The Lifecycle of a Revocable Trust, 0220 COBJ, Vol. 49, No. 2 Pg. 56
| Author | BY JENNIFER M. SPITZ |
| Position | Vol. 49, 2 [Page 56] |
TRUST AND ESTATE LAW
BY JENNIFER M. SPITZ
This article discusses the creation, funding, administration, distribution, and termination of a revocable trust. It addresses salient Colorado Uniform Trust Code provisions, other relevant laws, and practical considerations.
There are several phases in the life of a revocable trust: creation and funding, the settlor's lifetime, the period following the settlor's death, and finally, termination. This article discusses considerations unique to each phase of a revocable trust's lifecycle.1
Creating a Revocable Trust
CRS §§ 15-5-401 and-402 provide the methods and requirements for creating a trust. Typically, a revocable trust is created upon execution of the trust agreement by the settlor and trustee, who are often, but not necessarily, the same person. The trust agreement contains terms applicable during the settlor's life and at his or her death.
The trust may or may not be funded during the settlor's life. Typically, the settlor executes a pourover will directing that assets passing under the will be added (poured over) to the trust at death, and a power of attorney that allows the agent to add assets to the trust during the settlor's life. The personal representative is usually the trustee (or successor trustee, if the settlor is the original trustee). In addition, the trust may be named as beneficiary of certain assets, such as life insurance policies.
To avoid any questions about revocability, it is advisable to specify in the trust agreement that it is revocable by the settlor. However, even without this language the trust is presumed to be revocable and amendable by the settlor unless the trust agreement specifies it is irrevocable.2
The trust agreement outlines amendment procedures. For example, the trust agreement may require that all amendments be in writing and delivered to the trustee. However, the methods specified in the trust are not the only ways to amend or revoke the trust, unless the trust provides that they are the exclusive methods.3
While the settlor is living, the settlor's social security number can serve as the trust's tax identification number, and the trust income can be reported directly on the settlor's tax return. The trust does not need to file a separate tax return.
As long as the trust is revocable by the settlor, transfers to the trust will not be completed gifts for gift tax purposes. Therefore, the settlor can transfer assets to the trust without reporting the transfers on a gift tax return; the trust assets are included in the settlor's estate for estate tax purposes.
A revocable trust serves a valuable purpose if the settlor becomes incapacitated by allowing someone else to serve as trustee and directing the use of trust assets in that event. For example, the trust agreement usually authorizes distributions for the benefit of the settlor, and it may allow for gifts to others. Although a power of attorney can be used in place of a revocable trust to manage assets in the event of incapacity, a power of attorney has limited usefulness. For example, if the client wants to name a bank or trust company to manage the client's assets, the bank or trust company typically will refuse to serve as agent under a power of attorney but will agree to serve as trustee of a trust.
The trust agreement contains the meat of the settlor's estate plan at death. It may include directions for distribution of specific assets, cash distributions, and distribution of the balance (the residuary).
Funding the Trust
As noted above, in some cases the trust will not be funded during the settlor's life. However, there may be reasons to fund the trust during the settlor's life, such probate avoidance. Different types of assets present different challenges in transferring assets to the trust.
Real Estate
Real estate is transferred to the trust by the property owner (usually the settlor) signing a deed to transfer the property to the trust. The property can be transferred directly to the name of the trust, rather than showing the name of the trustee as the grantee,4 through a quitclaim, bargain and sale, or warranty deed. If a quitclaim or bargain and sale deed is used, the settlor does not provide any tide warranties, so the settlor cannot be held responsible for any tide defects. But conveying with a warranty deed may preserve any tide insurance coverage that the settlor obtained.5
In some cases, a property transfer is subject to a local transfer tax, such as the real estate transfer tax imposed by the Town of Vail on real property transfers. There are several exemptions from the tax, including " [a]ny gift of real property, where there is no consideration other than love and affection."6 Therefore, a transfer to a revocable trust should be exempt. However, the Town of Vail requires documentation to establish that an exemption applies.7
Before transferring real estate to the trust, practitioners should consider the implications for the tide insurance, property insurance, and mortgages. If the settlor obtained tide insurance when acquiring the property, the settlor is the insured, but the trust may not be insured under the settlor's tide insurance.8 Therefore, it may be worthwhile to purchase a title insurance endorsement to extend coverage to the trust.9
If real property subject to a mortgage is transferred to the trust, the transfer could trigger the due-on-sale clause in the deed of trust, thereby giving the lender the right to call the loan due. Federal and Colorado law prohibit lenders from calling a loan due in some, but not all, cases, so it is good practice to obtain the lender's consent before the transfer.10 In any event, once the trust holds the real estate, the lender may require that the property be transferred back to the settlor to obtain a new loan or to refinance.11
The settlor should advise the property insurance carrier of the change of ownership so the policy can be updated.
Bank and Investment Accounts
Transferring bank and investment accounts to the trust presents different challenges. The bank or investment company may not be willing to simply change the name of the owner on the account. Instead, they may require that a new account be opened. This may be inconvenient for the settlor, who may have automatic deposits and transfers set up for existing accounts. Further, it may be necessary to keep an account titled in the settlor's name because certain benefits, such as pensions, may require that automatic deposits be deposited into an account titled in the settlor's name rather than the trust's name. As an alternative to transferring the accounts to the trust, practitioners should consider whether the planning goals can be achieved by keeping the accounts in the settlor's name and naming the trust as a beneficiary.
Partnerships, LLCs, and Closely Held Corporations
The governing documents for a business, such as the partnership agreement, operating agreement, or shareholder's agreement, may contain provisions that address whether a transfer of the business interest to a trust is permissible, or whether consent from the other owners is required. A transfer without proper consent could give the other owners the right to purchase the transferred interest, or a transfer may cause the interest to become a non-voting interest.
The transfer of a partnership interest or LLC interest is typically accomplished by preparing an assignment. Corporations have stock certificates, so the existing stock certificate should be submitted to the comp any and a new certificate issued in the name of the trust.
Strict federal rules regarding ownership of stock in Subchapter S corporations permit only certain trusts to hold S corporation stock. A revocable trust is a grantor trust for income tax purposes and therefore can hold S corporation stock if the grantor is a U.S. citizen or U.S. resident. After the grantor's death, the trust is permitted to hold the S corporation stock for up to two years from the grantor's death without terminating the S corporation's status.12 If the stock needs to remain in trust beyond that time, consult the S corporation rules for possible elections to keep the assets in trust and maintain the S corporation status.
Tangible Personal Property
A bill of sale can be prepared to transfer untitled personal property to the trust, such as household items. To transfer vehicles to the trust, they need to be retitled with the Department of Motor Vehicles. The settlor should advise the property insurance carrier of the change of ownership so that the policies can be updated.
Operation During the Settlor's Life
The trust permits distributions to the settlor and may permit distributions to others, such as the settlor's spouse and dependents. While the trust remains revocable, the trustee's duties are owed exclusively to the settlor, unless the trust agreement provides otherwise.[13]
The revocable trust is essentially an alter ego of the settlor. As noted above, the trust uses the settlor's social security number, and transfers to the trust by the settlor are not completed gifts for gift tax purposes. The trust's income is reported on the settlor's income tax return (Form 1040), so...
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