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INTRODUCTION

TRUSTS

DEATH TAXES

PROBATE
I.    WILLS OR TRUSTS TO TRANSFER ASSETS?
A.    Saving Taxes – Trusts Offer No Tax Advantage Over Wills
B.    Avoiding Probate Is Not Always Wise
(1) Delay in Distribution of Your Estate
(a)    Trusts and Probates Must Wait on The Tax Man
(b)    Reform Has Streamlined the Probate Process
(c)    A Problem In Probate Is A Problem In A Trust
(d)    Trustees Often Submit Your Trust to Probate Jurisdiction Anyway
(2)    Ease of Transfer of Assets
(a)    “Wild Card Assets” Plague Trusts
(b)     Trust Beneficiaries May End Up In Court
(3)    Excessive Compensation
(a)    Trusts Cost More To Set Up
(b)    Unregulated Fees Make Trusts More Expensive Than a Probate
II.    A WILL OR TRUST? OTHER CONSIDERATIONS
A.    Dependents are Protected By A Will Or A Trust
B.    Living Trusts Offer No More Privacy Than Wills
C.    Better To Litigate In Probate Than With A Trust
D.    Probate Provides For Family Support
III.    ALTERNATIVES TO REVOCABLE TRUSTS
A.     Wills
B.    Other Alternatives
1.    Real Estate
2.    Personal Property

SUMMARY

INTRODUCTION

The revocable living trust is also known as the “family,” “intervivos,” “living,” or even “loving” trust, and has become the vehicle of choice for almost all estate plans.

There are many estate planning situations where a trust is appropriate.  During our fifty years of service to our clients, we have used the revocable trust for their benefit when it is appropriate to do so. For some of our clients over 55, and most over 65 we recommend a revocable living trust because of the fact that it permits management of a disabled person’s estate without the need for a cumbersome and expensive court conservatorship.  The conservatorship process, whereby a relative, friend or care giver seeks appointment by the court to completely take over and manage a person’s estate while the ward is still living is to be avoided unless there is no one who can be trusted to administer a private trust.   However, in the event of death, the widespread use of the “revocable living trust” as the estate planning and administration device of choice has many times turned out not to be in the interest of the client or the client’s beneficiaries.

We are concerned that many people enter into these trusts without fully understanding what it is they are buying. The problem we see is that the revocable trust often fails to provide the advantages claimed for it and there are cheaper and more efficient legal vehicles available to do the job the living trust is supposed to do. Too often the revocable trust is promoted as a wealth transfer device when it is not appropriate to do so.

What we want you to know is that there is nothing wrong with using a will to transfer assets in many estates, even substantial estates.  A will can do as well as or  better than a revocable trust to protect your estate from creditors, lawsuits, audits, and heirship claims and do it for less money.  To understand why this is so, you need to know some basic facts about trusts, taxes and probate.

TRUSTS

WHAT IS A TRUST?  The trust form of property ownership was devised in England long ago to permit legal title to be transferred by the owner of property (the trustor or settlor) to another person (the trustee) for the benefit of the trustor/settlor or a third person (the beneficiary).  With a trust, the beneficiary does not have legal title to the property, but has the right to enjoy the use and benefit of the property placed in trust according to the terms of the trust (this is known as a “beneficial interest”).

Trusts can be established for varying lengths of time, even for several lifetimes (but not in perpetuity, except in a few states), or can be revocable, that is terminable at the whim of the settlor or upon certain conditions or events specified by the settlor.

HOW DO YOU CREATE A TRUST?  By signing a deed, declaration, or agreement, all of which are effective to create the trust immediately, or by signing a will, which is effective to create the trust only on your death.

WHAT IS THE PRACTICAL DIFFERENCE BETWEEN A REVOCABLE TRUST AND A TESTAMENTARY TRUST?  None.  The only difference is that a trust established on your death by a will is called a “testamentary trust,” and a revocable trust established before your death is called a “living trust.”  Both forms become irrevocable on your death.  A testamentary trust provides the same protection as a revocable trust for your beneficiaries.

A revocable living trust is supposed to transfer your assets on your death without a proceeding in probate court.  To do this, it must be funded while you are alive.  A revocable living trust used to transfer your assets is not subject to court control like a testamentary trust, although a beneficiary can petition the probate court to take jurisdiction of the trust.  Very often the successor trustee is a bank.  Our position is that once you are gone, your trustee’s actions, particularly if it is a bank, should be subject to probate court review and accountability to protect the trust estate from abuse, particularly overcharging.

DEATH TAXES

We do not have a death tax in California.  However, your estate may be liable for federal estate tax.  Beginning in 2009, no federal estate tax will be due in estates valued at  less than $3,500,000 for single persons, and $7,000,000 for married couples who plan properly, and the death tax will be fully repealed in 2010, although the “sunset” provisions of the Byrd Amendment (which is intended to avoid a federal deficit), will reinstate the tax in 2011 as it existed in 2000 unless Congress votes to override that Amendment.

Regardless of the size of your estate, if you are married when you die, the 100% federal estate tax marital deduction is available to your spouse.  This means that there is no tax due at the first death, no matter how large the estate. Tax is imposed on the spousal estate only after the surviving spouse dies.  However, if one spouse dies without using his or her exemption, only the second spouse’s exemption will be available on the second death.

If a married couple sets up a simple “bypass” trust for the survivor and places $3,500,000 of marital property in that trust on the first death, the decedent’s lifetime exemption is preserved, and a total of $7,000,000 can go to the heirs tax free.  A bypass trust does not require a living trust, but can be set up in your will along with trusts for the protection of children or other dependents.

PROBATE

While it may be desirable to transfer your assets without filing a petition in probate, at least if you have no tax problems or disgruntled heirs, probate is not something to be shunned and feared out of hand.  Probate is a shorthand way of describing the court supervised procedure designed to pass your property as you have instructed in your will, while protecting your heirs.  Many people don’t really know what probate is or what it does, and do not realize that probate avoidance may have a high price if a revocable living trust is used as a will substitute to avoid probate.  For married clients, formal transfer procedure can be avoided on the first death by simply holding title in co-tenancy.  We will discuss this and other less expensive alternatives after comparing wills and revocable trusts as estate transfer devices.

I.    WILLS OR TRUSTS TO TRANSFER ASSETS?: The two major selling points used to promote revocable trusts are: (A) saving taxes, and (B) avoiding probate.

A.    Saving Taxes – Trusts Offer No Tax Advantage Over Wills.

Now that you have an overview of the death tax applicable to your estate, we can examine the tax advantages of revocable trusts over wills.  There are none.  Nevertheless, our clients who have attended lectures, read estate planning articles, or been advised by well-meaning relatives and friends, are often under the mistaken impression that the revocable living trust is a device to save taxes.  It is not.  Rather, it can result in excessive fees and costs in the short and the long run, with no tax benefit over a will.

When it comes to taxes, a revocable living trust has no advantage over a testamentary trust set up under a will.  This is because of a basic fact of life and the cardinal rule of tax planning – you don’t get something for nothing.  In order to effect a tax savings with a trust, or otherwise, you must give up something.  The thing you must give up is control of your estate while you are alive.  Therefore, the only trust that can effectively save you taxes is an irrevocable trust.  Once you’re assets are in an irrevocable trust, there’s no getting out of it or changing it, regardless of changes in your circumstances or wishes.  For this reason living trusts used as will substitutes must be revocable.

The fact that your estate planning trust is revocable means that its legal effect is identical to that of a will.  A will does not have any effect on your property until your death and can be changed or revoked at any time.

B.    Avoiding Probate Is Not Always Wise.  The principal reasons given for avoiding probate are: (1) eliminating perceived delay in distribution of the estate; (2) making it easy to transfer assets to your heirs,  and (3) avoiding excessive compensation to lawyers and executors.  Let’s look closely at the supposed benefits of probate avoidance:

(1) Delay in Distribution of Your Estate.   For most estates that we administer there is no difference in the amount of time required to distribute an estate under a will or a trust.   The reasons for this are:

(a)    Trusts and Probates Must Wait on The Tax Man.  Whether you use a will or a trust, if a federal estate tax is due because the value of your estate exceeds the available estate and gift tax credit, it will take at least six months to transfer all of your estate to your beneficiaries.  This is because the federal estate tax law gives your executor or trustee the choice of valuing the estate either as of the date of death or a date six months later.  Both a trustee and an executor must wait for the alternative valuation date to pass before distributing your estate, or risk overpaying death tax.    In fact, the federal estate tax return is due nine months after your death, and most estates stay open at least that long, even if a revocable trust is involved.

(b)    Reform Has Streamlined the Probate Process.   In response to criticism of the probate system nationwide, remedial statutes have been passed streamlining the system and eliminating most of the perceived problems.  Ironically, California, where the revocable trust device has found perhaps the greatest favor, has been for many years an example of progressive and efficient probate administration.  The Probate Division of the Los Angeles County Superior Court pioneered progressive methods of court administration which were followed in many other parts of this state and others.  The passage of the California Independent Administration of Estates Act several years ago gave executors much more flexibility and freedom in administering probate estates without time consuming and costly court supervision, while maintaining essential protections for heirs, creditors and the taxing authority.

(c)    A Problem In Probate Is A Problem In A Trust.  Even if your estate owes no estate tax, your trustee must pay claims, handle property transfers, wind up your business affairs, and settle heirship proceedings or law suits before he or she releases the assets to your beneficiaries.  It is true that it is possible (although rare) for a trustee to distribute trust assets earlier than an executor distributes assets in probate because an executor must allow the creditor’s claim period to run before closing probate (four months in California).  Once the probate creditor’s claim period has run, creditor’s claims are barred.   Far from being a hindrance to distribution, the protection of the probate creditors claim statute has now been made available for trusts, and many trustees elect to subject trust assets to probate jurisdiction to take advantage of the four-month time limit for filing claims.

(d)    Trustees Often Submit Your Trust to Probate Jurisdiction Anyway.  For years the revocable trust has been sold as a probate avoidance device, but now that people are dying with revocable trusts in place (they become irrevocable on death, remember), the post death administration of these trusts not only looks like a probate, but is in fact becoming a probate proceeding.

Due to the failure of the revocable trust to perform effectively as a will substitute (and an upsurge in trust litigation), a number of new provisions have been “cobbled” onto the California Probate Code in the last few years to try to solve some of the problems facing trusts and trustees as they struggle to deal with issues already addressed in the probate of a will.   Division 9 of the Probate Code has been expanded to cover creation and validity of trusts, trust administration, powers of trustees, liabilities of trustees to beneficiaries, judicial proceedings concerning trusts, liability of trustees to third persons, and, as stated above, payment of claims, debts, and expenses of a deceased settlor.   These new provisions allow your trustee to invoke probate court jurisdiction to resolve any issues he or she may be worried about, but at your trust’s expense and without fee regulation.

(2)    Ease of Transfer of Assets.  If the trust is properly set up, and maintained, your assets will be transferred quickly and efficiently.  The problem is that proper set up and maintenance does not often occur. In fact, the revocable trust device often results in a more complicated and difficult transfer procedure following your death than is the case with a will.  There are two reasons for this:  (a) an inherent problem of the revocable trust device is that assets are often left outside the trust and require the use of both a probate and a trust administration (we call these “wild card assets”), and (b) even if all of your assets are transferred to the trust, there is no one pushing your trustee to meet deadlines and transfer those assets.   In probate, the Court routinely reminds counsel and the executor of deadlines and insists that the matter go forward expeditiously.

(a)    “Wild Card Assets” Plague Trusts.  You must transfer all your assets to your revocable trust if it is to work as planned.  Anyone who adopts a living trust will find that the lawyer who drafts the trust with the purpose of avoiding probate, always insists that the client have a will as well as a trust.  The lawyer will tell you that this is to take care of any assets that are not transferred to the trust.  This happens more often than you might think.  Rather than have such assets “fall through the cracks,” the will that accompanies all revocable living trusts provides for transfer of any “wild card assets”  to your trustee when you die, but that won’t happen until they have been through probate.   Revocable trusts are promoted precisely because they are supposed to permit your estate to avoid the dreaded probate courts, but many estates end up with a probate and a trust administration.

(b)     Trust Beneficiaries May End Up In Court.  In probate, your executor and his or her lawyer are required to meet deadlines for filing your estate inventory, for paying your bills, and winding up and distributing your estate.  If they don’t meet the deadlines, the court sends a letter demanding action.  If they still don’t respond, they may be hauled into probate court and see their fees reduced, or they may be replaced.  No such system exists for trusts. There is a real chance that an unregulated trustee may drag his or her feet, failing to communicate with beneficiaries, and not accounting for their actions.  In California, beneficiaries have been given the means to force trustees who delay or even refuse to account or make distribution to toe the mark, but that requires your beneficiary to file a trust petition in probate court.

(3)    Excessive Compensation.  If your estate is held in a revocable trust at your death, it can end up in a probate proceeding anyway.  Disputes following death can arise in a trust setting also. If that happens, about the only protective provisions of the probate code not applicable to your trust are provisions limiting the freedom of trustees and their lawyers to charge fees.   Provisions do exist in probate to regulate fees of executors and their lawyers, but none exist with living trusts.  This is a truly ironic result,  given the fact that a major selling point for revocable living trusts is avoidance of supposedly excessive fees in probate.   If he believes they are excessive, a  trust beneficiary may petition to reduce fees, but must file a petition and appear in probate court to do this.

In fact, living trusts usually cost a great deal more than wills to set up. In addition, unregulated trustee fees following your death are often higher than probate fees for an estate of comparable size.  If you pay for a revocable living trust, it is often with the desire to save on lawyers’ fees and other administration expenses.  Let’s examine the facts about compensation for estate planning and for estate administration and its impact on your desire to save money for your beneficiaries:

(a)    Trusts Cost More To Set Up. A revocable trust does not save fees.  It costs more to set up a trust than to execute a will which, in our offices, ranges from $500 for a very simple will to $1,500 for a will which includes a testamentary bypass trust for married couples to make sure each spouse’s federal estate and gift tax lifetime exemption is used so that the maximum exemption is obtained, and a testamentary family trust to protect children and grandchildren, if any.

In comparison to wills, revocable trusts are often hugely complex, some with more than fifty typed pages.  Fees quoted for revocable living trusts range from $2500 to $7,500 and often more.

(b)    Unregulated Fees Make Trusts More Expensive Than a Probate.  In most states, lawyers’ fees in a decedent’s estate are fixed by statute, and in California they are set as a percentage of the value of the estate  However, this was not done because lawyers wanted it!  In California, fee regulation came about in the early part of the Twentieth Century because, without regulation, there were wide swings in the cost of estate management and distribution unrelated to the value or complexity of the estate.  The only criterion for setting fees was “whatever the traffic will bear.”

The legislature responded with a two-part system for the control of compensation for executors and their lawyers, adopting the concept of statutory and extraordinary compensation.

Statutory (sometimes called ordinary) fees are fixed as a percentage of the value of the estate, including gains and losses on sale of assets., and cover run of the mill services normally required to transfer your assets to your heirs.  This includes locating and listing your assets, preparing an inventory, paying claims, and distributing the assets to your heirs and beneficiaries.

In the case of fees for statutory or ordinary services, the court is prohibited by the statute from allowing more than 70% of statutory fees until the estate is actually closed and distributed.  Trusts have no such hold back.

In probate, any services of an unusual or extraordinary nature are also covered by statute, but are not paid as a percentage of the estate.  They are awarded only after a hearing in court on a written fee petition.  Extraordinary services involve such things as preparation of estate tax and income tax returns, tax audits, litigation and settlement of substantial disputes with heirs, creditors or other claimants.  Remember, if your estate has problems which may result in “extraordinary” compensation in a probate, it will have those problems whether it’s administered under a “revocable trust” or in probate court.

In the case of fees for extraordinary services, fees are rarely allowed by the court until the particular extraordinary matter is resolved.   The lawyer must tell the court in writing what he or she has done and how those services benefit the estate to justify an award.   A judge or the court probate staff looks at the written fee application and weighs all these factors very carefully.  Generally, probate extraordinary fees are awarded at a rate of 10-30% less than the going hourly rate of most lawyers in the community.

The important thing to note is that lawyers’ fees in a probate setting are regulated, either by the statutory table or by the review of a skeptical judge.  Contrast this with a revocable trust where there is no review or regulation.  In the case of a trust, the trustee and the lawyer are paid unregulated fees at whatever rate they may set, and they may collect monthly, even if the estate has not been distributed.  Therefore, ask yourself what  incentive they have to administer the estate efficiently of quickly.

A probate lawyer is not bound to charge the full statutory fee and can take less.  It has been our custom to enter into agreements with our clients or their heirs which limit our statutory fee to an amount calculated by multiplying the number of hours which we spend in connection with the probate administration times our normal hourly rate, or by applying the statutory fee table, whichever fee is less.  Tell your executor that this sort of fee arrangement is possible and that he or she should negotiate with the lawyer who will do the probate work.  If the lawyer will not agree to such a fee arrangement, your executor should take the probate somewhere else.

Compensation paid for the services of a lawyer or an executor is a tax deductible expense of the estate.  The executor has the choice of deducting compensation on the federal estate tax return or the estate’s income tax return.

II.    A WILL OR TRUST? OTHER CONSIDERATIONS:  Additional advantages often cited in favor of the revocable trust include protecting minor children and incompetents, securing privacy, avoiding litigation, and providing a ready means of supporting family members during estate administration.

A.    Dependents are Protected By A Will Or A Trust.   We generally suggest that wills provide for a trust if there are minor children, or if you must care for someone who is not mentally competent or is unreliable.   Provisions in testamentary trusts set up by a will to do this job are identical to the provisions used in living trusts.

B.    Living Trusts Offer No More Privacy Than Wills.   At least in California, the so called “privacy” of the revocable living trust is, for all practical purposes, nonexistent and never was meaningful.

Before your death a will is an absolutely  private document, after your death, it must be filed with the probate court.  This probate filing is not a bad thing unless you are a rock star whose family will be hounded by the pulp newspapers,  or a reclusive billionaire with secrets to hide who sets up a trust for that reason.  However, even if you are a rock star or an eccentric, you can no longer keep your final wishes a secret using a living trust.  Your trustee must divulge the terms of your trust to all your potential heirs.  The California Probate Code now provides that once a trust, or part of a trust, becomes irrevocable (upon the death of a spouse, for instance) the trustee must give notice to potential heirs and deliver a copy of the trust on request.

Even before your death trust privacy is circumscribed.  You cannot sell real estate or stocks without showing the buyer or transfer agent your revocable trust, or a summary prepared by your lawyer under the probate code, which summary must be paid for by you.   In a lawsuit, the other side can discover the provisions of your trust.  With a will, at least pre-death privacy is assured.

C.    Better To Litigate In Probate Than With A Trust.  If you die and leave unpaid creditors, unhappy business partners, heirs who have potential disputes, tax problems, etc., your representative, whether a trustee or an executor, is faced with identical problems.  Having a trust won’t stop a litigant from suing.  If a suit is filed after your death, your trust ends up in civil litigation instead of the less formal, usually more efficient and responsive probate court system.    In Los Angeles County (and most other counties) there is a professional staff of attorneys and assistants who review, prepare and comment to the judge on all proceedings.  Because of this, matters which might otherwise drag on in the civil courts are often disposed of at the procedural level or in settlement.

D.    Probate Provides For Family Support.  You may hear that with a will your money can be tied up in probate with no immediate provision for protection of surviving family members.  This is not so.  When your spouse dies, co-tenancy bank accounts can make it easy to obtain funds immediately without a trust.  On the second death, when a probate may be required, the California Probate Code allows dependents (or their guardians) immediate access to funds by way of the probate family allowance, as well as the right to live in the family residence during probate,  without the delay of a court hearing.   The fact that the court continues to have jurisdiction over the amount and duration of family allowance payments is a positive.  The court will not allow excessive payments and will not let them continue to the detriment of the estate.

III.    ALTERNATIVES TO REVOCABLE TRUSTS.   One purpose of the revocable trust if you are married is to transfer title to your spouse without going through probate.  However, you do not need a revocable trust to achieve this goal.  A will is an obvious alternative and, if you are married and do not have a complex estate, we recommend that you hold your community property with your spouse as “Community Property With Right of Survivorship” instead of in a revocable trust. See ¶B. 1., below.

A.     Wills:   A will is the most obvious alternative to a complex revocable trust and should be used in most instances when a client’s estate does not exceed the federal estate and gift tax lifetime exemption.  This may mean a probate (unless, in California, the estate is worth less than $100,000 and there is no real estate), but that is not something to be avoided by the application of the revocable trust device where it makes no economic or practical sense.

B.    Other Alternatives:

1.    Real Estate:  Beginning in 2002, a married couple can avoid probate of real estate without a trust by holding real property as “Community Property With Right of Survivorship” (California Family Code §750).   This form of ownership assures California couples that when one of them dies, the other will receive a full step up in basis of all the community property for federal income tax purposes, while retaining the survivorship benefits of joint tenancy.

With the advent of Community Property With Right of Survivorship under California Civil Code §682.1 (operative July 1, 2001) you don’t have to have a probate or other court proceeding to transfer property to you on the death of your spouse.  A simple “affidavit death of spouse” can be used to clear title to assets.  If it is advisable for income or estate tax reasons to have a court proceeding, you may use the inexpensive, streamlined spousal property confirmation petition now available in California.   You do need wills for each spouse to transfer what’s left on the second death.  Your wills may or may not contain a trust for minors or other dependents, and a “bypass” trust if you have a fairly large estate and want to take full advantage of the lifetime federal estate tax exemption granted to each spouse.

2.    Personal Property:  In California (Probate Code §5100, et seq.), and many other states, bank accounts, stocks and other intangibles held in the names of both husband and wife, are transferred upon presentation of a death certificate without the need for court proceedings or a trust.  Community property with right of survivorship is also an inexpensive and practical way to transfer any property between spouses.

SUMMARY
Remember that we stated at the beginning of this article that Revocable trusts are definitely not panaceas, and are often oversold, although they have their place in an appropriate setting.  For instance, we may recommend a revocable living trust for incapacitated persons, or those with debilitating illnesses, or those over age 65 who wish to delegate management of their estate assets without giving up all control, or where the client owns assets in several states or countries (particularly real property), or owns intellectual property which requires ongoing management during his or her lifetime and after death.  However, we use revocable trusts only when there is a good reason for doing so.  This is in large part because of the additional drafting and set up expense and the problems of unregulated fees post death, and especially in the event of litigation over the estate.

Feel free to call us with any questions.