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On death of the settlor (the person who created the trust), a living trust must be “settled.” Settling a living trust means administering and managing the trust according to the terms of the document. The person responsible for settling a trust is either the surviving trustee or the successor trustee. This examines some of the issues attendant to settling a living trust.
Assets and Debts
After a settlor dies, the surviving or successor trustee must familiarize himself with the assets of the settlor, and determine whether all the assets have been placed in the trust. If an asset was not placed in trust, probate administration of that asset may be required.
Any asset held as community property with right of survivorship, or as joint tenants with the right of survivorship, automatically passes to the surviving owner. Any asset that has a “pay on death” beneficiary or a “transfer on death” beneficiary will be paid directly to the named beneficiary, regardless of any contrary language or instructions contained in the trust. If the trust is named as the beneficiary, the asset will be paid over to the trustee, and the terms of the trust will control the distribution of that asset.
After the settlor’s death, the trustee should quickly move to determine whether the settlor was owed money. If so, the trustee should proceed to collect the debt. If the settlor owed money at the time of his death, the trustee generally should pay the settlor’s debts as they become due. This is particularly true if the debt is secured by an asset of the trust, so as to not risk losing the asset through foreclosure or other means.
In settling a trust, the trustee must value the estate assets. Determining the value of the assets is important for a number of reasons, including to facilitate proper apportionment of the assets between beneficiaries and any sub-trusts; and to allow the trustee to determine if estate taxes are due and if an estate tax return should be filed.
Under current law, assets receive a stepped-up basis on the settlor’s death. This means that the value of the asset is the market value as of the date of death, and not what the settlor paid for the asset. The stepped-up basis generally benefits the beneficiary of the asset, who receives it at the higher valuation.
A separate tax identification number is needed for any trust that is created upon, or which continues after, the death of the settlor. The trustee may apply for a tax identification number online at www.irs.gov.
It is a good idea to promptly open a separate bank account for any sub-trust in order to accurately document transactions therein. Each account will have a separate tax identification number.
Funding the Trusts
The trustee must determine which assets are to be kept in trust and which assets are to be distributed to the beneficiaries. Any specific bequests, whether for money or for a specified asset, should be distributed to the named beneficiary. The trustee should allocate the remaining assets to any new trusts created upon the death of the settlor. The trustee would be well advised to engage the help of a professional, such as an accountant, attorney, or financial advisor, in allocating the assets, because of the legal and tax implications involved.
The trustee may be required to file tax returns as part of the settlement process. If more than $600 of income is generated from the assets of the decedent held in trust, the trustee should file IRS Form 1041, U.S. Income Tax Return for Estates and Trusts. On this income tax return, the trustee will report the income generated in the trust. Any income paid to a beneficiary is properly reported on the recipient’s individual tax return, IRS Form 1040.
In some cases, it is necessary to file an estate tax return, IRS Form 706. An estate tax return is necessary if a person’s estate exceeds the applicable federal estate tax exemption amount. In the case of a married couple where the surviving spouse is the sole beneficiary, no estate taxes are due upon the death of the first spouse, regardless of the amount of the estate, but it may still be desirable to file an estate tax return for certain valuation and reporting purposes. Form 706 must generally be filed and any tax due must be paid within nine months of the decedent’s date of death. The trustee is advised to consult an accountant or qualified tax advisor to determine if a tax return is required or if one should be filed.
The above article is an excerpt from Estate Planning in Arizona: What You Need to Know, 2nd Edition (Wheatmark, 2019), by Donald A. Loose, republished with the author’s permission.
Disclaimer: Laws change constantly. Specific legal advice should be obtained regarding any legal matter. The information contained on this website does not constitute legal advice and no attorney-client relationship is created.
Donald A. Loose is an Arizona attorney, and the author of Arizona Laws 101: A Handbook for Non-Lawyers, and Estate Planning in Arizona: What You Need to Know. Mr. Loose is a regular guest on radio shows featuring local newsmaker interviews. He may be contacted at email@example.com.