“The term “estate” consists of all the property a person owns or controls, whether in his or her sole name, held in a partnership, in a joint ownership arrangement, or through a trust, and all other monies that would be generated on the person’s death, such as through life insurance” (Advice Company, 2006a). If an estate plan is in effect, upon the death of an individual the estate plan documents, such as a will, manage the distribution of property.
The estate “is administered by a person named in the will of the deceased person Income, deductions, gains and losses of estates, and distributions to beneficiaries are reported on Form 1041 – U.S. Income Tax Return for Estates and Trusts (SOI Tax Stats). There is no double taxation in relation to estates, because the estate “receives a deduction for the income it distributes to its beneficiaries” (Pope et al., 2006, p. 14-4). Estates with a total value under $2,000,000 do not require the filing of an estate tax return (Estate Tax Questions). In addition, there are deductions available to help reduce the amount of estate tax liability:
1. Marital Deduction: One of the primary deductions for married decedents is the Marital Deduction. All property that is included in the gross estate and passes to the surviving spouse is eligible for the marital deduction. The property must pass “outright.” In some cases, certain life estates also qualify for the marital deduction. 2. Charitable Deduction: If the decedent leaves property to a qualifying charity, it is deductible from the gross estate. 3. Mortgages and Debt. 4. Administration expenses of the estate. 5. Losses during estate administration.
“A Trust is a well recognized type of legal entity which is used to hold legal title to property for the benefit of one or more persons” (Advice Company, 2006b). A trust may be created at any time and can be created by either a living person or a will.
There are several terms used in conjunction with trusts, some of which will be defined below:
Trust Estate – the property that is transferred to the Trust
Grantor – the person who creates the Trust
Trustee – the person or organization that holds legal title to the Trust estate
Beneficiaries – the person or persons who will benefit from the Trust
Trusts provide many benefits, some of which will be discussed. The first is that a Trust can result in tax savings. “Historically, with income splitting, the income from the trust assets was taxed to at least one taxpayer (i.e., the trust or the beneficiary) at a lower marginal tax rate than that of the grantor” (Pope, Anderson & Kramer, 2006, p. 14-5).
Another benefit is reduction of estate taxes. Transferring property to the Trust removes that property from the gross estate. Since the estate tax liability is calculated based upon the gross estate, removal of property from the gross estate will result in a lower estate tax liability.
The creation of a trust can also help to avoid probate. The Trust is a separate entity from the deceased. Therefore, “the successor Trustee can take over management of the Trust estate and pay bills and taxes, and promptly distribute the Trust assets to the beneficiaries, without court supervision, if the Trust agreement gives the Trustee that power” (Advice Company, 2006b).
Additionally, Trusts help maintain privacy, because they are usually private documents, whereas wills are not. Trusts also ensure the separation of private property.
“A Trust is a separate taxpaying entity that files a Form 1041, and if it has any taxable income, it pays an income tax” (Pope et al., 2006, p. 14-3). Just like estates, there is no double taxation in regard to Trusts.
Simple Trusts must distribute all income during the current year. Therefore they have no tax liability, because the beneficiaries report the income on their tax returns. Complex Trusts are taxed “at a very compressed rate schedule. Trusts with less than $2,000 income are taxed at a 15% rate. This rate graduates up to a 35% tax rate with income over $9,750. Long-term capital gains and qualified dividends are taxed at a 15% rate through 2008, which is the same as an individual’s tax rate” (Colorado Technical University Online).
Differences
Following is a list of a few of the notable differences between an estate (with a will and/or living will) and a Trust.
Estate
Subject to probate
Becomes public record upon death
Requires Power of Attorney or Conservatorship to manage assets while living
Requires Executor to carry out wishes after death
Relatively inexpensive to prepare
Probate costs can be very expensive
Trust
Not subject to probate
Remains private upon death
Grantor may manage assets while living
Successor trustee manages after death
More costly than a will to prepare, fund, and manage
Probate costs are avoided
Conclusion
When an individual dies without a will or Trust, state law controls and distributes the property to the closest heirs and appoints the administrator of the property. Individuals should consider the differences between an estate with a will and a Trust and create one based upon their situation. This will help to ensure that their wishes are carried out after death.
Colorado Technical University Online. “Phase 1 course material text.” URL: https://campus.ctuonline.edu/classroom/multimediacoursetext.aspx?classid= 176366&tid;=36&uid;=51898&HeaderText;=Course%20Materials:%20ACC456-0701A-01%20:%20Tax%20Accounting%20II
“Differences between wills and living trusts.” (2002). Lectric Law Library website. URL: http://www.lectlaw.com/filesh/qfl05.htm
“Estate tax questions.” Internal Revenue Service website. URL: http://www.irs.gov/businesses/small/article/0,,id=108143,00.html
Pope, T. R., Anderson, K. E., & Kramer, J. L. (2006). “Federal taxation 2006.” Upper Saddle River, NJ: Pearson Prentice Hall.
“SOI tax stats – income from trusts and estates.” Internal Revenue Service website. URL: http://www.irs.gov/taxstats/indtaxstats/article/0,,id=96425,00.html
