One of the keys to understanding living and testamentary trusts is to know the meanings of a few basic terms.

First, there must be a trustor. This is the person that sets up the trust. He or she transfers property to the trustee and sets up the basic rules for distribution of the income and principal from that trust.

The trustee receives property and a written trust document. The document tells the trustee who should receive the income from the property and how long the trust will last and who will finally receive the corpus or principal. The principal is the property held in the trust. A basic and important definition is the difference between income and principal. Income is the dividends or interest or other types of payments that are earned by investing the trust principal. The principal includes the underlying assets which may include land, stocks, bonds or other types of property.

Beneficiaries under the trust instrument come in two general categories. First, there are the income beneficiaries, those persons or organizations which will receive the income payments. Second, there are the principal beneficiaries, sometimes called the remaindermen because they receive the principal only after all the income payments have been made.

Finally, there are terms of the trust. A trust may last for many years and the trustor must tell the person drafting the trust what these terms should be. Simple terms might be paying out a certain percentage to one party or to other parties, an ability to make distributions of trust principal at certain times and under certain conditions and the final distribution of trust principal to the remainderman.

Charitable Trusts

There are several different forms of charitable trusts. One of the most popular is a trust that has attractive tax benefits, pays income to family for a period of time and then passes as a remainder to West Texas Boys Ranch. This illustration shows property being transferred into such a charitable trust.

The primary benefits are the ability to sell tax free and bypass capital gains and also receive a generous income tax deduction. After the property is sold and reinvested the two donors in this case receive income for their lives. They are able to receive a significantly increased income over prior income. Best of all, the full value of the trust, with no decrease due to payment of capital gains tax, is earning income for their joint life times. This income might be stable or could have a feature that allows it to increase each year.

After the substantial income payments have been made for two lives, the principal is then eventually distributed to West Texas Boys Ranch. The reason this trust is permitted to have the generous tax benefits is that the remainder will eventually be distributed to West Texas Boys Ranch.

Trusts Now and Later

There are two primary descriptions used for trusts. Some trusts are set up during life and are called living trusts or, inter vivos. Inter vivos is a fancy legal word that means among the living. These are set up by people who are currently living and typically benefit living individuals.

Testamentary trusts are set up by your "last will and testament." These trusts take effect at the death of the person who is creating the trust. Most of these are done by the will or they could be a trust that is funded by a revocable living trust that, at the death of the initial trustor, becomes a testamentary trust. Think of estates when you hear the words testamentary trust.

"Give It Twice" Trusts

Many families with medium-sized estates desire to benefit both family and charity. The "Give It Twice" Trust is an excellent way to do that. This version of the trust enables the family to take the estate, in this case $500,000, and transfer it to a trust that pays income to charity for ten years. Each year, one-tenth of the principal is distributed to family. The dvantage of this trust is that the income given to charity is free from income tax, while the principal given to family is also not subject to either income or estate tax. The charity progressively receives less and less income each year as the principal is distributed to family. In many families, the idea of distributing the principal over ten years is very attractive to parents.

Another example of a "Give It Twice" Trust

In this illustration, a family with a medium-sized estate decides to benefit both the family and charity. After mother and father pass away the $500,000 estate is transferred into a trust. This trust pays income to family members until a total of $500,000 has been distributed as income. Typically, this will take from twelve to fifteen years. After the $500,000 has been given as income to family, the principal is then distributed to the charity.

While the family will have to pay tax on the income, it is an excellent way for parents to remember family for a period of years and distribute the balance of their estate to a charity.

Lead Type Trusts

There are three general types of lead trusts. These are the grantor lead trust, the family lead trust and the super lead trust. A grantor lead trust includes a provision, such as a power to reacquire assets or a reversionary interest greater than 5% that causes grantor inclusion under IRC Sections 671 - 678.

Normally, with a grantor lead trust, the assets will revert to the grantor. Because the assets can revert to the grantor, the trust income and capital gains are taxable to the grantor. Fortunately, under Section 170(f)(2), if the income is taxable to the grantor, then an income tax deduction is permitted up front.

With a family lead trust, the assets will benefit charity for a period of years and then be transferred to family. A family lead trust may be created during life or through a testamentary document. The principal purpose of the family lead trust is to transfer assets to family members with minimal transfer taxation. Family lead trusts are especially appropriate now for individuals who may not survive until the potential elimination of estate taxation in the year 2010.

Finally, the super lead trust is a family lead trust and, for income tax purposes, a grantor lead trust. It, therefore, produces both an income and a gift deduction.