Dear Ray,
My parents are getting up there in years. While they don’t like to talk about it, when we ask about their estate planning, they say not to worry as they have a revocable living trust, so we won’t need to go through probate or pay estate taxes. Is this true?
— J.
Your question is an important one. For answers, I’ve turned to Jeannie O’Brien, of Selander O’Brien Attorneys in Seattle:
Living trusts were very popular in the ‘80s and ‘90s, and probably came about when Californians were moving to Washington state in droves, bringing their thoughts about probate and trust law with them.
First, a bit of background: Trusts have been around since medieval England. A trust allows the trustee to maintain and control the property on behalf of the heirs or beneficiaries who hold the sole right to enjoy the property.
Living trusts are popular in California since probates there can be very expensive, and probate attorneys are allowed fees based on a percentage of the gross estate.
Trusts do not always serve as a way to avoid probate. The lawyer who drafted the trust for your parents probably included a pour-over will to use if property was acquired after the creation of the trust and was never properly recorded with the trust as owner. This property then passes to the trust using the will, which needs to be probated.
Probate is not very expensive in Washington, and probate lawyers here do not charge a percentage of the gross estate, so having to do a probate is not that big of a deal.
It is costly, however, when a trust gets set up and a probate needs to be done on top of it, since one major objective of a trust is to avoid probate. Depending on the number of assets, the cost of setting up a trust can be more expensive than executing a will and doing a probate after death.
Another reason people may prefer a trust is to avoid a public, on-the-record probate proceeding.
Washington law has evolved to protect privacy. The preparation of the Inventory and Appraisement is required after a probate has started, but the document itself — with all of the specifics of the assets and their values — is no longer filed as a public record. An interested party can still request a copy of it, so it is a good idea to prepare one.
A living trust can be a great way to avoid probate, as long as it is drafted and fully funded. But does it mean you won’t need to pay estate tax when they die? Yes and no.
Any significant transfer of property (during life or after death) needs to be reported to the IRS. Any transfer to a living trust must be reported. A testamentary transfer after death gets reported on this same return.
Taxes
So how much can be transferred without paying gift or estate tax? The IRS now allows gifts (during life or after death) in an amount up to $5 million per person. The amount given during a lifetime is kept track of on the gift/estate tax return, and the amount that is transferred upon death tax-free is what remains.
For example, your parents make a gift to their living trust of the family home that is worth $2 million on the date of transfer. Both parents have used $1 million of their exclusion amount, and now each have another $4 million to leave to you and your siblings when they die, without incurring estate or gift tax.
But if the net estate — gifted during their lifetimes or transferred upon death — is worth more than $10 million when they die, the estate will need to pay estate tax to the IRS. This amount may change when Congress revisits the gift/estate tax law that expires in 2012, and it is expected to decrease.
Washington state has a separate estate tax on amounts passing after death that exceed $2 million. But Washington state does not have a gift tax at all, so it does make sense to make lifetime transfers if an estate will be valued between $2 million and $5 million after death. This lifetime transfer can be done by using a trust or just by making gifts, as long as they are recorded on the gift-tax return.
Simply put, a living trust can work to avoid probate but does not shelter an estate from paying tax any more than a will would.
Will vs. living trust?
Whether you should have a will or a living trust depends on your situation.
The best place to nominate a guardian for minor children is in a will. Credit shelter trusts can be set up in a will. And other trusts — trusts for children, trusts for people with special needs, trusts for charities — all have a place in a properly drafted will.
If your parents will share it with you, it would be a great idea to have an expert take a look at their trust, especially if it was done 20 years ago, and decide whether it will work as a substitute for a will and a probate proceeding.”
RAY AKERS has been a licensed Realtor for more than 25 years. Send your questions to ray@akerscargill.com or call (206) 722-4444.
Jeannie O’Brien practices in the areas of estate and tax planning and can be reached at (206) 723-8200 or jeannie@selanderobrien.com.
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