TRUST AND ESTATE PLANNING GLOSSARY What is estate planning? Estate planning is the process by which one protects and disposes of his or her wealth, sometimes during life and more often at death, in accordance with his or her wishes with attention to minimization of taxes and other expenses. Estate planning may also include arranging for property management in the event of physical or mental disability. I. Names Given to Relevant Parties. Administrator- A person or entity appointed by the Clerk of Superior Court to administer the estate of a person who has died without a Will. Administratrix is the feminine form of Administrator. Attorney-in-Fact- The person or entity named in a Power of Attorney to act on behalf of and as an agent for another person who has made the appointment. The specific powers of the attorneyin-fact will depend on what powers are granted in the Power of Attorney under which the attorney-in-fact is appointed. Beneficiary- A person or organization that is entitled to receive property under a Will, trust, insurance policy, retirement account or other legal document. Custodian- In general, a person appointed to collect, protect and manage the property of a minor. In North Carolina, a person may make a gift to a minor under the North Carolina Uniform Transfers to Minors Act and appoint a Custodian to manage the property given to the minor until age twenty-one. Decedent- The person who has died. Executor- The person or entity named in the decedent s Will to administer the decedent s estate pursuant to the terms of the decedent s Will. Executrix is the feminine form of Executor. Fiduciary- A person or entity legally and ethically obligated to act in the best interests of another person. A trustee, personal representative, attorney-in-fact, custodian and guardian are all fiduciaries. Grantor - The person who makes a transfer of property to trust. The grantor of a trust is also known as the settlor or trustor.
Guardian - A person appointed to manage the financial affairs ( Guardian of the Estate ) or to have care and custody of the person ( Guardian of the Person ) of a person (the Ward ) who is legally incapacitated due to mental incapacity or being under age 18. A General Guardian is a person appointed to both manage the Ward s financial affairs and to have care and custody of the Ward s person. Heir - A person legally entitled to receive property from a person who dies without a Will. Issue- Natural and adopted lineal descendants from unlimited generations (i.e., children, grandchildren, great-grandchildren, etc.). Personal Representative- The person(s) or entity appointed by the Clerk of Superior Court to administer the decedent s estate. An Administrator and Executor are both considered Personal Representatives. Testator- A person who signs the Last Will and Testament that disposes of that person s property. Testatrix is the feminine form of Testator. Trustee- The person or entity that holds legal title to assets that are held in trust and who manages and distributes the trust assets according to the terms of the trust. The trustee has a fiduciary duty to the beneficiaries of the trust. II. Basic Estate Planning Documents. Advance Directive-A document in which you give directions as to your desires regarding the use of life-prolonging procedures (such as a respirator) in end-of-life situations. In North Carolina, an Advance Directive can be in single documents such as an Advance Directive for a Natural Death (Living Will) or the an Advance Directive can be combined with and included in a Health Care Power of Attorney. Codicil- An amendment to a Will that must be executed (signed) with the same formalities as a Will. Durable Power of Attorney ( DPOA )- A document that gives the power to another individual or entity to act on behalf of the person signing the Durable Power of Attorney in matters such as paying bills, managing investments, and making gifts. The DPOA may be as broad or as narrow as the principal desires. A DPOA is durable in that it contains specific language that says that it remains in effect after the disability of the principal. The DPOA becomes void upon the death of the principal. A DPOA may become effective upon signing or it may be drafted so that it springs into effect only when the principal becomes incapacitated. Health Care Power of Attorney- An advanced medical directive in which a person (the health care agent) is named to act on another s behalf regarding health care decisions, including mental 2
health treatment decisions. This document becomes effective only when the person appointing the agent does not have the capacity to make or communicate health care decisions. The Health Care Power of Attorney may contain instructions directing the health care agent about the initiation, continuation, withholding or withdrawal of life-sustaining treatment. Living Trust- See Revocable Trust. Pour-Over Will- A Will that transfers or pours-over assets from the probate estate into a trust that was in existence immediately before the death of the decedent. The assets move from the executor s control to the control of the trustee. Revocable Trust- Also known as a Living Trust, a revocable trust is a trust that may be modified or terminated by the grantor (creator) at any time during his or her life. Upon the death of the grantor, the trust becomes irrevocable, generally provides for the disposition of trust property, and acts as a Will substitute so that no probate of the trust assets is required. Commonly, the assets of the decedent that are not in the name of the revocable trust at the time of his or her death will pour-over into the revocable trust at death pursuant to directions in the decedent s Will. Self-proving Will- A Will that is executed in compliance with the state statues regarding the number of witnesses required and notarization by a Notary Public. If these requirements are met, the Will is deemed to be proved without the necessity of having witnesses appear before the Clerk of Superior Court to attest to the signature of the testator. Trust- Arrangement by which a person (a grantor) transfers legal ownership of property to a trustee for the benefit of one or more beneficiaries. A trust may be created during the grantor s life (revocable or irrevocable) or at death as a part of the decedent s Will. Will- A document executed for the purpose of directing the disposition of an individual s property upon his or her death. The Will generally names an executor, names a guardian for minor children/dependents, and directs the distribution of one s property. A Will must be executed with certain formalities in order to be valid. A Will generally controls the disposition of property owned in the name of the testator at his or her death, but a Will does not control the disposition of property that is owned as joint tenants with right of survivorship or property which passes by contract to a designated beneficiary (i.e., life insurance or retirement accounts). III. Basic Planning Terminology. Bypass Trust- An estate planning technique (also called a credit shelter trust or a family trust) used to minimize the estate taxes. With a married couple, at the death of the first spouse, the bypass trust is funded with the amount that can pass free of federal estate tax under the Applicable Exclusion. The terms of the bypass trust give the surviving spouse certain benefits from the trust s assets but not such benefits that would cause the bypass trust to be taxed as a part of the surviving spouse s estate. 3
Credit Shelter Trust- See Bypass Trust above. Disclaimer (also known as a Renunciation)- A beneficiary s refusal to accept property to which he is entitled from a transfer during life or at death, including property inherited under a Will, by intestacy, under a trust, by survivorship, by beneficiary designation, etc. If properly done, the Disclaimer will result in the disclaimed property passing to other beneficiaries as if the person who disclaims had predeceased the original transferor. Often, persons disclaim to save estate and/or gift taxes. In order for a disclaimer to be qualified for estate and gift tax purposes, the Disclaimer must be carried out in accordance with Chapter 31B of the North Carolina General Statutes and Section 2518 of the Internal Revenue Code. Discretionary Trust- A trust in which the grantor gives the trustee the discretion to make specified decisions regarding the distribution of the income and/or principal of the trust. The trustee may have discretion to determine which beneficiary(ies) receive trust income or principal, the amount to be received by the various beneficiaries and the timing of distributions of trust property. Generation-Skipping Trust-An irrevocable trust created to benefit a group of descendants and designed to last as long as possible without causing the trust to be subject to estate tax in any descendant s estate. Guardianship- A court proceeding in which an adult is determined to be incapacitated and a guardian is appointed to mange his or her property and/or to have custody and control of his or her person. A guardianship proceeding may also be undertaken when a minor child s parents are deceased and it is necessary to appoint a third party (usually a family member, friend or professional fiduciary) to have care and custody of the minor and/or to manage the minor s property. A guardianship requires periodic reports to the court. Inter Vivos Trust- A trust that is created during the Grantor s lifetime. An Inter Vivos Trust may be a Revocable Trust or an Irrevocable Trust. Intestacy. The situation that exists if a person dies without a Will or with a Will that does not dispose of all of his or her property. The intestate succession laws of the State of North Carolina determine who is entitled to take the decedent s property and also the share that each beneficiary is entitled to receive in this situation. Irrevocable Trust- A trust that cannot be changed or altered after it is executed. Joint Tenants With Right of Survivorship- A form of property ownership (including bank and investment accounts) by two or more persons whereby when one joint tenant dies, the joint tenant s interest in the property automatically passes to the surviving joint tenant(s). Property held as joint tenants with rights of survivorship does not pass under a person s Will nor does it pass to a decedent s heirs if the decedent dies without a Will. Property owned in this form avoids probate. 4
Non-Probate Estate (Non-Probate Assets). Those assets in which the Decedent had an ownership interest at death but are payable directly to another person by contract or other arrangement. Examples include life insurance proceeds, 401(k), IRA and other retirement benefits, bank and investment accounts owned jointly with rights of survivorship, real estate owned by husband and wife as tenants by the entireties, and assets titled in the name of the decedent s Living Trust at the time of death. Personal Property - Property other than real property that can be owned. Personal property may be tangible (furniture, jewelry, clothing, art, etc.) or intangible (stocks, bonds, notes, etc.). Per Stirpes- A process of distributing assets to beneficiaries that means by representation or by branch. When a trust or estate is distributed per stirpes, each branch of the family receives an equal share of the trust or estate. If a beneficiary in the first generation below the person whose property is being distributed predeceases that person, the share that would have been distributed to the deceased first generation beneficiary would be distributed among the deceased beneficiary s issue (descendants). The issue of the deceased beneficiary step into the shoes of the deceased beneficiary and take by representation. Example: A, the testator, directs in his Will that his estate shall be distributed in equal shares to his children, B, C, and D, and that if a child predeceases the testator, that child s share shall be distributed to the issue of the deceased child, per stirpes. When A dies, only B and D are living and C has died leaving 3 children. Under a per stripes distribution, B and D would each receive one-third of A s estate and C s children would take their deceased parent s one-third share of the estate, with each grandchild receiving one-ninth of A s estate. Power of Appointment- Authority conferred in a Will or trust that allows a person to appoint or direct the disposition of property in favor of one or more recipients. A power of appointment allows the holder of the power to control the ultimate disposition of the property subject to the power. A "general" power of appointment places no limitation on who may receive the property which is subject to the power and allows the holder of the power to appoint the property to himself or to anyone he may choose. A "special" or "limited" power of appointment limits the persons to whom the power of appointment holder can transfer the property which is subject to the power. A special or limited power of appointment cannot be exercised in favor of the holder, his estate, his creditors or the creditors of his estate. Probate- The legal process of administering the estate of the decedent by satisfying the decedent s obligations and distributing the decedent s assets to his or her beneficiaries, under the supervision of the Clerk of Superior Court, which acts as the probate court in North Carolina. Probate Estate (Probate Assets). Those assets in which the Decedent had an ownership interest at death and which were owned in his or her sole name. Probate Assets pass into the control of the Personal Representative and are distributed according to the Will or under the intestate laws if there is no Will. 5
Residuary Estate- The part of the decedent s estate that remains after payment of debts, taxes, expenses of administration and any special/specific bequests. Sprinkling Trust- A type of discretionary trust that gives the trustee the power and discretion to sprinkle the income and/or principal of the trust among the trust beneficiaries in unequal amounts in response to different needs of the beneficiaries. Taxable Estate. Those assets that are taxable as part of the gross estate for federal estate tax purposes (or state estate tax purposes). The taxable estate may include both Probate Assets and Non-Probate Assets. Testamentary Trust- A trust that comes into being upon the death of the testator and is created pursuant to the directions in his or her Will. Such a trust is an irrevocable trust. Uniform Transfers to Minors Act- The law that provides a mechanism under which gifts (lifetime or testamentary) can be made to a minor without the necessity of appointing a guardian for the minor. The property is managed and invested by the custodian until the minor reaches a certain age when the custodianship ends. In North Carolina, the custodianship terminates at either age 18 or age 21, depending on how the property was transferred. IV. Basic Tax Terms. Applicable Exclusion Amount (Applicable Credit Amount or Exemption Exclusion)- This is the cumulative amount that an individual may transfer either during life or at death which is not subject to federal estate tax. In 2009, the Applicable Exclusion Amount for federal estate taxes was $3,500,000. Because there is no federal estate tax in 2010, there is no Applicable Exclusion Amount. In 2011, the Applicable Exclusion Amount is scheduled to be $1,000,000. The Applicable Exclusion Amount for federal gift taxes is $1,000,000. This amount is in addition to the annual gift tax exclusion. Applicable Federal Rate ( AFR )-The minimum interest rate published monthly by the Internal Revenue Service that must be charged on a transaction to avoid imputation of interest under Section 1274 of the Internal Revenue Code. Short-term AFR is for a debt instrument with a term of not more than 3 years. Mid-term AFR is for a debt instrument with of term of over 3 but not more than 9 years; Long-term AFR is for a debt instrument with a term of over 9 years. Charitable Deduction- A deduction allowed in computing income, estate and gift taxes when property is transferred to a qualified charity. Crummey Power (Crummey Withdrawal Right; Crummey Demand Right)-A power given to a trust beneficiary to demand, for a limited period of time, the distribution to him or her of all or part of the assets given to a trust for his/her benefit. If the power is not exercised within the stated time period, the power lapses and the assets that could have been withdrawn remain in the trust. The Crummey Power is used to make gifts to a trust present interest gifts that qualify for the Gift Tax Annual Exclusion. 6
Federal Estate Tax-A taxed imposed by the federal government on the right of a person to transfer property at death. In 2009, the highest federal estate tax rate was 45%. There is no federal estate tax in 2010. In 2011, the highest federal estate tax rate is scheduled to be 55%. Federal Gift Tax- A federal tax imposed upon lifetime gratuitous transfers. The gift tax must be paid by the donor when the transfer is made. Each taxpayer can use a lifetime exemption that protects $1,000,000 in transfers from gift tax. Future Interest Gift- A gift to which the donee does not have an immediate and unrestricted right of use, benefit and enjoyment. If a parent gives $10,000 to a trust for a child to receive when the child reaches age 35, the gift is a gift of a future interest and will not qualify as an Annual Exclusion gift. Generation-Skipping Transfer ( GST ) Tax- A tax on transfers to relatives deemed to be two or more generations below (i.e., grandchildren) that of the transferor or non-relatives who are more than 37 ½ years younger than the transferor. GST tax is a tax that is separate and apart from income, estate and gift taxes. The federal GST tax rate is a flat 55%. Each transferor has an exemption from the GST tax that is the same as the estate tax exemption amount in effect for that calendar year. North Carolina also has a generation-skipping tax. Gift Tax Annual Exclusion- The inflation-indexed amount that a donor may give to an individual donee each year without it being considered a taxable gift. The 2010 gift tax annual exclusion is $13,000 for each donor to each donee (or $26,000 for a married couple to an individual donee). To qualify for exclusion from gift tax under the Annual Exclusion, the gift must be a gift of a present interest. Marital Deduction- A deduction allowed in computing estate and gift taxes when property is transferred to a spouse. Under current federal tax law, the marital deduction is unlimited for transfers to a spouse who is a United States citizen. North Carolina Estate Tax-North Carolina imposes a tax on transfers at death that is roughly equal to the State Death Tax Credit as contained in Section 2011 of the Internal Revenue Code, with several limitations. There is no N.C. Estate Tax Return due unless a federal estate tax return is due. North Carolina Gift Tax-North Carolina has no gift tax. It was repealed for transfers made after December 31, 2008. Present Interest Gift-A present interest gift is one in which the donee has an immediate and unrestricted right of use, benefit, and enjoyment. Section 7520 Rate-Discount rate that is published monthly by the Internal Revenue Service and used to value an annuity, interest for life or term of years or any remainder or reversionary 7
interest. Equal to 120% of annual federal mid-term rate under Section 1274(d)(1) of the Internal Revenue Code State Death Tax Credit- Section 2011 of the Internal Revenue Code contains the state death tax credit ( SDTC ). Prior to 2002, a decedent s estate could take a credit on the federal estate tax return for the death taxes paid to a state, but the credit was limited to the SDTC rate schedule contained in Section 2011. Beginning in 2002 and continuing through 2004, the amount of the credit allowed was reduced. Beginning in 2005, the SDTC was replaced with a deduction instead of a credit but North Carolina s estate tax is still based in large part on the SDTC rate schedule contained in Section 2011. V. Advanced Estate Planning Techniques. Family Limited Partnership ( FLP )- A limited partnership generally owned by members of the same family and used for the common investment in real estate, securities or other assets. The ownership interests are divided into general partnership interests and limited partnership interests. Senor family members usually own the general partnership interests that allow them to retain control of the entity. Limited partnership interests are often given to younger family members, or trusts for them, after discounts for lack of control and lack of marketability are taken in valuing those interests for estate and gift tax purposes. Family Limited Liability Company ( FLLC )-A family limited liability company is an entity formed and operated for the same purposes as a Family Limited Partnership, but with a limited liability company as the legal entity rather than a limited partnership. Grantor Retained Annuity Trust ( GRAT )- An irrevocable trust in which the grantor retains the right to receive annuity payments over the term of the GRAT and at the end of the trust term, the property remaining in the trust passes to the designated beneficiary(ies). The annuity payments are often designed so that over the term of the GRAT, the grantor will receive back from the GRAT the value of what he/she transferred to the GRAT plus growth during the trust term at the Section 7520 interest rate. The annuity payments may be satisfied by returning to the grantor assets held in the GRAT equal to the value of the annuity due. The Trustee does not have to sell assets in order to make the annuity payments in cash. If the GRAT assets do not grow by more than the Section 7520 interest rate, everything placed in the GRAT will be returned to the grantor and the grantor is no worse off than if the technique had not been attempted. If the GRAT assets grow by more than the Section 7520 interest rate, there will be assets in the GRAT at the end of the trust term, after the payments to the grantor, and these assets will be distributed to the grantor s chosen beneficiaries. Clients create GRATs using assets that are likely to earn more than the Section 7520 interest rate during the GRAT term in an effort to pass the appreciation in the assets to the beneficiaries of the trust free of gift and estate tax. Qualified Personal Residence Trust ( QPRT )- An irrevocable trust in which the grantor retains the right to use and live in his or her personal residence rent-free for a specified period of years, after which time the residence belongs to the remaindermen. Placing the grantor s residence in a QPRT removes the value of the home from the grantor s taxable estate if the 8
grantor survives the trust term. The transfer is considered a gift for gift tax purposes; however, the value of the gift is only the value of the remainder interest; the value is discounted by the value of the retained use of the residence. If the grantor wishes to remain in the home after the trust term, he or she must pay fair market rent to the remaindermen. A QPRT is used to transfer a residence to children or other family members at reduced gift tax cost where the grantor believes that he or she will outlive the number of years for which he or she has retained use of the personal residence. Grantor Trust (sometimes call a Defective Trust or an Intentionally Defective Grantor Trust)-A grantor trust is a trust of which the grantor is considered the owner for federal income tax purposes. The grantor must report on his or her income tax return all items of income, gain, loss, deductions, etc. arising from such a trust. Transactions, such as a sale, between the grantor and the grantor trust are disregarded for income tax purposes. However, a trust can be a grantor trust for income tax purposes and still be treated as a separate entity for estate and gift tax purposes. Trusts are often intentionally made defective for estate planning purposes to make them grantor trusts in order to take advantage of the opportunity to have the grantor pay the income taxes on trust assets that are treated as being owned by other family members. A trust is made defective by inserting in the trust instrument certain provisions that are contained Sections 671-678 of the Internal Revenue Code. Sale to Intentionally Defective Grantor Trust ( IDGT )-A fairly complex planning technique under which a grantor sells an interest in a family limited partnership or limited liability company to an intentionally defective grantor trust in exchange for a promissory note from the defective trust. The grantor s children or other family members are the beneficiaries of the defective grantor trust. The sale is ignored for income tax purposes because the grantor and the defective grantor trust are treated as the same person for income tax purposes. In valuing the interest in the entity that is sold to the trust, discounts are generally taken for lack of marketability and lack of control, allowing more underlying value to be transferred to the trust. The interest rate on the promissory note is the minimum rate to avoid imputation of interest under Section 1274 of the Code, a rate that has been fairly low for the last several years. Due to the fact that the trust does not pay income tax on its income, the relatively low interest rate and the discounts used to value the purchased assets, it is hoped that income and growth in the trust assets will accrue to the benefit of the beneficiaries of the defective grantor trust. After the transaction, the grantor s estate includes only the promissory note paying a low interest rate, with the assets subject to growth being in the defective grantor trust. Qualified Terminable Interest Property ( QTIP ) Trust- An irrevocable trust for the benefit of the grantor s spouse which qualifies for the estate and gift tax marital deductions. The trust must provide that the spouse receive all of the trust income, payable at least annually, and that no other person has an interest in the trust (i.e., power of appointment) while the spouse is alive. At the death of the surviving spouse, the property passes pursuant to the decedent s direction. A QTIP trust is commonly used where the grantor has children from a previous marriage. Charitable Lead Trust ( CLT )- Irrevocable trust that provides for charitable and noncharitable beneficiaries. The charitable beneficiaries receive either a fixed dollar amount each 9
year (charitable lead annuity trust) or a fixed percentage of the value of the trust each year (Charitable lead unitrust). At the end of the trust term, the trust property reverts to the grantor or is transferred to other non-charitable beneficiaries. This is an effective way to transfer assets to others at a discounted value because the gift is valued for tax purposes at the discounted present value based on IRS tables. Charitable Remainder Trust ( CRT )- Irrevocable trust that provides for charitable and noncharitable beneficiaries. The non-charitable beneficiaries receive either a fixed dollar amount each year (charitable remainder annuity trust) or a fixed percentage of the value of the trust each year (Charitable remainder unitrust). The charitable beneficiaries are the charities you name that receive the trust property at the end of the trust tern. The transfer of appreciated assets in this way usually avoids capital gains recognition. The donor receives an immediate income tax charitable deduction for the present value of the remainder interest upon funding the trust. Generation-Skipping Transfer ( GST ) Trust- An irrevocable trust created for the benefit of a descendant to avoid estate tax in a descendant s estate to the extent possible within the GST tax exemption. Irrevocable Life Insurance Trust ( ILIT )-An irrevocable trust created to own a life insurance policy on the life of a grantor so that the policy and its proceeds will not be taxed in the estate of the grantor/insured. The trustee of the ILIT is the owner and beneficiary of the life insurance policy and usually the grantor/insured makes gifts to the trust to allow the trustee to pay the premiums on the policy. Upon the death of the grantor/insured, the policy proceeds can be held in trust and used for the benefit of the grantor s spouse and/or children and avoid having the proceeds taxed as a part of the estate of either spouse. IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, unless specifically indicated otherwise, any tax advice contained in this communication or in any attachment is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or tax related matter addressed in this communication or any attachment. 10