CPA financial planners frequently receive telephone calls from clients who say that their friends and neighbors have suggested that a revocable trust, prepared during the testator's lifetime, has substantial advantages over the use of wills in estate planning. The clients have been told that trust assets escape probate costs and can be managed during the testator's lifetime and after death in accordance with the client's wishes. This is especially true of clients who have moved to states where attorneys who prepare wills heartily endorse the "Living Trust."

Estate planning is particularly important under our restructured tax laws. The maximum federal income tax rate is now 28% (after the 33% notch). By comparison, federal estate tax rates begin at 37% and go to 55%. Estate planning frequently is more important than income tax planning because of the large dollar amounts involved, not that income tax planning should be overlooked. The question of revocable living trusts compared with wills as estate planning devices must be decided on a case by case basis. Both approaches have their place as can be seen upon careful examination.

A revocable living trust provides for management of trust assets while the individual is living and provides for the disposition of the assets upon the individual's death, at which point the revocable living trust operates essentially the same as would a will. In addition, a revocable living trust should also be accompanied by a "pourover" will which provides that any assets of the individual that are not held by his or her trust at death are to be added to the trust following the probate process applied to such assets.

Probate v. Non-Probate

The use of a revocable living trust generally entails the preparation of two separate documents, as opposed to one document, when only a will is used. Thus, the legal fees and expenses for document preparation may be greater where a revocable living trust is used.

Carefully Evaluate the Advantages

of the Living Trust

The primary advantages generally attributed to the use of a revocable living trust, along with a second look at the will alternative, include:

Avoidance of Probate. Probate expenses are avoided upon an individual's death with respect to those assets that have actually been conveyed (funded) to his or her revocable living trust before death.

However, probate still takes place for assets that have not been conveyed to the revocable living trust before death.

A revocable living trust, however, provides no federal income tax or estate tax advantage that cannot also be achieved with a will that provides for the establishment of trusts following an individual's death.

With regard to legal fees incurred through the probate process, many law firms will agree to fees determined based on normal hourly rates and not based upon a percentage of the estate. Therefore, the expenses saved if probate is actually avoided by use of a revocable living trust may be quite modest.

The probate laws of most states provide specific procedures under which the claims of an individual's creditors can be expeditiously resolved or terminated after an individual's death. If the entire probate process is avoided through the use of a revocable living trust, an individual's beneficiaries may stand subject to the claims of creditors with respect to the assets received.

Asset Management. A funded revocable living trust may be used to provide an individual with asset management assistance through co- trustees or successor trustees. Management assistance may be particularly important in the event of an individual's incompetency.

However, the same management assistance, including that used during an individual's incompetency, can be provided through the effective use of a durable family power of attorney. Durable family powers of attorney should be considered whenever a will is also prepared, even with a revocable living trust. An attorney-in-fact nominated in a durable family power of attorney can convey the individual's assets to the revocable living trust in the event of the individual's incompetency, but prior to the individual's death.

However, in some states an individual may execute a durable family power of attorney designating only certain related persons as his or her attorney-in-fact (as in Florida where a person may designate only spouse, parent, child, brother, sister, niece, or nephew). Therefore, if an individual wishes to name someone not included in this list of individuals to assist him or her with financial affairs, a revocable living trust will be more useful than a durable family power of attorney.

Privacy and Confidentiality. A revocable living trust allows greater privacy and confidentiality regarding an individual's assets and financial affairs after death. The assets in the revocable living trust prior to death are not subject to probate and therefore do not have to be disclosed through the probate process. Generally, state probate laws require that an individual's assets that must pass through probate be disclosed through the filing of inventories and accounting with the court. The disclosures then become public documents. However, in some states an estate inventory is subject to inspection only by the clerk of the court or a representative, by the executor or personal representative and attorney, and by other persons financially interested in the estate, unless otherwise ordered by the court for good cause shown.

Distribution of Assets. Use of a funded revocable living trust may expedite the process of distributing funds and assets to an individual's beneficiaries, as opposed to the use of a will where such assets must first pass through the probate process.

In part, the delay of estate administration and distribution is caused by the period of time that assets are held pending identification, resolution or termination of creditors' claims. As mentioned above, this particular delay may actually be inured to the benefit of estate beneficiaries by terminating creditors' claims.

In addition, where a federal estate tax return must be filed, a probate estate should not be terminated nor assets distributed to estate beneficiaries until the estate tax return has been filed, (generally within nine months of death), any audit by the IRS is completed, and the tax is paid. A trustee of a revocable living trust under similar circumstances would be ill-advised to distribute trust assets prior to the receipt of a federal estate tax closing letter. Therefore, the use of a revocable living trust does not necessarily expedite asset administration and distribution unless no estate tax return is required to be filed.

Income Taxes

The comparison of a revocable living trust versus a will and an estate that must pass through probate must also take into account certain subtle differences that stem from aspects of federal income taxation of trusts and estates. Generally, under the following conditions federal income tax aspects will favor the use of a will and probate estate as opposed to a funded revocable living trust:

* Where an individual has significant federal taxable income that is expected to continue after his or her death; or

* Where a portion of an individual's assets are left to one or more charitable organizations and such assets may produce income after the individual's death and prior to their distribution to the charitable beneficiaries.

Pursuant to IRC Sec. 645, all trusts, including revocable living trusts, must use the calendar year as their taxable year for income tax purposes. Therefore, revocable living trusts do not provide flexibility to defer taxation of trust income that may be accumulated for or distributed to individual trust beneficiaries. A probate estate may elect a fiscal year for income tax purposes that is other than the calendar year and that is different from the fiscal years of estate beneficiaries, thereby facilitating beneficial post-mortem income tax planning designed to reduce or defer income taxation of estate taxable income.

Pursuant to Sec. 642(c), an estate is entitled to a federal income tax deduction with respect to its income set aside for ultimate distribution to certain charitable and educational beneficiaries, even though such amounts of income are not currently distributed to such organizations. This income tax set aside deduction is not available where a trust (including a revocable living trust) is used to ultimately pass such amounts to charity.

Right or Wrong?

There is no universal right or wrong answer to the question of using a funded revocable living trust as opposed to a will. Generally, if a revocable living trust and pourover will can be produced for an individual at a cost not significantly greater than the cost of a will, and the testator wishes to delegate management of his or her assets, then the use of a funded revocable living trust may be preferred. However, if an individual intends to use a revocable living trust primarily for probate avoidance purposes, he or she must be impressed with the fact that probate will only be avoided if all of the assets are owned by the trust at the time of death. The testator must be willing to live with all assets titled in the name of the trust, must cooperate during the initial process of conveying assets to the trust, and must also maintain that arrangement. The potential income tax advantages of a probate estate, as opposed to the use of a funded revocable living trust that owns an individual's assets prior to death, must also be considered. Federal income tax planning after an individual's death may produce significant tax savings for an individual's beneficiaries and may favor the use of a probate estate for this purpose. A summary of the issues is presented Exhibit 1.