When creating a Revocable Living Trust it is important to carefully choose who will administer the assets of the trust. The party or parties responsible for ensuring that the instructions found in the trust document are followed is called the Trustee. In most estate plans, it is common for a Revocable Living Trust to be structured so that the Trustors, the creators of the trust, serve as the Trustees throughout their lives. Upon their deaths or incapacity, it is not uncommon for a child to be named as the Successor Trustee of the various trusts established under the document. Although this may be a wise choice in many circumstances, it is important to consider all the complications that may arise when a child is selected for such a significant role.
Unintended Adverse Taxation to the Trustee
No Ascertainable Standard
Take caution when naming a child as the Trustee of a trust where the child-Trustee is also a beneficiary. If broad discretion is given to the child, as Trustee, to distribute trust assets to beneficiaries, that discretion will cause the trust assets to be taxed in the child’s estate upon his or her death. Because the distributions are not based upon what is termed an “ascertainable standard,” the power will be treated as a “General Power of Appointment” which causes the trust to be taxed in the child’s estate as if he or she owned it. Therefore, trust terms must be carefully crafted when naming a child as Trustee.
A simple way of avoiding this dilemma is to limit the child-Trustee’s discretion in the trust agreement by an ascertainable standard. Traditional ascertainable standards include distributions of income and principal for a beneficiary’s health, education, maintenance and support (“HEMS”). Although the child’s discretion over the trust assets are limited under these standards, most people find that sufficient access still remains.
Another way of preventing the trust assets from being treated as being owned by the child and taxed in the child’s estate, while still naming the child as the Trustee over a trust in which he or she remains as a beneficiary, is to name a Special Co-Trustee. This is an independent third party who holds any Trustee powers that would cause adverse tax consequences if held by the child-Trustee. Although the child’s role as Trustee would be minimized by having to relinquish the power to distribute trust assets to himself or herself, the child-Trustee can still perform other non-controversial acts as Trustee, such as making distributions to the other trust beneficiaries.
Distributions to Descendants
Regardless of whether the trust document contains an ascertainable standard, estate inclusion also can occur when a Trustee has the ability to use trust assets to discharge his or her own legal obligations. This problem can occur when the trust agreement allows the Trustee to make distributions to the descendants of a trust beneficiary. As a beneficiary of the trust over which he or she is the Trustee, it is possible for the child-Trustee to make distributions to his or her descendants, discharging his or her legal obligation to support such descendants, thereby causing the trust assets to be taxable in the child-Trustee’s estate.
Quite obviously, a way to avoid such unintended tax treatment is to avoid drafting the trust with such a power. The trust agreement can limit the power of the Trustee to make distributions that would satisfy his or her own legal obligations. However, should such access be desirable to the Trustors for the benefit of the beneficiary’s descendants, a Special Co-Trustee can be provided for in the trust agreement to step in and save the day.
In addition to estate inclusion, distributions under this type of power allows the child-Trustee to divert trust assets to other beneficiaries thereby causing the distribution to be treated as a gift for gift tax purposes. To prevent gift tax treatment, the law has provided an exception for those transfers subject to an ascertainable standard as discussed above.
An additional problem triggered by naming a child as the Trustee of a parent’s trust is where the Trustors have more than one child, but choose to place only one in the role of Trustee. The Trustors may have valid reasons for naming only one child. Perhaps the parents acknowledge that it is much easier to have one party agree to act on behalf of the trust than to have multiple parties try to reach a unanimous decision. Maybe the choice is based upon the child’s acumen and flair for handling finances. Or maybe the decision is simply made because of the strength of the relationship between the parents and that particular child. Whatever the reasons, naming one child out of multiple children is a possibility to consider.
However, it is important to keep in mind that when family considerations are mixed with finances, emotions can run high. When one child is given the ability to distribute trust assets among his or her siblings, there may be accusations of favoritism. Luckily, this can be tempered by naming each child as the Trustee of his or her own trust. Nonetheless, should the Trustors feel the other children are not responsible enough to take on such an important role, this solution may not be feasible.
Consult with a Qualified Estate Planning Attorney
Choosing the right Trustee to be responsible for ensuring that your wishes are followed after you are gone is an important and often difficult decision. Naming your child may be a wise choice for you. If you are considering creating a trust, make sure you consult with a qualified attorney specializing in estate planning to be sure your trust agreement doesn’t contain any terms that will cause tax or relational problems for your loved ones. If you already have a trust, have an estate planning attorney review your trust agreement to be sure the tax pitfalls don’t trap your child in the future.
Mr. Morrison is a board-certified estate planning attorney with experience in both simple and complex estate matters. He has devoted its practice to estate planning and elder law matters for more than 18 years and has been a Member of the American Academy of Estate Planning Attorneys since 2017. The firm has helped thousands of clients meet their estate planning goals and pass on lasting legacies to their loved ones. To learn more about how you can achieve your estate planning goals, please call (504) 831-2348 or visit our website at www.morrisonlawplc.com.