Important Considerations for Irrevocable Income Only Trusts

August 10, 2011

This post is the second in a two part series covering the financial advantages of Irrevocable Income Only Trusts. Part One covered Using Trusts to Protect Assets from Nursing Homes.

Irrevocable Income Only Trusts must be very carefully and specifically drafted in order to shield assets from the nursing home and Medical Assistance or Medicaid. All too regularly, Irrevocable Trusts are improperly drafted and thus fail to protect assets and fail to take advantage of tax provisions which can protect the creator and children from unnecessary taxation.  Care must be taken to ensure the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. complies both with the Wisconsin Medical Assistance, Family Care or nursing home laws, as well as complying with important tax laws.

Through proper planning and the use of a properly drafted Irrevocable Income Only TrustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries., we can accomplish the following objectives:

1. Protect Assets

Protect assets from the nursing home (Family Care, Medical Assistance, Medicaid, Creditors, etc.)

2. Provide Income

Allow the person setting up the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. to obtain income from the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. and to be taxed on the income just as they are now.  This is important because in many cases the person establishing the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. may have to pay less in taxes than if the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. were to be taxed on the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. income.  (At Wokwicz Law Offices, LLC, we utilize different techniques, depending upon the client’s situation, to take advantage of tax laws allowing the person creating the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. to be taxed on any trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. income.  We often utilize Internal Revenue Code section 674(a) to take advantage of income tax provisions in the tax code that allows a “non-adverse” party to accumulate or direct income to the person setting up the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries..)

3. Control Trust Beneficiaries

Even though the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. is Irrevocable, it can be set up so that the creator can change who willA written document that sets forth and names the personal representative who will be in charge of overseeing the probate process and names the specific bequest and residual beneficiaries of property who are to receive and inherit assets and property through probate. A Will does not avoid probate, and must be properly drafted and executed to be legal. A Will can also avoid the use of a surety bond in many instances and can help utilize an “informal” Wisconsin probate process if it has the proper clauses and attestation clause. receive the assets at death, through the retention of a “special power of appointment.”  Where appropriate, this can be a very useful feature for allowing the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. creator to change who the beneficiaries in the future.

4. Tax Basis Step-Up

Allow a tax “basis step-up” at death as if the person setting up the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. still owned the asset for tax purposes.  This is important as it can allow the children or other chosen beneficiaries of the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. to avoid capital gains taxes upon death. This is achieved by retaining the right to choose the beneficiaries of the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. even after the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. has been set up and made irrevocable.

5. Avoid Gift Tax

Avoid any gift taxA tax on gifts that are completed from one person to another. Wisconsin does not have a gift tax, but there is a federal gift tax. We often can gift in excess of the “annual exclusion” amount that is currently $14,000.00 per donee per year without incurring any gift tax or reporting requirements. The gift tax is often misunderstood and should be discussed if undertaking any significant gifting. The gift tax lifetime “exclusion” amount is $5.34 million for 2014. on transfers to the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries..  Again, a properly drafted Irrevocable Income Only TrustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. willA written document that sets forth and names the personal representative who will be in charge of overseeing the probate process and names the specific bequest and residual beneficiaries of property who are to receive and inherit assets and property through probate. A Will does not avoid probate, and must be properly drafted and executed to be legal. A Will can also avoid the use of a surety bond in many instances and can help utilize an “informal” Wisconsin probate process if it has the proper clauses and attestation clause. prevent the gift taxA tax on gifts that are completed from one person to another. Wisconsin does not have a gift tax, but there is a federal gift tax. We often can gift in excess of the “annual exclusion” amount that is currently $14,000.00 per donee per year without incurring any gift tax or reporting requirements. The gift tax is often misunderstood and should be discussed if undertaking any significant gifting. The gift tax lifetime “exclusion” amount is $5.34 million for 2014. and prevent required filing of a gift taxA tax on gifts that are completed from one person to another. Wisconsin does not have a gift tax, but there is a federal gift tax. We often can gift in excess of the “annual exclusion” amount that is currently $14,000.00 per donee per year without incurring any gift tax or reporting requirements. The gift tax is often misunderstood and should be discussed if undertaking any significant gifting. The gift tax lifetime “exclusion” amount is $5.34 million for 2014. return.

6. Retain House Tax Advantages

Preserve the lifetime home sale tax advantages for principal residences allowed to individuals under Internal Revenue Code section 121 to avoid capital gains up to $250,000.00 for a single person and up to $500,000.00 for a married couple on the sale of a principal residence.  This is important, so that if your principal house is sold during your lifetime, you willA written document that sets forth and names the personal representative who will be in charge of overseeing the probate process and names the specific bequest and residual beneficiaries of property who are to receive and inherit assets and property through probate. A Will does not avoid probate, and must be properly drafted and executed to be legal. A Will can also avoid the use of a surety bond in many instances and can help utilize an “informal” Wisconsin probate process if it has the proper clauses and attestation clause. not be subject to any capital gains, as long as you meet the proper criteria.

7. Avoid Probate

The use of an Irrevocable Income Only TrustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. can be one of the tools utilized to help avoid probateThe court process proving the validity of a Will and conducting the orderly Inventory, Accounting, and Administration of a decedent’s assets under a Will or under Intestacy laws if there is no Will. The probate process in Wisconsin typically takes between six to twelve months in Wisconsin and can take longer in some cases. Probate can be avoided by proper Estate Planning and through the use of beneficiary designations, Transfer on Death Deeds, Marital Property Agreements and Trusts. at death.

It is important that attorneys drafting this type of trust be well versed in both the relevant nursing home laws (Medical Assistance, Medicaid, Family Care, Title 19, etc), as well as the relevant tax laws.  If the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. fails in either area, the assets of the trustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. could be lost to the nursing home, result in negative tax treatment, or both.

Prior planning is important to fully utilize the benefits of an Irrevocable TrustA trust that cannot be terminated, revoked or amended by the creating person. In Wisconsin and in estate planning an irrevocable trust can refer to a trust that is set up to protect assets from a nursing home and Medical Assistance if prepared and funded well in advance. See Using Trusts to Protect Assets from Nursing Homes.  We encourage clients to plan ahead and not wait until it is too late to use an Irrevocable TrustA trust that cannot be terminated, revoked or amended by the creating person. In Wisconsin and in estate planning an irrevocable trust can refer to a trust that is set up to protect assets from a nursing home and Medical Assistance if prepared and funded well in advance. See Using Trusts to Protect Assets from Nursing Homes.  Drafting and funding a properly drafted Income Only TrustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. is ideally completed at least five years before having to apply for Medical Assistance, Medicaid, Family Care and Title 19.

Please contact Wokwicz Law Offices to discuss if an Income Only TrustThe arrangement creating the legal ownership of assets by a trustee for the benefit of the Settlor and/or other beneficiaries. is the right choice for you.