Many people believe Trusts are the greatest invention since sliced bread. Others say Trusts are more flexible than a politician. While neither of these statements may be completely accurate, Trusts can and do perform a myriad of estate planning purposes.

A trust is really a very simple device. It is one person's promise to hold property for the benefit of another. You can create a trust in two ways, either during your lifetime through a trust instrument (an inter vivos trust) or at your death through your will (a testamentary trust).

Likewise, you can create two different types of inter vivos trusts. Your trust can be revocable (you can amend or revoke it at any time during your lifetime) or irrevocable (once it is executed, it cannot be changed, so you better be sure you’ve got it right the first time)

There are several different types of trusts and each serves a particular purpose. In this and later articles, I’ll be discussing the basic types available to you. The first is the By-Pass Trust or Credit Shelter Trust.

Currently, the Internal Revenue Code allows you to pass up to $1.5 Million during your lifetime and upon your death to anyone or any entity of your choice without incurring a federal estate tax. If you and your spouse have a joint marital estate of $3 Million, with proper planning you can pass all of it to your children or other named beneficiaries without incurring any federal estate tax. The state tax rules in Oklahoma are different from the federal rules, so you may still incur an Oklahoma estate tax in this situation. Be sure to consult with your estate planning attorney to see what can be done to minimize or eliminate Oklahoma estate tax.

You and your wife either establish a joint trust or divide your $3 Million estate and each put $1.5 Million into separate his and her trusts. Then let’s say you die first. Rather than leaving your $1.5 Million to your spouse, you leave it to a By-Pass or Family Trust. The Trustee of the By-Pass Trust can be your surviving spouse. The beneficiaries during your spouse’s lifetime can be her or her and your children. She can be given a special power of appointment, but not a general power of appointment as this would defeat the tax free nature of the trust.

At the death of your surviving spouse, the property in the By-Pass Trust passes directly to your children without tax. It is not considered a part of your spouse's gross estate (it by passes her estate for tax purposes), so her estate only consists of her $1.5 Million, which can also be passed to your children free of tax under current tax law. Thus, each of you has transferred $1.5 Million to your children without taxation.

The Marital Deduction Trust, like the By-Pass Trust, can be created by will or by an inter vivos trust (often called a Living Trust). Current federal tax law allows you to give as much property to your spouse as you want without any taxation. This is referred to as the "unlimited marital deduction." Any remaining property that passed to your spouse as part of a Marital Deduction Trust will be taxed in her gross estate at her death. This only makes sense. Uncle Sam wants to have the chance to tax this property at least once.

There are two common marital deduction trusts. The first is the "QTIP" (Qualified Terminal Interest Property) Trust and the other is the "QDOT"(Qualified Domestic Trust ). A QTIP Trust is often used by couples who have children from a prior marriage. The QTIP Trust provides your surviving spouse with all the income from the Trust during her lifetime and often allows the Trustee to invade the principal of the Trust under certain circumstances. When your surviving spouse dies, the remaining principal in the Trust passes to your children.

The QDOT Trust is a very special creation of the law and is required to be used if your spouse is a foreign national. The IRS wants to be able to collect estate tax on the trust assets at the death of your surviving spouse. In the past, this was a problem because many foreign national spouses returned to their native countries taking their trust assets with them. The IRS couldn’t find the property and wasn’t able to collect from these spouses’ estates at their death. To correct this problem, the only way your foreign national spouse can qualify for a marital deduction is if the property is in a trust that can be reached by the IRS and for which the Trustee is a U.S. corporation or citizen.

The various types of Marital Deduction and By-Pass Trusts are the basic building blocks of most estate plans of couples with taxable estates of $3 Million or more.

Over the next week or so, I’ll talk about some additional types of trusts, including the Generation Skipping Trust, the Qualified Minor's Trust, the Irrevocable Life Insurance Trust, and some Charitable Trusts.

As with anything else you do, the key is to find the tool that is appropriate for the job you want done. You wouldn’t use a sledge hammer to drive a tack and you shouldn’t use a complex trust for a simple estate. By the same token, you want to use the tool that works best in your particular situation. The only way you can be sure you have made the right decision is to consult with an experienced estate planning attorney who can explain the various options available and why his or her recommendation is the best one for you.

Stay tuned next week for more information on planning your estate.

© Jerry E. Shiles 2004

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