions can establish dispositive arrangements lasting indefinitely which can carry out the client’s very specific desires for their beneficiaries. They can name the initial and successor trustees and grant creative powers to the trustees to carry out their wishes in the management of the trust assets for the benefit of the trust’s beneficiaries. The beneficiaries can also be given rights or powers such as the power to withdraw trust assets at specific ages.
b. Probate Avoidance. Another advantage of holding assets in trust is to avoid court supervised estate administration (guardianship and/or probate) both for the original property owner and for his or her beneficiaries if the beneficiaries are incapacitated or die while the trust is in place.
c. Protection from Creditors’ Claims. A trust can be designed to protect a beneficiary’s inheritance from the claims of his or her creditors.
d. Protection from claims of spouses and ex-spouses. Assets managed in trust for a beneficiary can provide better protection from the claims of a beneficiary’s spouse than an outright distribution to the beneficiary. Furthermore, assets held in a trust created by a parent or grandparents for their descendants can be managed and used for their descendants’ benefit, avoiding the involvement in the management and enjoyment of the assets by persons who are only related to the parent or grandparent by marriage, such as the ex-spouse of a child with regard to the inheritance left for the child’s children.
Advantages of trusts for persons creating trusts
a. Incapacity Planning. If the creator of the trust (often referred to as the Settlor) is ever incapacitated by an illness or injury, the successor trustee(s) chosen by the Settlor can manage the trust for the Settlor’s benefit without the expense and complication of a court supervised guardianship. The Trustee can pay expenses and manage the assets without any court approval or accountings.
b. Complicated Family. Family can get complicated, even dysfunctional. If you have more than one marriage and children from each marriage, or a blended family where you and your spouse both have children from prior marriages, or your children have step-children, you may need special provisions to address the special needs and your particular wishes in these situations. Additionally, if there is a disabled beneficiary or a beneficiary who has drug or alcohol issues or who simply cannot manage money well, then a trust can be an effective mechanism to specifically plan for these ongoing circumstances and complications.
c. Probate Avoidance. The Trustee can administer the trust at the death of the Settlor without any court intervention. It is usually much quicker, more private and less expensive than probate. There is not a filing of a list of assets or the provisions for distribution of a trust in public records as there is in probate.
d. Trustee. If you have unique assets, you can appoint a trustee who is skilled in the management of those unique assets. Examples would be collectibles such as artwork, patents, intellectual property, farming and ranching interests, or oil and gas.
Disadvantages of trusts
a. Costs. There are ongoing costs for maintaining a trust, if the beneficiaries do not receive the assets outright. There may be trustee fees and accounting fees for tax returns and accountings. The Trust income and principal can be used to pay for these additional expenses as related to trust administration.
b. Complexity. The trustee must be involved in the management of the trust assets and the administration of the provisions of the trust for the beneficiaries until it is completely distributed, which adds a layer of extra administration.
Even without the incentive of saving estate tax, the majority of our clients choose to use trusts in their planning in order to avoid probate, plan for incapacity and make specific provisions to ensure their wishes for the best interest of their beneficiaries will be achieved. It is our goal to help each client understand the pros and cons in order to make the best decision for their situation.