While many clients establish trusts and execute estate plans to eliminate or reduce the estate tax burden of their estates, there are non-tax benefits to creating trusts that are especially relevant to the clients of family lawyers. With the possibility of estate tax repeal on the horizon, the timing is right to focus on these non-tax benefits and remind ourselves and our clients of the valuable protections and control available through the use of trusts. Regardless of whether or not the federal estate tax is permanently repealed, the possibility of such repeal allows us to put aside many of the complexities of tax planning and focus on the key family issues and concerns that motivate clients to initiate trust planning.

Protection of Assets for Children

Individuals are motivated to create trusts to preserve assets for their children. In blended families, this simple goal becomes challenging and often emotional. When a spouse has children from a prior marriage, it is often appropriate for the spouse's death benefit to be held in a qualified terminable interest property trust (QTIP trust). (For more information about the use of trusts in divorce, see Stober L: Using Trusts in a Divorce. The Matrimonial Strategist, 22.3, April 2004, p. 1.) QTIP trusts are desirable because they allow one spouse to leave the other a lifetime income interest, but preserve the trust property for his or her children at the death of the surviving spouse. From an estate tax perspective, QTIP trusts are attractive because they qualify for the estate tax marital deduction. However, even without the marital deduction, a QTIP trust remains a useful tool. The trust protects the donor's assets from the surviving spouse and preserves them for the donor's children.

In addition to protecting assets from the donor's second spouse, trusts also protect assets from the children themselves. Instead of giving property outright to children, transferring assets to a trust for their benefit provides more limited access to the property. When children are either spendthrifts or minors, trust planning can be invaluable, regardless of the estate tax consequences. The donor can distribute his or her assets in any manner he or she decides. The donor can limit distributions to the discretion of an independent trustee, provide for distributions at certain ages, or provide for distributions at the achievement of certain life events such as attendance at college or the purchase of a home.

Many children need protection not only from themselves, but from creditors as well. Future creditors are often unanticipated and trust planning offers a layer of protection against them. If a married child later divorces, his or her divorcing spouse becomes a creditor. Unless the donor's assets are adequately protected in a trust, the ex-spouse could gain access to the donor's inheritance. When drafting with creditors in mind, the most protective trusts provide distributions only at the discretion of an independent trustee.

A donor also may want to protect his or her assets for grandchildren and further descendants. If assets are given outright to children, there is no guarantee that anything will be left for succeeding generations. When property is given to a trust, the trust can be drafted to ensure that the donor's wealth will be available for more family members. Dynasty trust planning is appealing particularly to wealthier families and may become even more attractive if the generation-skipping tax is repealed along with the estate tax. (The generation-skipping tax is an additional tax levied for passing property to individuals more than one generation below the donor.)

Protection of Assets from a Spouse

Once the children are provided for, the next goal often is to protect assets from a spouse - either current of former. In a bitter divorce and its aftermath, the parties struggle to protect their own assets. Trust planning allows ex-spouses to continue to protect their assets after death. For instance, if property is given outright to a child, the child could choose to distribute some of that property to the ex-spouse, either during the child's life or at the child's death. If instead the property is given to a trust for the benefit of that child, the donor can limit the distributions to the child during the child's life and also control the disposition of the property at the child's death.

In addition, if property is paid outright to minor children, the ex-spouse may control those assets. If property is paid into a trust, the donor may name any individual and/or institution he or she desires to serve as the trustee to control the investments and discretionary distributions of the trust property. In some situations, the donor may want the ex-spouse to serve as a trustee, but trust planning allows for the flexibility to exclude the ex-spouse when appropriate.

When a couple is married, one spouse may want to benefit the other, but also establish certain limitations on the gift. This is true especially with respect to second marriages. By transferring assets to a trust for the benefit of the surviving spouse, the donor can control how and when and under what circumstances the surviving spouse may benefit. Trusts, especially when they do not have to qualify for the marital deduction for estate tax purposes, can be drafted with great flexibility and customization. For instance, to qualify for the federal estate tax marital deduction, income must be distributed at least annually to the spouse and he or she must be the sole beneficiary. If a marital deduction is not necessary, then the income stream could be more limited and subject to any conditions that the donor desires. Distributions could terminate if the surviving spouse re-marries. Alternatively, the donor could limit the income stream so that the surviving spouse is comfortable, but limit extravagant purchases. The donor's children also could be co-beneficiaries with the surviving spouse so that the children would not have to wait until the surviving spouse's death to benefit from the trust.

Planning for State Estate Taxes

In response to the phase-out of the state credit for death taxes which began in 2001, many states have since passed their own separate estate tax laws. Until 2001, most states received a portion of the estate taxes paid to the federal government. As a result of the elimination of this revenue sharing between the federal government and the states, many states changed their estate tax systems. As such, despite the potential repeal of the federal estate tax, trust planning may still be used to eliminate or reduce the state estate tax burden.

State estate tax planning focuses on preserving the exemption amount in each spouse's estate. As with the federal estate tax, most states tax only those assets in excess of a certain exempt amount. In Massachusetts, for example, as of 2005, assets in excess of $950,000 are subject to a Massachusetts estate tax. Each spouse can leave an amount equal to the exempt amount in trust for the benefit of the surviving spouse and children. The rest of the donor's estate could benefit, either in trust or outright, the surviving spouse. If the trust holding the exempt amount is drafted correctly, then at the death of the surviving spouse, the trust property would not be included in that spouse's gross estate. The trust property would pass to the children free of any state estate tax. Assuming the state also allows for an estate tax marital deduction, no state estate taxes would be due at the death of the first spouse. Then, at the death of the second spouse, an additional exempt amount would be available to apply to her estate. This plan permits each spouse to use his or her exempt amount. It also defers the payment of any state estate taxes until the death of the surviving spouse. Even when no federal tax planning is necessary, estate planners can use trusts to reduce or eliminate state estate taxes.

Disability Planning

Irrespective of the federal estate tax, trusts offer unique planning opportunities with respect to the beneficiaries of disability and other government benefits. Property given to a disabled individual, including an inheritance, can disqualify the individual from needed government funds and programs. If property is given to the individual in trust, the trust, if drafted correctly, will provide only limited access to the property. As a result, the individual will not be disqualified from the receipt of any government benefits. The discretionary trust distributions are designed to supplement, not supplant, the government benefits. Trust planning makes it possible to provide additional care and support for disabled individuals without disqualifying them from their government assistance.

Conclusion

While it cannot be denied that tax planning motivates trust planning, family planning and protection will remain necessary with or without the federal estate tax. In fact, the repeal of the estate tax would allow estate planners to draft trusts with greater flexibility and customization. Whether or not the federal estate tax is repealed, the motivation to provide for certain family members and deny others, has been and will continue to be the focus of estate and trust planning.