Joint revocable trusts enjoy popularity among clients while inviting debate among practitioners. For clients, joint revocable trusts provide a sense of simplicity that’s enticing in an estate tax environment that’s generally negated the need for credit shelter planning and estate equalization techniques. Nevertheless, the debate among practitioners remains warranted, as there’s no single solution that will be best across all clients or all jurisdictions.
Individual Trusts
Individual revocable trusts have long been the standard for planning, particularly for those with complex estates. With an individual trust, there’s one grantor who retains revocation rights and is the primary lifetime beneficiary. Accordingly, individual trusts naturally provide for delineation of asset ownership and control, allowing for greater certainty when funding the trust and structuring its testamentary provisions.
Unfortunately, funding individual trusts can be complicated for spouses who own their assets jointly. Funding typically requires severing the joint ownership of their assets and contributing separately to the trusts. Although once common when estate equalization was key to avoid wasting exemption, the strategy is less often necessary given modern portability rules. The resulting separate trusts aren’t intuitive for clients who are accustomed to managing their assets jointly and thinking of their assets as a combination. Designating both spouses to serve as trustees of the trusts can ameliorate this to a degree, but clients may resist disturbing joint assets while both are alive.
Joint Trusts: Simple and Complex
Joint trusts present an alternative for spouses. It’s crucial when discussing joint trusts, however, to distinguish how the trust agreement is structured. There are simple joint trusts that consist of a single unified share. There are also complex joint trusts that establish separate shares and define the spouses’ interests in those shares. The simple joint trust is often what’s meant by a “joint trust.” In this type of trust, the trust agreement doesn’t distinguish the interest of the spouses in the trust assets, holding all assets in a common share for the spouses. Both spouses will be grantors and primary beneficiaries, and generally both will have revocation rights until their respective deaths.
In complex joint trusts, the trust agreement would typically establish a share for separate assets of each spouse in addition to a joint share in which joint assets are intended to be held. This combines the flexibility of individual trusts and a joint trust under a single trust agreement, although at the expense of more complicated drafting.
Drafting a complex joint trust requires special attention throughout the trust agreement to the separation of the shares. The individual shares should be separately identifiable so there’s a way to clearly transfer assets to and from those shares. Specify the nature of the ownership of the spouses in the joint share if seeking to claim a particular type of joint ownership, and structure accordingly. As a safety, provide default rules to allocate contributions and withdrawals that fail to specify a particular share.
State Variations
There’s yet a third option for joint trusts available in states that have created special types of trusts by statute. One variant is a tenants by the entireties trust, which expressly preserves tenants by the entireties ownership for assets contributed into the trust. Tenants by the entireties is a unified form of ownership between spouses recognized in certain states that’s notable because assets held as tenants by the entireties may be shielded from creditors of either individual spouse. Whether this type of ownership can exist within a trust may be uncertain absent a specific statute, such as in Florida, where cases have been inconsistent.1
Another is the community property trust, which separate property states have developed to create community property treatment for assets in such trusts. One notable difference between community property and separate property is that community property receives a full step-up in basis on the death of the first spouse under Internal Revenue Code Section 1014(b)(6), whereas joint assets owned by spouses in these separate property states would generally receive a step-up on one-half under IRC Section 2040(b).
Tenants by the entireties trusts can be found in Delaware, Illinois, Missouri, Tennessee and Virginia.2 Community property trusts can be found in Alaska, Florida, Kentucky, South Dakota and Tennessee.3 As these are statutory creations, drafting trusts in these scenarios of course requires adherence to the applicable statute.
Finding the Right Fit
When starting the analysis of whether an individual or a joint trust is the best fit for a particular set of clients, the extent of separate assets held by the clients should be one of the first points for consideration. In a community property jurisdiction, there may be very little the clients truly own separately due to their community property rights. In these settings, simple joint trusts are often used as they function similarly to community property ownership. Likewise, in separate property jurisdictions, spouses who own essentially all of their assets in joint form will often find simple joint trusts to be an analog to how they view and manage their assets.
Nevertheless, there are many situations in which spouses in a separate property jurisdiction may have a number of separate assets. Anecdotally, those who marry later in life are less likely to unify their assets. Those with family business interests may also have significant separate assets by value, even if by count most assets are held jointly. Some clients may separately hold family inheritance rather than commingle it with marital assets. Clients in these situations already recognize some separation of assets and may find individual trusts to be intuitive.
Individual Trust Use
The clean delineation of ownership offered by individual trusts makes these trusts better candidates for tax planning. They avoid entanglements of interests and control that can occur in joint trusts, particularly simple joint trusts. While complex joint trusts can provide for separate shares, more client guidance is necessary to ensure the separate shares and joint shares are appropriately funded and administered. It’s more likely that over time, such a trust won’t be correctly funded.
Maintaining separation may also be a positive for asset protection purposes in the event there’s one spouse in a particular risky profession or otherwise at higher risk of claims. Individual trusts will maintain separation of the spouses’ assets. Additionally, in this situation, individual trusts permit defensive planning such as lifetime qualified terminable interest property (QTIP) trusts in those jurisdictions where that structure offers protection.
Individual trusts are also generally the better solution for second marriages, when it’s more likely that the spouses have both separate assets and different distributions for their children. Those situations will often warrant QTIP trust planning and will benefit from cleaner separation of the spouses’ assets. That said, client dynamics will vary, and there may be situations in which joint trusts still have a complementary role within the plan.
Joint Trust Use
Simple joint trusts will be the starting point in community property jurisdictions, but they also have a place in separate property jurisdictions for clients who have previously acquired significant community property assets. Community property retains its characteristic even after leaving the community property jurisdiction, so these clients will have a mixture of existing community and newly acquired separate property. A separate, simple joint trust for the community property—or a statutory community property trust where available—may be an optimal vehicle for that carryover community property, if for no other reason than to cleanly identify and isolate those assets from the separate property assets the spouses acquire.
In separate property jurisdictions, the simple joint trust is going to be a viable option primarily for clients with modest estates. It’s most suitable in situations in which there are no significant individually owned assets and no reasonable probability of exceeding taxable estate thresholds. The variant of a complex joint trust with separate shares may similarly be suitable for certain clients with some, but not exclusively, separate assets. Of course, additional caution is warranted if attempting to build in estate tax planning mechanisms due to the increased complexity of the trust agreement.
Finally, consider using a joint trust as a final receptacle for assets of the second spouse to die. For the first spouse to die, survivorship rights and beneficiary designations can serve to transfer assets to the surviving spouse, and the trust can serve as the contingent beneficiary. Having one joint trust simplifies the beneficiary identification. After the death of the first spouse to die, the surviving spouse can opt to transfer assets into the trust or simply maintain it as the beneficiary of their assets.
Missteps With Joint Trusts
Joint trusts belie a sense of simplicity. In many ways, they’re simple for spouses to operate, but, like a duck swimming through the water, what appears simple can involve a lot of work under the surface.
Perhaps the most common misstep is not clearly addressing revocation rights in the context of the surviving spouse. A provision simply requiring that the trust may be revoked by the spouses leaves open the question of whether the trust may only be revoked by action of both while living or if the survivor may alone revoke. Similarly, the trust agreement will need to be clear on procedures in the event of incapacity of either spouse separately. In complex joint trusts, clarity in revocation and incapacity rights are even more critical.
Gift Issues
If a joint trust is used, consider whether disproportionate funding of the trust could constitute a non-exempt gift to the other spouse. The funding of the trust may not qualify for the marital deduction if the contributing spouse will receive the assets back if they survive, and if the recipient spouse isn’t solely entitled to the income during their lifetime. Those elements will cause the contributed funds to be a terminable interest that won’t qualify for the gift tax marital deduction. This wouldn’t matter if the funding is considered an incomplete gift, but that may not be the case if the contributing spouse’s right to revoke is only exercisable jointly with their spouse. To avoid this result, the trust could provide that each spouse may withdraw from the trust any property they’ve contributed without the consent of the other spouse, but that would require careful recordkeeping. Providing each spouse with the ability to unilaterally revoke may also resolve the completed gift issue, but could lead to unintended consequences if, for example, the marriage of the spouses is failing.
When the clients intend that a portion of the joint trust become irrevocable on the death of the first spouse, another issue that can arise is that the surviving spouse could be viewed as making a completed gift to the remainder beneficiaries.4 Again, to avoid a completed gift, the trust could provide that each spouse may withdraw from the trust any property they’ve contributed without the consent of the other spouse.
Estate Tax Issues
From an estate tax perspective, determining estate inclusion for a joint trust can be complicated. Under Section 2040(b)(2), assets held jointly by the spouses alone will typically be a qualified joint interest, which would be one-half includible. However, this requires verification that the interest in the trust is truly a qualified joint interest and that no other beneficiaries could be deemed joint tenants with the spouses.
It’s also important to remember that inclusion doesn’t automatically yield a basis adjustment. Some practitioners would provide the contributing spouse with a testamentary general power of appointment (GPOA) to cause inclusion of all of the trust assets in their gross estate, arguing that this should qualify the joint trust assets for a full basis adjustment under IRC Section 1014. The Internal Revenue Service has denied this result on the basis of Section 1014(e) citing the retained right to revoke.5
A simple joint trust may also impede disclaimer planning. When assets are commingled in a common share, the resulting credit shelter trust could be viewed as being funded by assets contributed by the surviving spouse, who will generally retain a life interest, causing inclusion in the surviving spouse’s estate under IRC Section 2036. It may be possible to overcome this result by providing each spouse with a testamentary GPOA over all the joint trust assets.6
Non-Tax Issues
Funding joint trusts also involves non-tax considerations. In jurisdictions with tenants by the entireties ownership but without statutory tenants by the entireties trusts, it’s possible that contributing assets into a joint trust will break the entireties ownership. This may not be desirable for clients who predominantly hold their assets in entireties form.
Additionally, joint trusts can invite complications in the event of a breakdown in the marriage. If both spouses have full control over the trust, it can invite malfeasance in the days leading to divorce. Issues can arise when state laws modify trusts to deem divorced spouses as predeceased on dissolution of the marriage. If the joint trust isn’t terminated and distributed during the divorce proceedings and before entry of the decree, the impact on the trust would almost certainly not be what was intended. Best case, having to transfer all of the assets out of the joint trust is less convenient than if the spouses had individual trusts.
Options Exist
There’s no one-size-fits-all answer when it comes to deciding between individual and joint trusts, so beware of becoming lost in the search for the correct answer. Individual and joint trusts aren’t mutually exclusive options, nor do you need to pledge your loyalty to only one. Many factors will determine what may work best for a particular set of clients, including the types and titling of their assets, their family dynamics, their applicable state laws and their exposure to state and federal estate taxes. We all aim to help our clients balance such factors when presenting the options for structuring their estate plans, and we have more than one option for structuring a revocable trust. When advising spouses, don’t unduly dismiss the joint revocable trust.
Endnotes
1. SeeIn re Romagnoli, 631 B.R. 807 (Bankr. S.D. Fla. 2021); but see In re Givans, 623 B.R. 635 (Bankr. M.D. Fla. 2020).
2. See Del. Code Ann. tit. 12, Section 3334, 765 ILCS 1005/1c, MO Rev. Stat. Section 456.950, Tenn. Code Ann. Section 35-15-510 and Va. Code Ann. Section 55.1-136.
3. Alaska Stat. Sections 34.77.010 to 34.77.995, Tenn. Code Ann. Sections 35-17-101 to 35-17-108, S.D. Codified L. Sections 55-17-1 to 55-17-14, KRS 386.620 to 386.624 and
Fla. Stat. Section 736.1501 et seq.
3. SeeCommissioner v. The Chase Manhattan Bank, 259 F.2d 231 (5th Cir. 1958).
4. See Private Letter Ruling 200101021 (Jan. 5, 2001).
5. Seeibid. and PLRs 200210051 (March 8, 2002) and 200403094 (Jan. 16, 2004).