Don't let your trust fall short: how the US tax season can reveal funding gaps

Tax season each year is a convenient time to ensure that your estate plan is effective by confirming that all your assets (other than retirement accounts and certain other assets) are properly titled in the name of your revocable trust. As you receive 2023 tax reporting and prepare your 2023 income tax returns, consider the following:

Why is trust funding important?

Your revocable trust is a powerful tool to avoid probate, protect your privacy, and provide for your beneficiaries according to your wishes. However, your revocable trust only controls the assets that are titled in its name. If any assets are still in your individual name, they may not pass according to your trust and may be subject to probate or other judicial process, which can be costly, time-consuming, and public.

How can income tax season help you confirm your trust funding?

A convenient way to confirm that your assets have been properly transferred to your trust is to review the annual income tax forms (e.g., Forms 1099 and Schedule K-1) you receive each year from your various investments, such as investment and business interests along with bank and brokerage accounts. These forms should identify your trust, rather than you individually, as Recipient, Partner or Shareholder, or at a minimum should identify you as the owner as trustee (e.g., “Jane Smith, Trustee” instead of simply “Jane Smith”). 

Another way to confirm your trust funding is to double-check the property tax bills for your real property, such as your home, vacation property, or rental property.  Most owners of real property deduct their property taxes on their income tax return, and therefore will review their property tax bills during income tax season (even though property tax bills may arrive at a different time of year, such as in autumn in California). The property tax bills should list your trust as the owner of the property, or at least reflect that you are the owner in your capacity as trustee.

If you notice that tax forms do not list your trust or identify you as trustee, this is a good indication that follow up is needed.  

When should your trust not be identified on tax forms? 

Be aware that certain assets will never identify your revocable trust as owner on tax forms. Examples include retirement accounts (IRAs, 401(k)s, etc.), health savings accounts (HSAs) and medical savings accounts (MSAs). For these accounts, tax time is a good opportunity to confirm that you have valid pay-on-death beneficiary designations in place and that they are consistent with your estate plan. 

Tax reporting of wages (Form W-2) and social security benefits (Form 1099-SSA) will not identify your revocable trust as owner either because the wages or benefits are payable to you individually. 

In addition, sometimes those who have a revocable trust intentionally keep certain assets outside of their revocable trust for various reasons. If your plan includes such assets, they will not be titled in your trust. Examples include:

• Real estate held in a single member LLC, with your revocable trust owning the LLC instead of the real estate itself.
• Joint bank account with a spouse or relative intended to provide the spouse or relative with immediate access to funds (with the knowledge the account will pass automatically to the joint owner at death rather than pursuant to the terms of your revocable trust).
• A safe deposit box, or bank or brokerage account, that designates your revocable trust as a transfer on death beneficiary because the bank does not allow you to transfer it to your revocable trust or makes the process very difficult. (Note, however, that we do recommend if at all possible that the revocable trust be owner of these types of boxes and accounts).
• Vehicles usually are not transferred to your revocable trust because it is relatively easy to transfer vehicles without probate, and vehicles are rarely a significant value asset.

If you notice that tax forms do not reflect ownership of certain assets by your revocable trust and are not sure whether that is appropriate, this is a good indication that follow up is needed.  

Should you also update your trust?

As you check your tax forms to confirm ownership by your revocable trust, this is also a convenient time to consider whether changes to your family, financial, or personal situation over the past year require updates to your estate plan. If there have been significant changes, such as the birth, death, marriage or divorce of a key beneficiary, decision-maker or family member, significant change in financial assets, or a change in your wishes, we recommend that you schedule a review meeting with us to ensure that your trust reflects your current goals and circumstances. If it doesn’t, we can help you update your estate plan as necessary. 

Conclusion

Trust funding is a vital part of your estate plan, and we hope that this alert serves as a helpful reminder and a useful resource for you as you complete your income tax returns. If you would like to discuss trust funding or any questions or concerns you have in response to this alert, please contact us or your Withers attorney. 

This article is authored by David Bawden.