Understanding the Difference Between a Trust Account & Estate Account

When someone dies and their assets pass through the Massachusetts Probate Court process, in order to adequately pay off any estate debts and make distributions to the ultimate beneficiaries, the Personal Representative must first set up what is called an estate account. Many clients get confused, however, when an estate passes through probate, but the decedent also has a Revocable or Irrevocable Trust. While many clients think these accounts are interchangeable, estate accounts and trust accounts serve very different purposes and are not setup in the same way. This legal blog post breaks down the key differences, and the importance of keeping funds separate in the event that both are required after the death of a loved one.

What’s an Estate Account?

When someone passes away and they hold assets in their individual name, their estate must go through the Massachusetts Probate process. For an in-depth overview of the Massachusetts Probate process and its requirements, click here to read our full legal blog. Probate requires that a Personal Representative (often a surviving spouse, family member, or loved one named in a Will) file a petition with the probate court seeking the authority to take the necessary actions to close out the estate. Once the Personal Representative receives their Letters of Authority from the Court, they will have the power to open up an estate account and obtain an EIN (employment identification number) from the IRS.

The estate account is a dedicated bank account opened in the name of the decedent’s estate (for example: “The Estate of John A. Smith”). Only the Personal Representative has the authority to open this account, and make any transactions to or from this account. The only assets that should be liquidated and added to the estate account are the assets that passed through probate, which were held in the decedent’s individual name.

For example, if the decedent died with $50,000 in a checking account held in their individual name, this account would pass through probate. Once the Personal Representative is appointed, they can’t make disbursements to the legal heirs or named beneficiaries from this account directly. Instead, the $50,000 balance must be liquidated and added to the estate account first. This is primarily for tax and record keeping purposes. Once funds are added to the estate account, the proper distributions can be made from there.

Key characteristics:

• The estate becomes a separate taxable entity for federal tax purposes.
• As such, the Personal Representative or their Probate Attorney will assist in obtaining an Employer Identification Number (EIN) from the Internal Revenue Service for the estate (Lane, Lane & Kelly obtains this for all of our probate clients).
• The Personal Representative must be officially appointed by the Probate Court, having received “Letters of Authority” from the court in order to open an estate account. For a full overview of what “Letters of Authority" are, how to obtain them, and why they are necessary, click here to read our full legal blog.
• The estate account is used to collect, hold, manage and distribute the decedent’s assets, as well as to pay debts, taxes, and costs of administration. Prior to the complete settlement and closure of the estate, all remaining estate assets will be distributed to either the legal heirs (if there is no Will) or to the named beneficiaries in a Will.
• It is imperative to use a separate estate account to avoid commingling the estate assets with personal funds, or funds held and distributable under the terms of a Revocable or Irrevocable Trust (discussed later in this article).

Why the EIN matters:

• Because the estate is a separate tax entity, any income generated after the decedent’s death (for example, interest, dividends, rental income, etc.) must be reported using Form 1041 (U.S. Income Tax Return for Estates and Trusts).
• Obtaining the EIN is a crucial step and should be done before opening the estate account and performing further administration. Many banks will not honor transactions or even allow you to open an estate account without proof of an EIN.

When is an Estate Account Required?

An estate account is only required if probate is necessary to facilitate the transition of assets from the decedent to the legal heirs or named beneficiaries. If the decedent dies with assets titled in their individual name, then those assets must pass through Massachusetts Probate.

The Probate process can be costly and take several months or potentially years. If assets or real estate are tied up in the Probate Court, then additional expenses such as taxes, utilities, and mortgage payments can add additional carrying costs and expenses to the overall estate as well. This is why creating an estate plan is imperative to keep the overall costs down for your loved ones. The Attorneys at Lane, Lane and Kelly have helped countless clients in crafting an estate plan that fits their specific needs, all while avoiding the Probate Court entirely. If you haven’t created an estate plan or need to update yours, please contact us today to get started.

What’s a Trust Account?

A trust account is an account held in the name of a trust (either a Revocable or Irrevocable Trust). A Trust account may be established either during a person’s lifetime or after their death, depending on the type of trust and its intended purpose. The trust has its own Trustee(s), beneficiaries, terms, and multiple types of assets can be titled in the name of a trust (such as bank accounts, brokerage accounts, real estate, investment properties, etc.)

For example, it is very common for a husband and wife in creating their estate plan to setup a Revocable Trust. In doing so, they would retitle their primary residence to be owned by themselves, as Trustees of their Revocable Trust. In the event that they sold this property and downsized to a new home, they would both buy the new property and sell their previous property in their fiduciary capacity as Trustees of their Revocable Trust. Let’s say they sold their primary residence for $850,000 and purchased a condo for $600,000. Because this transaction was done in their capacity as Trustees rather than individually, they would need to open a Trust account to receive the proceeds of the sale of their primary residence, to purchase the new condo in the name of the trust, and finally to hold the $250,000 in sale proceeds in accordance with the terms of the trust. 

Key characteristics:

• The type of trust created determines the tax status of the trust itself. A Revocable trust is not a separate legal entity, and the tax consequences pass through to the Settlor’s of the Trust. A Revocable Trust is a legal relationship between the Settlor of the Trust and the Trustees. Any assets held in a Revocable Trust are treated as the Settlor’s for tax and liability purposes during their lifetime. In the previous example, if you and your spouse own your home as Trustees, any tax implications that may result from selling your home would be the responsibility of you and your spouse, not the trust itself.
• In contrast, an Irrevocable Trust is a separate legal entity, and requires the trust to obtain its own tax identification number (EIN) from the IRS. Irrevocable Trusts are typically more complex and are setup for things like MassHealth protection or estate tax savings and avoidance. Some common types of Irrevocable Trusts are MassHealth Income-Only Trusts, Spousal Lifetime Access Trusts (SLATs), or Irrevocable Life Insurance Trusts (ILITs). Irrevocable Trusts do carry their own financial obligations and require the filing of tax returns in the name of the Trust itself.
• For both Revocable and Irrevocable Trusts, the trustee holds legal title to any trust assets and has a fiduciary duty to manage them for the benefit of the beneficiaries.
• Assets held in either a Revocable or Irrevocable Trust generally avoid the probate process altogether, because the the assets are titled in the name of the trust rather than in the decedent's individual name.

When is a Trust Account Required?

• If you set up a Revocable Trust during your lifetime and have transferred assets into the trust, it is best practice to create a Trust account.
• Upon the Settlor’s death, the trust will continue to hold all trust assets. At this point, the terms of the Trust will outline whether the Trustee should continue to hold the assets in trust, or sell and liquidate any assets and distribute them to the named beneficiaries of the trust instrument.
• Anytime trust assets are sold, the proceeds must be flow into a trust account for record keeping and tax purposes.

Why the Distinction Matters and Why You Should Never Commingle Funds

The estate account is only required if a probate proceeding must be filed, and is solely a tool for probate administration (gathering and liquidating assets, paying debts, taxes, or estate expenses, and making final distributions to legal heirs or beneficiaries). An estate account will only ever be opened after the decedent’s death, probate is filed, and an EIN is obtained in the name of the estate.

A trust account can be established either during the Settlor’s lifetime or after their death. This account is created only for the management and distribution of assets titled in the name of the trust itself.

Clients often get confused when probate is required because the decedent dies with some assets titled in their individual name, and the decedent died with a Revocable Trust they created during their lifetime. In this instance, both types of accounts are necessary, and it is imperative not to commingle funds across both types of accounts.

It is easy to see where people get confused. An EIN must be obtained for the estate account. The decedent’s social security number is used to obtain an EIN for the estate account. Then the estate account will hold all funds and proceeds of any estate assets. However, a trust account must also be created for any assets held in the name of the Trust. While many people assume that when someone dies, one account is all they will need, this can lead to major complications down the road. Assets must be held separately based on how they were titled, and commingling funds between accounts can result in major tax consequences, liability issues, or a potential breach of fiduciary duty. Similarly, the Personal Representative or Trustees personal funds should never be commingled in either of these accounts either, and could result in personal liability.

A Real Life Example:

Let’s say Mike has $50,000 in a checking account and $100,000 in a brokerage account that is titled in his individual name, with no pay-on-death beneficiaries named. Mike also owns his primary residence. This residence is titled in the name of "Mike, Trustee of the Mike Family Revocable Trust."

When Mike dies, probate must be filed to facilitate the distribution of his checking and brokerage accounts. In Mike’s Will, he named his brother, Roger, as Personal Representative of his estate. His Will also names Mike’s son, Brendan, as his sole beneficiary.

Mike also named his brother, Roger, as successor Trustee of his Revocable Trust, in the event that Mike became incapacitated or died. Mike’s house does not pass through Probate. It will be distributed under the terms of the Trust instrument itself. The Trust document specifies that upon Mike’s death, his house should be sold as soon as possible, and all sale proceeds shall be distributed to his daughter, Melinda, outright and free of trust.

Roger now serves two distinct roles, both with fiduciary duties to the beneficiaries, Brendan and Melinda. As Personal Representative of Mike’s estate, Roger will file probate in the Massachusetts county where Mike was domiciled. Once he obtains Letters of Authority from the Probate Court, Mike will open a bank account in the name of “The Estate of Mike.” Once he has the authority from the court, he can contact the bank where the $50,000 is held, liquidate it, and then transfer it to the estate bank account. He will also contact the custodian where the brokerage account is housed, liquidate the $100,000, and transfer it into the estate account. Once complete, Mike can make a final distribution of the $150,000 to Brendan, the sole beneficiary named in Mike’s Will.

Simultaneously, as Trustee of Mike’s Revocable Trust, all Roger has to do is file Mike’s death certificate and acceptance of his appointment as Trustee of Mike’s Revocable Trust with the appropriate Registry of Deeds or District of the Land Court. Once these documents are on record evidencing Roger’s role as Trustee, Roger has the power to immediately hire a broker, list Mike’s house for sale, and sign any applicable Purchase & Sale Agreement. Upon the closing, the proceeds of the sale would be wired or transferred directly into the Trust bank account that was either already setup during Mike’s lifetime, or created by Roger after his death. Then, Mike would distribute the sales proceeds directly to Melinda, the sole beneficiary named in the Trust.

While both of these steps sound similar enough, it is imperative that the Personal Representative and Trustee keep these funds separate, and take the proper steps in administering the estate as compared to carrying out the terms of any Trust document. This is especially true when the named Personal Representative and successor Trustee of an estate plan, like Roger in the aforementioned example, are the same person, which is a very common occurence. 

How we Help our Clients on the South Shore and Greater Boston Area

Many families incorrectly assume that when someone passes away, all of their assets automatically move into a trust, or that everything gets lumped together. However, if the decedent had a trust and assets subject to probate, the fiduciaries (Personal Representative and Trustee) must carefully separate the administration of the estate from ongoing trust management. Keeping detailed records of all expenses and distributions is imperative to avoiding liability and costly mistakes down the road.

At Lane, Lane & Kelly, we help families navigate the complexities of probate administration when a loved one passes away during a very emotionally-grueling time. We have also helped countless families across the Commonwealth with proactive and comprehensive estate planning for the ultimate peace of mind. Regardless of your goals and your situation, our Attorneys are here to help you. Voted the Top Law Firm on the South Shore, don’t trust just anyone to handle your most sensitive legal needs. Contact our Attorneys today to get started.

This blog is made available for educational purposes only as well as to give you general information and a general understanding of the law, not to provide specific legal advice. By reading this blog you understand that there is no attorney client relationship between you and Lane, Lane & Kelly, LLP.