Estate Planning Glossary
Annual Gift Exclusion: This is the amount that someone can give to another person during the calendar year without having to pay gift tax. Under IRC Sec. 2503 the annual gift exclusion is $10,000, but that amount is inflation adjusted periodically. For gifts in 2014-2017 the annual exclusion is $14,000 per beneficiary. Annual gift exclusion amount increases typically get posted by the IRS in a publication in late Q3 or early Q4 each year, but they are adjusted on a different basis than the AEA.
Applicable Exclusion Amount (AEA): This is the amount that someone can leave to their heirs free of estate tax. For decedents dying in 2017, the applicable exclusion amount is $5,490,000. AEA increases typically get posted by the IRS in a publication in late Q3 or early Q4 each year.
Basis: Is the tax value of an asset, usually measured by the date on which the asset was acquired. Capital Gains tax is paid based on the increase in value (gain) from the owner’s basis to the value when the asset is sold. For example, if you pay $10 for something and it increases over time to $100, you have a basis of $10 and a “capital gain” of $90. If you sell the asset, you pay capital gains tax based on that $90.
- Carry-Over Basis: If you give that property away during your life, the person who receives it has the same basis you had. This is “carry-over” basis. So if they sell it for $100, their basis is still $10 and they pay the tax on the $90 gain. Carry-over basis is generally undesirable, because the person who sells the asset has to pay the capital gains tax liability based on the original owner’s “carried over” basis.
- Step-Up Basis: If you die with an asset that has increased in value and it goes to someone, that person generally gets a “step up” in basis to the value measured at your date of death. Assume again that the asset you bought for $10 increases to $100 by the time you die. After you die your kids receive the asset from your estate (valued at $100), and they then sell the asset for $100. Your kids have taxable capital gain of $0 because their basis got “stepped up” in your estate when you died. Estate planning strategies that target basis adjustment seek to eliminate carryover basis and give step up basis to your beneficiaries.
Beneficiary: This is the person, entity, or group for whom a trust is established. A beneficiary may be a present interest beneficiary, entitled to receive distributions from a trust right now, or a future interest beneficiary, entitled to receive distributions at some point in the future. They may also be vested, where their rights under the trust cannot be taken away, or contingent, where their rights are still subject to conditions that may or may not occur in the future.
Bypass / Credit Shelter Trust: This is the portion of the deceased spouse’s property that gets charged against the decedent’s AEA (Applicable Exclusion Amount; see that definition). The bypass trust can provide benefits for the surviving spouse or other beneficiaries (or a combination) and typically is designed so that it’s not included in the surviving spouse’s estate when he or she later dies.
CLT: Charitable Lead Trust: With charitable lead trusts the donor can donate an asset's income stream for a period of years to a charity instead of the remainder interest. The remainder interest can then pass to a private party under the direction of the grantor (i.e. grandchild, child, etc.)
CLAT: Charitable Lead Annuity Trust. Here the Settlor establishes a trust and names a charity to receive an annuity amount from the trust for a specified amount of time (the “initial term”). At the end of the initial term the remainder pays back to the Settlor or to other noncharitable beneficiaries named in the trust.
Clayton Election: This is a very popular method of determining the amount of a deceased spouse’s estate that will be set aside for the surviving spouse. The name is based on the case, Estate of Clayton v. Commissioner, 97 T.C. 327 (1991). It requires a trustee or personal representative to decide during the trust administration how big the marital deduction should be. The property set aside for the marital deduction gets transferred to the marital trust, which is set up as a QTIP trust. A 706 (Federal Estate Tax Return) is required to notify the IRS of the QTIP election and disclose the amounts going into the marital QTIP and bypass trusts. The Clayton election is a very flexible marital deduction planning tool and is most desirable for clients who have moderate to nearly-taxable estates, or in times of significant uncertainty in the estate tax.
CLUT: Charitable Lead Uni-Trust. Here the Settlor establishes a trust and names a charity to receive a percentage of the trust’s value for a specified amount of time (the “initial term”). At the end of the initial term the remainder pays back to the Settlor or to other noncharitable beneficiaries named in the trust.
Community Property; CP States: Community Property refers to property acquired by a couple during marriage, or property that is combined - or commingled - between spouses. It only applies in nine states (the “community property states”): Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Alaska and Tennessee have optional, or elective community property laws, allowing married couples to elect to have jointly-held property treated as community property. The biggest benefit of community property is that the entire value of the property gets a basis adjustment (step up; see that definition) when one of the spouses dies. So if a surviving spouse sells community property after the death of their spouse, the capital gain is based on the increase in value from the first spouse’s death (where the basis got adjusted on both spouses’ shares) to the value at the date of the sale. This allows the survivor to save money on capital gains tax liability.
Community Property Trust (Alaska or Tennessee): This is a special type of joint revocable trust that takes advantage of special laws in Tennessee and in Alaska that allow people to opt in to the state’s favorable community property laws. The value behind the strategy is to allow a married couple to get a “double step-up” in basis - a step up in the deceased spouse’s property AND in the surviving spouse’s property - when the first spouse dies. (This is a unique feature of community property law, and TN and AK allow people who live in separate property states to elect into community property treatment using these strategies.)
CRAT: Charitable Remainder Annuity Trust. A Settlor establishes this trust and puts property in, keeping the right to receive an annuity payment from the trust for an initial term - either for a term or years or for the Settlor’s life. After the initial term the amount remaining in the trust (the “remainder”) is distributed to a charity named in the trust.
CRT: Charitable Remainder Trust: This is a tax-exempt irrevocable trust designed to reduce the taxable income of individuals by first dispersing income to the beneficiaries of the trust for a specified period of time and then donating the remainder of the trust to the designated charity. The whole idea of a charitable remainder trust is to reduce taxes. This is done by first donating assets into the trust and then having it pay the beneficiary for a stated period of time. Once this time-frame expires, the remainder of the estate is transferred to the charities deemed as beneficiaries.
CRUT: Charitable Remainder Uni-Trust. A Settlor establishes this trust and puts property in, keeping the right to receive a percentage, or unitrust amount, of the trust assets for an initial term - either for a term of years or for the Settlor’s life. After the initial term the amount remaining in the trust (the “remainder”) is distributed to a charity named in the trust.
DAPT: Domestic Asset Protection Trust. This is a type of irrevocable trust that allows a person to set aside assets in trust and protect those assets from creditor claims. The DAPT is established under the laws of a state that has favorable asset protection laws. There is an increasing number of states that have DAPT statutes. Delaware, South Dakota, Alaska, and Nevada are all states with DAPT statutes.
Decanting: This is the process by which a trustee exercises the power to distribute property from one trust (the “originating” trust or the “inception” trust) into a new trust for the benefit of a beneficiary. Decanting is an increasingly popular strategy to allow a trustee to create new, more favorable trust terms for a beneficiary. A trustee can only exercise a decanting power consistent with the trustee’s fiduciary duties to the beneficiaries.
Delaware Tax Trap (DTT): Refers to the process of exploiting the Rule Against Perpetuities (RAP) provision in a trust by allowing a beneficiary to exercise a limited power of appointment in a way that extends the original RAP in the trust. The upshot is that the person who exercises the power causes the property subject to the power to be included in their estate (getting a basis adjustment) when they die. The DTT "loophole" is found in IRC sec. 2041(a)(3) when someone who holds a limited power of appointment exercises it in a way that "...postpone[s] the vesting of any estate or interest... or suspend[s] the absolute ownership or power of alienation of [the interest]... for a period ascertainable without regard to the date of the creation of the power." This is a complicated way of saying that, if someone who holds a limited power of appointment exercises that power to give someone else a presently-exercisable general power of appointment, the person who exercised the limited power of appointment will have estate inclusion over the property for which the PEG power was granted to the other person.
Disclaimer: A disclaimer is a legal “no thank you.” It’s a technique under IRC Sec. 2518 that allows someone who is entitled to receive property to disclaim that property, allowing it to be distributed somewhere else. In the context of marital deduction planning, the disclaimer method allows the surviving spouse to disclaim property into a bypass trust, providing some flexibility in marital deduction planning.
DSUEA: Deceased Spouse Unused Exemption Amount. This is the amount of AEA that is leftover after the estate plan has allocated part of a deceased spouse’s estate exemption to a bypass trust.
- Husband dies in 2017 and has $1,000,000 in his gross estate. His estate plan is designed in a way that allocates his AEA against that $1,000,000, causing that amount to be put into a bypass trust. Assuming he had made no other gifts that would reduce his AEA, after his estate plan goes into effect he has a remaining unused exclusion of $4,490,000 (his $5,490,000 AEA minus the $1,000,000 put into the bypass trust). His surviving wife now has her own AEA of $5,490,000 plus husband’s $4,490,000 DSUEA, for a combined estate tax exclusion of $9,980,000. Surviving spouse will need to make a portability election on a timely-filed estate tax return.
Executor / Personal Representative: This is the person who is named in a will to administer the estate of a deceased person. The trustee administers the trust; the executor or personal representative administers the probate estate.
FAPT: Foreign Asset Protection Trust. This is another form of an asset protection trust that is established under the laws of a foreign country that has even more favorable asset protection for clients. Nevis, the Cook Islands, and other remote countries are popular choices.
Fiduciary: This describes the nature of a relationship where one party owes a series of duties to another party and is held legally responsible for the outcomes of their actions.
Trustees are fiduciaries of trusts, owing duties to the beneficiaries
- Executors are fiduciaries of wills, owing duties to the beneficiaries
- Guardians and conservators are fiduciaries, owing duties to the ward
- Agents and attorneys-in-fact are fiduciaries, owing duties to the principal under a Power of Attorney
- Health Care Agents are fiduciaries, owing duties to the maker of a Health Care Directive
- Trust protectors may or may not be fiduciaries, depending on the nature of the power that they’re given.
Funding: This is the process of transferring property to the trust. The trust must hold title to property in order for it to work -- just like a car needs fuel to run. Funding should take place during the trust maker’s lifetime. If there is any property that has not been funded to the trust (and has not designated the trust as beneficiary) when the client dies, that property must generally go through state probate proceedings before anyone can do anything with that property.
GPOA: General Power of Appointment. This is a power that is reserved by a trust maker or given to someone else to direct how property in a trust gets distributed. General powers of appointment are included in the power holder’s estate under IRC sec. 2041(b)(1). To be a “general” power of appointment, the person holding the power must be able to appoint the property to any one of the following four:
· Their estate
· Their creditors, or
· The creditors of their estate
Grantor / Settlor / Trust Maker: These terms are generally synonymous, though there are subtle, technical differences. In general, they refer to the individual who establishes a trust. Think of it this way: The Settlor / Trust Maker establishes the trust and determines how the trust will operate. The Grantor (a technical tax term) puts his or her property into the trust. (Thus, the Grantor and Settlor-Trust Maker is usually the same person.) The trustee manages and administers the trust for the benefit of the beneficiary or beneficiaries.
GRAT: Grantor Retained Annuity Trust. A GRAT is a sophisticated gifting & wealth transfer strategy based on a special type of irrevocable trust. The Settlor establishes the trust and puts property in, and takes back an annuity (calculated as a dollar amount) for a specific amount of time based on the value of the property in the trust. After the annuity period ends the GRAT pays to other beneficiaries.
GRIT: Grantor Retained Income Trust. A GRIT is similar to a GRAT except that the Settlor receives the income stream from the trust assets, rather than a fixed annuity amount from the trust for a specified period of time. After the initial term ends the GRIT pays to other beneficiaries.
GRUT: Grantor Retained Uni-Trust. A GRUT is similar to a GRAT but instead of taking out an annuity interest the Settlor receives a percentage of the trust (called a unitrust amount) for a specific amount of time based on the value of the property in the trust. After the initial term ends the GRUT pays to other beneficiaries.
Guardianship / Conservatorship: These are the court proceedings that are undertaken when an individual lacks the legal capacity to make decisions for themselves or otherwise protect their own interests. That lack of legal capacity can be due to mental or physical illness, injury, or because the person is a minor child. A guardian or conservator is a fiduciary appointed by the court to make decisions on behalf of the disabled person (who is called the “ward”). That fiduciary must provide periodic accountings to the court and the guardianship or conservatorship continues until the ward (disabled person) dies or is no longer under the legal disability. Durable powers of attorney and trust-oriented planning helps avoid guardianship or conservatorship proceedings.
IDGT: Intentionally Defective Grantor Trust. This is a form of irrevocable trust that gets the value of the trust assets out of the client’s estate but allows the client to continue to be treated as the owner for income tax purposes only. One of the main advantages is that the (often wealthy) client can add value to the trust by paying the income tax that is due on the income in the trust without those tax payments being treated as additional taxable gifts to the trust. Also, it gets the trust out of the more aggressive income tax rate tables that apply to trusts.
ILIT: Irrevocable Life Insurance Trust. This is a very popular form of irrevocable trust that is designed to own high-value life insurance. A client establishes an ILIT and pays enough money into the trust to allow the trustee to buy life insurance on the life of the client (and often, the client’s spouse). When the insured person dies, the death benefit of the life insurance is paid into the trust but is not included in the gross estate of the client (thus keeping it away from estate tax liability).
Intestate / Intestacy: This describes the condition of someone who dies without having a will or trust in place. If you don’t do your estate planning your property will pass through the laws of intestacy in the state where you resided. The laws of intestacy vary from state to state and are set forth in state statutes.
IRT: Irrevocable Living Trust. A trust that can't be modified or terminated without the permission of the beneficiary. The grantor, having transferred assets into the trust, effectively removes all of his or her rights of ownership to the assets and the trust.
LPOA: Limited Power of Appointment. This is a power to appoint property to someone else, but in a way that does not cause the property “subject to that power” to be included in the power holder’s estate. Any powers of appointment that are not “General” Powers of Appointment (see definition above) are limited powers.
Marital Deduction: The marital deduction allows a married individual to leave property to his or her surviving spouse free of estate tax. U.S. citizens can leave an unlimited amount for their surviving spouse, assuming the survivor is also a U.S. citizen, and assuming the gift qualifies under IRC Sec. 2056. There are lots of different ways a trust or will can determine the amount set aside for the marital deduction, including:
- Fractional formulas, which compute a fraction that gets applied to the dead spouse’s estate;
- Pecuniary formulas, which compute a dollar amount to be applied to the dead spouse’s estate;
- Specified dollar amounts or percentages, which are typically based on requirements of a premarital agreement or state law;
- The Clayton election, which provides that a trustee can later decide how much to use for the marital deduction; and
- The Disclaimer method, which allows the surviving spouse to decide what property to keep and what property to put into the bypass / credit shelter trust
Marital Trust: This is the portion of the deceased spouse’s property that is transferred into a trust that qualifies for the marital deduction. When the surviving spouse later dies the value remaining in the marital trust is included in that spouse’s estate.
PEG Power: A Presently-Exercisable General Power of appointment, or "PEG" Power is a power that can be immediately exercised by the power holder to appoint property to that person's self, their estate, their creditors, or the creditors of their estate. Possession of a PEG power causes the value of the property over which the power may be exercised to be included in the power holder's estate.
Portability: The concept of portability allows married couples to effectively combine their individual AEAs, allowing them to pass up to $10,980,000 (adjusted for inflation) to their heirs. If a spouse dies and doesn’t use all of his or her applicable exclusion amount (AEA) in their estate plan, the amount they don’t use is called the DSUEA, and the surviving spouse is allowed to use that amount in their own estate tax planning. In order to take advantage of portability the trustee of the deceased spouse’s estate must file a federal estate tax return to claim
Probate: This is the court proceeding that must be undertaken to transfer the property of a decedent to surviving beneficiaries. Probate procedures vary widely from state to state but generally they’re public proceedings and can be time consuming and rather expensive. One of the objectives of trust-based planning is to avoid probate, primarily to save time, minimize the likelihood of disputes among heirs, and preserve privacy.
- Domiciliary probate: This refers to probate proceedings where the decedent lived at the time of death (i.e., where the decedent was domiciled).
- Ancillary probate: This refers to possible additional probate proceedings where the decedent owned property, but where he or she did not live. An example would be a Colorado resident who died, but who owned a vacation property in Florida. The domiciliary probate would be in Colorado, and an ancillary probate would be in Florida. (Both could be avoided if the decedent had used a trust!)
QDOT: Qualified Domestic Trust. This is a form of marital deduction that can be used for surviving spouses who are not citizens of the U.S. The QDOT rules are found under IRC sec. 2056A and generally function to defer estate tax on the property transferred to the QDOT until it’s distributed from the trust.
QPRT: Qualified Personal Residence Trust. A QPRT works like a GRAT except that the property transferred to the trust is the Settlor’s personal residence. The Settlor keeps the right to live in the home for a specified number of years and after that term ends, the Settlor must move out or begin paying rent to the trust, since other beneficiaries are entitled to the trust property after the initial term.
QTIP election: This stands for Qualified Terminable Interest Property, and is often associated with a QTIP Trust. This is a form of marital deduction that allows a trust maker to set aside property for the surviving spouse in a trust in a way that qualifies for the unlimited marital deduction. (It’s covered under IRC Sec. 2056(b)(7).)
RAP: Rule Against Perpetuities. This is legal issue that basically determines how long a trust can legally remain in effect. This rule is the bane of most lawyer’s existence in first-year law school. The original rule is generally “lives in being” (that is, people who are alive or who can be easily identified) at the time the trust becomes irrevocable plus an additional 21 years. An increasing number of states have dramatically expanded the RAP, and several have eliminated it completely. The upshot is that if the trust is subject to a RAP, the trust can’t last forever. It can last for hundreds of years sometimes, but it must end and distribute at some point for the trust to be valid and enforceable.
RLT: Revocable Living Trust. This is the main document & planning solution most trusts & estates attorneys implement for their clients. The client transfers their property to the RLT during their life so that their trustee (see below) can manage that property for the client if the client becomes disabled and when the client dies. Because the trust owns the property, probate is not necessary to transfer property after the client dies.
- Individual / Separate RLT: This is a trust established for an individual. The client may be a single person, or they may be a married person (typically in a separate property state; see that definition).
- Joint RLT: This is a trust established for a married couple. If the couple’s marriage is not recognized by law, there can be really bad gift tax consequences for a joint RLT. For married clients in community property states (see that definition), a joint RLT is mandatory to maintain community property status and the favorable tax treatment that follows. Married clients in separate property states may use either a joint RLT or may use separate RLTs.
Separate Property/Common Law State: Unlike community property, separate property receives a basis adjustment only when the owner of that separate property dies. For married couples in separate property or common law states, they may own their property jointly, but it is not treated the same as community property. When a spouse / co-owner of joint property dies in a separate / common law property state, only that deceased person’s portion of the property receives a step up in basis. The survivor keeps the same original basis. This means that if the surviving spouse sells an appreciated asset after the death of the other spouse, there will be capital gains computation based on the mixed basis of the stepped-up share of the deceased spouse and the carried-over basis for the surviving spouse. All states that are not community property states are separate property states.
SNT: Special / Supplemental Needs Trust. This is a special type of trust designed to set aside assets for the benefit of a beneficiary whose disabilities may allow the beneficiary to receive public assistance for medical and other care expenses. There are generally two types: first-party trusts that someone establishes for their own benefit, and third-party trusts that someone establishes for the benefit of someone else, like a spouse, child, parent, etc.
SRT: Standalone Retirement Trust. This is a special type of trust designed to receive “qualified retirement accounts” like IRAs, 401(k)s, etc. It can be set up as either revocable or irrevocable, and it’s designed to allow trust beneficiaries to continue to defer income tax on the account balance for as long as possible. (This is referred to as a “stretch out.”) SRTs also provide a lot of protection for retirement account balances after they’re inherited by beneficiaries. The SRT gained relevance in 2014 following the Clark v. Rameker case.
Survivor’s Trust: This term only applies in the context of a joint RLT plan. The survivor’s trust is the surviving spouse’s share of the joint trust property, plus any separate property the surviving spouse had. The deceased spouse’s property will typically flow into the marital and/or bypass trusts. The survivor’s trust is fully revocable by the surviving spouse for the remainder of the survivor’s life. It’s treated just as if the surviving spouse had established his or her own individual RLT.
Testate: This describes the condition of someone who dies WITH a will or a trust (often referred to as a “will substitute”).
Trust: A “trust” is really just a formal relationship where someone (the trust maker) appoints someone else (the trustee) to hold title to and manage trust property for the benefit of one or more people (the beneficiaries). When folks talk about “trusts” they’re usually referring to documents, but in its basic form a trust is simply a specific type of fiduciary relationship. Trust documents take many forms, which are generally listed in this glossary.
Trust Advisor: Many attorneys use this term interchangeably with Trust Protector. Whether those terms are truly synonymous is open to question, and is still an evolving issue under the law.
- Investment Advisor: This is a Trust Advisor whose role is limited to advising the trustee on the kinds of assets to invest in.
- Distribution Advisor: This is a Trust Advisor whose role is limited to advising the trustee on when to make or withhold distributions from the trust.
Trust Protector: This is a special type of power holder who can control certain aspects of irrevocable trusts. There is little consensus among attorneys as to what the protector can and cannot do, whether they serve in a fiduciary or non-fiduciary capacity, who should be the trust protector, etc.
Trustee: This is the day-to-day decision maker for a trust. The trustee has a series of fiduciary duties to the beneficiaries to make sure that the trust is administered properly according to the trust’s terms and governing law, and that the beneficiaries’ interests are protected. There must always be a trustee for a valid trust to exist, and all trustees are always held to a fiduciary standard.
- Investment Trustee: This is a special trustee whose job is limited to making investment decisions for the trust.
- Distribution Trustee: This is a special trustee whose job is limited to making distributions from the trust to beneficiaries.
- Administrative Trustee: This is a special trustee whose job is limited to keeping documents and records for the trust, often for the purpose of establishing an adequate connection between the trust and the desired state where the law should apply.
UTC: Uniform Trust Code. This is a body of law drafted by the National Conference of Commissioners on Uniform State Laws (NCCUSL) that is intended to consolidate the law of trusts as it is applied among the states. Although many states have enacted significant portions of the UTC, important distinctions are made as state committees and legislatures review and enact the UTC. It’s safe to say that the Uniform Trust Code is far from “uniform."
Various relevant IRS terms & forms
- 706: Federal Gift & GSTT Tax Return. This is the form a taxpayer will file to report taxable gifts and generation-skipping transfers.
- 709: Federal Estate Tax Return. This is the form a trustee or personal representative files after someone dies to report the value of the deceased person’s estate. It is also where a QTIP election gets made to calculate the amount of property passing to a surviving spouse under the marital deduction, and where the DSUE Amount gets computed and reported.
- 1041: Federal Fiduciary Income Tax Return. When a trust is irrevocable - either because it was set up as irrevocable or when it becomes irrevocable when the trust maker dies - the trustee has to report income on the 1041, instead of on a 1040.
- Form 56: Notice of Fiduciary Relationship. This form is used to notify the IRS that someone besides an individual taxpayer is entitled to receive tax-related information for that individual. It comes up a lot in trust administration when a trust maker becomes disabled or dies and the trustee is appointed for the 709, 706, 1041, etc. or when an irrevocable trust or other non-person entity is established.
- IRC: Internal Revenue Code. This is the Federal law of taxation.
- PLR: Private Letter Ruling. This is a type of decision the IRS hands down for a specific client on a specific strategy question. PLRs are handed down to tell a taxpayer how the IRS will treat a strategy if it is enacted. (Thus, they’re forward-looking.) There is an expensive application process involved and a PLR does not carry the weight of law except for the taxpayer who personally obtained the PLR. That said, PLRs often indicate how the IRS is inclined to handle a certain situation, so many practitioners refer to PLRs and PLR-driven strategies. This can be risky, since the PLR does not bind the IRS except for the taxpayer who paid to receive the PLR on their personal strategy.
- Regs: Regulations. This simply refers to the specific rules established by the Internal Revenue Service (IRS) under the Internal Revenue Code. They attempt to clarify what the IRC means, and often provide clarifying examples.
- SS-4: Application for Employer / Taxpayer Identification Number. This is the form a trustee or entity director completes to get an EIN or TIN for a trust or entity. That number works like a Social Security number for an individual; it’s the tax ID number against which the 1041 or other trust / entity income tax returns get filed.
- TAM: Technical Advice Memorandum. This operates like a PLR except that is backward-looking; it is binding on the IRS and on the taxpayer as to how the IRS has ruled on a completed transaction.