Avoid Unnecessary Family Disputes With a Letter of Instruction

The time immediately after the death of a loved one can be stressful and overwhelming. Family members are grieving, and on top of this, they must handle a variety of organizational and legal tasks. In many cases, there can also be disputes concerning who gets certain possessions, which can make the whole situation even messier and create some ugly conflicts. Fortunately, you can minimize many of these complications by addressing these matters ahead of time and creating a letter of instruction, which is generally broken down into three parts.

1) Funeral Arrangements
This typically begins with making a list of all the people, organizations, agencies, and professionals who should be notified upon your death. You should include contact information like phone numbers, email, and mailing addresses, along with any other pertinent details. If you are an organ or tissue donor, you will want to also include relevant information.
You will need to leave everything your loved ones should know about your burial method, including whether you will be buried in a plot or cremated. In the event that you have paid for funeral arrangements in advance, you should include this information as well.

2) Financial and Personal Affairs
When it comes to finances, you can start by listing contact information for your attorney, stockbroker, employer, insurance agent, financial planner, etc. You should make it as easy as possible to reach anyone involved with your financial matters. It’s also important to make note of all your financial accounts such as checking, savings, retirement funds, and credit cards. If you want to contribute to any charitable organizations, you will also need to include their contact details.

For personal affairs, you should state the location of documents like your birth certificate, marriage certificate, divorce papers, diplomas, etc. This should streamline things and make it much easier for your loved ones to get your documents organized.

Since there is a lot of sensitive information concerning financial and personal affairs, you need to ensure that all records are kept in a safe place like a fireproof lock box in your home. The only people who should have access to the lockbox are you and your executor.

3) Distribution of Personal Effects
Finally, it’s smart to go in-depth about how your personal possessions should be distributed among family and friends. Basically, this will elaborate upon your will and take it one step further so there is no confusion or disputes. This is where you state who gets smaller items like your electronics, books, dishes, and so on.

While there is some debate as to whether you should discuss whom you plan to give what ahead of time, it’s usually not a bad idea to sit down and go over things while you can still get everyone’s input. If a certain family member has no interest in a particular item, then you could give it to a different family member who could make better use of it. Also, don’t forget to make arrangements for who will care for your pets.

Undue Influence . . . Part I

Sometimes clients have concerns about whether their Estate Plan could withstand a challenge after their death. If the plan deviates from the equal treatment of all beneficiaries in the same class, then that may cause a client to worry about how best to protect the plan. Often the unequal treatment results because one beneficiary took on a caregiver role as the testator aged. Perhaps a niece or nephew stepped in when the client’s children were out of state. Regardless of the reason, many a beneficiary who has not received what they considered their “fair share” of an estate has challenged an Estate Plan based upon undue influence. This first part of a two-part series explores the concept of undue influence and the second part will provide practical advice for preventing an undue influence challenge in an Estate Plan. 

Undue influence occurs when someone takes unfair advantage of another individual, usually elderly, especially when the first individual holds real or apparent authority over the elderly person. Simple enough to explain but harder to understand. To gain an understanding of what constitutes undue influence requires an examination of the underlying behavior. The American Bar Association indicates that undue influence occurs when an individual in a fiduciary capacity or other confidential relationship substitutes their own desires for that of the influenced person’s desires. Put another way, a person influenced the testator in such a way that convinced the testator to alter his or her Estate Plan, usually in favor of the individual exerting the undue influence and to the detriment of the testator’s other beneficiaries. 

The states vary widely in their definition of undue influence. Some states, like Florida, Georgia, Louisiana, Nevada, North Dakota, South Dakota, and Ohio, have partial definitions in their statutes which broadly define undue influence as something that occurs when a fiduciary or confidential relationship exists and one person substitutes his own will for that of the donor’s will. Other states have definitions of undue influence in their civil code or penal code, rather than their probate code. In addition, most states, like California, have case law that sets out defining aspects of undue influence. It appears that most states rely upon case law to determine what constitutes undue influence and most of the time it occurs in the probate context. Each state lists certain factors that indicate the presence of undue influence, such as intimidation, physical threat, or coercion. Perpetrators of undue influence use subtle tactics and usually enjoy a close relationship with the testator. 

In any undue influence case, it’s vital to understand which party has the burden of proof. While you may assume that all states impose that burden upon the plaintiff, that’s an oversimplification of the matter. Some states, like Florida, allow the plaintiff to demonstrate a few threshold facts that will raise the presumption of undue influence. Accordingly, when the presumption of undue influence arises, the alleged wrongdoer bears the burden of proving there was no undue influence. Usually, the defendant can easily overcome the presumption and the testator’s Estate Plan will stand. 

Interestingly, Virginia recently enacted a statute effective July 1, 2022, essentially creating a presumption that undue influence occurred when alleged. While it’s unclear what facts the plaintiff will need to show to raise the presumption, this represents a departure from prior law which created a temporary presumption that defendants could easily overcome. The new law alters the burden of persuasion in most circumstances. Under the new statute, the plaintiff receives the benefit of a “presumption” that undue influence was exerted over the decedent, and the burden now shifts to the defendant to rebut that presumption. In other words, the defendant now has the job of convincing the jury or judge that undue influence did not occur, and if the defendant does not meet that burden of persuasion, the defendant will lose. 

As this article demonstrates, undue influence is a grey area of the law. Certain facts provide clues that undue influence may have occurred. As noted above, if the person leaves their assets in a way that departs from the norm or favors one child to the exclusion of all others, that might be a sign of undue influence. If an elderly person disinherits their children or grandchildren in favor of their caregiver, that might also signal undue influence. Of course, that doesn’t mean that you cannot leave your assets in a usual manner. It simply means that if you choose a unique disposition for your assets you need to take additional precautions in creating your plan. Keep the possibility of an undue influence claim in mind.

There are many factors to consider when creating your Estate Plan and potential challenges to it. It’s important to evaluate your beneficiaries and understand whether they have expectations regarding an inheritance and how far they might be willing to go if your plan fails to meet those expectations. While many state legislatures are doing more to protect the elderly and their Estate Plans, others seem to be opening the door to increased litigation. By consulting with me, you can minimize the risk of a challenge to your Estate Plan based upon undue influence. 

How Do I Trust . . . Part III

Many Estate Plans rely upon a revocable trust as one of the foundational documents in the plan to avoid probate. Sometimes, plans include irrevocable trusts to achieve tax-driven results or for other reasons. No matter which kind of trust a client considers, of the many decisions that clients make when creating an Estate Plan, naming a trustee tops the list in importance. Some clients prefer to name an institution or entity to serve as trustee.

Entities serving as trustees provide numerous benefits. For example, a client naming a corporate trustee generally has less concern regarding the judgment, experience, impartiality, investment sophistication, accounting, record-keeping, or potential conflicts of interest of the entity. Most institutional fiduciaries bring substantial business skills to the office of trustee. The individuals working for the entity and monitoring and administering the trust account usually report to a board, committee, superiors, or a combination of all three to confirm proper investment, administration, and distribution of trust assets. Corporate trustees understand the market and have experts to guide investment choices. Clients benefit from this knowledge. In addition, most corporate trustees have a plethora of attorneys, accountants, and other professionals to whom they can refer a beneficiary, even on an unrelated matter. The grantor and beneficiary benefit from both the internal and external relationships of the institutional trustee.

As noted above, a corporate trustee brings experience, objectivity, and professional resources to the office of trustee. For this reason, corporate trustees tend to dampen family squabbles that might otherwise result from naming an individual to serve as trustee. Consider the resentment that could occur from naming one family member as trustee of the trust created for the benefit of another. Further, with an individual trustee, beneficiaries may wonder whether another beneficiary has influenced the trustee because anytime the trustee says yes to one beneficiary, that almost universally means saying no to another. Corporate trustees operate without bias and comply with both federal and state regulations. Thus, what the trust and beneficiaries lose in personalization, they gain in oversight.

Corporate trustees bring continuity to the office of trustee. Entities have perpetual life absent catastrophic circumstances, whereas, all individuals die, sometimes unexpectedly. Naming a corporate trustee removes the burden of naming a successor trustee and guarantees that the same trustee continues to serve for the duration of the trust unless removed. A corporate trustee possesses the potential ability to manage the trust in perpetuity from record-keeping to asset management which, given the increasing length of most trusts, adds another benefit to the beneficiaries.

Finally, corporate trustees should understand the complex tax implications for a trust. For example, they understand and can explain the impact that allocation of gains and losses will have on the income of the trust and its beneficiaries. Naming a corporate trustee may also provide gift and estate tax benefits as well because provisions of the Internal Revenue Code qualify an entity as an independent trustee which could carry significant tax benefits for the grantor and beneficiary by preventing inclusion of the assets in the estate of either. This also allows the grantor to include broad discretionary distribution powers in the trust.

All these benefits come at a cost. Institutional trustees tend to charge higher fees than individuals and some beneficiaries miss the personal touch that comes along with the use of an individual trustee. Many of us have heard stories about an unresponsive corporate fiduciary. Typically, only specified financial institutions, such as banks and trust companies may serve as trustees. In some states, a charity may serve as trustee of a trust benefitting that charity, or another one. Some states require the institutional trustee to have a substantial presence in the state in which administration of the trust occurs. Other states have reciprocity rules and permit a corporate fiduciary from another state to serve if the other state recognizes corporate fiduciaries from the first state. Even if the foreign entity otherwise meets the requirements to serve in another state, the entity needs to file all necessary documents to qualify to do business in the new state. This often requires designation of a resident agent along with other information.

Although many clients may fear the perceived loss of control that comes with a corporate trustee, as this article demonstrates, naming such a trustee provides many benefits. The size and complexity of the trust plays a role in determining whether an individual or corporate trustee should serve. The individuals administering the trust for a corporate fiduciary interact with other highly qualified individuals to provide the best result for a beneficiary. Corporate trustees can ignore family tension and have well-defined policies regarding distributions. The grantor may include broad discretionary distribution powers without worrying about the potential income tax implications for the corporate trustee. Corporate trustees combined with broad discretionary distribution power may provide significant creditor protection. Finally, clients may leave a level of control with the family by allowing the beneficiaries to remove and replace a corporate trustee. The grantor of a trust has competing interests to consider in naming a trustee. With my assistance, a client can determine whether a corporate trustee or an individual trustee will serve the family’s needs better.

How Do I Trust . . . Part II

Many Estate Plans rely upon a revocable trust as one of the foundational documents in the plan to avoid probate. Sometimes, plans include irrevocable trusts to achieve tax-driven results or for other reasons. No matter which kind of trust a client considers, of the many decisions that clients make when creating an Estate Plan, naming a trustee tops the list in importance.

After clients create the basic documents in their Estate Plan, they begin to consider more advanced techniques, usually involving the use of irrevocable trusts. Many clients use irrevocable trusts to lower their potential estate tax liability. These same clients may want to ensure that the beneficiaries cannot retrieve the funds before their death or to prevent a beneficiary’s creditors from acquiring trust assets. Some even want assurances that they could access the funds, if necessary. In most circumstances, retaining too much power causes the gift to fail, resulting in estate tax inclusion thereby thwarting the original goal.

If a client creates an irrevocable trust to remove rapidly appreciating assets from his or her taxable estate, then any appreciation on those assets will escape taxation upon the client’s later death if structure correctly. If the trust gives the trustee the sole, unlimited, or absolute discretion to make distributions of income or principal to the beneficiaries, then the Internal Revenue Service (“IRS”) considers that an incomplete gift for gift tax purposes, and Internal Revenue Code (“Code”) Sections 2036(a)(2) and 2038 would pull those assets into the trustor’s estate if the trustor is the trustee. If, however, the trust includes the ascertainable standard of health, education, maintenance, or support (“HEMS”), then the IRS considers the gift complete and the assets outside of the grantor’s estate. If the trustor insists upon serving as trustee, any power to make distributions not limited by the HEMS standard needs to be exercisable by a trustee other than the trustor. As explained in more detail below, other trust powers could cause inclusion in the trustor’s estate if the trustor serves as trustee. For that reason, if the trustor desires to avoid estate tax inclusion above all else, then the trustor should name another individual to serve as trustee.

Related to Code Section 2036(a)(2), Code Section 2036(a)(1) includes assets in the trustor’s estate if the trustor makes a gift but retains the possession or enjoyment of, or the right to income from, the property. If the trust named the trustor as a permissible beneficiary of the trust and an independent trustee had the sole, unlimited, and absolute discretion to make distributions from the trust, then it seems that the trustor Ha avoided this Code Section. However, that’s not always the case. In many states, even if the trustor has named an independent trustee, acting in their sole, unlimited, and absolute discretion to make distributions to the trustor, that causes the inclusion of the trust assets in the grantor’s estate. Although a handful of states including Alaska, Colorado, Delaware, Missouri, Nevada, Rhode Island, and Utah have passed statutes that permit the grantor to be a discretionary beneficiary of a trust without causing estate tax inclusion, if there is an understanding regarding distributions to the trustor, then that could lead to estate tax inclusion. Even in these states and even absent an implied understanding regarding distributions to the trustor, the planner needs to follow the statutory requirements carefully, otherwise, the trust may not achieve the desired result.

By serving as trustee of an improperly drafted trust, the trustor could defeat that plan. This is the case even if the trustor is a co-trustee rather than the sole trustee, or if the trustor retains the power to veto power of distributions. Thus, it’s usually best for the trustor to refrain from serving as trustee unless there is an explanation of the permissible exercise of power, includes the appropriate distribution standard, and sanitizes the trust of any power that could cause inclusion. However, most I recommend that the Trustor name another individual to serve as Trustee to avoid any possibility of inclusion. Thankfully, the trustor need not ignore the office of trustee entirely. The trustor may retain the power to appoint a co-trustee or successor trustee without causing inclusion of the trust assets in the trustor’s estate upon death. In fact, according to Revenue Ruling 95-58, the trustor may even retain the right to remove a trustee and appoint a successor trustee not related or subordinate to the trustor within the meaning of Code Section 672(c).

Finally, if the trustor is not serving as trustee, the trustor needs to understand whether the trust contains powers to make it a grantor trust. If the trust contains certain powers that make it a grantor trust, then the grantor will be treated as the owner of the trust for income tax purposes and will need to include any trust income on their Form 1040. Certain powers, for example, the power to pay life insurance premiums, the power to add beneficiaries, or a charity, to the trust, and the power to substitute assets in a non-fiduciary capacity all-cause grantor trust status. Well-drafted trusts cause grantor trust status for income tax purposes but avoid estate tax inclusion for the trustor upon the trustor’s death and often serve as the base for advanced estate planning techniques.

Most people understand the need for foundational documents and have less trouble deciding who should serve as trustee because that trustee will not serve as trustee until after the trustor’s death. Those clients who want to take advantage of tax planning and create irrevocable trusts during life inevitably want to name themselves as trustee. As is demonstrated herein, a trustor needs to consider the purpose and the provisions of the trust to comprehend the potential income, gift, and estate tax consequences that could result from serving as trustee.

How Do I Trust My Trustee?

A revocable trust is often the foundational document in the plan to avoid probate. Probate can be an expensive, time-consuming, and public process. Some plans include irrevocable trusts to achieve tax-driven results or for other reasons. No matter which kind of trust we consider, of the many decisions that clients make when creating an Estate Plan, naming a trustee tops the list in importance. While any competent adult may serve as trustee, many states place restrictions on which entities may serve as trustee.

Let’s start with location, which should be one of the more obvious considerations for a trustee. A trustee should be a United States (U.S.) person for tax purposes. If any of the following are true: a non-U.S. person serves as sole trustee, non-U.S. persons constitute at least half of the trustees, or if a non-U.S. person may make any “substantial decisions,” then according to Treas. Reg. 301.7701-7(d)(1)(ii), the trust will be considered a foreign trust for income tax purposes. Generally, foreign trusts have increased reporting requirements for contributions to or distributions from the trust. The U.S. grantor of the trust needs to file the Form 3520, Annual Return to Report Transactions with Foreign Trusts, and the Trustee needs to file the Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner. If the Trustee fails to file that form, then the U.S. grantor may face penalties. In addition, Internal Revenue Code (“IRC”) Section 684 triggers gain recognition when no U.S. beneficiaries exist or when the trustor dies. Thus, if possible, name a U.S. person as trustee or find a suitable entity to serve. Note that under some circumstances, naming a trustee who lives in another state may subject the trust to state income tax if the trustee resides in a state that determines the domicile of the trust-based upon the residence of the trustee. Clearly, a Grantor(s) needs to analyze location when determining who to name as trustee.

Aside from selecting a U.S. person to serve as trustee, let’s examine some of the important characteristics that a trustee should possess. The word “trustee” contains the word “trust” which provides the first clue about who will make a good trustee: someone the Grantor(s) trusts. An individual serving as trustee will have to make numerous decisions throughout the administration of the trust and these decisions require a certain degree of judgment, experience, impartiality, investment sophistication, record-keeping ability, and the ability to avoid conflicts of interest. The trustee will need to follow the letter and spirit of both the trust agreement and the governing state statutes. These decisions become more complex when tension exists between the beneficiaries. Many clients believe that naming siblings as co-trustees will force the siblings to work together. Often, it has the opposite effect and causes resentment and a situation in which quid pro quos are the norm. Another common situation involves a trust created for the benefit of a spouse during their life with the remainder to children who are not the biological children of the surviving spouse. Giving the trustee power to make distributions of principal for the surviving spouse would reduce the amount passed to the children upon the death of the surviving spouse. The individual serving as trustee needs to understand these family dynamics and the potential for rifts to occur. Clients often believe their family to be immune to these behaviors, but a well-counseled and wise client understands that these problems occur frequently and plans for them.

Once the Grantor(s) has confidence that the proposed individual trustee possesses the power to navigate a messy situation involving beneficiaries, the Grantor then needs to understand the powers that the trust agreement gives to the trustee and the impact of those powers. This begins with deciding what distribution standard will guide the Trustee. Giving a trustee absolute, unlimited, or sole discretion puts the trustee in complete control of distributions and makes it harder for a beneficiary to compel distributions if the trustee isn’t making them. While this standard provides the highest level of asset protection, it comes at a price. One option would be instead to insert a power to distribute for health, education, maintenance and support, also knowns as the “HEMS” standard. The HEMS standard provides less asset protection because if a potential creditor falls into any of those categories, that creditor may be able to defeat the asset protection component of the trust.

The HEMS standard plays an important role in trust distributions for other reasons as well. If a beneficiary serves as trustee of their own trust, but can make distributions in their absolute, unlimited, or sole discretion, then that beneficiary has a general power of appointment over the assets in that trust. IRC Section 2041 will include assets over which a beneficiary has a general power of appointment in the estate of that beneficiary upon the death of said beneficiary. If the beneficiary does not have a taxable estate, then estate tax inclusion may not matter. Further, if a beneficiary trustee may make distributions to another beneficiary under the absolute, unlimited, or sole discretion standard, then that beneficiary-trustee may have made a gift to the other beneficiary. Clearly, using the HEMS standard for distributions provides safeguards, especially when a beneficiary serves as trustee.

Finally, the Grantor(s) needs to consider who will serve should the original choice be unable or unwilling to serve. The same considerations discussed above should guide the Grantor(s) in selecting a successor trustee. Clearly, competing interests color the appointment of an individual trustee. An individual with the right temperament may reside in an undesirable location. The Grantor(s) may lack individuals with the right temperament. Finally, even if the trustee resides in the U.S. and has the other necessary skills, the Grantor(s) needs to review and understand the distribution standards in the trust to avoid undesirable consequences.