By: Barry E. Haimo, Esq.
March 21, 2017 (revised April 17, 2018)
UNDERSTANDING TRUSTS AND THE DUTIES AND RESPONSIBILITIES OF TRUSTEES
A trust is a separate legal entity that owns and administers property for the benefit of certain beneficiaries. One or more Trustees are appointed to administer the trust pursuant to the document’s precise instructions. Trustees are fiduciaries who are held to a higher standard of care, so they must adhere to the trust’s instructions at the risk of being held personally liable for damages relating therefrom. Trusts can be provide enormous flexibility and control to the creator’s wishes with respect to the devise of trust property to the creator and his or her beneficiaries including who receives it, when they receive it, how they receive it, under what conditions they receive it, all of which can happen both during the creator’s life and after death.
Please click on the links below to familiarize yourself with trusts before proceeding farther.
Distributions of Trust Property
The assets of the trust are distributed to beneficiaries as directed by the creator of the trust. Often, the Trustee may make distributions of income and principal of the trust to the beneficiary or beneficiaries as frequently or infrequently as the Trustee desires, in his or her sole discretion. Other times, the trust will dictate exactly when the trust income and/or principal is to be distributed to the beneficiary or beneficiaries. For example, specific events can trigger distributions and divisions of the trust estate, such as the death of the creator or a beneficiary reaching a certain age. Most commonly though, there will be clauses in any trust agreement that leave certain decisions subject to the discretion of the Trustee. Discretion is particularly common in situations where the beneficiary is a close family member, such as spouse, child or parent.
The most common provisions are in the discretionary standard known as HEMS (or health, education, maintenance, and support), which is a term of art that is widely used in estate planning. It means that health-related expenses of a beneficiary can be paid for out of trust assets, including both regular and usual expenses (health insurance, dental exams, etc.) and irregular and unusual expenses (emergency treatments, expenses not covered by insurance, etc.). It means that the Trustee may distribute income or principal to a beneficiary for tuition, career training classes, and books, but also for costs of living (rent and food, for example), as part of the educational expenses. The most discretionary provisions of these distribution standards are the provisions for maintenance and support, which allow for distributions for everything from living expenses, property taxes, and vehicle needs, to the cost of regular social activities or vacations.
A purely discretionary trust will have the most protection provided the beneficiary is not also the trustee, but even still there are ways around that. The bottom line with respect to asset protection is that it’s a delicate balance between protection and control. You cannot have both. A lesser form of discretion is the HEMS standard, which originates from a tax context. HEMS can arguably be used as a discretionary standard to protect a beneficiary from creditors of a beneficiary who would otherwise be able to force trust distributions for the benefit of the creditors. For additional protection, the creator of a trust may also add additional protections by disallowing a former spouse of a beneficiary from receiving any benefits from the trust assets, and/or add a clause that empowers the Trustee to stop distributions of trust assets to a beneficiary if a beneficiary: i) is abusing alcohol or narcotics; ii) has a gambling problem; iii) is incarcerated; iv) develops a disability; v) is acting in a way that shows total disregard of morality; and vi) any other behaviors or scenarios that a grantor may choose.
Any words that indicate the creator’s intention to impose a direct restraint on the transferability of the beneficiary’s interest can be used to create a spendthrift trust. Such trusts do not limit the rights of the spendthrift’s creditors to the property after it is received by the beneficiary from the Trustee (one appointed or required by law to administer the trust). The creditors cannot compel the Trustee to pay them directly. This means that any of the spendthrift’s creditors can seek to have the money the spendthrift has already received applied to satisfy their claims. A creditor’s claims to future payments under the trust, however, are restrained. The key here is once it’s out it’s out.
Prudent Investment Standard
The Trustee of a trust has a duty to invest and manage investment assets as a prudent investor would considering the purposes, terms, distribution requirements, and other circumstances of the trust. This standard requires the exercise of reasonable care and caution and is to be applied to investments not in isolation, but in the context of the investment portfolio as a part of an overall investment strategy incorporating risk and return objectives reasonably suitable to the trust. If the Trustee has special skills, or is named Trustee on the basis of representations of special skills or expertise, the Trustee is under a duty to use those skills.
Under Florida law, a Trustee has a legal obligation to keep the qualified beneficiaries reasonably informed of the trust’s administration. As a result, the Trustee must maintain accurate records of all the trust’s income, expenses, and disbursements. It is, therefore, important that the Trustee keep all important documents and statements relating to the trust together in a safe place. Without maintaining these records thoroughly and accurately, it will be impossible for the Trustee to provide required annual accountings to which qualified beneficiaries are reasonably entitled to receive under the law. An accounting is a document that reasonably discloses the trusts’ assets and liabilities and transactions relating thereto. The right to an accounting is waivable in Florida, which under certain circumstances should be exercised to reduce expenses.
The two principal parties that are entitled to request an Accounting are current and future beneficiaries and a Co-Trustee:
- Generally, when a beneficiary requests an accounting, they want to see that the trust assets have been managed appropriately including receipts and expenses and that the Trustees have not been negligent in the performance of their fiduciary duties.
- A Co-Trustee, on the other hand, may seek to compel an Accounting of the trust in order to prove that they have correctly discharged their duties. A Trustee employs the accounting as a means of being released from further liability to the beneficiaries of the trust. Until they obtain such a release, they are personally liable for damages to the trust caused by their inattention or malfeasance. This is very important, for example, when a Trustee seeks to resign, so that the successor Trustee may assume his or her role with the knowledge and confidence that they will not be held accountable for their predecessor’s acts.
The accounting will provide a reasonable account of identity of the trust’s assets as well as income and expenses associated therewith. It will reveal the various fees that have been paid to individuals or companies that have provided assistance to the trust, for example, the fees paid to an accountant for the preparation of tax returns. Similarly, it will include the sources and amount of trust income, new investments made on behalf of the trust, taxes paid by the trust, compensation paid to the Trustee, and distributions to beneficiaries.
Federal Income Tax on Trust Income
The revocable trust is ignored for federal income tax purposes during the creator’s lifetime. The income and deductions are reported directly on the creator’s individual income tax return. The trust will use the creator’s social security number as its tax identification number.
The trust becomes a separate taxable entity for federal income tax purposes when it becomes irrevocable, usually upon the death of the creator or if the creator revokes his or her ability to amend the trust. The Trustee is then required to file an annual fiduciary income tax return. Taxable income, deductions and credits are determined in much the same way as for an individual. The trust is also allowed deductions for distributions to beneficiaries. In this way, the trust passes on income and deductions to the beneficiaries to be taxed on their personal income tax returns. Income that is not distributed to the beneficiaries is taxable to the trust at very unfavorable rates. There are a few ways to reduce the impact of these adverse tax consequences of trusts, which are presented below in no particular order:
- Distribute income to the beneficiaries;
- Invest in tax-exempt investment vehicles; and/or
- Invest in appreciating property instead of income-producing property.
Additional Trustee Requirements and Considerations
The trustee cannot mix trust assets with their own. Hence, they must keep separate checking accounts and investments. Unless the trust authorizes it, the trustee cannot use trust assets for his or her own benefit or discriminate among the beneficiaries.
Trustee may seek help from professionals, especially with the accounting and investing. The Trustee will also need to consult with an attorney from time to time. However, as trustee, they are ultimately responsible to the beneficiaries for prudent management of the trust assets.
Remember that the trustee/beneficiary relationship is exactly that, a relationship. They must work together to meet the trust’s objectives. A needy beneficiary can be equally as destructive, both financially and emotionally, as a domineering trustee. Great care must be taken to be a Trustee.
It’s important to understand that serving as Trustee is a job. It requires time, effort and energy. In addition to other duties, it requires a relationship with the beneficiaries, which requires ongoing engagement and interaction. Remember, the Trustee is exposed to liability for failing to do its job. As a result, Trustee’s are usually compensated for their time and work. The law in Florida is that Trustee’s are entitled to reasonable compensation unless otherwise indicated in the trust agreement.
Always Check the Trust Agreement
Please note that successor trustees and contingent and remainder beneficiaries are designated in the trust agreement. Don’t forget, the trust frequently will have provisions which are intended to assist the trustee to understand and comply with their obligations to the trust. The first step is to always look to the trust agreement for direction. An attorney at Haimo Law can help you to understand these further, in the context of the specific circumstances and beneficiaries for whom the trustee acts.
Barry E. Haimo, Esq.
Strategic Planning With Purpose
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