By Nancy L. Feldman, Attorney at Law

What Are Trusts?

The trust is a 14th century British idea. " Equity" courts, called Courts of Chancery (because headed by the King's Chancellor), were established to provide more relief than was available through the limited remedies of the courts of law.

An equitable institution, the trust, was created, to allow someone to hold property for another person's benefit. The appointees were called trustees. They had a duty of undivided loyalty, to act faithfully for another, and that made them "fiduciaries" and held to a high standard.

TheUnited States (except for Louisiana) adopted the British common-law system, including courts of equity and law. Today, most states have merged these two forums, but still give special treatment to the equity actions (injunction, specified performance or certain promises instead of just monetary damages, and administration of estates) and trusts, which are now a hybrid of law and equity.

Trust -- the formal construct (treated in modern times as a legal entity, like a company)

Settlor -- sets up the trust and transfers assts to fund it; also called Grantor or Trustor

Trustee -- the "legal" owner of the assets in the trust, with a duty to use them for the benefit of the beneficial owner under general principles of equity

Beneficiary -- the "equitable" or beneficial owner of the trust assets

Trust estate -- assets titled in the name of the trust or trustees, and protected from the creditors of both the beneficiary and the trustee as a private individual

Trust indenture or instrument -- the charter document that sets out the trust's rules

Reasons to Establish a Trust

• Property management

Can be done under a power of attorney, guardianship or conservatorship or later under the Will, or in another combination of arrangements, but a trust can provide stable, long-term management and is respected. It is useful when the owner fears incapacity, hasn't a family or other close local network to manage financial affairs, or wants to have most assets under one grouping.

• Probate avoidance

Less important in jurisdictions such as the DC Metro area, where probate has been streamlined, but still a factor in Florida, California and New York, for example. Even if a trust is used, there usually are still some assets to be probated, such as last employment or pension checks, tax refunds or other money not yet deposited in the trust account when the Settlor dies.

• Avoiding multiple jurisdictions

Useful when the Settlor owns real estate in several jurisdictions, to avoid multiple ("ancillary") probate filings. Also used to group the ownership of assets in a jurisdiction that has special advantages, such as low or no local taxes, or convenience to the trustee.

• Privacy

The trust instruments may reduce or eliminate the need for public filings and court supervision, and the requirement to notify or report to future beneficiaries. The recent adoption of the Uniform Trust Code in the District of Columbia and Virginia, and its consideration in Maryland , requires careful drafting to preserve the privacy elements.

• Litigation protection

A trust that has been operating well for years, and was set up by the decedent in good health, is easier to defend than a disputed Will which may have been executed when the decedent was ill or dying.

Types of Trusts

• Testamentary trust -- found in a Will ("Last Will and Testament"). It doesn't come into being until the testator (settler) dies. Even then, it may not be funded and become operational until the estate property is probated, expenses paid, specific bequests met, and the remaining assets distributed, including distribution to the trust.

• Living trust -- (inter vivos trust) is established during the Settlor's lifetime, and assets may be transferred to it at any time.

• Revocable trust -- can be changed (amended) anytime by the Settlor, or even closed out (terminated). The IRS ignores revocable trusts, so no extra income-tax filings or tax ID numbers are needed.

• Irrevocable trust -- cannot be amended, with certain exceptions: A court can "reform" the trust instrument to fix mistakes or conform language to the Settlor's original wishes (usually because of mistakes or bad drafting). The trust itself may allow limited changes, for tax implementation, typo correction or changing location. Revocable trusts generally become irrevocable upon the Settlor's incapacity or death.

• Constructive trust -- courts can impose a protective hold on property, calling it a constructive trust, if an equitable remedy is needed to avoid fraud or a patently unfair result.

Importance of Trust Instrument

The trust instrument can provide as much specific direction regarding gifts and property distribution upon the Settlor's death as a Will, and usually has a lot more detail, because it also addresses the activity taking place while the Settlor is alive and healthy, in the event of incapacity. Look closely at this document; it may substantially change the statutory rules that would otherwise apply to property.

When Does a Trust Apply to Property?

Even if you create a living trust and execute it in front of witnesses and notary, it is ineffective unless you actually transfer assets into it. That means that you have to change the title: of real estate, of brokerage and bank accounts, of insurance policies if a trust is to hold them for you, on beneficiary designation forms of pension plans and insurance policies, etc. You can put personal property into a trust by executing a "deed of gift." Property that is jointly held can't go into an individual's trust unless the other owner dies first or the ownership is divided into "tenants in common" shares.

Most people setting up living trusts put some but not all of their property in the trust, and create "pour-over wills" to add other holdings to the trust after they die. Those holdings first go through probate, but there are distinctions, for example regarding real estate, in the different jurisdictions.

Trusts through their trustees may also acquire assts directly, by purchase or gift. The method may determine the tax treatment, especially in charitable trusts and insurance trusts.

Trust titles on accounts may be the name of the trust, and the date the trust was created; the names of the trustees, identified as such; or the names of the trustees of the named trust. In the typical living trust, the account title would be changed from "John Doe" to "John Doe, Trustee of the John Doe Trust, dated ____," and you would sign checks as John Doe, Trustee.