Creation of an Estate or Trust: Estate Planning

These legal entities play a crucial role in managing assets, preserving wealth, and ensuring the smooth distribution of property. In this blog, we will elaborate on estate planning as a creation of an Estate or Trust.

Q. What is the Difference Between an Estate and a Trust?

An estate is formed upon the death of a taxpayer, encompassing all their assets and liabilities. It represents the culmination of a person’s life’s work, including real estate, investments, personal belongings, and financial accounts.

In contrast, trust can be created during a taxpayer’s lifetime or established through their last will. A trust serves as a vehicle to hold and manage assets on behalf of beneficiaries, whether during the settlor’s lifetime or after their demise.

Both are Different on the Basis of Control and Management

After a person’s death, an estate is administered by an executor or personal representative appointed by the probate court. This individual settles debts, distributes assets to heirs, and ensures the deceased person’s wishes, as outlined in their will, are fulfilled.

On the other hand, a trustee manages a trust, following the instructions specified in the trust document. They have a fiduciary duty to act in the best interests of the beneficiaries.

Probate, the legal process validating a will and distributing assets, is typically associated with estates. It can be time-consuming and expensive, often resulting in public records of the deceased person’s financial affairs.

In contrast, trusts offer privacy advantages as they generally bypass probate, keeping details of assets and beneficiaries confidential.

Both are Different on the Basis of Taxation

Another critical aspect is taxation. Unfortunately, US citizens are subject to estate taxation on their worldwide assets.

(Yikes! That hurts!)

When a property is directly inherited from an estate, beneficiaries are typically not taxed on the transfer. However, the estate itself is responsible for any applicable taxes before distributing the property. Should assets be distributed before taxes are settled, beneficiaries might be held liable for the tax debt up to the value of the assets received.

Here’s an Example:

John died 5 years ago. He had two children, Tom and Sam who are the only beneficiaries of his estate, which was worth $10 million at the time of his death. Tom and Sam immediately began to argue over the will and their late father’s assets. While they are petitioning the court, John’s estate continues to earn revenue from various assets such as stocks, rentals, crypto, land, and other investments. In this situation, John’s estate will not terminate until an agreement is made between the beneficiaries and the estate assets are distributed. In the case of John, his estate continues to earn revenue from various assets while his children, Tom and Sam, dispute their father’s estate.

In closing, understanding the difference between estates and trusts is vital for effective estate planning.

Proper management and timely distribution of assets can help avoid complications, maintain privacy, and ensure the desired outcomes for beneficiaries.

Consulting with estate planning professionals is essential to navigate the complexities of these legal entities and create a plan that aligns with individual circumstances.

We hope this newsletter has shed light on the distinctions between estates and trusts, highlighting their significance in managing and preserving wealth. Stay tuned for our future newsletters where we explore more exciting topics in the realm of estate planning. 

Relationship Between the Estate and its Executor

Jane, a CPA, shares a close friendship with Lorie. In 2020, Lorie passed away, leaving behind two sons, aged 18 and 22. In her final will, Lorie designated Jane as the executor of her estate. Jane agreed to take on this role as a favor to her late friend.

It’s important to note that Jane is not engaged in the business of being an executor and has no prior experience in this capacity.

As the executor, Jane will undertake various responsibilities. Firstly, she will file both Lorie’s final tax returns and the estate’s tax return, recognizing that these are separate tasks.

Additionally, Jane will assist in the distribution of Lorie’s assets to the beneficiaries, who happen to be her two sons.

According to Lorie’s will, the executor of the estate is entitled to receive 2% of the estate’s income. Any fees paid to Jane for her role as the executor will be reported as other income on her individual Form 1040, specifically on Line 21 of Schedule 1. While these amounts are subject to income tax, they are not subject to self-employment taxes since Jane is serving as an executor solely due to her friendship with the deceased.