Unless you live the life of a pharaoh, you may not plan to have your pets buried with you when you die. As you may suspect, courts usually will not enforce a “euthanasia order” for pets that stems from a Will, usually resulting in a pet being dropped off at the local humane society. So the question is: who will take care of your pets when you are gone? More importantly, what estate planning tools are available for pet owners to provide for their pets? What tax effects do these different tools have? This article will point out some leading estate planning tools for pet owners and their tax treatment under federal law and Nebraska state law.
A statutory trust is created in Nebraska with a barebones reference in a Will, such as, “I bequest in trust upon my death $30,000 to Fluffy.” While a statutory trust is usually less complicated to draft, the future tax liability may be larger than preferred. This is because the IRS has ruled that all pet trust income will be taxed to the trust, even if used for the care of the pet. Additionally, there is no deduction for the amounts distributed for pet care.
More importantly, it may not provide the type of care you desire. Since a statutory trust is created with a Will reference, the exact trust terms are set by state law, making the executor of your Will the “guardian” of your pet. Are you confident that the executor of your Will is going to provide the best care for your pet?
The recommended estate planning tool in this situation is the traditional trust. Under a traditional trust, the beneficiary of the trust is a human caretaker. While a statutory trust begins when you die, a traditional trust can begin anytime during or after your life to provide a smooth transition for the care of your pet. Traditional trusts require the trustee to make distributions to the beneficiary to cover the pet’s expenses. While a traditional trust may be more complicated to draft, equating to more upfront costs, it will provide you with vastly more options to tailor the trust to the long-term care of your pet. For example, this trust can be modified to provide for specific care instructions such as required yearly trips to the veterinarian, decisions on how and when to euthanize the pet, or even daily belly rubs!
Regarding the taxation of traditional trusts, the beneficiary (human) would be taxed on any distributions from the trust. They would report this income on their personal tax return. The traditional trust would receive a deduction for any amounts distributed to the beneficiary. This presents an additional problem of compensation for the beneficiary, since the beneficiary would have to report this additional income without a corresponding deduction. Therefore, a traditional trust must be drafted to cover a caretaker’s additional income tax liability.
In total, the traditional trust provides greater flexibility for providing specific types of pet care with the possibility of a lower tax burden.
Estate and Gift Tax Rules
Amounts given to pet trusts (traditional or statutory) may be subject to federal gift tax. The IRS has stated that since a pet is not a “person,” any distributions from a charitable remainder trust for the benefit of a pet do not qualify for the charitable estate tax deduction. Additionally, a gift to your pet trust may not be able to fall under the annual gift tax exclusion since the IRS does not recognize a pet as a beneficiary. However, such amount should not be subject to gift tax if the gift to the pet trust falls under your, the pet owner’s, life-time gift tax exemption.
Pet Protection Agreements
Because estate administration is not a speedy process and because a pet owner could become incapacitated during life, a pet owner should also consider creating a Pet Protection Agreement. A Pet Protection Agreement is a binding contract between a pet owner and a pet guardian or pet guardian organization. It provides for intermediate care of a pet during the administration of the deceased pet owner’s estate and/or the owner’s incapacity. Nonetheless, these agreements seldom provide funding for the care of the pet. Thus, they should only be used for short durations, and in conjunction with a planned funding source, to avoid leaving someone else with your pet’s bill. (That was not a duck joke.)
We recommend that pet owners consider the creation of a Traditional Pet Trust along with a Pet Protection Agreement. In concert, these tools generally provide the best protection for your pets and allow planning to support tax-efficient transfers. Feel free to contact any member of the McGrath North Tax Group to discuss these estate planning techniques in more detail.