Archive for the ‘Trusts’ Category

Compressed Tax Brackets on Irrevocable Trusts

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What is this rumor I have heard about compressed tax brackets and irrevocable trusts?

Great question.

The answer to the question is something everyone should be aware of when deciding to use a trust as the means to distribute assets after death.

When your trust becomes irrevocable, it has compressed tax brackets when compared to the tax brackets of individuals.

Income tax brackets that apply to irrevocable trusts:

If taxable income is:      The tax is:

Not over $2,500          15% of the taxable income


Over $2,500 but          $375 plus 25% of

not over $5,800           the excess over $2,500


Over $5,800 but          $1,200 plus 28% of

not over $8,900           the excess over $5,800


Over $8,900 but          $2,068 plus 33% of

not over $12,150         the excess over $8,900


Over $12,150              $3,140.50 plus 39.6% of

the excess over $12,150

Income tax brackets for individuals: Single Filers

10% – $0 to $9,225

15% – $9,225 to $37,450

25% – $37,450 to $90,750

28% – $90,750 to $189,300

33% – $189,300 to $411,500

35% – $411,500 to $413,200

39.6% – $413,200+

Why do we care …. and what should we do?

It is usually a goal of the families we work with to minimize the taxes paid in a given situation. The upshot of the bracket differences is that, after your death, if you keep enough gain in the irrevocable trust, the gain will typically end up taxed at the higher rates than if the beneficiaries receive the gain and the related tax. Knowing this is a possibility, most of the gain in the irrevocable trust over a given calendar year should be distributed to the beneficiaries via care and maintenance payments and other discretionary distributions rather than held in the trust and taxed. If it is paid to the beneficiary, the beneficiaries rate is used.

One recent example that comes to mind is the small family-held business where the shares are held by the irrevocable trust. The business can be run in various ways (e.g., salaries to the employees or dividends declared to shareholders) in such a way that the income retained in the trust is not excessive. Another alternative is to have the ownership of the entity transferred out of the irrevocable trust sooner rather than later and run externally or sold.

Who decides what to do when the trust faces these issues?

All of these decisions are usually provided in the trust language and leaves these tax decisions in the full discretion of the trustee. The trustee can then, as time progresses, weigh tax options and respond accordingly.

We Just Inherited the Family Cabin. How Ugly Can it Get if Someone Wants Out?

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Siblings inheriting the family cabin tend to do things informally together. Siblings also can make promises to each other that they may not be able to stick to later. One such promise is, “If I ever want out of cabin ownership, I will leave the ownership without compensation.”  Sadly, a well-intended handshake plan to have others exit ownership without paying them is unrealistic. Invariably, this solemn promise is broken later on. Things can get very ugly at that point.

One reason things can get ugly is that Wisconsin real estate law empowers the lone wolf against the wishes of the pack. When two or more people own real estate under a deed they are said to have “concurrent ownership.”  A popular form of concurrent ownership is as “tenants in common.”  You would need to review your deed to determine if you are in that boat. If you are in a tenancy in common, you are in a position right now that could lead to an expensive mess. The reason is that any one of the tenants in common holds a legal right called the “right to partition.”  The right to partition allows one owner to sell the property out from under the others.

Here is an example of what might occur: Imagine that four siblings own a cabin up north together.  They plan to enjoy the property together. They proceed to do this for quite a few years. One sibling hits on hard times. He is in need of money and realizes that his share of the cabin is the last valuable asset he possesses. With reluctance, he asks the others to buy him out for the fair market of his share of the property. The other two owners say no because you agreed verbally that you would not do that.  This rejected sibling then seeks the advice of a real estate attorney who describes the right to partition to him. The sibling, feeling he is cornered, files suit to partition the real estate. The judge rules that the land cannot be physically divided into many parcels and orders the land sold to satisfy the one sibling’s right to partition the land. The remaining siblings are stunned when they have to sell the cabin against their will or buy the other sibling out at fair market value.

A good cabin plan will allow family members to gracefully exit on terms that permit the rest of the family to afford to keep the property.  One way to approach the issue of buy-outs is to consider placing the land into a limited liability company or “LLC” owned by all of the current owners listed on the deed. This approach is used regularly for family cabins in Wisconsin as a way to cover issues such as the buy-out of a family member who wants out or to plan for successive generations owning a family parcel. A prime reason for creating a land LLC is to prevent any co-owner from forcing a sale by filing a partition lawsuit like the example stated above.

A carefully drafted LLC can be used to establish a reasonable value for any buy-out and a reasonable value would not be zero. Still, discounts on the fair market value of the seller’s interest in the LLC are often used to help maintain the family ownership of the property on a buyout.

You should not hesitate to contact a qualified attorney for answers on this cabin law issue.

Revocable Living Trusts: Are We Funded Yet?

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The Review

We recently had a new client present us with her revocable living trust so that we could review it for her. We took a good look.

The trust had a beautiful binder cover on it. It was drafted by a reputable attorney. It was carefully worded. It contained special language in it so that the trustee could take care of her if she became disabled. It contained language delaying large payments to minors until, one would hope, they reach an age when they are able to grasp money management. It also had a provision in it that would pay a residual distribution to a nice local non-profit group.

The trust looked great so far.

The Surprise

We then asked our client a critical two-part question that is a standard part of our trust review process.  What assets had she put into the trust so far and how is the trust to be funded upon her death?  She could not recall.

We then took a look at a few of her assets to see whether she changed titles and beneficiary designations into the name of the trust.

  • Life insurance? No. Still had her deceased spouse named as beneficiary.
  • Bank accounts? No. Still in her name, no trust as the owner or beneficiary.
  • Her vintage car? No.
  • Her farmette? Not a chance. It was still in her name.

We quickly realized that a very important step in trust planning was not accomplished. She had no assets in her trust.  No assets were set up to go into her trust outside of the probate process.  In short: She failed to properly fund the well-crafted trust she paid for.

Why It Matters

A revocable living trust can only control the assets that are put into it. Think of a revocable living trust as a legal container. The container is filled and then, at certain points along a timeline, its contents (some or all) can be distributed.

How Do I Fund These Things?

Trusts can be filled in various ways and at various points in time after they are drafted for a client. One way to accomplish this funding is through non-probate methods. Some examples of non-probate funding include taking actions, such as:

  • Deeding your house from you to the trust.
  • Transferring other assets outright to the trust using a bill of sale.
  • Placing the trust in as your beneficiary on accounts, policies and contracts.

These transfers all occur without the need for probate. The trust then administers the assets under its terms outside of probate. In short, the trust can help to avoid the delays and expenses of the probate process.

Finally, as a safety valve, the funding can occur after death and through probate via a last will that names the trust as beneficiary. This kind of will is commonly called a pour-over will. This is a probate method of funding. While it does cause the asset to make their way into the trust, it is only after the assets (if above $50,000 in Wisconsin) are probated.

The Fix

In our case, our client had a good trust prepared and a pour-over will. The trust was not filled with the assets in a manner that avoids probate. It appeared to be destined to remain empty until after a probate filled it. If the goal of her living trust is to avoid probate at death and court intervention at incapacity, then she should fund it now, while she is able to do so. If she fails to do so, the wording in the trust and the trust itself could be irrelevant when she becomes disabled or dies. If she relies on the pour-over will for the asset transfer, the money may not go to her minor grandchildren in the way intended under the trust, but instead to lawyers, court fees and other places that were unintended. The charity could have been out of luck if the residuary money was spent in the probate process.

If you have signed your living trust document but haven’t changed titles and beneficiary designations, you should get to it. Luckily, we caught the issue in our case. We made sure our client’s trust was properly funded.

Be sure and ask your attorney how to fund your revocable living trust. There is no doubt that you and your heirs will be glad you finished what was started.

No Need to Disinherit–SNTs are Here!

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Before the use and official recognition by Congress of Special Needs Trusts (SNTs), “disinheritance” was commonly used by families. Disinheritance is accomplished by leaving the disabled loved one out of the last will or trust. Leaving nothing to the disabled loved ones left them without assets. That, in turn, would qualify them for government benefits.

It was also common practice for the families that did disinherit the disabled loved one to leave a share of money informally to a sibling to use for care of the disabled brother or sister. When this was done as a means of providing for a disabled loved one, the assets were put at risk. A non-disabled sibling holding assets for the benefit of a disabled sibling could be subject to such liabilities such as judgments from automobile accidents, a bankruptcy, or a divorce. In such circumstances, the assets meant to benefit the disabled loved one could go to pay the judgment creditors or the estranged spouse of the non-disabled sibling.

A Special Needs Trust is designed to benefit an individual who has a disability. A Special Needs Trust is a specialized legal document. A Special Needs Trust is often a “stand alone” document, but it can form part of a Last Will and Testament or be a subpart of another family trust. It provides for supplemental and extra care over and above that which the government provides. It enables a person under a physical or mental disability, or an individual with a chronic or acquired illness, to have, held in Trust for his or her benefit, an unlimited amount of assets.  In a Special Needs Trust, those assets are not considered countable assets for purposes of qualification for certain governmental benefits.  Such benefits may include Supplemental Security Income (SSI), Medicaid, vocational rehabilitation, subsidized housing, and other benefits based upon need.

Using a Special Needs Trust will guarantee that the funds will be held only for the benefit of the person under the disability or chronic illness, and not for any other purpose whatsoever.

Each Special Needs Trust is its own “entity” with its own Federal Identification Number issued by the Internal Revenue Service. The Trust is not registered under either the Grantor’s or the Beneficiary’s Social Security Numbers.

A Special Needs Trust can be established at any time before the disabled loved one’s 65th birthday. It is very common to create a Special Needs Trust early in a disabled child’s life as a long-term means for holding assets to benefit the disabled family member. This is particularly true of parents who wish to leave funds for a child’s benefit after the parents’ death. The Special Needs Trust is the estate-planning tool of choice for those parents. As a part of Estate Planning, the costs of the creation of the Trust are tax deductible.

Also, the disabled person may at some time during his or her lifetime come into funds from third party sources, such as a personal injury settlement or a bequest from relatives or friends, Social Security back payments, insurance proceeds, or the like. This particular type of special needs trust (First Party SNTs) has some unique rules that apply to it that would not apply to a special needs trust set up by someone other than the disabled person (Third Party SNTs).

It is great to know that disinheriting disabled loved ones is no longer a necessary evil. With a Special needs trust as an option, a disabled loved one can have many funds for some of life’s special comforts without losing needed governmental benefits.