Trusts DEFINITION: Legal entity (legal relationship between the trustee and BFY) (RT= alter ego of Trustor)

Trusts

1. DEFINITION: Legal entity (legal relationship between the trustee and BFY) (RT= alter ego of Trustor)

2. TRUST BFY’S:

   1. Income Beneficiary: Receives income from income-generating assets

   2. Remainder Beneficiary: Typically receive trust principle upon death of income beneficiary (when trust dissolves)

   3. Regular BFY: pulls from principle (Like takes $20 annually from the trust)

   4. Unitrust: when person receives percentage of the principle (like 3% each year)

   5. Mandatory distribution: “A shall pay B”, usu a rqmt that income be paid to income beneficiary each year.

   6. Discretionary distributions: “A may pay B”, often have a safety net allowing BFYs to receive principle in case of medical emergency, support, etc.

3. Trustee: holds legal title to assets, but holds a fiduciary responsibility to BFYs and can be held accountable for misuse of funds. If trustee purchased something, opened account, would say: A, trustee of the J & J trust

4. Revocable Trusts

   1. Reasons to Create (always created during lifetime)

      1. Avoid Probate

      2. Avoid Conservatorship- crt supervised proceeding (like probate) created for mentally incapacitated person

   2. Revocable trusts DO NOT

      1. Save Income Tax – tax ID is same as indiv’s SSN  revocable trust is simply an alter ego during your life

         1. Still have to report income from assets held in RT on your individual tax return during your life

      2. Save Estate Tax – assets held in RT will be included in your gross estate for fed estate tax purposes when you die (just like assets held in your individual capacity)

         1. may have provisions to help mitigate estate tax like will, but per se RT has no special way of reducing it

      3. Provide Asset Protection – RT is your alter ego  assets are treated as your own

         1. Trust is revocable – you can revoke/amend/defund it during your lifetime

            1. Only difference = you are doing it in your fiduciary capacity

         2. Creditors can reach RT assets (just like assets held in indiv. capacity) b/c> complete control over them

   3. Will substitute – provides dispositive terms for the distribution of trust assets without the need for probate

      1. Settlor’s death> successor trustee immediately>RT trustee>starts administering trust/ distributing assets to BFYs

         1. NO PROBATE– assets are held by trustee of RT in fiduciary capacity NOT by trustee in individual capacity

            1. Assets held in your name as individual>subject to probate unless have JT or BFY designation

   4. Funding = all assets are held in RT

      1. Assets with Formal Title – should be held by individual in his fiduciary capacity as trustee of revocable trust

         1. Magic words = transfer deed/account from A as an individual to “A, trustee of the A revocable trust”

         2. Examples of Assets = bank account, real property, brokerage accounts, partnership, etc.

      2. Assets not susceptible to Formal Title – e.g., Tangible Personal Property (or intangible if no> formal title)

         1. General Assignment – broad to assign all other assets to RT (used to get tangible personal property into RT)

            1. ALWAYS do it cause want everything in RT other than retirement plans

            2. Could be a schedule attached to RT or a separate document

            3. Magic words = “I hereby transfer [all my tangible personal property] into my revocable trust”

         2. Generally, you make General Assignment broad enough to also include real estate and brokerage accounts

            1. NO GUARANTEE that broad language will actually be sufficient to avoid probate (but it might work)

            2. GUARANTEED to work for tangible personal property as well as intangible w/ no formal title

         3. DON’T USE FOR IRREVOCABLE TRUST- only used for specific transfers

      3. Exception = retirement plans are an exception to rule that you should hold all assets in a RT

         1. RT CANNOT hold retirement plans – fed law prohibits anyone other than employee frm owning retire plan

            1. No practical consequence – retirement plans avoid probate anyway b/c it has a BFY designation  no real reason why you would want to put retirement plan in revocable trust even if you could

   5. Pour Over Will

      1. Signed when you sign a revocable trust

      2. Contains only one dispositive provision = “everything that is subject to this will gets distributed at the end of probate according to the terms of my revocable trust”

         1. NOTE: pour over will must pass through probate but assets will still be disposed of according to terms of pour over will instead of through rules of intestacy

      3. Goal = fully fund revocable trust – you want to put all assets into RT if you can b/c ONLY the assets held in revocable trust are subject to terms of revocable trust upon death

         1. Pour over will = superfluous if revocable trust fully funded

         2. Pour over will = necessary to transfer to revocable trust any assets not held in revocable trust

            1. Property not held in revocable trust subject to probate under terms of pour over will

   6. Administrative Trust: when settlor dies, RT becomes irrevocable Administrative Trust

      1. Fiduciary duties are same that PR of estate has to do, w/o crt involvement (unless BFY file objections)

5. Irrevocable Trusts – no one can revoke

   1. Reasons to Create – irrevocable trust almost always created in lieu of making an outright gift to beneficiary

      1. Control Distributions – allows distributions to be controlled over time

         1. E.g., Settlor does not think it prudent to give X $1MM outright  rather than gifting money outright, Settlor can put money in trust so that X cannot access that money all at once (restrict recipient’s access)

      2. Asset Protection

         1. Outright gift of money to X allows creditors to come after X; BUT, creditors can’t access assets in an IrrT

      3. Tax Reasons- allocate GST exemption to that trust (and no estate tax either) + all lifetime gift tax benefits

   2. Two Irrevocable Trust Types

      1. Inter Vivos – trust that is created during the lifetime of the Settlor

      2. Testamentary – trust> comes into existence upon death of the Settlor  a new entity=recipient of a bequest

         1. Created under Will OR Revocable Trust (e.g., “when I die, I want $X to go to A irrevocable trust, which will be created upon my death and administered under these terms”)

   3. Funding – functions as a gift to that irrevocable trust

      1. Same way as you would fund RT – title to any property transferred to X, trustee of the Y irrevocable trust

         1. Testamentary Irrevocable Trust

            1. Created by fully-funded Revocable Trust  assets do not pass through probate

            2. Created by Will  irrevocable trust would be funded after will passed through probate

      2. Clearly defined assets – you need to identify specific assets and put those assets into the irrevocable trust

         1. NO General Assignment

         2. You no longer own assets that are transferred to irrevocable trust – like a gift

   4. Beneficiaries

      1. Two Types for Irr. trusts

         1. Income Beneficiaries- net income from trust (dividinds on stock, interest on bonds, income frm real estate)

            1. Could have successive Income BFY’s but won’t have Remainder until trust dissolves

         2. Remainder Beneficiaries- whatever left over is given to Remainder BFY when trust is dissolved

      2. Clarity important

         1. TO WHOM can assets be distributed?

         2. WHEN can assets be distributed?

         3. Under what circumstances MAY assets be distributed?

         4. Under what circumstances MUST assets be distributed?

   5. Distributive Provisions – limited only by imagination of Settlor

      1. Distributions can be

         1. Mandatory or Discretionary

         2. Income or Principle

            1. Income= dividends, interests, etc. (generated income)- put million in stocks> income is extra that stocks make (often have an income BFY who gets paid based on how well the $ did)

            2. Principle= original money- put million in trust> that million is the principle

      2. Typical Scenario: income BFY=adult child of Settlor; remainder BFYs=grandkids of adult child of Settlor

   6. Powers of Appointment – apply only to those assets subject to the Power of Appointment (Optional)

      1. Definition = power that is given to someone else to change the BFYs of an irrevocable trust

         1. Can only be exercised in the manner that the trust instrument prescribes

      2. Purpose = builds flexibility into dispositive plan (allow for circs that Settlor can’t foresee when trust is created)

      3. Scope = limited only by terms of trust – can be broad or narrow

         1. Can say which assets it governs

         2. Can say who Permissible Appointees are

         3. Can say if assets can be put in trust or not

      4. Terminology

         1. Settlor = creator of PofA (grandma-donor)

         2. Holder = persons who holds PofA (daughter-donee)

            1. Usually, holder = income beneficiary of trust, but doesn’t have to be

         3. Takers-in-Default = those who will get prop if Holder does not exercise PofA (grandkids)

         4. Permissible Appointees = person to whom prop can be distributed (or held in trust) under PofA

            1. Class of Permissibles can be broad or narrow – Settlor can make them anyone he wants:

               1. 
                  E.g., everyone in world  broad Power of Appointment
                  
               2. 
                  E.g., X’s kids, issue, or charity  narrow Power of Appointment
                  

      5. Function

         1. If Holder does nothing  Takers-in-Default get property in equal shares

         2. If Holder exercises Powers  estate plan has flexibility b/c Holder can change dispositive plan

            1. E.g. can alter proportions, put some funds in trust for another, remove someone completely as BFY, etc.

         3. Example: Grandma creates IrrT for Daughter w/ D as income BFY & D’s children as remainder BFYs

            1. Problem = G doesn’t know how grandkids will turn out (e.g., drug problem; independently wealthy)

            2. So, G gives D Power of Appointment to alter percentages GC get – now D has flexibility

               1. 
                  Can reduce or eliminate share (e.g., if doesn’t need or deserve the money)
                  
               2. 
                  Can provide that a GC’s portion is held in further trust with other conditions
                  

      6. Types

         1. General Power of Appointment – term of art – if Power of Appointment is exercisable in favor of the Holder, Holder’s estate, Holder’s creditors OR creditors of Holder’s estate  General Power

            1. Consequences = Bad

               1. 
                  Assets subject to General PofA will be taxed as part of Holder’s estate for federal tax purposes
                  
               2. 
                  Holder’s creditors can reach assets held in trust and subject to General Power
                  

         2. Limited Power of Appointment – term of art – limited if it is not general

            1. Almost always preferable to a general power

               1. 
                  Assets will not be taxed as part of Holder’s estate–at least PofA by itself won’t cause this
                  
               2. 
                  PofA itself won’t cause trust assets to be accessible to Holder’s creditors
                  

6. Amending Trusts

   1. Trust instrument will prescribe procedures for how trust can be amended

      1. Failure to follow procedures  amendment NOT valid

7. Incapacity & Conservatorship

   1. Definitions

      1. Incapacity – physical or mental inability to manage one’s own financial affairs

      2. Conservatorship (aka lifetime probate)– crt supervised entity created when an individual is deemed> incapacitated

      3. Conservatee = incapacitated individual

      4. Conservator = fiduciary appointed to manage conservatee’s affairs

   2. Process – more difficult cause crt wants to ensure that conservatee’s civil rights are not taken away from him/her (usually for the rest of conservatee’s life) unless it is absolutely necessary

      1. Similar to probate process (including all the headaches)

         1. Same expenses, delays, inconveniences, and public disclosure as probate

      2. Additional process– special protections to ensure necessity of taking away conservatee’s civil rights (right to manage own assets, to K, etc.; crt wants> more careful supervision) conservatorship can be even worse than probate

         1. Physician’s certificate – crt declaration that person is actually incapacitated

         2. Court investigator often appointed– interviews proposed conservatee to make sure> really needs conservatorship

         3. PVP Attorney(Probate Volunteer Panel)-pool of attorneys some crts use to appoint attorney to represent cnsrvtee

      3. Conservator Duties – same fiduciary responsibilities as PR owed to conservatee

   3. Avoiding Conservatorship– assets held in your name as individual are subject to conservatorship if you are incapacitated UNLESS

      1. Revocable Trust = best way

         1. If fully funded, RT allows successor trustee to step in immediately after incapacity to manage assets – assets are held in name of trustee in his fiduciary capacity not in name of conservatee in his individual capacity

            1. MAKE SURE RT is fully funded– otherwise assets subject to conservatorship (lifetime probate) regardless of trust terms

         2. Successor trustee owes incapacitated Settlor a fiduciary duty during lifetime of incapacitated Settlor

      2. Durable Power of Attorney = adequate

         1. Agent under durable power of attorney could manage assets held in individual’s name after incapacitated

            1. But financial institutions are less leery of and more comfortable with revocable trusts b/c the fact that assets are actually held in trust means the person really intended for the asset to be in the trust in the first place

8. Representation of Minors

   1. Problem = minors (<18) cannot protect his/her interests as a beneficiary of trust/estate

   2. Solution = get someone else involved who will protect minor’s interests

      1. Parents = natural guardians of minor

         1. If no conflict of interest  parents can provide protection (e.g., notice can be sent to parents)

         2. If conflict of interest  parents cannot effectively represent minor (e.g., two competing wills submitted to probate where one leaves everything to parents and other leaves everything to children of parents)

      2. Virtual Representation – if parents are unavailable  kid representative needs court approval

         1. Doctrine of Virtual Representation = a person may represent the minor’s interest in the proceeding if he/she has identical interests to those of the minor

            1. KEY = identical interest

               1. Ex – a will leaves residue to four people in equal shares one of whom is a minor  any of the other 3 residual beneficiaries can represent that minor child b/c they have identical interest

               2. Ex – remainder BFY& a contingent remainder BFY – trust provides that X is income BFY& remainder goes to Y when X dies, but if Y is not alive at time of Xs death, then prop goes to Ys nieces & nephews

                  1. 
                     Y = remainder BFY and Y’s nieces and nephews are contingent remainder BFYs  Y can represent his nieces and nephews b/c the only interest they would have is identical to that of Y
                     

         2. Critical ?= is person who wants to virtually represent minor really in position to look out for minor’s interest?

            1. Depends on the issue involved

            2. Example – income beneficiary and remainder beneficiary  interests are not identical at all

               1. Income BFY: wants investments made to ensure as much income as possible (e.g., high-yielding bonds)

               2. Remainder BFY – wants investments made to ensure growth of estate (e.g., growth stocks)

               3. So, if parents are income BFYs & children are remainder BFY  parents could not effectively represent minor children’s interests (conflicts as parents and conflicts as virtual representation)

      3. Guardian ad Litem

         1. Appointed by crt for this particular issue/proceeding to represent interests of the minor who is not in a position to represent his/her own best interests

         2. Usually a trust/estate lawyer in whom the court has confidence

9. 
   
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