§3.4 Testamentary Trusts
Jurisdiction | Washington |
§3.4 TESTAMENTARY TRUSTS
A testamentary trust may be provided for in a trustor's will to become effective upon the death of the trustor. Such a trust differs from an inter vivos trust, whether revocable or irrevocable, that is established while the trustor is alive.
(1) Use of testamentary trusts
A testamentary trust looks to the future and does not at the time of execution of the will divest the trustor of property or any interest therein or vest a present property interest in the beneficiaries. Edwards v. Edwards, 1 Wn.App. 67, 71-73, 459 P.2d 422 (1969) (valid trust may be created by provisions of will to become effective upon death of life tenant, even though trust would not come into existence until after the trustor's death).
A revocable living trust declaration or agreement may provide for establishment of further trusts upon the death of the trustor. Such trusts may be similar to and are intended to accomplish the same purposes as trusts created through a decedent's will. RCW 11.12.250 states, however, that unless the will provides otherwise, property given to the revocable living trust "shall not be deemed to be held under a testamentary trust of the testator." Rather, the statute provides that the property
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transferred is subject to the terms of the instrument establishing the trust. RCW 11.12.250. For purposes of this section, references will be to testamentary trusts, but many of the same principles, provisions, and objectives apply to and may be accomplished through a properly drafted revocable living trust.
(a) Tax purposes
Testamentary trusts are incorporated into estate plans for a variety of reasons, including each of the purposes discussed further below. A significant amount of planning is with tax objectives in mind, e.g., to reduce federal or state estate taxes, to preserve a generation-skipping transfer tax exemption, and to defer income tax on retirement plans or IRAs directed to trusts. This section does not contain forms for federal tax-related trusts because continuing changes in federal tax laws may result in a need to modify forms for any such trusts. Use of an out-of-date form could result in unintended tax consequences for estates and potential exposure for the drafting attorney. Sources for forms and clauses that are updated at least annually—and more often if there have been significant tax changes—are identified in §3.4(7), below. A more detailed discussion of federal and estate taxes is found in Chapter 7 (Tax Primer) of this deskbook.
(b) Nontax purposes
There are numerous reasons for the decision to leave property in trust other than tax planning. If there is a surviving spouse, these may include a desire to allow property to be available for a spouse for the lifetime of the spouse while preserving the property left, or trust remainder, for other beneficiaries, most commonly children and issue or charities. For surviving spouses who are physicians or have other potential creditor exposure, a testamentary trust may provide future creditor protection for assets left by the decedent. In some cases, there may be an actual or perceived need for a trustee to assist with management of property for the surviving spouse. As discussed in greater detail below, testamentary trusts also may be established for the benefit of children and issue, for the benefit of charities, and for the benefit of some pets.
(2) Estate and generation-skipping transfer taxes
State and federal estate and generation-skipping transfer tax issues are discussed below.
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(a) Federal estate tax issues
Eliminating or reducing federal estate taxes often is an objective in trust planning for surviving spouses. This subsection discusses means for meeting that objective.
Use of federal applicable exclusion
Use of the federal applicable exclusion amount in the estate of the first spouse to die is one of the most basic, common objectives for any estate plan involving a person who is married or is in a state registered domestic partnership. This objective is accomplished by assuring that the first spouse to die has a "taxable estate." If all of the spouse's estate goes outright to the surviving spouse, there is no "taxable estate" because the marital deduction is applied to reduce the decedent's estate by the amount of the marital deduction. Through use of a properly drafted trust, funded upon the testator's death with all or at least a part of the decedent's "applicable exclusion amount," property may be set aside for the lifetime benefit of the surviving spouse. The remainder of the property—not used during the spouse's lifetime—remains available for the decedent's other named beneficiaries ("exclusion trust" or "applicable exclusion trust") and transfers to them free of estate taxes.
Even if only one spouse or domestic partner is a client, federal estate planning for spouses must be considered and, if another attorney represents the other spouse for conflict or other reasons, the subject of coordination and use of both spouses' applicable exclusion should be considered. Adoption of the "deceased spouse unused exclusion amount" (DSUEA), I.R.C. § 2010(c)(4), reduces the need for federal estate tax planning when both spouses' combined estates are not expected to exceed the applicable exclusion amount, currently $11,400,000 per person as of the publication of this deskbook ($22,800,000 when combined for both spouses). The availability of the DSUEA is often referenced as "portability" of the applicable exclusion, as it allows a surviving spouse to make use of the decedent's applicable exclusion together with the exclusion of the survivor. For combined estates that equal less than the spouses' combined exclusion amounts, the case for establishing a trust for estate tax reasons is less compelling. For combined estates that may exceed the applicable federal exclusion amount and for estates that hold property likely to substantially appreciate in the future, a properly drafted testamentary trust should still be considered to allow property from the estate of the first spouse to die to be held in a trust that will not be subjected to tax upon the death of the second spouse.
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Caveat: | The desire to avoid federal estate taxes must be balanced against I.R.C. § 1014 which provides to a decedent's estate a basis adjustment for appreciated property subject to capital gains taxes. If property is placed into an applicable exclusion trust upon the death of the first spouse to die, that trust property may not receive the benefit of the basis step-up when the second spouse dies. If the combined estates of the spouses are under the combined federal applicable exclusion amount available to their estates, a basis step-up will have been lost even though there was no estate tax benefit from using a trust in the estate of the first to die. If there is an anticipated basis step-down in the survivor's estate, use of a trust may provide an income tax benefit. |
Planning for the Washington applicable exclusion
For a detailed discussion of the Washington estate tax, including the calculation of the applicable exclusion amount for 2019 and beyond, see Chapter 7 (Tax Primer) of this deskbook. For purposes of considering testamentary trusts, the conventional advice applicable to federal tax planning and use of the DSUEA may not always apply in Washington for several reasons.
First, Washington's applicable exclusion, $2,193,000 as of 2019, is substantially less than the federal applicable exclusion amount. For federal tax purposes, the combined spousal estate must exceed $22 million before estate taxes are a consideration. Combined spousal estates in excess of $4,386,000 in 2018, however, would be subject to Washington estate taxes. To reduce or eliminate Washington estate taxes, a properly drafted trust upon the death of the first spouse to die may be appropriate. This is accomplished by provision for what is known as a "Washington QTIP" trust. See discussion below.
Second, Washington's estate tax does not allow for the second spouse to use the unused applicable exclusion of the second spouse to die. There is no Washington DSUEA. Although for federal estate tax purposes, some trust planning may be unnecessary to reduce or avoid estate tax, in many instances, trust planning may be appropriate for any combined spousal estates that exceed the combined Washington applicable exclusions.
Third, for federal tax purposes, there is a unified gift and estate tax such that certain gifts made during the lifetime of an individual will reduce that individual's remaining available applicable exclusion amount. Washington has no gift tax, so unlimited gifts may be made during an individual's lifetime to reduce that individual's taxable estate
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below the Washington applicable exclusion amount. This planning must consider potential federal gift tax implications. For as long as there is no Washington gift tax and there is a spread between the federal and Washington state applicable exclusion amounts, however, there are planning opportunities for any individual who is able and willing to make gifts to persons who would receive the individual's estate upon death.
Caveat: | Any gift planning also must take into account income tax basis adjustments. For instance, appreciated gifted property transferred to avoid gift and estate taxes will retain its basis and not receive a step-up upon death. If the income tax rates are higher than gift or estate tax rates, the decedent's beneficiary might receive less overall upon later sale of the property. |
Marital deduction planning
Although a detailed discussion of trusts that qualify for the marital deduction is beyond the scope of this chapter, much of the planning for spouses involves assuring that the marital deduction is available to reduce or eliminate estate taxes upon...
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