Glossary of Estate Planning Terms

Annual exclusion: the amount that a donor may give to a donee each year which is exempt from federal gift tax; the current amount is $10,000, but it is inflation-indexed to the nearest $1,000; to qualify for the annual exclusion, a gift must be a "present interest"; if the donor’s spouse joins in the gift, the amount doubles to $20,000 per donee per year; the annual exclusion does not reduce an individual’s applicable exclusion (see below).

Applicable exclusion: also known as the “exemption equivalent,” the cumulative amount that an individual can transfer either during life or at death which is not subject to federal estate tax; in 1999 this amount is $650,000 and will increase gradually to $1,000,000 in 2006; it is in addition to the gift tax annual exclusion.

Charitable remainder trust (“CRT”): an irrevocable trust with charitable and non-charitable beneficiaries in which one or more individuals receive either a fixed dollar amount each year (charitable remainder annuity trust) or a fixed percentage of the value of the trust each year (charitable remainder unitrust); the term of the trust must be for a life or lives or for a period of years not exceeding 20; at the end of the trust term the trust property belongs to one or more charitable organizations; transfer of appreciated assets usually avoids recognition of capital gain; funding entitles donor to immediate income tax charitable deduction for present value of remainder interest passing to charity.

Charitable lead trust (“CLT”): an irrevocable trust with charitable and non-charitable beneficiaries in which the charitable beneficiaries receive either a fixed dollar amount each year (charitable lead annuity trust) or a fixed percentage of the value of the trust each year (charitable lead unitrust); the term of the trust must be for a life or lives or for a term of years; at the end of the trust term the trust property can revert to the grantor or belong to other non-charitable beneficiaries; can be an effective technique to avoid percentage limitations on income tax charitable deductions or to reduce gift or estate taxes.

Community property: a property regime which exists in eight states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington) and treats all property acquired during marriage, except property acquired by gift, inheritance, or devise, as owned equally by both spouses.

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Conservatorship: a court proceeding in which an adult is determined to be unable to manage his or her estate and affairs effectively and a third person (family member, friend, or professional fiduciary) is appointed to do so; conservatorship can be based on reasons such as physical or mental illness, chronic intoxication or use of drugs; includes numerous due process protections for the protected person and typically requires periodic accountings to the court.

Crummey trust: an irrevocable trust in which a beneficiary possesses a right to withdraw some or all of the property contributed for a period of time (usually 30 days), after which time the power lapses and the property is governed by the terms of the trust document; the beneficiary’s right to withdraw is considered a gift of a present interest for gift tax purposes, thereby qualifying contributions for the gift tax annual exclusion; irrevocable life insurance trusts (see below) are usually Crummey trusts.

Durable power of attorney: a power of attorney that remains valid after the disability of the principal; can be valid upon execution or “spring” into existence when the principal becomes incompetent; can be as broad or as narrow as the principal wants in defining the scope of the agent’s authority; often preferable to guardianship/conservatorship.

Durable power of attorney for health care: durable power of attorney that gives the named agent or agents the authority to make health care decisions for the principal; the principal can specify the aspects of health treatment that are included and can give the agent the authority to select medical personnel, access the principal’s medical records, spend money for medical care, and consent to or withhold medical or surgical procedures; contrast with living will (see below).

Estate planning: the term used to describe a process the intended result of which is the protection, orderly administration, and disposition of a client’s wealth in accordance with his or her wishes upon the occurrence of major events in the lives of a client and his or her family, such as birth, marriage, divorce, incapacity, and death, with significant attention to minimization of taxes and expenses of administration. Estate planning requires knowledge of state property, probate, and trust laws, as well as federal and state income, gift, inheritance, estate, and generation-skipping transfer tax laws. A list of some of the most commonly used terms in estate planning and a short definition of each of those terms are set forth below. (State law concepts vary from state to state, and the definitions set forth below are based primarily on Arizona law.)

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Family limited liability company (“FLLC”): a limited liability company in which family members control the entity for purposes of the special valuation rules under the gift and estate tax law; although one or more non-tax business purposes are required, this entity is frequently used to own family assets, thereby permitting transfers of interests therein to be discounted for gift and estate tax purposes; creditors of a member may only obtain a charging order against the member’s interest, thereby providing a degree of asset protection.

Family limited partnership (“FLP”): a limited partnership in which family members control the entity for purposes of the special valuation rules under the gift and estate tax law; although one or more non-tax business purposes are required, this entity is frequently used to own family assets, thereby permitting transfers of interests therein to be discounted for gift and estate tax purposes: creditors of a limited partner may only obtain a charging order against the limited partner’s interest, thereby providing a degree of asset protection.

Generation-skipping transfer (“GST”) tax: a separate 55% flat rate federal transfer tax in addition to the gift and estate taxes imposed on transfers to persons two or more generations below the transferor; each transferor has $1,000,000 of inflation-indexed exemption from the GST tax.

Grantor retained annuity trust (“GRAT”): an irrevocable trust in which the grantor retains the right to receive a fixed dollar amount (which can be increased within limits from year to year) at least as often as annually for a period of years; at the end of the trust term the trust property typically belongs to the grantor’s children; present value of remainder interest is considered a taxable gift for gift tax purposes; can be an extremely effective device for transferring wealth to children at greatly reduced gift tax cost, but produces no tax savings if grantor fails to survive trust term.

Guardianship: a court proceeding in which an adult (the ward) is determined to be incapacitated and a third party (family member, friend, or professional fiduciary) is appointed to make provision for the residence, care, comfort, and maintenance of the ward; a guardian has the same powers, rights, and duties respecting the ward as a parent has with respect to his or her unemancipated minor child; can be combined with conservatorship (see above); includes numerous due process protections for the protected person and typically requires periodic reports to the court.

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Intentionally defective grantor trust (“IDGT”): a type of irrevocable trust in which the grantor continues to be taxed on the income for federal income tax purposes; since transactions between the grantor and the trust are ignored for federal income tax purposes and since the income generated by the trust assets remains taxable to the grantor, this type of trust can present significant wealth transfer planning opportunities, particularly with installment sales of appreciated assets.

Irrevocable life insurance trust (“ILIT”): an irrevocable trust designed to own and possess all incidents of ownership of one or more policies of insurance, typically on the life or lives of senior generation family members, in order to avoid having the death benefits subjected to federal estate tax; premiums are paid by the trustee, usually with funds contributed to the trust by the insured(s) which qualify for the gift tax annual exclusion through the use of Crummey powers.

Living will: also known as a directive to physicians or advanced medical directive, a living will is a declaration by a person of his or her wishes concerning the use of extraordinary medical measures or procedures in the event of coma or a terminal illness; a physician can refuse to honor a living will if it conflicts with the physician’s values; contrast with durable power of attorney for health care.

Private annuity: an unsecured right in a seller (the annuitant) to receive payments from the purchaser of assets in the form of a life annuity, rather than a fixed amount payable for a certain time period; payments stop upon the death of the annuitant, leaving nothing to be included in the annuitant’s estate for estate tax purposes; if the present value of the annuity payments promised to the seller equals the fair market value of the assets sold, there is no taxable gift element to the transaction; the risk with this technique is that the seller/annuitant lives beyond his or her life expectancy.

Qualified personal residence trust (“QPRT”): an irrevocable trust in which the grantor retains the right to occupy his or her personal residence rent-free for a specified period of years, after which time the residence belongs to the remaindermen (typically children); the value of the gift to the children is discounted by the value of the retained use of the residence; produces no tax savings if grantor fails to survive trust term, but grantor is no worse than if he or she had not created a QPRT; potentially very effective technique by which to pass equity in home to children; if grantor wants to continue to use residence after trust term ends, he or she must pay fair market rent to remaindermen.

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Qualified terminable interest property (“QTIP”): an irrevocable trust for the benefit of the grantor’s spouse which qualifies for the gift and/or estate tax marital deduction; must provide that spouse receives all of the trust accounting income at least as often as annually for life (e.g., cannot provide for reduction or cessation of income interest in the event of spouse’s remarriage) and that no other person has any interest in the trust while the spouse is alive; principal benefit is that the grantor can control the disposition of the trust property at the spouse’s death and still obtain the gift and/or estate tax marital deduction.

Qualified domestic trust (“QDOT”): an irrevocable trust for the benefit of a non-citizen spouse which qualifies for the gift and/or estate tax marital deduction; tax law imposes numerous requirements to ensure that the trust property cannot be expatriated during the non-citizen spouse’s lifetime.

Self-canceling installment note (“SCIN”): promissory note sometimes used in connection with the sale of an asset from senior to younger generation family member that combines the features of a private annuity (see above) and an installment sale; basically, an installment note with a fixed number of payments, but the payments cease upon the seller’s death prior to the final payment; to compensate for the possibility of the seller’s death prior to final payment, the seller must obtain a sale premium, which can take the form of a higher price, a higher interest rate, or both; potential transfer tax savings results from note holder’s death before repayment of the entire price.

Trust: an arrangement by which one or more persons (referred to as the "trustors", "settlors", "grantors", or "donors") transfer legal ownership of property to a trustee or trustees for the benefit of one or more persons (the beneficiaries); in a revocable trust the creator reserves the right to revoke or terminate the trust, and in an irrevocable trust the creator relinquishes those rights; a living trust is a trust created during the lifetime of the creator, as opposed to a trust created under a will, which is referred to as a testamentary trust; typically a more private document than a will and more easily amendable; assets transferred to a trust while the creator is alive will not be subject to probate at the creator’s death.

Will: a document that identifies those who are intended to receive money, property, and other possessions standing in the testator’s name at his or her death; it normally appoints a personal representative (executor) and may also include funeral and burial instructions; typically requires execution with certain formalities, such as witnesses and a notary public; a will does not control the disposition of property held as joint tenants with right of survivorship or property which passes by contract to a designated beneficiary, such as life insurance, retirement plan accounts and IRAs, annuities, or P.O.D. (pay on death) or I.T.F. (in trust for) bank accounts, unless the testator’s estate itself is the beneficiary.

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