Joint revocable trusts (“JRT”) for spouses seem to be gaining popularity in Iowa. Attorneys professing to use them cite to the good, warm feeling that it gives their clients knowing that their marital assets are all in one pot which is a little like that feeling a spouse may have after secretly installing “find my friends” app on hubby’s cell phone. Both can cause lots of problems.
The difficulty that arises when spouses contribute assets to a common pot is who owns what and when. Although trusting spouses may not care much about the answers to these questions, the IRS does. As much as spouses may consider themselves one family unit, the IRS always considers them as two units. This is true for gift, estate and income tax purposes. Gift tax problems can occur upon the funding of a JRT when spouses make disproportionate contributions to a trust but share equally in income and distributions. Such gifts may not qualify for a marital deduction leaving one spouse using up some unified credit or paying gift tax. Ouch. Gift tax problems can occur again at the time of the first spouse’s death if a credit shelter trust is utilized. Without knowing which assets belong to which spouse, the surviving spouse’s trust assets could be deemed to fund the credit shelter trust which may constitute a gift to the credit shelter trust beneficiaries (usually, the children). Estate tax problems could occur when commingled assets are included in the estate of a first deceased spouse and later included in the second spouse’s estate.
Gift and estate tax problems are only issues for those who have assets exceeding the applicable exclusion amount ($5,490,000) which eliminates 99.6 percent of individuals. However, JRTs will affect every beneficiary who receives (or doesn’t receive) a step up in basis of inherited assets. Section 1014 of the Code provides for a step up in basis for assets held in trust that (1) are subject to the grantor’s right of revocation, or (2) are included in a decedent’s estate for estate tax purposes. This can be very difficult to interpret when revocation requires the unanimous consent of the spouses. The rules of Sections 2036 and 2038 may require that the assets of the JRT be traced back to the contributing grantor to determine which assets are included in a spouse’s estate and thus become stepped up. This can be an awful task if the JRT has been around for a decade or two with assets purchased and sold.
Special attention also needs to be given to whether the surviving spouse has sufficient rights to trust income and assets to be taxed as a grantor trust under Code Sections 673 through 679. In many cases, trusts do not provide sufficient rights and the trust is taxed as a complex trust.
To ameliorate the concerns of the client, first think about the primary concern that the client has presented: “They want to keep their assets together as one economic unit.” This does not necessarily mean one trust. Instead, what the clients want is to maintain, (1) one bank account, (2) one investment brokerage account, (3) one house. Separate trusts can accommodate this desire by having each trust be equal, undivided co-owners of all assets. Separate trust instruments should not give clients any more pause for concern than having separate wills. Revocable trusts are essentially will substitutes.
Next time, I will discuss the problems that can occur from secretly tracking your spouse.
The material in this blog is not intended, nor should it be construed or relied upon, as legal advice. Please consult with an attorney if specific legal information is needed.
– David Repp