Author Archives: Robert Mondo

While judicial and nonjudicial modification and decanting derive from state law, trust protector provisions originate from the trust instrument itself and by extension, from the grantor. The grantor decides which powers to give a trust protector. For example, the trust protector may possess the power to remove and replace a trustee or appoint additional trustees; to direct, consent, or veto investment decisions; to modify the trust in response to changes in tax or state law; to change governing law or situs; to appoint assets to a class of people or charity in a non-fiduciary capacity; to alter beneficial interests in the trust; to modify the trust in response to changes in trust assets; or to turn off grantor trust status. Think about the trust protector as someone who fixes a specific issue only and has no input regarding daily trust administration.

You may be wondering how a trust protector differs from a trust advisor, distribution advisor, or special trustee. The powers given, rather than the name used, determine whether the party is a trust protector. Trust protectors have a limited but vital role and maintain the power to adjust the trust in the future, long after the creation of the trust and perhaps, after many generations when the trust needs a quick fix. Any time you change an irrevocable trust, ensure that there are no unintended tax consequences, either to a beneficiary, or the grantor.

While it is tempting to think of a trust protector as a trustee, remember that the trust protector may not have the same fiduciary duties as the trustee. State law determines whether trust protectors have fiduciary duties. Some states, like Missouri, have statutes that presume that the trust protector is a fiduciary but allow the grantor to override that presumption in the trust instrument itself. Other states, like Alaska, impose the reverse presumption that a trust protector is not a fiduciary and require that the trust protector be made a fiduciary in the trust itself, if desired. Remember to consider the interplay between the trustee and the trust protector, especially if you intend for the trustee to take direction from the trust protector.

Donald established a trust for the benefit of his nephews, Huey and Dewey, naming his nephew, Louie, as trustee and Webby Vanderquack as trust protector. Louie makes distributions to Huey and Dewey in his sole discretion, for the lifetime of each of Huey and Dewey. Huey, Dewey, and Louie recently had a falling out over rights to their latest movie. Louie threatens to withhold distributions to Huey and Dewey. Webby, as the trust protector, can remove Louie and replace Louie with Donald’s friend, Mickey. In this situation, the trust protector exercises her power to name a new trustee who will resume distributions to the beneficiaries without the current trustee’s cooperation and without court intervention thereby solving the issue. This is but one example of the many ways that a trust protector can exercise her listed powers and fix the trust to better address beneficiary needs.

If you have concerns about how an irrevocable trust can adapt to changing needs over time, consider naming a trust protector who can adjust the trust to account for changes in beneficiaries’ needs or changes in the laws. Trust protectors avoid court, do not require the cooperation of the trustee or beneficiaries, and can solve a problem quickly. The use of a trust protector adds flexibility to a trust, especially when limitations or obstacles prevent judicial and nonjudicial modification or decanting. Remember that the trust protector has the powers listed in the trust. With some careful consideration of the trust protector’s powers, it’s easy to create an irrevocable trust that will evolve with changing needs.

Have you ever wondered what information they need to create a moving, memorable memorial service or funeral? You can use this checklist of questions to have answered BEFORE a loved one dies. Many of these questions are directed to “you,” but you can direct them to someone else.

Have arrangements been made for cremation or burial with a funeral home/cemetery, cremation service provider, or body donation service?

What is the contact information for that (those) service provider(s)?

If arrangements have been made, has funding been provided through insurance (pre-need, final expense, or other), a payable on death account, or some other method?

These next questions cover the Five W’s: the Who, What, When, Where, and Why of holding a memorial service — important details that will help make a memorable, meaningful, moving event.

Who do you want to conduct a celebration of life, memorial service or funeral? That could be trusted clergy, a celebrant, a talented friend or relative, or another special person. What is their contact information?

Who else do you want to speak at this event about your life? Would you want to honor specific people by inviting them to participate in another way, such as singing, dancing, playing music, or reciting a reading?

Who needs to be invited to your life celebration and what is their contact information?

What organizations need to be contacted to alert fellow members and friends about the memorial service?

What — if any — organization(s) would you have people support with memorial donations in lieu of flowers?

What three or four pieces of music are meaningful to you and why? Would you want a musician to play a particular instrument as part of the event?

What poems, prayers or other readings have significance for you?

What motif or theme best represents your life? Items reflecting your values, hobbies, and handiwork can be on hand at the event, and even given away to attendees as memorial gifts.

What are your favorite colors and flowers (if any)?

What words of wisdom would you want to share with those who want to celebrate your life?

What do you want done with your remains, if cremation is your choice? (Saying you don’t care isn’t helpful.)

When would be a good time to celebrate your life? Would you want to associate this event with a particular holiday or time of year? Does your family need to coordinate travel around school schedules?

Where do you want to hold your life celebration event? If you are religious, would you want it held in your congregation’s house of worship? If you aren’t religious, what meaningful places could accommodate a ceremony and a party?

Why is a specific location for your life celebration important to you?

What other details might you wish to specify? To provide particular foods or drinks? Have a balloon release or candle-lighting ceremony? Gifts to give the guests?

Do you have any special requests for guests attending your life celebration? Some suggestions – dress in a particular color or style of clothing, bring a donation for a charity, or bring a story or photo to share at the event.

Unlike judicial and nonjudicial modification or the use of a Trust Protector, decanting relies upon an extension of the trustee’s existing power to distribute trust assets.  In states that recognize decanting, the trustee exercises their power to distribute trust assets and moves them from a trust with unfavorable terms to a trust containing more favorable terms, much like pouring wine from the bottle into a decanter brings better flavor to the wine.

Depending upon state law, the new trust could provide opportunities to correct a drafting mistake, clarify ambiguities, correct and update trust provisions, remedy problems in administration, change trust situs, expand or limit trustee powers, restrict beneficiaries’ rights to information, provide asset protection, adjust trustee succession, appoint a trust protector, alter distributions, or adapt trust provisions to address changes in beneficiaries’ circumstances.  Over half of all states have enacted statutes authorizing decanting.  Each state’s statutes regarding decanting vary widely, although most recognize that if a trustee has discretionary power to distribute trust corpus to the beneficiaries, such power constitutes a special power of appointment enabling the trustee to appoint the trust corpus to a new trust for the benefit of those same beneficiaries.

Even if your state statutes do not specifically authorize decanting, you may still have options.  If the problematic trust allows for a change in situs, then the trustee or other authorized party can utilize that provision to move the administration of the trust to a state that allows decanting.  Once the trustee changes situs, then the trustee can take advantage of the new state’s decanting statutes.  Most states that allow decanting have adopted some form of the Uniform Trust Decanting Act. Note that experts tend to cite South Dakota as the state with the most favorable decanting statute.

Let’s review an example to see the practical application of decanting.  Assume that Donald established a trust for the benefit of his nephews, Huey, Dewey, and Louie naming Webby Vanderquack as Trustee (Webby is an independent trustee because she is not related or subordinate to Donald).  Webby makes distributions to Huey, Dewey, and Louie in her sole and absolute discretion and the terms of the trust provide for outright distribution to each of Huey, Dewey, and Louie in a few years.  Huey recently became disabled and receives government benefits.  Huey has expressed concern that he will lose his benefits if he receives the trust assets outright.  Dewey just finished his third stint in rehab and Louie is in the middle of a nasty divorce.  Webby proposes to decant the trust assets to a new trust that contains a special needs trust for Huey’s benefit and lifetime trusts for each of Dewey and Louie.  This new trust provides additional protections for Huey, Dewey, and Louie, based upon circumstances that Donald could not have reasonably anticipated when he established the trust.  This is but one example of the myriad ways that decanting allows the Trustee to create a new trust that better addresses the beneficiaries’ needs without unfavorable tax consequences.

If you think that decanting might provide a solution for your trust troubles, make sure that you consult a qualified Estate Planning attorney regarding your state’s decanting rules.  The trustee needs to comply with their fiduciary duties which becomes more difficult if the trustee occupies the dual role of trustee and beneficiary.  You want to ensure that you avoid unintended tax consequences to the grantor and beneficiaries.

Decanting provides a great estate planning opportunity in the current environment.  Clients alike are encouraged to review their plans, especially irrevocable trusts created many years ago to confirm that those trusts accomplish the goals of the grantor and properly protect the needs of the beneficiaries.  If the trust fails to properly address beneficiary needs or otherwise could use some tweaking, decanting provides a great opportunity to re-write the trust with more favorable terms.

Sometimes circumstances change in ways you never anticipated when signing your irrevocable trust. While you cannot reverse time, there are a few ways that you might be able to modify an irrevocable trust.

Many think that an irrevocable trust cannot be modified, amended, or terminated without great difficulty. While that may have been true years ago, that’s no longer the case. If you want to modify an irrevocable trust, you have several options to consider. An experienced estate planning attorney can decide on the best course after consideration of your unique circumstances.

For the thirty-five states that have enacted the Uniform Trust Code (“UTC”), section 411(a) allows a trustee, beneficiary, or the grantor of the trust to bring an action to modify such trust if the grantor and all beneficiaries agree, even if the modification violates a purpose of the trust. This powerful provision allows the parties to re-write the trust if everyone consents. Section 411(b) of the UTC allows modification without the grantor’s consent or, in the case of a deceased grantor, if the proposed modification is not inconsistent with a material purpose of the trust. Lastly, section 411(e) of the UTC allows modification over the objection of a beneficiary if such modification is not against a material purpose of the trust and if adequate protections exist for the objecting beneficiary.

Even in the fifteen states that have not enacted the UTC, it may be possible to bring an action to modify an irrevocable trust. For example, some non-UTC states have statutes similar to those of UTC states and allow modification if the objecting party has adequate protection. Review your state’s statutes to determine whether a judicial modification is an option and if so, the requirements for modification.

For those looking for a less expensive and faster way to modify trusts, section 111 of the UTC allows interested persons to enter into a nonjudicial settlement agreement (“NJSA”) as to any matter involving a trust. The agreement cannot violate a material purpose of the trust and must include terms and conditions that could be approved by the court. The UTC limits the matters resolved by an NJSA; however, interested parties have broad latitude in the use of an NJSA to resolve trust matters. Some non-UTC states such as Delaware, Idaho, Illinois, and Washington have adopted statutes allowing the use of NJSAs. Ultimately, reviewing proper statutes, determining the interested parties, and confirming allowable modifications are threshold questions to the inquiry.

Let’s review an example to see how this might work. Mike set up an irrevocable trust for the benefit of Greg, Peter, Bobby, Marcia, Jan, and Cindy naming Carol as trustee and Alice as successor trustee. Mike and Carol subsequently divorced and pursuant to the terms of the trust, Carol was removed as trustee and Alice began serving. Unable to deal with the loss of her job when Mike and Carol divorced, Alice begins making questionable decisions, including investing trust assets in a failing cleaning company. Mike dies shortly after his divorce from Carol. Greg, Peter, Bobby, Marcia, Jan, and Cindy all live in a UTC state and decide that Alice has failed in her duties as trustee. They wonder if the use of an NJSA could remove Alice and appoint Carol as trustee in her place. Alice has agreed to resign and Carol’s appointment does not violate a material purpose of the trust, thus the parties can use an NJSA to appoint Carol as trustee in place of Alice.

For UTC and non-UTC states alike, multiple options exist to modify an irrevocable trust. Given the current high exemption and possible changes to the tax code, now is a great time to review existing estate plans that include irrevocable trusts. Using judicial or nonjudicial modification can add flexibility to those trusts to account for changed circumstances. For advisors with clients desiring to make changes to their irrevocable trusts, review local statutes to determine whether court approval is required or whether an NJSA will work. For those properly motivated, these methods provide certainty and an opportunity to achieve tax benefits, provide asset protection, and other potential benefits.

When a taxpayer makes a charitable gift, typically they get an offsetting charitable income tax deduction. However, sometimes it doesn’t end up reducing their taxes. Normally, in order to take a charitable income tax deduction, the taxpayer needs to itemize their deductions. However, if the charitable contribution and other itemized deductions don’t exceed the standard deduction amount, it makes sense to take the standard deduction and forego the itemized deductions.

For example, Charlie Charitable has taxable income of $100,000 each year. He is a single taxpayer and his standard deduction amount is $12,550 (in 2021). He has $10,000 of state and local taxes (an itemized deduction). In addition, he makes a charitable contribution each year of $2,500 to his alma mater. His itemized deductions would be $10,000 plus $2,500 = $12,500, i.e., less than the standard deduction amount of $12,550. It doesn’t make sense for Charlie to itemize his deductions since they would be less than the standard deduction he could take without itemizing.

A taxpayer could do several years’ worth of gifts in one year, thus pushing past the standard deduction amount. Then the taxpayer could make no charitable contributions in the “off” years and still take the standard deduction amount.

In our example, Charlie could make a charitable contribution of $10,000 in 2021. He’d have total itemized deductions of $20,000. This would save him the tax on $20,000 (his itemized deductions) less $12,550 (the standard deduction) = $7,450. Assuming he’s in a combined state and federal bracket of 40%, that would result in savings of nearly $3,000. In the “off” years of 2022, 2023, and 2024, he’d take the standard deduction amount each year and the strategy would not impact his taxes in those years. In 2025, he could repeat the large charitable contribution for another itemized deduction.

When Charlie makes the large contribution, he could make it to a Donor Advised Fund (“DAF”). He would get the income tax deduction in the year he makes the contribution, but he wouldn’t have to distribute the money from the DAF to the charity that year. He could recommend grants from the DAF to any public charity he desires. So, he could continue distributions to his alma mater, if he wished. But Charlie could decide to switch to a different charity. In the interim, Charlie could invest the funds as he determined was appropriate prior to their distribution to a charity.

A DAF can be used with other strategies. For example, Charlie could give his appreciated publicly-traded stock to the DAF. With that strategy, Charlie would get an income tax deduction for the full value of the appreciated stock, even though he never paid tax on the gains.

For example, let’s say the $10,000 Charlie gave to the DAF was in the form of a publicly-traded stock which was worth $10,000 but which Charlie bought for only $1,000. If Charlie had sold the stock, he would have had to pay tax on the $9,000 gain. Assuming a state and federal combined capital gain tax rate of 30%, he’d owe $2,700 on the gain. If he then contributed the proceeds to charity, he’d only have $7,300 to contribute to charity. By giving the appreciated publicly traded stock directly to the charity (or DAF), he would get even more bang for his charitable donation.

A DAF can be a great way to complement a charitable giving strategy. It allows one to maximize the tax benefit from charitable giving, while retaining a say over the timing and recipient of the money.

Sometimes, a family will have land and they want to keep it just the way it is. They don’t want the land developed. They want the family to continue to farm it just as they have for generations.

In the right circumstances, a charitable conservation easement can be a useful tool to help achieve this goal. The donor must be willing to put an easement on the property in perpetuity. The easement prohibits development but allows prior use, like farming. There are many more requirements which must be navigated. The charitable income tax deduction is spelled out in IRC section 170(h)(5)(A). If the land qualifies, the deduction is for the difference in the value of the land before the easement and the value of the land subject to the easement. (There may also be an estate tax exclusion available under section 2031(c) in addition to the property’s reduced value.)

Let’s look at an example:

The Smith family came from Europe to the United States three generations ago. They settled on a farm. They’ve been growing crops and raising livestock on the land ever since. Bob Smith is the current owner of the Smith farm. He’s getting up in years. Things have really changed since he was a boy. The farm used to be a two-hour drive from a major city. After new highways and suburban expansion, the farm is now surrounded by houses on three sides and is adjacent to a state park on the fourth.

As a farm, his land is worth about $1 million. Due to development pressures, the land would now sell for $2 million. Bob wants to keep the land in the family.

Assuming the land qualifies, if Bob places a conservation easement on the land, he and his family could continue to keep farming as they have for three generations. They just couldn’t develop the land. In exchange, they’d get a charitable deduction for the $1 million reduction in value. As with other charitable deductions, it would be subject to limitations based on Bob’s income, but the excess could be carried forward for five years. Once the land is subject to the easement, it’s fair market value would be lower in his estate at his death. It may even lower his property taxes, though that depends upon his local taxing authority.

Perhaps the biggest benefit to Bob is that his children won’t be pushing him to develop the land anymore!

A conservation easement may be a great way to achieve your goals while reaping tax benefits, too. However, be sure to avoid promoters pushing the abusive transactions laid out by the IRS in Notice 2017-10.

Estate Planning is about far more than documents. It’s also about the knowledge and experience of the attorney who drafts the plan.

Occasionally, those who aren’t Estate Planning attorneys will attempt to do their own Estate Planning. They think they can find a document online or use a friend’s document and can figure it out. Unfortunately, there are many pitfalls one could run across.

Let’s look at three of these pitfalls which one must sidestep.

Bill and Mary had a house worth $500,000, an IRA worth $500,000, and investments of $500,000. They have three children, Aaron, Betty, and Charlie. At the death of the survivor of Bill and Mary, they want to leave the house to Aaron, the retirement plan to Betty, and the investments to Charlie.

The first problem with this plan, even assuming they draw up documents which accomplish this distribution pattern, they may not have considered the downsides. Bill and Mary’s plan didn’t anticipate that they might sell the house, which they did. The specific bequest of the house to Aaron lapsed. They added the proceeds from the house to the investment account. Since their plan left the investment account to Charlie, those assets went to him instead of Aaron.

There’s a second problem with this plan, even assuming they draw up documents which accomplish the plan. They’ve not considered the income tax implications. While the three assets are the same value currently, the house and the investments get a step-up in basis at death. In other words, when the beneficiary receives the assets, they won’t owe income tax on them. However, the IRA is “Income in Respect of a Decedent” or “IRD,” which is an exception to the step-up rules. Assuming Betty has a marginal state and federal income tax rate of 40%, $200,000 of the IRA would be lost to income taxes. It might have been better to leave the IRA to Charlie who is in a lower tax bracket or spread the tax consequences over all three of them. After taxes, Betty would end up with $300,000, while each of her brothers would end up with $500,000.

There’s a third problem with this plan, even assuming they draw up documents which accomplish it. They’ve not considered fluctuations in the values of the various assets. Let’s say they die ten years after they draft the plan and the assets are then worth $3 million. But, their children won’t each get $1 million. In fact, one of the children might get far less than the others. How is that possible? The house bequeathed to Aaron could be in a neighborhood of decreasing property values. Its value declined to $100,000. Bill and Mary continued to contribute to the IRA designated to Betty and it was worth $1 million at the death of the survivor of Bill and Mary. The investments bequeathed to Charlie did quite well and were worth $1.9 million by the death of the survivor. Thus, Aaron would get the house worth $100,000. Betty would get the IRA worth $1 million (but subject to income taxation of $400,000). Charlie would get the investments worth $1.9 million. Thus, Charlie would get more than triple the after-tax value of his sister and 19 times the value of the bequest to his brother.

Estate Planning is about far more than documents. It’s also about the knowledge and experience of the attorney who drafts the plan.

Often, there is confusion regarding how a trust or a subtrust may report income and the TIN which should be used. Treasury regulations spell this out quite clearly. Treasury Regulation 1.671-4 is the relevant section.

A “nongrantor” trust is a trust which is not substantially owned by anyone pursuant to the provisions of section 671 and following. A nongrantor trust should obtain and use its own TIN. The trustee of the trust should provide the TIN of the trust and the address of the trust to banks and other institutions at which it has assets.

The income of the trust gets reported on the trust’s own tax return, Form 1041. The trust would receive a distribution deduction for distributions which carry out Distributable Net Income (“DNI”). These distributions to the beneficiary which carry out DNI then get taxed on the beneficiary’s tax return. The trustee would provide a Form K-1 to the beneficiary advising the beneficiary of the amount of income which the beneficiary must report on their tax return.

Let’s look at a quick example.

Mary set up an irrevocable trust. The trust contains nothing that would deem Mary or any other person as the substantial owner under Sections 671 and following. In other words, the trust is a nongrantor trust. The trust had $50,000 of income in the year. The trust made $20,000 of distributions to the beneficiary of the trust, Ben (Mary’s son). Those distributions were of cash and carry out DNI. Mary’s sister, Alice, is the trustee of the nongrantor trust. Alice will file a Form 1041 for the trust and report the $50,000 of income and a distribution deduction of $20,000. She’ll also provide Ben with a K-1 for the distribution of $20,000 to him. Ben will include the $20,000 of income from the K-1 on his tax return for the year.

Grantor trusts and nongrantor trusts each have their place in Estate Planning. Remember, whether a trust is a grantor trust or a nongrantor is not indicative of whether it is included in the taxable estate of the grantor for estate tax purposes, only income tax purposes.

Often, there is confusion regarding how a trust or a subtrust may report income and the TIN which should be used. Treasury regulations spell this out quite clearly. Treasury Regulation 1.671-4 is the relevant section.

Section 1.671-4(b)(2) provides that if a trust is treated as owned by one grantor or one other person, the trustee must either A) Furnish the name and TIN of the grantor or other person treated as the owner of the trust and the address of the trust to all payors for the taxable year, or B) Furnish the TIN of the trust and address of the trust. Of course, the latter method would also be used if the trust is a nongrantor trust.

A grantor of a trust is spelled out in Sections 671 to 677. For example, the power to revoke is listed as a power making a trust owned by the grantor under section 676. Under Section 678 someone other than the grantor may be treated as the owner of the trust for income tax purposes. Under Section 678, someone other than the grantor would be treated as the owner of the trust if they had the power to vest the corpus or income of the trust in themselves (i.e. a general power of appointment), or if they previously had such a power and they retained other powers under sections 671 to 677. There is an exception if the original grantor still is considered the owner of the trust. (Of course, upon the grantor’s death, the grantor is no longer considered the owner of the trust.)

Let’s look at two quick examples.

Example 1: Mary has a revocable trust. The trustee of Mary’s trust (who might be her or might be someone else) wants to use Mary’s TIN (which is her social security number). This is appropriate because Mary has the power to revoke the trust and is the owner pursuant to section 676. If the trustee preferred, they could choose to use a separate TIN for the trust.

Example 2: Upon Mary’s death, her trust sets up a subtrust for John. Under the subtrust, John has a right to withdraw the assets and income from the trust. This type of trust is commonly referred to as an “Access Trust” or a “Divorce Protection Trust.” Since John has a right of withdrawal and Mary is dead, John is considered the owner pursuant to Section 678 of the Code. The trustee of John’s subtrust may use John’s TIN (which is his social security number) as the TIN for the trust. If the trustee preferred, they could use a separate TIN for the trust.

If the trustee chooses to use the substantial owner’s TIN, the income would go directly to the substantial owner’s tax return and there’d be no need for a separate tax return for the trust. If the substantial owner isn’t the trustee, the trustee would need to provide the substantial owner a statement showing all items of income and deduction and other information which might be necessary for the substantial owner to take into account in computing their taxable income.

A grantor trust is “substantially owned” by someone under Code Sections 671 and following a common power which causes a trust to be a grantor trust is the retention of the power to revoke the trust under Section 676. A revocable trust is income taxed to the grantor and it’s also included in the estate of the grantor for estate tax purposes. However, a trust need not be included in the taxable estate of the grantor to be a grantor trust. A trust could be called what is known commonly, though confusingly, as an “intentionally defective” grantor trust. In reality, there’s nothing at all “defective” about such a trust. It’s excluded from the estate for estate tax purposes, but, taxed to the grantor for income tax purposes.

For example, if the grantor retains the power to substitute other assets of an equivalent value for the assets of a trust, it’s a grantor trust, pursuant to Section 675(4)(C).

A grantor trust can offer many advantages. First among those is simplicity from an income tax perspective. A grantor trust does not need to file its own income tax return but can report the income on the grantor’s taxpayer identification number. Second, the income from the trust is taxed to the grantor, whether or not it is distributed to the grantor. This may sound like a flaw, but it’s a huge advantage if the grantor is trying to remove value from their taxable estate. It allows the assets in the trust to grow tax-free because the grantor is paying the taxes on the income of the trust. It’s important to note that the payment of taxes by the grantor is not considered a gift by the grantor, but rather the grantor’s own legal obligation.

Let’s look at a quick example. Mary set up a trust and contributed $1,000,000 to the trust. The trust has $50,000 in taxable income and no distributions in the year. The $50,000 of taxable income is taxed on Mary’s income tax return. Mary pays the tax which she owes on the $50,000 of income, which comes to $20,000. Mary pays the taxing authorities the $20,000 from her own funds, not diminishing the trust’s assets. When Mary pays the $20,000, she is not making an additional gift to the trust.

A grantor trust allows assets to grow tax-free, much like a Roth IRA. This increased compounding power is a very powerful advantage for a grantor trust. The next article in the series will examine the tax reporting of trusts. In other words, what tax identification number and address does the trustee provide to the bank or brokerage company?