What is a joint revocable living trust? A joint revocable living trust is a single trust created by a husband and wife, into which they transfer their assets. The trust provides that while both spouses are living, the trust income and principal shall be paid to either or both of them as they direct. Any assets remaining in the trust after both of them have passed, avoid probate.
There are a number of significant tax problems often presented by the administration of joint revocable living trusts. Many of these potential pitfalls have not yet received IRS attention, so there are not many definitive cases or rulings to provide guidelines. Estate planners who recommend using these trusts for individuals who have assets subject to federal gift and estate tax cannot guarantee that the intended tax results will in fact be achieved. Some of these potential tax issues are listed below:
• Transfers of assets to the trust may be taxable gifts which may not qualify for the unlimited gift tax marital deduction;
• If the trust, or a portion of the trust, becomes irrevocable at the death of the first spouse, the surviving spouse may be considered to have made a taxable gift to the beneficiaries of the irrevocable trust;
• At the death of the first spouse, it is unclear whether one‑half the value of the trust is included in his/her estate or whether the entire trust is included;
• At the death of the first spouse in a non‑community property state like Virginia, it is unlikely that a basis step up will be obtained for the entire principal of the trust;
• If assets contributed to the trust by each spouse are commingled in a joint trust, it may not be possible to keep what is intended to be a credit‑shelter trust from being included in the surviving spouse’s estate;
• At the death of the first spouse, an adverse tax consequence may be the result with assets such as annuities and retirement plans that either have to be divided and distributed to take advantage of the lifetime credit (causing an income tax problem), or those assets may be unavailable to fund the lifetime credit (or by-pass) trust thereby wasting the decedent’s estate tax credit.
Funding of joint revocable living trust may give rise to immediate taxable gifts. To the extent that property contributed to a joint trust by the spouses is unequal in value, a gift may be considered to have occurred. Even if the value of the property contributed by each spouse is equal, the spouse with the shorter life expectancy may be considered to have made a gift to the spouse with the longer life expectancy because the actuarial value of the second spouse’s interest in the trust is larger.
Further, if a gift is considered to have been made by one spouse to the other on the creation of a joint revocable living trust, that gift may not qualify for the unlimited gift tax marital deduction because (1) the interest is terminable because the donor‑spouse will receive an interest in the property if he survives the donee spouse, and (2) the interest doesn’t qualify for the QTIP marital deduction election because under the terms of the trust the donee spouse is not entitled to receive all the income from the trust and the trustees are authorized to distribute trust principal to the donor‑spouse during the donee‑spouse’s lifetime.
Death of the first spouse may result in taxable gift by surviving spouse. If a joint revocable living trust provides that on the death of the first spouse a portion or all of the trust becomes irrevocable, the surviving spouse could be considered to have made a taxable gift at that time to the beneficiaries of the irrevocable trust. The IRS has ruled that where spouses transferred property to a joint revocable trust and retained life income interests, with the remainder to go to charity, the gift to the charity was complete at the death of the first spouse when the trust became irrevocable.
Use of a joint revocable living trust can hinder estate tax planning with credit shelter trust. If a joint revocable living trust is used by spouses whose assets exceed the applicable exclusion amount of one lifetime credit, the trust should provide that, at the death of the first spouse, the joint revocable trust will be divided by placing the protected amount into a trust for the benefit of the surviving spouse and children (credit shelter trust). The marital deduction would not be claimed for this credit shelter trust in the first spouse’s estate and would therefore not be included in the estate of the surviving spouse at her death.
The credit shelter trust must be funded with property which was originally contributed to the trust by the first decedent spouse if this tax saving plan is to succeed. If the joint trust assets are not carefully segregated into “his” and “her” contributions during the administration of the trust, the value of the credit shelter trust may be includible in the surviving spouse’s estate at her death, thereby defeating the attempt to avoid death taxes. If the trustee cannot establish that the assets in the credit shelter trust originally came from the decedent spouse, the trust will be included in the survivor’s estate and the tax saving opportunity will be lost.