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Trustee Tests
Traditionally both the client (settlor) and the attorney
believed that the estate planning and life planning work was complete after the
trust document had been signed and the assets correctly titled. Nonsense!
The completion of the documents is critical, but it is
really the starting place for the equally important next phase - implementation.
Planning starts the journey but you only get to your destination by implementing
the plan. Does the person or company you named to take over at your incapacity
or death have the expertise of a seasoned trust department? If the person you
named to serve as your successor trustee cannot deal comfortably with the
following questions, then the success of your plan implementation may depend on
your successor trustee’s decision to utilize competent legal, investment and tax
advice.
Question 1:
Do
you understand the terms of the trust agreement and can you explain them to the
trust’s beneficiaries?
Answer:
I am amazed at how often trustees want to ignore or avoid
the terms of a trust. All beneficiaries of the trust have a right to expect that
the terms of the trust will be carried out as directed in the document. The
successor trustee does not have the ability to change the trust’s beneficiaries
or to amend the terms of the trust, except in very specific circumstances.
Question
2:
Is there a current beneficiary entitled to income for
life? If so, do you know how to calculate the income distributions?
Answer:
One of the most challenging fiduciary jobs is to serve as
trustee of a trust naming a life beneficiary with others to receive assets on
the death of that beneficiary. Life beneficiaries are usually looking to the
trustee to maximize income and to invest trust assets accordingly. The remainder
beneficiaries want the trustee to invest for growth over income.
Typically, the trust agreement will state that all net
income must be distributed to the life beneficiary on a stated basis. The
trustee must know how to calculate net fiduciary income in order to determine
how much to distribute. Additionally,
Florida law gives certain
trustees the power to adjust between principal and income, if the adjustment is
fair and reasonable to all beneficiaries. Finally, Florida law also allows
certain trustees to convert the trust from paying net income to a unitrust
amount, which is a percentage of the trust’s market value on a certain date.
Therefore, the trustee must know: 1) how to calculate income, 2) when to
consider using the power to adjust and if the trustee has this power, and 3)
when to consider converting to a unitrust and if the trustee has this right.
Question
3:
Is the current beneficiary
entitled to discretionary principal distributions? Do you understand the
standards which are listed in the trust agreement for making principal
distributions? Do you need to consider the impact of all principal distributions
on the remainder beneficiaries?
Answer:
The trustee must be careful, consistent and even-handed in
making discretionary principal payments to a current beneficiary, unless the
settlor is the current beneficiary. While the settlor is still living, the
settlor is the sole beneficiary of the trust unless the trust agreement states
otherwise. During the settlor’s lifetime, the trustee usually must distribute
the trust assets to the settlor as requested by the settlor or based on the
terms contained in the trust.
After the trust’s death, the trust agreement may include
specific circumstances when the trustee may distribute principal to a current
beneficiary, such as for that beneficiary’s health, education, support or
maintenance. The current beneficiary may also have a right to withdraw the
greater of $5,000 or five percent of the trust’s market value at the end of the
year. The trustee must keep in mind that any distributions from principal
ultimately reduce the amount that will be distributed to the remainder
beneficiaries. Additionally, any distributions from principal reduce the amount
invested to produce income.
Question 4:
Do you know who the qualified beneficiaries are?
Answer:
Trust beneficiaries have significant rights. Identifying
beneficiaries is often critical and somewhat surprising. The trustee is required
to account to all qualified beneficiaries. Qualified beneficiaries are all
current beneficiaries, intermediate beneficiaries and first line remainder
beneficiaries whether their interests are vested or contingent.
Therefore, the trustee must account to the beneficiaries
who are named in or can be ascertained from the trust document, even if the
beneficiary is an alternate beneficiary. For example, the trust names Joe as the
current beneficiary to receive income for life. At Joe’s death, he has a power
of appointment to distribute the trust property to his children and, if his will
does not include a power of appointment, the assets will remain in trust for his
children. If the assets remain in trust, then after the death of all of Joe’s
children, the trust will distribute outright to Trudy. Therefore, the qualified
beneficiaries in this case are Joe, Joe’s children and Trudy.
Question
5:
Do you understand Florida’s
Principal and Income Act? Do you know how to determine if a receipt is principal
or income or should be allocated between both? Do you know how to determine if
an expense is principal or income or should be allocated between both?
Answer:
Most certified public
accountants are not experts at principal and income accounting. Net income
calculated based on tax laws is usually not the same as net income calculated
based on fiduciary law. The trustee must be familiar with the Principal and
Income Act and, typically cannot rely on the accountant to prepare the fiduciary
accountings or calculate net income.
If there is a life income
beneficiary and remainder beneficiaries, each receipt and disbursement must
effectively be allocated among these beneficiaries. If a receipt is income, it
benefits the income beneficiary and if a receipt is principal, it benefits the
remainder beneficiaries. Conversely, if a disbursement is income, it reduces the
income beneficiary’s distribution and if a disbursement is principal, it reduces
the ultimate amount distributed to the remainder beneficiaries. These
allocations are complicated and one of the most important of the trustee’s
duties.
Question 6:
Do you think that a brokerage statement is an annual
fiduciary accounting?
Answer:
Brokerage statements are not fiduciary accountings because
they do not allocate principal and income. If the accounting is done in the
proper format, beneficiaries have six months to complain or the accounting is
accepted. If appropriate annual accountings are not
prepared and sent to the beneficiaries, the statute of limitation barring the
beneficiaries from initiating legal proceedings against the trustee may be four
years or more. With the benefit of hindsight, a disgruntled beneficiary
could sue the trustee for breach of duty going back many years.
Question 7:
Do you know what happens if a qualified beneficiary does
not receive annual accountings?
Answer:
If a qualified beneficiary does not receive an annual
accounting, there is no time limit on when that beneficiary can sue for breach
of fiduciary duty.
Question 8:
Do you know how to develop a portfolio that complies with
Florida’s Prudent
Investor Rule?
Answer:
A majority of states,
including Florida, have adopted the “Prudent Investor Rule.” A “prudent
investor” diversifies the trust’s assets to obtain an investment strategy that
incorporates suitable risk and return based on the projected needs of all
beneficiaries and based on the responsibilities described in the trust document.
A prudent investor either: 1) has the expertise to invest appropriately under
the Prudent Investment Rule or 2) delegates this function to a professional
investment agent. A prudent investor has a written strategic plan for investing
and meets regularly with his or her attorney and investment advisor to be sure
the plan is implemented and changed where necessary. Many investors in the 1990s
did very well whether or not they had investment expertise. However, recent
market conditions have made determining appropriate fiduciary investments a very
difficult decision. We are starting to see progressively more lawsuits being
filed against trustees for violation of the Prudent Investor Rule.
Question
9:
Do you know how to determine the tax cost bases of the
trust’s assets?
Answer:
Basis calculation depends on how the assets were acquired.
Any assets that the settlor purchased during his or her lifetime retain their
original tax cost. However, after the settlor’s death, the tax cost bases
changes to the market values of the assets on the settlor’s date of death. The
trustee must take the tax cost into consideration in deciding which assets
should be sold and the timing of the sale. If the trustee does not know the
basis information, unexpected income tax can become due.
Question 10:
Do you know which tax returns you will need to file as
trustee?
Answer:
The trustee is usually required to file an income tax
return, even if no tax is due. Typically, the trustee will file a U.S. Income
Tax Return for Estates and Trusts (IRS
Form 1041). This return is significantly more complicated than an individual’s
tax return (IRS Form 1040). Therefore, a certified public accountant or tax
lawyer who is totally versed in fiduciary income tax law, should prepare these
returns. These are not do-it-yourself returns or returns to take to mass‑market
income tax preparers. Additionally, an accountant or tax lawyer familiar with
fiduciary tax returns will need to determine if other returns, beside an income
tax return, need to be filed with the Internal Revenue Service and/or with a
state revenue department.
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