What Trusts Can and Cannot Do, with Houston Attorney John Strohmeyer

0:02 As a probate real estate agent, I often find out about litigation where somebody tried to do something a trust that didn't work. And we have an attorney today here who specializes in helping educate us on no, you can't do that with a trust. We have attorney John Strohmeyer returning back to our podcast Probate Weekly. John, what can you not do with a trust that you see people try to do?

0:23 Well, Bill, it's great to be back. Thanks for having me back. What I see people do is think that they're going to not pay any income tax by setting up a trust and then, you know, exploit what the IRS doesn't want you to know and what the billionaires are using to not pay any tax, their tax secrets. The short reality is no, you can't use a trust to avoid income tax. The way the system works, you're going to be paying income tax and if you layer a trust in, you're just going to change who's paying the tax but not that the tax gets paid.

1:01 So, you're changing who's paying the tax and the rate might be different based on the entity or the limits might be different based on the entity, but at the end of the day, there's income, somebody's going to claim it and somebody's going to pay taxes on it.

1:14 Right. There's I mean, the what we'll end up talking about is something that's known as the non-grantor irrevocable complex discretionary spendthrift trust, which is a real type of trust, but what it doesn't do is allow you to defer income tax payments past the taxable year in which those that income is received.

1:34 And that's what you see lots of people online who claim otherwise, but unfortunately, it's not a good place to be. Well, you know, my father my late father was an attorney used to say, you can deduct whatever you want. The question is whether you can audit it and whether it stands up. So, there was the YouTube channels usually like two or three years old because something happens after two or three years that they get busted and the whole thing kind of falls apart. So, there are some strategies that effectively allow people that are legitimate to defer taxes on certain types of income. The most common one, obviously, is real estate because real estate gets a step up and then there's ways to put property in trust and decide where the depreciation goes and the values Talk a little bit about what you can do as far as deferring taxes or deferring them in a way that they may end up I want to say disappearing, but not being having to be paid as taxes.

2:22 Right. So, I mean, you know, we think about kind of three main types of trusts. First and what a lot of people think about is the revocable management trust. This is used as basically an alter ego for whomever your, you know, whoever's setting it up. Used a lot in California, New York, Florida, places that have really kind of onerous probate regimes to avoid the formal court-mediated probate process. It's not necessarily going to limit the work that has to be done when somebody dies, but it's just going to limit how much you have to go to court. The good news about this is, well, there are no tax ramifications. It's like transferring something from your left hand to your right hand. It's still yours. There's nothing really that's changed. Where people get confused is, oh, well, maybe you can get some asset protection or you can get something else out of it. And unfortunately, that's just not the way it's going to work for a lot of people. It's, you know, and most of the states, these revocable trusts get set up and they're there as just an alternative vehicle to manage things for you if, you know, if you pass away, it speeds up the probate process. Does it eliminate all of the probate work. It just kind of speeds things along if you funded your trust. And during lifetime, it can minimize the needs for a guardianship or custodianship, depending on what your state calls it. Basically, if you lose capacity, it's a way for people to manage your assets without you. So, that's trust type number one.

3:58 Trust type number two, these are irrevocable gifting trusts. People set these up during lifetime to transfer assets away. You know, they're putting them in trust, they're giving them away during their lifetime, waving goodbye so that the beneficiaries can see the benefit of those assets now while they're alive. This is, you know, usually estate and gift tax motivated for why you do it. Not always, but it's something that drives a lot of why my clients do it. The last type of trust are testamentary trusts. So, these are set up the triggering event for when they are set up is somebody's passed away. And we're setting these up, assets are held in these trusts. The person who owned them before death, whether it's another trust or the, you know, the donor, grantor, settlor of that trust, held onto it until they died and then they let it go onto this new trust once they'd passed away. Now, that's basically it. You know, we can get some different tax benefits. You may shift the income tax burden from one place to the to another, but you're not eliminating an income tax burden. And you're also, you know, you may be able to get some estate and gift tax benefits from it.

5:17 So, obviously though, the key to this is when you get tax benefits, you have to get more benefit than the cost of the work and the time putting together. So, in my experience, there have been tremendous savings of taxes by using I would say fairly modest of the of the things you mentioned, things that I can understand, would have tremendous tax implications. Gifting to children where they're you can't put it in the account, the children are minors and don't have necessary access to it. So, instead of you saving it and them inheriting it, they're getting some of this during their lifetime and I guess it's certain amounts are exempt from taxes and now it's not your asset, so when they inherit, they don't inherit those assets. Is that what they're primarily to avoid the estate tax penalty or is that done you know, you can't write off a gift to your minor children, can you?

6:12 Correct. It's not a an income tax deductible gift, though this is where the you know, there are multiple tax systems and you're we're juggling a lot of them when we figure out what we're doing. So, the two systems we primarily think about estate and gift tax on the one hand, you know, if you have too much and you give away too much or you die and you own too much, there's a tax 40% if you go over the limits. And we also have to juggle that with income tax. The income tax system we're all familiar with, you're paying your annual income tax filed on form 1040 every year. Now, for the revocable management trust, again, income tax is nothing's changed. That's your trust, you're setting it up for your benefit. When it comes to estate and gift tax, well, you're not getting any benefits while you're alive, though it may manage the tax payments and kind of how you do things after you pass away. But you could get the same planning out of a will. There's no magic in that trust. For the irrevocable lifetime gifting trust, you're giving assets away now, so we're doing things, we're kind of triggering some sort of estate and gift tax consequence. Doesn't necessarily mean that there will be any state or gift tax payment or primarily gift tax because it's during lifetime.

7:33 But there are things to consider there. It may be those annual exclusion gifts, currently $19,000 per person. It be much more than that. For those trusts, you do have a choice when you're setting them up. Is it going to be a grantor trust, meaning the person who set up the trust, generally, some exceptions, that person is going to continue and to pay the income tax due on any assets generating income within the trust, or is it a non-grantor trust, meaning once the trust is out there, it's sink or swim on its own, it's paying income tax on its own assets. Finally, that type of trust, the testamentary trust, well, there may be estate and tax consequences because it's being set up on somebody's death or triggered by somebody's death. Income tax-wise, it's generally only going to be a non-grantor separate taxpayer trust.

8:32 Seems to me that, you know, when you're giving when you when you mentioned the latter trust where you're liable still for the taxes. If you're transferring something that doesn't generate income, that would be ideal. So, you have stock that doesn't have dividend, but it's appreciating rapidly, that would be something you might put into a that kind of trust. Real estate, I guess, really is difficult. I mean, I can imagine you could gift a percentage point or two percentage points equal $19,000 every year. And if it's not generating income, or the income's being offset by depreciation or expenses, then that would might be effective. Are those the types of assets you're putting into those trusts?

9:09 Yeah, it really does depend on who's giving what away. For those gifting trusts, sometimes, you know, it's obviously very easy to gift away you know, $19,000 in cash or $19,000 in marketable securities. When you start when you start looking at, well, I'm going to transfer a portion of this business, 1% or 2% portion of the real estate, well, you've got to get an appraisal of that to go along with it to satisfy your disclosure rules with filing that return. You know, the IRS needs to know, well, how much did you pay? How much was done? How do we make sure that we got all of the right values and the right taxes were paid because it's they're based on the value that's transferred, which is not necessarily, you know, what you received, and there's not necessarily a price tag on that, either.

10:00 Right. Right. Interesting. So, obviously, there's another complication, which is we deal with larger estates, multi-jurisdictions. I'm in California.

10:12 I'm sorry. I've got to pause for 1 second. I've got to check here on my One of the challenges I deal with in California is we're obviously a high-tax state, one of the highest, and I deal a lot with professional fiduciaries that deal with large estates. But, where the problem comes in is where there are assets in multiple jurisdictions, some with no taxes. So, for example, if an estate has you know, property in California and all kinds of assets, and then has another property in a no-tax state like Nevada or Florida, the income of those assets become taxable perhaps to the trustee if they're the trust for an estate. Well, who pays that? And the answer is do you have multiple fiduciaries? Do you have fiduciaries that work together? How do you manage when you have multiple jurisdictions and you're trying to juggle the piece of puzzle? You need the service, but at the same time, you don't want to add a tax liability you otherwise don't have.

11:07 Right. And so, that's something where, you know, it's possible to have multiple trustees, and it's also possible to have just a single trustee who, you know, an individual, Uncle Bill, if you will, is able to serve as trustee for multiple trusts, and or and multiple jurisdictions. Sometimes, you will have a local trustee, you know, Uncle Bill is trustee in California, but there's real estate that needs somebody physically present in Wyoming to deal with it there. And so, it really does just depend Well, what do you need? Sometimes they're individuals, sometimes it is a corporate entity that's serving as your trustee.

11:48 Yeah, and I think the moral of the story is California can find someone to get the taxes if you Once you bring it to California, if you're fiduciary, they're going to charge him and if the assets are here, of course, there's no way around that. So, you got to be careful about that process. Talk Let's talk a bit about Now I got noise in the background here. Hold on a second. Sorry about that. So, you know, I'm increasingly with larger estates where to me, when I work with a professional fiduciary or professional trustee, it's like a whole different ball game than when it's Uncle Joe who's managing and maybe never ran a business before and now he, you know, in essence owns the business until it's distributed or whatever. Never managed sophisticated real estate. And obviously people try to save money, but saving money and getting bad advice or bad service obviously can, especially these matters, cost a lot more money tax-wise or productivity-wise. So, what's that discussion like with clients when You know, when do you recommend them to find a professional What's the kind What's the criteria or the trigger? And obviously they'll say, "Well, what's that going to cost?" It's more than if, you know, they do it.

12:58 Right. I think they expect you to be the attorney They I think often times customers assume the attorney does everything and there's a distinction between advising them and doing the actual work. What's that discussion like and what are the triggers that you rely on?

13:10 Yeah, and so, it's a lot about thinking about what are we leaving this person and, you know, who is this person? Are they going to be able to manage this themselves? Normally, I think about, well, if we're going to leave things to our, you know, clients' children, my assumption is those children are eventually going to be able to manage those assets themselves. They, you know, unless you tell me otherwise my assumption is your children can manage this themselves. Things that make me think twice about it. Well, there if we're going to leave them more than 10 million in assets, we may want a professional fiduciary in there just because that's a big pile and if your kids have never managed that much themselves, you don't want them learning on the job with that first 10 million that you've left them. You know, we want to put something together, put it in place so that they're protected from themselves. Again, it doesn't mean that they're never going to be in charge or they'll never have the ability to get up and, you know, take over on their own trust, but you may not want them, you know, immediately at age 18 or 25 or even 35 being in charge of that much by themselves.

14:22 I find that when the decedent leaves a business, unless one of the children is in the business, it's very difficult. Usually, the decedent who ran the business, you know, was a specialist in certain field. They really knew this product, this service, this manufacturing technique and that was their key advantage and absent them, it becomes not competitive and over time falls apart. It seems to and yet it's so important in transitions to jump into business to keep payroll going and clients paid or who, you know, where there's money being transferred around. It seems to make But that's a specialized fiduciary, right? To step in and run a business is different than managing assets, you know, stocks, bonds, and real estate. Are there particular fiduciaries you have that fit those kind of profiles or what do you're hiring a CEO of a company basically for 6-month or 9-month period maybe or year period, aren't you?

15:13 Right. And so, you know, it really just does depend. We have a number of fiduciaries we work with and some are better fitted for different ones. You know, some don't want anything less than 10 million in assets. Others will do court-created trusts if we need to manage those. Others will deal with smaller assets. And you know, some have a focus on estate and or real estate that may be useful for a particular client. Really is, you know, there's not there's not one answer for everyone.

15:45 I will say I had I had a attorney call me and ask me one time for a recommendation for a fiduciary to run a commercial property management company in Los Angeles. And so, property management and commercial are two different things. Los Angeles is a whole other cup of tea. And really it wasn't just about real estate, which you know, is one strategy, but managing was the business, right? You were really you're really hiring a CEO either sell the business or CEO until a family member can step into it or CEO till you hire a CEO to replace yourself. But somebody's running that business on a day-to-day basis. That's the fiduciary, I guess, until further notice, right?

16:22 Right. You know, it's whoever's named, they're in charge. And this is one of the benefits of trusts in that well, if somebody dies, well, you know, if the if the trustee dies, well, that the account doesn't get frozen like it you do if it's an individual. What's happening is you've got a succession of trustees or a way for that successor trustee to be named and to take over. And that's really what you're hoping for. It's kind of continuity. Again, going back to those revocable management trusts, one of the things we see in probate as a problem is, you know, husband and wife will have joint accounts and they won't have checked to see you know, what happens to the account when we die. Sometimes it'll just be a tenancy in common where when one spouse dies, they're freezing the account. The bank's freezing the account because that's the way it was set up. And now that surviving spouse, you know, in addition to the grief, now doesn't have access to any cash. They'd had a bank account inside of a revocable management trust, it should avoid that issue.

17:32 Seems to me the default for banks even when they're set properly is to freeze the account and make you prove otherwise. And I had one estate where we actually we the attorney and the client actually went to court and sued a major money center bank, one of the two or three largest, I don't want to say the name. And actually got damages of like $15,000 because it took them because what happened was the bank was had bought another bank so they waited 45 days and the other bank stepped in and all the time kept getting the runaround. They had certified letters the whole time. And the court realized it was just abusive. And I feel like you know, to me it's abusive. To banks, that's just their service level in many cases if you don't have a relationship with them. So again, another you know, think about what happens if you can't get access to your commercial bank to run your business for 45 or 60 days. You're not making payroll, what's that look like? You're not paying vendors, what's that look like? You're not in this case paying distributions to investors, what's that look like? It's not pretty. So again, another reason to manage the handoff.

18:31 Yeah, and you know, businesses generally aren't going to have that issue for business accounts that are in the name of the business. Again, an owner may have died but the business itself didn't die. And this is just kind of all of the probate headaches of kind of looking down, trying to figure out, well, how do we get this set up? How do we you know, what's going to happen if somebody dies? What's going to happen if somebody lives?

18:58 Right. And it should never be as easy as it should be. Like I said, in this case they had a we had somebody step in as the fiduciary. Theoretically, he was the acting president of the company and should have been able to have himself on the bank account. The just wouldn't accept it. It was just really icing. I think the other scenario I see often that requires professional fiduciaries is what I call sophisticated real estates. It's one thing to have a couple rental houses, you can hire property management company cheap enough, and there's a bunch of those. But when the property is commercial, industrial, multi-family, those are very sophisticated properties. I mean, I'm here in California, I imagine it's the same in other places in the country. And it just seems like at first blush, immediately, no, you can't manage this. We need find somebody who knows what they're doing. What's your experience there, and do you find fiduciaries have that kind of expertise?

19:46 I and I guess I'm not really sure how and then going back to the prior answer of like we get different fiduciaries for different purposes. So, I'm guess I'm clueing on I'm not sure how better to answer that.

20:01 No, I think you're right. I think you have to find It's one thing to have a great fiduciary who knows you know, trust and this and that, but if you if you're the decedent leaves a portfolio of industrial properties, you know, and the decedent was managing them or involved in running the management of the company, you better find somebody who can either do that work in his place or her place, or find somebody hire somebody who can do that. I mean, it's requiring one of those two things. It's not It's not a small thing. I guess I would say it's a You have to know your limitations, right? It's like anything else in business.

20:32 Right. Right. So, just kind of wrap up here time-wise, you know, obviously we've had you're in Texas. You've had tremendous inflow. You have tremendous volatility in our economy on one hand, up, down, people coming in, immigration up, down. You have major corporations that have IPO'd. What are the one or two major things that are driving your business as far as estate planning that you look at and say, you know, this is what we have to prepare for the next 6 months to a year, that's a little different than it was last year or two?

21:02 Yeah, I mean, the big things really are just helping people figure out what's going on. More than anything, you know, we're still here kind of doing what seems like basic boring planning. You know, with the estate tax exemption being $15 million per person, people think, "Oh, we don't have to do anything." But, the reality is taxes are only part of the issue. It's, you know, the people who realize you're going to leave something behind. You get a choice as to how much mess that's going to be. And you know, if you want to make it easy for people, that's what we're here to help people do. Of course, anybody can do this. This, you know, we just happen to do it all day every day. So, we've got some benefit of that experience. But, ultimately, that's what we want to do and what we're here to help clients with.

21:49 Well, look, I certainly appreciate it. John Strohmeyer, estate planning attorney, Strohmeyer Law, PLLC, professional legal law corporation. Is that what P

21:57 Professional limited liability company. There you go. I was close. Not really, but I'm I take credit for it. That's it. If you want to reach him, let me see. The website, strohmeyerlaw.com, is down below. And the office phone number, [phone number]. If you want to reach him, if you're driving, can't write that down. Feel free to reach out to me. I'll be more glad to make the introduction. John, thanks again for being on Probate Weekly. Really enjoyed it. I think we learned a lot about estate planning and some of the more traps to avoid. Thank you so much for your time today.

22:26 Oh, Bill, thanks for having me back. And for the record, this is Probate Weekly. We get together every week with attorneys on both probate administration, litigation, and how to avoid probate through proper planning. And today we went that deep level. Love hearing your comments, like, share. Send me a comment if you're interested at all. If I can help in any way, please reach out at Bill Gross Probate on social media. As always, make today your best day ever. Thanks.