Introduction to Trust Administration

When the settlor or settlors of a revocable trust die, the trust becomes irrevocable and the successor trustee is tasked with carrying out the settlor's final wishes as expressed in the trust agreement. One of the first tasks required of the trustee of such a trust by the Utah Code is to notify the trust beneficiaries that the trust exists, of the identity of the settlor(s), and that the beneficiaries have the right to request a copy of the trust agreement and the right to a trustee's report. This notice can be in the form of a letter that includes a copy of the trust agreement, the trustee's name and address, and a further notice that the beneficiaries have 90 days to commence a judicial proceeding to contest the validity of the trust until losing that right.

The trustee will need to marshal all trust assets, which will often require filing an affidavit of trusteeship with the county in which any trust real property is located, obtaining an EIN for the trust, making a claim for life insurance owed to the trust, and opening or taking control of any trust bank accounts or brokerage accounts. The trustee should also prepare an inventory of trust assets and maintain an accounting of all trust transactions. There are a number of potentially critical tax-related matters that may need to be attended to, particularly for large trusts, which are beyond the scope of this post. Another consideration is publishing notice to creditors of the trust (which can also be valid notice as to creditors of the decedent).

After all trust assets have been marshaled and debts and expenses paid, the trustee should send a letter to the trust beneficiaries with a "proposal for distribution" of the majority of the trust assets. This proposal should notify the beneficiaries of their right to object to the proposed distribution within 30 days; after this period, the right to object would terminate. This letter or a subsequent letter should enclose a "receipt and release" for each beneficiary and should explain that the trustee must receive all of the beneficiaries' receipts and releases before any distributions can be made. The trustee should withhold a small portion of trust funds for final expenses, such as a final tax return. Once all of the beneficiaries have signed and returned their receipt and release, the trustee can make the proposed distributions. Except for paying final expenses, closing accounts, and distributing any remaining amounts, the trustee's job in most cases will then be complete.

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Fundamental Supplemental Needs Trust Planning

Careful planning is necessary for individuals who have heirs with special needs that qualify for means-tested public assistance. At a minimum, such a plan should include a trust that restricts distributions to any special-needs heir. Any distribution that would otherwise pass to such an heir can only be made for the heir's "supplemental needs," or those needs that are not provided by a government assistance program. This trust provision is necessary to prevent a special-needs heir on means-tested public assistance from ceasing to qualify for such assistance due receiving an inheritance.

Assets subject to a supplemental needs trust are not countable resources for purposes of determining the special-needs heir's qualification for means-tested public assistance. Accordingly, the heir can continue benefiting from their public assistance programs while maintaining the beneficial interest in a supplemental-needs trust. The trust is able to provide benefits that the heir is not already receiving from his or her public assistance program. A trust that is funded solely with assets derived from someone other than the special-needs heir is known as a third-party supplemental needs trust. After the termination of the trust, assets remaining in a third-party supplemental needs trust can be passed to other family members.

If proper planning is not undertaken and a special-needs heir does inherit assets, they have two primary options: Spend down all of the inheritance until the heir qualifies once again for the public assistance program(s), or transfer the inheritance into a first-party or self-settled supplemental needs trust. First-party supplemental needs trusts are funded with assets belonging to the individual with special needs. The key downside of a first-party supplemental needs trust is that upon the termination of the trust, the government must be reimbursed from any property remaining in the first-party trust up to the total amount of medical assistance benefits received by the beneficiary during their lifetime. Accordingly, it is much better if all family members from whom a special needs individual could possibly receive an inheritance complete an estate plan that includes supplemental needs planning provisions.

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Trusts as Beneficiaries of Retirement Plans

In order to qualify as a "retirement plan" under the Internal Revenue Code, 401(k)s, individual retirement accounts, and other retirement arrangements must be distributed to the employee that owns the plan or that employee's designated beneficiaries pursuant to I.R.C. § 409(a)(9) and the accompanying regulations. For purposes of these rules, only individuals are permitted to be designated beneficiaries of a retirement plan. One reason for this is so that required minimum distributions can be calculated.

However, if certain requirements are met, a trust may be named as the beneficiary of an employee's retirement plan, and the individual beneficiaries of the trust will be treated as having been designated as the plan beneficiaries. For an excellent breakdown of how the required minimum distribution rules work where a trust is a beneficiary, see the chart prepared by Keebler and Associates located here. Naming a trust as a beneficiary of a retirement plan can be a useful estate planning technique, but after the employee passes away, the custodian of the retirement plan will need assurance that the requirements described in Treas. Reg. § 1.401(a)(9)-4 are satisfied.

These so-called "see-through" rules for a trust will be satisfied after the employee's death if the beneficiaries of the trust with respect to the retirement plan, if not specified by name, are identifiable from the trust instrument and certain documentation is provided to the custodian. The documentation requirements include (1) a list of all of the current beneficiaries of the trust, (2) a list of all the contingent and remainder beneficiaries of the trust as well as a description of the conditions on their entitlement, (3) a certification that this beneficiary list is correct.

Finally, the trust must be valid under state law and be irrevocable, and the trustee must agree to provide a copy of the trust instrument to the custodian upon demand. The trust agreement should be drafted with these rules in mind by restricting distributions of any retirement plan assets to individual trust beneficiaries and requiring that such assets be distributed in accordance with I.R.C. § 409(a)(9) and the regulations. Compliance with these rules will allow a trust to be a designated beneficiary of a retirement plan.

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Comparison of DAPT Statutes

The law has long allowed individuals to establish spendthrift trusts for the benefit of third-party beneficiaries and thereby remove the trust assets from the reach of creditors. However, until relatively recently, the law did not allow individuals to establish spendthrift trusts for their own benefit and successfully remove trust assets from the reach of their own creditors.

Alaska became the first domestic jurisdiction to allow this type of planning by passing an asset protection trust enabling statute in 1997. A Domestic Asset Protection Trust (DAPT) allows an individual to transfer assets to a trust, remain a beneficiary of the trust while removing the assets from the reach of creditors, and also achieve numerous tax planning objectives.

DAPTs offer significant protection for individuals residing in states that have adopted DAPT legislation. Whether a trustor residing in a jurisdiction that has not adopted DAPT legislation can form a trust pursuant to the laws of a foreign DAPT jurisdiction and successfully protect their assets from creditors has not been adequately settled by the courts.

A number of factors must be weighed in determining which jurisdiction a trustor should select as the situs for their DAPT. An excellent resource for comparing the provisions of the various DAPT statutes is David G. Shaftel's Comparison of the Domestic Asset Protection Trust Statutes. Sixteen states have passed DAPT enabling laws, the latest being Mississippi in 2014, and Mr. Shaftel's chart compares and contrasts the applicable laws in each of these jurisdictions.

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Irrevocable Trust Planning

Individuals with substantial assets can utilize a number of techniques to minimize gift and estate taxes. These techniques include making lifetime transfers of assets using irrevocable trusts. This post will describe some of the irrevocable trust planning techniques for income-producing assets. Such trusts will name an "income beneficiary," who will be entitled to the income generated by the asset and a "remainder beneficiary," who will be entitled to the asset itself after a defined period of time.

One way to classify such trusts is by how the income of the income beneficiary is calculated: In general, income is calculated as either a fixed amount (an annuity) or as a fixed percentage of the net fair market value of the trust assets (a unitrust amount). Another way to classify these trusts is whether they involve a charitable beneficiary. Finally, with respect to charitable trusts, the charitable beneficiary can be either the income or the remainder beneficiary. These different trusts can be described using the following chart:

	Annuity Income	Unitrust Income
Charitable Lead Trusts (CLTs)	Charitable Lead Annuity Trust (CLAT)	Charitable Lead Unitrust (CLUT)
Charitable Remainder Trusts (CRTs)	Charitable Remainder Annuity Trust (CRAT)	Charitable Remainder Unitrust (CRUT)
Grantor Retained Trusts (GRTs)	Grantor Retained Annuity Trust (GRAT)	Grantor Retained Unitrust (GRUT)

In summary, a CLAT and a CLUT both provide a charity with income for a period of time, in the form of an annuity or unitrust amount respectively, with non-charitable beneficiaries receiving the remainder interest when the income period ends. A CRAT and a CRUT are similar, except that the charitable beneficiary receives the remainder interest at the end of the income period, during which either an annuity or unitrust amount is paid to non-charitable beneficiaries. Finally, a GRAT and a GRUT provide for both an income interest and a remainder interest to non-charitable beneficiaries. Future posts will discuss the situations in which each of these trusts are typically used.

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Utah DAPT Update

Two recent developments in Utah Domestic Asset Protection Trust law are worth mentioning. First, the Utah Supreme Court issued a ruling in the case of Dahl v. Dahl, dealing with a DAPT in the context of a divorce. Ms. Dahl appealed a lower court's decision, arguing that it erred in holding that she had no enforceable interest in the assets of a DAPT established by Mr. Dahl, and the Utah Supreme Court agreed.

Although the trust agreement specified Nevada law as the law governing the trust, the Utah Supreme Court applied Utah law for public policy reasons. Whereas under Nevada law the trust would have been irrevocable, under Utah law the Court found that the trust was revocable. Even though the trust agreement stated that it was irrevocable, another provision said that Mr. Dahl could amend the trust with the consent of the beneficiaries, and the trust did not include any express restrictions on this power.

This case is not a "traditional asset protection planning case," according to Jay Atkisson writing for Forbes. However, it reminds planners and clients alike that in order for a DAPT to be effective, it should, at a minimum, be formed pursuant to the law in which the settlor is domiciled and not be used to try and "cheat another spouse."

In another development, a bill has been proposed in the Utah legislature, H.B. 318 - Domestic Asset Protection Trust Amendments, which would repeal and replace Section 25-6-14, the current Utah asset protection trust statute. The "new type of asset protection trust" the bill creates would, among other things, require asset protection trusts to be registered with the Utah Division of Corporations and reduce the value of a settlor's assets that would be protected from creditors. Specifically, a DAPT could assert only the following exemptions:

The Median Exemption is an amount equal to the sum of the median value of a Utah owner occupied housing unit and the median Utah household income as determined in the most recent American Community Survey conducted by the United States Census Bureau.

The 50% Exemption is determined on a claim by claim basis and is an amount equal to the sum of [certain amounts] reduced by the Median Exemption...

For 2013, the Median Exemption would appear to only be $211,400 for median owner-occupied unit value plus $59,770 for median household income. This would represent a significant creditor-friendly change to Utah's DAPT law.

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The Bypass Trust: To "B" or Not to "B"?

For many years, estate planners recommended planning that involved an "A/B trust" structure whereby assets of the first spouse to die equaling the estate tax exemption in value would end up in a trust to preserve that spouse's estate tax exemption. This prevented the surviving spouse from being "left with the couple's assets, but only their own individual exemption." Depending on a number of factors, this strategy could potentially save millions of dollars in estate taxes.

The costs of this trust, which is known by many names including a "B Trust," "Credit Shelter Trust," "Family Trust," or "Bypass Trust," are not insignificant. The surviving spouse's access to the assets of the B Trust are necessarily restricted, tax returns must be filed each year the trust is in existence and has income, legal responsibilities are imposed on the surviving spouse or a non-spouse trustee for trust management, and there is no step-up in basis for the B Trust assets at the surviving spouse's death.

Until recently, these costs could easily be justified by the potential estate tax savings. After the American Taxpayer Relief Act, however, the law allows the deceased spouse's unused exclusion amount to be transferred to the surviving spouse without the need for a B Trust. The unused exclusion must be calculated, and an election to transfer the unused exclusion made, on a timely filed estate tax return of the first spouse to pass away.

Rev. Proc. 2014-18, effective January 27, 2014, allows for an extension of time to make this "portability" election for decedents who passed away in 2011, 2012, or 2013 and who were survived by a spouse. Such elections, made in conjunction with the filing of an estate tax return, must be filed by December 31, 2014.

There are still benefits of a B Trust, namely, asset protection for the assets held by the trust, asset appreciation value that is excluded from estate tax, and greater certainty that the bequests contemplated by the first spouse to die will be carried out. However, the estate tax benefits to the B Trust have been reduced.

While it a good idea for everyone to review their estate plan every few years anyway, it is particularly appropriate for those with A/B trust provisions included in a revocable trust package to review whether that is still appropriate. For surviving spouses stuck managing a B trust that is no longer justified, it is appropriate to have the trust reviewed to see if it can be modified to better achieve that spouse's objectives.

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Defective Grantor Trust Overview

Irrevocable trusts are an essential part of sophisticated estate planning. Such trusts are normally used to hold assets that have been gifted or otherwise transferred by a grantor. Assets within irrevocable trusts, including future appreciation, are not included in the grantor’s estate for estate tax purposes.

A standard irrevocable trust is treated as a separate entity for income tax purposes and will be taxed on the income at the trust level. However, if an irrevocable trust is “defective,” the deemed grantor of the trust will be taxed on the income of the trust instead. This means the trust is disregarded for federal income tax purposes; such trusts are known as “grantor trusts.”

An intentionally defective grantor trust can be an effective planning technique for several important reasons. First, as with any irrevocable trust, the assets held within the trust are generally protected from creditors.

Second, since the trust is not a separate taxpayer, a sale to the trust by the grantor is not a recognizable transaction for income tax purposes and no gain will be recognized. Such a sale is often structured as an installment sale with a promissory note that has a self-cancelling feature effective upon the death of the grantor. This results in the balance of the note being excluded from the estate of the grantor; similarly, any increase in the value of the asset will also occur outside of the grantor’s taxable estate.

Third, since income generated by the irrevocable grantor trust is taxed to the grantor, the payment of that tax liability by the grantor is, in effect, a gift-tax free benefit to the trust and ultimately to the trust's beneficiaries. Since the trust is irrevocable, the trust principal will not be included in the taxable estate of the grantor. Therefore, the grantor can transfer assets into the trust by sale without the recognition of an income tax event, not have the trust assets included in his or her gross estate at death, and continue to reduce the value of his or her estate by the income tax payments on the trust income.

Although President Obama's current budget proposal would eliminate the value of using intentionally defective grantor trusts as an estate planning strategy, such trusts currently remain a useful tool.

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Personal Residence LLC and Trust Tax Considerations

Some asset protection attorneys recommend placing personal residences into entities, while others prefer trusts. While both have their pros and cons, no decision should be made without ensuring that the federal tax benefits of owning a personal residence are maintained.

The Internal Revenue Code provides a significant tax advantage to taxpayers who own a personal residence. First is the interest deduction of as much as $1 million of acquisition indebtedness and up to $100,000 of home equity indebtedness on a qualified personal residence. Taxpayers who do not hold legal title to a residence but who can establish they are the equitable owners of the property are entitled to deduct mortgage interest paid by them with respect to the property. Transferring a personal residence into an asset protected entity should not affect this deduction as long as the taxpayer remains the equitable owner of the property.

Second, and more important, IRC § 121 provides for an exclusion from taxable income of $250,000 ($500,000 for married couples) worth of gain on the sale of a personal residence. This exclusion may be claimed every two years as long as the taxpayers owned and used the property as their principal residence for two out of the previous five years prior to the sale.

Treas. Reg. § 1.121-1(c)(3)(i) provides that if a taxpayer owns his or her residence in a trust, as long as the taxpayer is treated as the owner of the trust, he or she is treated as owning the residence for purposes of satisfying the two-year ownership requirement. Treas. Reg. § 1.121-1(c)(3)(ii) provides that if an individual taxpayer owns his or her residence in an entity, as long as the entity has the taxpayer as its sole owner and is disregarded for federal tax purposes, he or she is treated as owning the residence for purposes of satisfying the two-year requirement.

One other possibility exists in community property states where a married couple owns the limited liability company 50-50, as the entity can elect to be taxed as a disregarded entity under Rev. Proc. 2002-69. The couple will be able to own their residence in the LLC and satisfy the two-year requirement.

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