The revocable living trust is a very versatile estate planning tool that can be the ideal choice for a wide range of people. Before we look at the taxation question, we will explain a few of the benefits so you understand why living trusts are so effective.
Some people assume that the executor of a will can act independently without supervision, but this is not the case. The will must be admitted to probate, and a court would provide supervision during the administration process.
No inheritances can be distributed while the court is probating the estate, and this will take somewhere between nine and 24 months in most jurisdictions. Probate expenses can include the executor’s payment, a filing fee, legal and accounting fees, appraisal and liquidation costs, and incidental expenses incurred by the executor.
The expenditures reduce the value of the estate before it is distributed among the heirs. Anyone that wants to access probate records can find out all the details, and probate opens a window of opportunity for disgruntled parties that may want to challenge the will.
When a living trust is used as an alternative, the trustee will follow the wishes of the decedent and distribute the assets directly to the beneficiaries. The probate court would not be involved at all and the details of the estate would remain private.
Control of Asset Distributions
You do not have to facilitate lump sum inheritances when you have a living trust. You can set up the inheritance your loved ones will receive in asset protected trusts for their benefit. This can help protect their inheritance from creditors, lawsuits, divorce or other claims. You can also name a third party trustee or co-trustee to prevent them from making unwise or inexperienced spending choices.
Flexibility During Your Life
While you are living, you do not lose control of the assets that you convey into a living trust. In a real sense, there is no difference in your day-to-day life with regard to your access to the resources.
The trust technically owns assets that you signed over to it, but you would be the trustee. You could write checks on a trust checking account, and you could live in your home as usual if you convey it into the trust. You would continue to file the same tax returns as you did prior to establishing the living trust because the trust would be revocable and use your social security number.
Income Taxes on Trust Distributions
Now that we have shared some of the reasons you may want to consider using a living trust, we can get to the main point of this post. Distributions of the principal are not taxable. As a result, if you arrange for the trustee to distribute all the assets as soon as possible after your passing, there would be no significant income tax liability.
However, the earnings that are generated by income producing assets in the trust are taxable. If they are distributed, the beneficiary would have to claim the income. The trust would be required to pay taxes on the earnings if they are not distributed.
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We have a number of resources that you can access through this website, and one of them is our estate planning worksheet. If you take the time to go through it, you will come away with a better understanding of this very important process.
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