What Happens When You Don’t Trust Your Trustee – Part I

Estate Plans use both revocable and irrevocable trusts for a myriad of reasons. Regardless of the type of trust created, naming a suitable trustee to administer the trust tops the list of important considerations. After all, the trustee acts as the gatekeeper for the trust, doling out distributions based upon the trust agreement using their own discretion. A beneficiary serving as trustee only works in certain circumstances. Sometimes it’s necessary to name a third party to act as trustee. If a third party serves as trustee, what happens when the beneficiaries, for whose benefit the trustee administers the trust do not trust said trustee? This is the first part of a two-part series exploring the various options that beneficiaries of a trust may use to rid themselves of a trustee.

As with most endeavors, it makes sense to start with the path of least resistance. In this context, that means asking the undesirable trustee to resign. While the conversation may be uncomfortable, the trustee may surprise the beneficiaries and agree to resign. After all, if the beneficiaries are unhappy with the trustee, they likely have let the trustee know that. Such a trustee may resign gladly, especially from a trust with disgruntled beneficiaries. The outgoing trustee may or may not have to prepare an accounting and likely would ask the beneficiaries to sign a waiver absolving the trustee of any wrongdoing now or discovered in the future.

If the trustee refuses to resign, then the beneficiaries need to explore other methods of removal. They should look to the trust agreement itself to see if the grantor gave them the power to remove the trustee. I can guide the beneficiaries through the removal process and ensure that they follow the terms of the trust instrument precisely in exercising the power. Even if the document fails to include a power to remove the trustee, I can help the beneficiaries use other trust provisions such as change of situs, or appointment of a trust protector as a backdoor way to accomplish the ultimate goal of removing the trustee. Again, the outgoing trustee may have to prepare an accounting and would want a waiver of liability.

If the trust contains no provisions allowing the beneficiaries to remove the trustee, then things become more complicated. Beneficiaries have several other options to pursue the removal of a trustee. For beneficiaries in states that follow the Uniform Trust Code (“UTC”), the UTC permits the use of a Non-Judicial Settlement Agreement (“NJSA”) for a matter, if the matter does not violate a material purpose of the trust. Use of the NJSA requires agreement by all interested parties. Determining which parties qualify as interested requires a Trusts and Estates practitioner familiar with the statutory definition to ensure all interested parties agree. The UTC lists several matters that the NJSA may address, although jurisdictions diverge on whether matters not listed may be resolved using the NJSA. Generally, statutes allowing the use of the NJSA do not require court approval, although obtaining court approval would certainly prevent future disagreements on the matter.

If the NJSA will not work, UTC states also allow modification of a noncharitable trust by consent. The comments to the UTC, state statutes, and one state court decision prohibit the removal of a trustee by consent, although the consent may be used to address other areas of contention between the beneficiary and trustee. Interestingly, even if the modification by consent violates a material purpose of the trust, if agreed upon by the grantor and all beneficiaries, it’s allowable. Some states require court approval, others do not. Modification by consent usually requires the consent of the grantor; however, if the grantor does not or cannot agree, modification may occur if such modification is not inconsistent with the material purpose of the trust. Here again, some states require court approval, while others do not.

This article has explored a few options available to beneficiaries desiring to remove a trustee. Well-designed Estate Plans last for years and include provisions that allow the plan to evolve with changes in circumstances. Even if the plan lacks specific provisions regarding the removal of a trustee, beneficiaries have options worth exploring. I can help the beneficiaries avail themselves of certain statutory provisions to oust the undesirable trustee.

The Not-So Transparent Corporate Transparency Act

As part of the National Defense Authorization Act for the Fiscal Year 2021, Congress enacted the Corporate Transparency Act (the “Act”). Beginning on January 1, 2024, the Act and final regulations issued thereunder require any “Reporting Company” to provide certain information about its “Beneficial Owners” and “Company Applicants.” Failure to report this information may result in civil and criminal penalties. The Act imposes the duty to report to the Financial Crimes Enforcement Network (“FinCEN”) on any Reporting Company.

The Act contains several definitions to help determine which entities must report thereunder. The Act defines a Reporting Company as any entity formed by a filing with a secretary of state or any foreign entity that’s registered to do business in the United States by filing with a secretary of state. This intentionally broad definition means that any corporation, limited liability company, limited partnership, or limited liability limited partnership, along with any other entity formed by filing a document with a secretary of state, will be subject to the duty to report. General partnerships, sole proprietorships, and trusts do not file documents with a secretary of state upon creation and thus are exempt from reporting. The Act exempts twenty-three categories of organizations such as banks, credit unions, depositories, and securities brokers and dealers, all of which are already highly regulated. The Act exempts both tax-exempt entities and large operating companies from its reporting requirements. The Act defines tax-exempt entities as (1) any organization described in Internal Revenue Code (“IRC”) Section 501(c)(3) that’s exempt from tax under IRC Section 5012(a)(2); (2) a political organization described in IRC Section 527(e)(1); and (3) trusts described in IRC Section 4947(a)(1) or (2). The Act defines a large operating entity as any entity that employs more than twenty full-time employees.

Although the Act excludes many entities from its application, most privately-owned businesses will qualify as Reporting Companies and will have to disclose the required information timely or be subject to penalties. Every Reporting Company needs to report its legal name, any names under which it does business, a principal business address, the jurisdiction of formation, its taxpayer identification number, and its Beneficial Owners. If the Reporting Company is newly created, it also needs to report the individual who filed the formation or registration document for the Reporting Company, called the “Company Applicant” and, if different, the individual “primarily responsible for directing or controlling such filing.” The Reporting Company will need to disclose the name, date of birth, street address, a unique identifying number from a passport, driver’s license, or another such document, and a copy of that document of each Company Applicant, limited to two individuals, to FinCEN. The Act permits individuals who anticipate being Company Applicants to register for a FinCEN number that such individuals will provide to the Reporting Company instead of their personal information. The Act separates Beneficial Owners into two categories: (1) those who exercise substantial control over the Reporting Company; and (2) those who own at least 25% of the Reporting Company. For a Beneficial Owner to meet either definition, the Reporting Company needs to disclose the same information required for that of a Company Applicant.

If an individual serves as a senior officer of the Reporting Company, has authority over the removal of a senior officer or a majority of the board of directors, directs, determines, or has substantial influence over important decisions of the Reporting Company, or has any other form of substantial control over the Reporting Company, then such individual exercises substantial control. The Act defines a senior officer as anyone holding the position or exercising the authority of a president, chief executive, financial, or operating officer, general counsel, or any other officer who performs a similar function. Note that neither treasurer nor secretary is included as the Act views those roles as ministerial in nature. However, if an individual serving in a ministerial role otherwise exercises substantial control, then such individual will need to be reported as a substantial owner.

If an individual has an interest in equity, capital, profits, convertible instruments, or options, that equals 25% or more of the entity, then the Act considers that individual an owner thereunder. The Act includes both direct and indirect ownership. Trust and Estate attorneys need to advise clients that the Act considers a trustee who can dispose of trust assets that include a Reporting Company as a Beneficial Owner of that Reporting Company. Similarly, the Act includes the sole income and principal beneficiary of a trust owning an interest in a Reporting Company as a Beneficial Owner of such Reporting Company. Any beneficiary with the ability to withdraw substantially all of the assets of a trust containing an interest in a Reporting Company will also be a Beneficial Owner of such Reporting Company.

The Act has some complex provisions that have broad applicability. This provides only a brief synopsis of the most relevant provisions.

What You Need to Know About The Secure Act 2.0

It might be appropriate to say that Christmas came early for retirement advisors and consumers in 2022 when Congress passed, and President Biden signed into law, the $1.7 trillion omnibus spending bill that included Setting Every Community Up for Retirement Enhancement (“SECURE”) Act 2.0 (the “Act”). President Trump enacted the original SECURE Act in December 2019, making radical changes to retirement planning by increasing the age at which a taxpayer could contribute to their Individual Retirement Account (“IRA”), creating a new class of beneficiary called the “Eligible Designated Beneficiary” (“EDB”), and eliminating the lifetime stretch for any beneficiary who is not an EDB and instead implementing the 10-year rule. For those needing a quick refresher, EDBs consist of surviving spouses, children who have not yet reached the age of majority, chronically ill or disabled individuals, and any other individual not more than ten years younger than the participant, or appropriately structured trusts for the benefit of those individuals. EDBs are the only beneficiaries exempt from the 10-year rule, which operated like the 5-year rule from pre-SECURE Act. Thus, under the 10-year rule, a non-EDB need not worry about Required Minimum Distributions (“RMDs”) and only needed to withdraw all funds by December 31st of the year of the tenth anniversary of the participant’s death.

That changed when the United States Treasury released much-anticipated proposed regulations updating, among other things, the rules regarding RMDs from IRAs. The proposed regulations backtracked on some of the published guidance by adding the requirement of lifetime distributions to any non-EDB in years 1-9 after the participant’s death if the participant died after his or her Required Beginning Date (“RBD”). Now, any non-EDB needs to take annual distributions based upon the beneficiary’s life expectancy over the nine years following the participant’s death and exhaust the IRA by December 31st of the year of the tenth anniversary of the participant’s death if the participant reached their RBD. Thankfully, the Internal Revenue Service realized that this represented a sharp departure from the advice that many advisors were giving their clients and promulgated Notice 2022-53 that confirmed waiver of any excise taxes resulting from failure to take RMDs in either 2021 or 2022 for those years. A taxpayer who fails to take the required RMD in 2023 will incur liability for the excise tax.

SECURE 2.0 continues to build on this foundation by extending, clarifying, and expanding provisions of the original SECURE Act. First, the Act increases the age at which the participant needs to begin taking RMDs to 73 beginning in 2023 and lasting until 2032, at which time the age increases to 75. Note that there seems to be an overlap for 2032 which likely will be resolved under technical corrections. These provisions affect anyone reaching age 72 after 2022. Individuals aged 50 and over may contribute an additional $1,000 to their IRAs. That amount will be indexed for inflation beginning in 2024. In addition, the Act boosts catch-up contributions for employer plans including 401(k), 403(b), 457(b), SIMPLE IRAs, and SIMPLE 401(k) plans, also indexing them for inflation. These provisions take effect in tax years beginning after December 31, 2024.

Interestingly, taxpayers will be able to use funds from Internal Revenue Code Section 529 Plans (“529 Plans”) for something other than qualified education expenses without income tax consequences. The Act allows taxpayers to convert up to $35,000 from a 529 Plan to an IRA. The Act imposes several restrictions on the 529 Plans allowed to take advantage of this rollover as follows: the Plan must have been maintained for 15 years prior to the rollover, the amount converted for a year cannot exceed the aggregate amount contributed to the 529 Plan in the 5 years prior to the rollover, the amount must move directly from the 529 Plan to the IRA, and the amount, when added to any other IRA contribution cannot exceed the contribution limit in effect for that year. This provision becomes effective for 529 Plan distributions after December 31, 2023.

The Act provided relief to taxpayers by changing the statute of limitations for two excise taxes, the excess contributions tax and the excess accumulations tax on an IRA. Under prior law, the statute for excess contributions or RMD failures started running on the date that the excise tax return was filed. Taxpayers were unaware of the requirement to file Form 5329 leading to an indefinite statute of limitation for the imposition of excise taxes. Under the Act, the new statute of limitations for RMD failures is three years and begins to run when the IRA owner files an income tax return for failure to take the required distributions. The new statute of limitations for excess contributions is six years and begins to run when the IRA owner files an income tax return. These new limitations periods became effective upon enactment of the Act.

As most readers know, owners of ROTH IRAs have no requirement to take distributions during lifetimes; however, participants in any of a ROTH 401(k), ROTH 403(b), or ROTH governmental 457(b) accounts all were required to take lifetime distributions. The Act repealed that requirement for distribution years beginning in 2024. This provides additional planning opportunities for taxpayers considering whether to keep assets in a designated ROTH account or to roll such accounts into their ROTH IRA. Now participants no longer need to consider RMDs during their lifetime and can focus on investment choices, expenses, and asset protection.

The Act allows a surviving spouse to elect to be treated as the deceased employee for purposes of the RMD rules, effective beginning in 2024. A surviving spouse making such an election would begin RMDs no earlier than the date the deceased participant would have reached their RBD.  If the surviving spouse made the election and dies prior to their RBD, the RMD rules apply as if the spouse beneficiary was the employee providing an avenue of additional deferral for beneficiaries of the surviving spouse.

Finally, section 337 of the Act allows an IRA owner to create a trust for a disabled or chronically ill beneficiary, which are otherwise EDBs, and name a charity as a remainder beneficiary without disqualifying the trust as an EDB. Now, the trust may pay out to public charity, other than a Donor-Advised Fund, upon the death of the disabled or chronically ill individual without negative impact. This provides additional planning opportunities for clients with disabled beneficiaries.

Of course, the foregoing article only highlights a few of the many changes ushered in with SECURE 2.0. More to follow . . .