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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.

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.

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.

Assets owned by an individual provide the landscape for an Estate Plan. This second part will analyze the effects that title to assets has in estate planning, especially when using trusts.

Many well-drafted Estate Plans use trusts. Sometimes, clients simply want to avoid probate, which can be an expensive, time-consuming, and often, public process, and trusts present a great way to do that. Other individuals use trusts because of the benefits that they provide both during life, for example during a period of disability, and after the death of the grantor by providing asset protection, remarriage protection, asset management, and other benefits which might not be otherwise available. While I know that that trusts provide many benefits, some clients might question whether it’s necessary to use a trust for a property that’s held as tenants in common, joint tenants with rights of survivorship, tenants by the entireties, or community property.

If you hold title to an asset as separate property or as a tenant in common, that does not avoid probate. In addition, assets titled in either of those ways offer no asset protection or any other trust benefit noted above. For example, upon your death, your interest in that property would be subject to probate and any proceeds received from the sale of such interest would be used to pay the creditors of your estate. Here it seems clear that transferring tenants in common property or separate property to trust benefits both the owner of the property by avoiding property and the future beneficiaries of that property by offering asset protection and management, among other things.

If we look at joint tenants with rights of survivorship property and contrast it with owning property in a trust, then the benefits of using a trust may not be as readily apparent. For example, a title held as joint tenants with rights of survivorship avoids probate and all joint tenants are entitled to equal use and possession of the entire property, along with any income or profits generated by the property. Unfortunately, it’s easy to destroy survivorship rights. One joint tenant acting unilaterally may sell or transfer their interest in the property thereby severing the rights of survivorship and converting the property to tenants in the common property. Additionally, in most states, a creditor of one joint tenant can attach the interest of that joint tenant terminating the survivorship rights. Finally, although all states except Louisiana recognize this form of ownership, most prohibit a trust from holding title as joint tenants with rights of survivorship because a trust cannot die. Thus, while joint tenants with rights of survivorship avoid probate, it does that only until the property ends up with the last joint tenant. At the death of the last surviving joint tenant, the property would be subject to probate.

In the states that recognize tenants by the entireties, some such as Illinois, Missouri, and Delaware allow residents to transfer tenants by the entireties property to their joint trust and maintain the ownership and benefits of tenants by the entireties. Michigan is in the process of updating its statutes to expressly permit its residents to hold tenants by the entireties property in a trust. In the states that do not authorize the transfer of tenants by the entireties property to a joint trust, planning professionals must give significant thought to the ramifications of breaking up tenants by the entireties property by transferring it to a trust. In most states that recognize tenants by the entireties property, a creditor needs to be a creditor of both spouses in order to attach the property. This unique protection may appeal to married individuals that have one debtor spouse. Issues arise, however, in a second marriage or blended family situation with the surviving spouse taking the entire interest in that property. That could cause undesirable results such as the surviving spouse disinheriting the children of the decedent spouse.

Community property provides various benefits, most importantly a step-up in the basis of the entire community property interest upon the death of one spouse, rather than just the decedent spouse’s portion, as would be the case for property held as tenants by the entirety, joint tenancy, or separate property. Community property allows for flexibility in estate planning and can be transferred to a trust and maintain its character. In addition, in community property states, it’s possible to convert other types of property to community property in the trust. Finally, spouses maintain the power to dictate how and to whom their portion of the community property will pass, even when titled in a trust,

Transferring property to a trust often provides the best protection for the property. It’s imperative to understand the forms of ownership that your state recognizes and the potential benefits associated with each as well as the benefits of trust ownership. Title to the property has a profound impact, even on those assets held in trust.

The parent-child relationship is pretty well defined. Children generally don’t advise their parents. It’s the other way around. However, this dynamic can shift as parents get older and children become adults. This becomes especially prevalent when considering estate planning and elder law issues.

As parents grow older, adult children may start to have certain questions about the way mom and dad have planned ahead for the eventualities of aging. Being aware of what plans have been made opens the door for a conversation about what planning is left to be considered to make sure their wishes are carried out as they’d like them to be.

What’s Next?

Once an adult child comes to the conclusion that a discussion is needed with aging parents, determining how to proceed can be difficult. It’s not easy to reverse roles and ask parents to provide their children with sensitive financial information. One way for a child to approach the subject would be to explain their own estate planning efforts. By telling parents what you have done and why, you can then ask them what they have done. The question would arise naturally and organically. You have just explained your estate plan to your parents, so they may feel compelled to explain their plan to you.

This interaction is in their best interests, and it’s not just a conversation about the eventual transfer of financial assets. There is the matter of long-term care to take into consideration. Most Americans will need assistance with their day-to-day needs at some point in time. You may in fact notice that your parents are starting to have trouble getting around. This is something that impacts the entire family because most of the living assistance received by senior citizens comes from family members, friends and neighbors. When this is not possible, seniors often enter assisted-living facilities. Medicare does not pay for an extended stay in an assisted-living community or nursing home. These facilities are extremely expensive, and many seniors may not understand the extent of the financial burden.

Sense of Relief

Once you have expressed an interest in the planning efforts of your parents they may actually be quite relieved. You are demonstrating a high level of maturity as you tackle a difficult subject as a caring family member. As you gain an understanding of their existing plan you can make suggestions. Assisting them in finding a qualified estate planning attorney may be an integral part of this process.

When your parents are aware of the fact that you want to be of assistance as they enter into the later stages of their lives, a new type of relationship may develop. They will know they can count on you as their own capabilities wane, and this can strengthen the parent-child bond.

It’s impossible to fully understand Estate Planning without considering the goals of the clients, along with their underlying assets. After all, many of the more advanced Estate Planning techniques depend upon obtaining discounts for assets and considering which technique to recommend based on a client’s assets. Some clients lack specific knowledge regarding not only the assets that they own but also the title to such assets, both of which shape the Estate Plan. Inexperienced attorneys may fail to use precise words when describing title and refer to property owned with another individual simply as “joint property.” Such individuals may fail to understand the difference between property held as joint tenants with rights of survivorship, tenants by the entirety, or as tenants in common.

If an individual owns the complete undivided interest in the property, that’s separate property, unless the individual resides in a community property state, as explained later. Generally, an individual may dispose of separate property freely. An owner may transfer separate property during life and bestow separate property upon death. Of course, a few exceptions to that general rule exist. For example, separate property states require a spouse to leave a minimum amount called the elective share to their surviving spouse upon death. If the decedent spouse fails to leave the appropriate amount, state statutes contain provisions that allow the surviving spouse to elect against the decedent’s elective estate to prevent the impoverishment of the survivor.

If a property has more than one owner, each of whom can transfer their interest in the property freely, then those individuals own the property as tenants in common. An interest held as a tenant in common works much the same as separate property. The owner has no restrictions on the disposition of the property either during life or at death. Many states use this type of ownership as a default when more than one owner exists on the title to an asset without specific reservation of rights of survivorship.

In contrast to ownership as tenants in common, if the co-owners reserve a right of survivorship in the property, then the owners hold the title as joint tenants with rights of survivorship. Property titled as joint tenants with rights of survivorship passes title to the survivors upon the death of one of the joint tenants automatically by operation of law. The other owners need not do anything to protect their ownership interest, although they may need to produce a death certificate to clear the title. While many individuals attempt to create a property that will pass in this manner, it often fails. To create joint tenants with rights of survivorship, the joint owners need the following unities upon acquisition of the property: interest, possession, time, title, and survivorship. If the owners lack any one of those unities, then the owners have created tenants in common property, rather than joint tenants with rights of survivorship. Every state recognizes this type of property ownership.

Some states recognize a special form of joint tenants with rights of survivorship called tenants by the entireties, available only for spouses. In addition to the unities described above, the parties need to have the additional unity of marriage at the time they acquire title to the property. Interestingly, not all states that recognize joint tenants with rights of survivorship recognize tenants by the entireties as a form of ownership. Even more interesting, in those states that recognize this form of ownership, some states allow it only for real property, while others recognize it for any type of property. The states that recognize the tenants by the entireties form of ownership afford property titled in this manner asset protection, meaning that only a creditor of both spouses can attach the property.

In contrast to property titled as tenants by the entireties, about fourteen states recognize another form of ownership available only to spouses known as community property. Community property means that each spouse owns one-half of any property acquired by either spouse during the marriage with two notable exceptions. First, if one spouse receives an inheritance that will remain the separate property of that spouse. Second, any earnings on separate property remain separate property. Community property provides various benefits, most importantly a step up in basis of the entire community property interest upon the death of one spouse, rather than just the decedent spouse’s portion, as would be the case for property held as tenants by the entirety, joint tenancy, or separate property. Community property states allow each spouse to dispose of their one-half of the community property without restriction. In pure community property states, no elective share rights exist, which allows for more flexibility in estate planning while guaranteeing that one spouse will keep at least their one-half share of the community property upon the death of the first spouse.

Unlike separate property or common law states, how clients hold title to property does not matter in a community property state. In determining whether property qualifies as community property one looks to the domicile at the time of acquisition of the property. Interestingly, California recognizes community property with rights of survivorship. In that situation, the title will pass automatically to the surviving spouse upon the death of the first spouse as it would with property held as joint tenancy or tenants by the entireties but with the added benefit of the double step-up in basis.

I often answer questions relating to the validity of Estate Planning documents. Sometimes, the testator or grantor simply wants to ensure that the documents carry out their last wishes. Other times, a beneficiary questions the terms or amount of their inheritance. Finally, loved ones have concerns that the Estate Plan does not accurately reflect the true intent of the testator. Let’s look at what could invalidate a Will or Trust. 

If a beneficiary, loved one, or other trusted source exerts undue influence on the testator, that might invalidate the Will. Simple enough to explain but understanding what constitutes undue influence requires a closer look at the 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 their estate plan, usually in favor of the individual exerting the undue influence and to the detriment of the testator’s other beneficiaries. 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 are often close to the testator. For example, the influencer may stop providing transportation to the testator or otherwise cause the testator to fear for their health and well-being. The emergence of elder abuse and mandatory reporting thereof has helped shine a light on the existence of undue influence and gives families a way to protect against it. 

In addition to undue influence, if the testator lacks capacity at the Will or Trust’s execution, then that invalidates the documents. Lack of capacity means that the testator executed the Will or Trust at a time when such a testator lacked a sound mind. Many a litigant has tried and failed to prove a lack of capacity, even though it’s common. Frighteningly, the Alzheimer’s Association estimates that nearly 6 million individuals have Alzheimer’s disease in the United States. This disease affects the mind at a time when the elderly individual may have other health issues. Most states require the testator to understand the nature and extent of their property, the natural objects of their bounty, the individuals who would naturally benefit from their estate, and finally, the effect of their Estate Plan. If the testator understands those things, then the testator has a sound mind. If the testator lacks that understanding most of the time but executes the Will or Trust at a time of clarity, then the Will or Trust is valid. Most states presume competence to make a Will or Trust and place the burden on the contesting party to prove that the testator or grantor lacked capacity. Note that a court may consider other factors, such as an unnatural distribution, as evidence of lack of capacity. 

Aside from undue influence or lack of capacity, any Will or Trust not executed with the requisite formalities is invalid. Most states require the presence of two witnesses who watch the testator sign, all of whom sign in the presence of a Notary Public. Although Trusts do not always require that level of formality, sometimes the testamentary provisions of a Trust will not work unless they are executed with the same formalities as required for Wills. 

Finally, any Will or Trust resulting from fraud, coercion, or forgery is invalid. If an individual intentionally misrepresents certain facts to the testator who relies upon the facts in making the Will, that’s fraud in the inducement. Common examples of this are when someone tells the testator that a particular beneficiary no longer needs the money because they have enough of their own or advises the testator that a beneficiary is stealing from the testator or speaking ill of them to other family members. If someone were to present a Will to the testator, while telling the testator that they were signing a Deed, that’s fraud in the factum. If someone else signs the testator’s name without their knowledge and without following the state statutes, then the Will is invalid. 

While these examples seem like they are out of a novel or movie, these things happen often. For example, Brooke Astor, a New York City philanthropist was abused and exploited by her only son who isolated and manipulated her to gain control of her assets, including millions of dollars that she wanted to give to charities. Brooke’s physical and cognitive impairment, dependency upon her son, and isolation made her susceptible to undue influence. If you worry that your plan may be invalid, it’s a great time to contact me to review and update the plan, as making sure that your assets get to the intended beneficiaries requires more than just good documents.

A cohesive Estate Plan focuses on the distribution of assets and the naming of fiduciaries to carry out the plan upon the death of the Grantor or Testator. I understand that taxes and the payment thereof play an important role as well. Often, even those individuals whose gross estate falls below the Applicable Exclusion Amount ($12.06 million in 2022) need to worry about taxes. In addition to the Federal Estate Tax, clients need to consider the impact of state estate or inheritance taxes, along with local taxes and cash flow to pull it all together. It’s important to understand how taxes will be allocated among your beneficiaries upon your death and to ensure that allocation honors your wishes. I attempt to control the allocation of taxes through the use of an apportionment clause. An apportionment clause specifies who among your beneficiaries will ultimately bear the burden of the taxes. Omission of this clause or inartful drafting may result in unintended consequences, or worse yet, litigation.

Tax apportionment clauses come in many varieties. For example, a Will or Trust may contain language that designates only those assets passing under the Will or Trust are to pay the taxes. Thus, beneficiaries who receive assets that pass outside the Will or Trust, such as beneficiary designated assets like Individual Retirement Accounts, life insurance, or Pay on Death or Transfer on Death Accounts, would not bear the burden of any taxes. That may or may not reflect the Grantor or Testator’s intent. Conversely, the Will or Trust may allocate taxes among all the beneficiaries, including those who receive the assets outside through a beneficiary designation. Alternately, the documents may direct payment of taxes from the residuary estate, after payment of all specific gifts, expenses, and liabilities. Of course, if the residuary lacks liquid assets sufficient to pay the taxes, that poses another problem altogether. Let’s review an example that highlights one of the potential problems with payment from the residue.

Assume that Ned has two children, Rob, and Sansa. Ned wants to leave his home, Winterfell, valued at $10 million to Rob and the other $10 million of his estate consisting of cash and stock to Sansa through his residuary clause. Ned was clear that he intended to leave equal amounts to his children; however, an inexperienced attorney included a tax apportionment clause that directed payment from the residue of Ned’s estate. Ned died in 2022 leaving an approximate estate tax liability of $3.2 million. Because Ned’s Estate Plan directs payment from the residuary estate, the taxes will diminish the residue, which was going solely to Sansa. Thus, after payment of taxes, Sansa will receive a mere $6.8 million, while Rob will receive $10 million. If the tax clause directed apportionment between the beneficiaries proportionately based upon their share of Ned’s estate, then each of Rob and Sansa would bear $1.6 million in taxes. If we assume that Rob had no assets other than Winterfell, then the attorney needs to consider other sources of payment for the tax or structure the plan in another way to prevent a sale of Winterfell to pay the taxes. Perhaps the best plan gives each of Rob and Sansa half of Winterfell and half of the cash and stocks to ensure equal treatment.

Let’s change the facts a bit to mimic those of a recent Nebraska Supreme Court case, Svoboda v. Larson, 311 Neb. 352 (2022). Now assume that Ned lives with Catelyn and has only one child, Jon. Ned and Catelyn have a business and personal relationship but remain unwed. Ned’s estate plan leaves half of Winterfell to each of Catelyn and Jon and half of his sword-making business to each of Catelyn and Jon. Ned gives his livestock along with the residue of his estate containing minimal assets to Catelyn. Ned’s documents directed payment of estate and inheritance taxes through the residuary estate. A state statute imposes inheritance taxes at different rates based upon the beneficiary’s relationship to the decedent. Catelyn’s portion of Ned’s estate produced an inheritance tax liability of approximately $2,000,000, while Jon’s portion of Ned’s estate produced a tax liability of approximately $70,000. Ned’s residuary estate lacked assets sufficient to bear the burden of these taxes. State law indicates that if the direction given in the Will or Trust results in insufficient funds to pay the tax liability, then such direction fails and the burden of payment falls where the law places such burden, unless the testator made contingent plans in the governing documents. In Ned’s case, Catelyn will be responsible for coming up with $2,000,000 resulting from her bequest, while Jon will be responsible for the much smaller amount of $70,000 because of his legal relationship with Ned. Of note, Catelyn and Jon received substantially similar amounts but because of insufficient planning and state statutes ended up with vastly different results.

As the above examples demonstrate, we always need to consider the tax implications of a plan carefully. It’s important that the Will and Trust coordinate to avoid any confusion. In addition, we consider what assets the Personal Representative or Trustee will use to pay the liability and provide for various contingencies, for example, an insufficient residuary. Finally, remember that state laws and a beneficiary’s individual circumstance will also impact the ultimate responsibility for payment of taxes.

I often guide clients in naming trustees and personal representatives (collectively “fiduciaries”) as part of the Estate Planning process. These conversations cover many topics including the fiduciary’s duties and responsibilities upon taking office. For example, fiduciaries marshal the assets of the estate or trust; make decisions regarding the distribution of assets to the beneficiaries; and potentially undertake litigation. Fiduciaries may have to appear in court, and certainly, they will have to liaise with the attorney handling the estate or trust. Often, the individuals nominated to serve as fiduciaries have limited or no understanding of their duties and responsibilities, one of which includes the filing of all outstanding income, gift, and estate tax returns for the decedent.

Internal Revenue Code (“Code”) Section 6012 imposes a duty on a fiduciary to file outstanding income tax returns. Treasury Regulation Section 25.6019-1(g) imposes a duty on the fiduciary to file any outstanding gift tax returns for a deceased donor. Finally, Code Section 6018 requires the fiduciary to file an estate tax return if the decedent’s estate exceeds the basic exclusion amount. The Code holds the fiduciary responsible for filing all outstanding tax returns. That the fiduciary may have no independent knowledge regarding whether the decedent was diligent in filing their returns does not matter. For this reason, it’s vital for the fiduciary to prioritize filing of the tax returns and as the rest of the article demonstrates, the payment of any tax liabilities.

Code Section 6321 gives the United States Government (U.S.) a general tax lien on all estate and trust property upon assessment of the tax. In addition, Code Section 6324 provides two special liens for estate and gift taxes that arise upon death, or at the date of the gift, as appropriate. In addition, federal priority statutes provide that the fiduciary must use assets in their custody to pay the U.S. before making other distributions, including distributions to beneficiaries. If the fiduciary fails to pay the government first, he or she may end up personally liable to the IRS for amounts paid to the beneficiaries or any other creditors. Three factors in combination trigger personal liability under the federal priority statute: the fiduciary controlled the assets and distributed the assets to others aside from the U.S.; the fiduciary knew that the U.S. had an unpaid claim; and the fiduciary paid others when the estate was insolvent or the payment made the estate insolvent.

Code Section 2202 and Treasury Regulation Section 22.2002-1 require the fiduciary to pay the estate taxes, even if the fiduciary never had control of those assets. This lack of control causes both a liquidity problem and an unsatisfied tax liability which can be a dangerous combination. The duty to pay taxes extends beyond estate taxes to include unpaid gift taxes, even if the gross estate no longer contains those assets. Many tried and true Estate Planning techniques involve the use of lifetime trusts or planned payment of life insurance proceeds to a beneficiary other than the decedent’s estate, for example, a surviving spouse or an Irrevocable Life Insurance Trust. Estate Planning during life could cause both a liquidity problem along with an unpaid tax problem at death, something that clients and attorneys alike should consider.

Of course, the fiduciary does not remain liable forever. The fiduciary may apply for and receive a discharge from personal liability for estate tax by written application and early determination by the IRS of the amount of tax owed. The IRS must determine within the later of nine months after the executor files the return or nine months after the executor makes a written application. Upon determination and payment of the tax, the IRS will discharge the executor. Code Section 2204(a) allows the executor to receive a discharge if such fiduciary furnishes a bond after determination of the tax. The IRS may issue the notice of discharge later, thereby relieving the executor of personal liability.

If the fiduciary knows that the trust or estate has an unpaid tax liability, then the fiduciary should consider the following steps: ask the IRS to enter into an agreement allowing the fiduciary to make distributions without personal liability; make the IRS aware of each proposed distribution and give the IRS opportunity to object or accept said distribution; maintain current records on solvency; if a court controls the assets, then determine whether the custodian will make distributions pursuant to court order; and finally, consider requesting a private letter ruling to determine whether a distribution may be made without personal liability. If you have concerns about any of the parties that you have named in your documents, reach out to me about your concerns and update your documents. If you have been named as a fiduciary and need help understanding your duties, you can always seek my help to guide you through this complicated process.

To do my best job, I need to understand each client’s family dynamic, identify areas of concern, provide advice regarding the best course of action and consider potential tax ramifications while protecting beneficiaries from themselves. All that occurs before I ever put pen to paper. I need to create documents that accomplish these competing goals while considering facts and circumstances that may impact the effectiveness of the plan in the future. Sounds impossible, right? It’s not. It just takes careful consideration of all the tools I have at my disposal. A power of appointment is one of those tools. In simple terms, an appointment provides flexibility. Powers of appointment allow the holder to direct his or her share of property held in Trust to another individual or entity, either outright, or in continuing trust. Powers of appointment exist in two types, general or limited, sometimes called special.

An individual holding a general power of appointment (“GPOA”) may exercise that power in favor of anyone or any entity including themself, their estate or the creditors of either. The GPOA has no restrictions. If the holder has a GPOA over assets, that causes inclusion of those assets in the holder’s taxable estate. As a result, the assets subject to the power get a step-up (or down) in basis at the death of the holder. Sometimes, I include a GPOA to prevent another result. For example, some documents I prepare include language that permits an Independent Trustee to give a beneficiary a GPOA to avoid the application of undesirable tax consequences. If the Independent Trustee grants this power, then the powerholder’s estate will include the assets subject to the power, even if the powerholder fails to exercise the power. Holding the GPOA causes estate tax inclusion. It matters not whether the powerholder exercises the power.

A beneficiary holding a limited power of appointment (“LPOA”), by contrast, cannot appoint the assets to themself, their estate, or the creditors of either. The donor granting the LPOA may impose additional limits, but usually the beneficiary may exercise the LPOA in favor of a very broad class, including any one of the billions of people on earth. The overarching prohibition exists only as to the beneficiary, the beneficiary’s estate, or the creditors of either. An LPOA does not cause inclusion in the holder’s taxable estate and does not cause a step-up (or down) in basis if the LPOA is not retained by the grantor of the trust. The LPOA gives the beneficiary the opportunity to use the information existing at their death to direct to whom assets will be distributed, without subjecting the assets to estate tax.

Let’s review a quick example that demonstrates the power of an LPOA. Suppose a spouse establishes a trust for their surviving spouse and gives that surviving spouse an LPOA over the trust assets remaining at death to their descendants. If the spouse fails to exercise the power, then the trust assets will pass in equal shares to the couple’s children. If one of those children recently became a multi-millionaire, while another struggles to pay bills, that power allows the surviving spouse to alter the distribution pattern to account for those changes. Perhaps a third child recently had a disabling accident and now receives government benefits. The surviving spouse could use the LPOA to appoint assets for the disabled child to a newly created stand-alone trust.

Powers of appointment provide a great option to add flexibility to an Estate Plan. They give the powerholder the ability to account for changes in circumstances that were not contemplated at the time the plan was created. They allow a beneficiary to adjust a distribution pattern to ensure a more equitable distribution of assets gifted to them but left to their descendants upon their death. The trust or other instrument granting the power may provide requirements for the effective exercise of the power and it’s vital to exercise the power exactly as required.