Castle Estate Planning:
AN ASCERTAINABLE TRUST TRAP
BY: BRUCE ALAN DANFORD, LLM
A common mistake many make in forming a trust is in the description of what a Trustee has the power or ability to do. A quick review of a few simple trust terms might help first.
Trustor - Also sometimes called the “Settlor”, a “Trustor” is the person who forms the trust and is frequently, but not necessarily, the one who places assets in the trust.
Trustee - The “Trustee” is the person who manages the trust on behalf of the beneficiary of the trust.
Beneficiary - There are two basic types of Beneficiary. The first is the “Income Beneficiary” and the second is the “Remainder Beneficiary.” An “Income Beneficiary” usually receives the income and sometimes the “Principal” or “Corpus” of the trust during the lifetime of the trust. The “Remainder Beneficiary” is usually the person who receives whatever is in the trust after the trust is terminated.
Corpus - “Corpus”, also known as the “Principal” of a trust is what is placed in the trust, usually money, stock, insurance policies, etc.
When a trust is formed, the trustor gives the trustee certain powers to act on behalf of the trust. Commonly the powers might include the ability to distribute the income, and sometimes principal, to the income beneficiary of the trust for certain purposes. The trustor might not want the income beneficiary to have the distribution for any purpose the beneficiary may want but may want to restrict the distributions for limited purposes. Frequently the purposes might be for medical bills, college, living expenses, a home, etc.
The problem that can arise is with the estate tax. See Internal Revenue Code (IRC) § 2041 and IRC § 2014. These two code sections address Powers of Appointment. A general power of appointment is generally described as “a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate…”. If that definition is met then; in the case of estate tax, the entire value of the property may be included in the decedent’s estate at their death.
A classic example is where a trust is formed by dad in his will for the benefit of mom as long as she lives with the remainder going to his children from a previous marriage. Dad has passed away and now mom is both a beneficiary of the trust and the trustee of the trust. The trust gives the trustee the power to make distributions of the income and corpus “as they see fit” for the benefit of mom. Mom now dies. Because mom had a general power of appointment, the entire trust is included in her estate and may be subject to estate tax.
If the trust agreement had limited the power of appointment to the ascertainable standards of health, education, support and maintenance then none of the remaining trust would have been included in mom’s estate for estate tax purposes. These “ascertainable standards” are found in IRC § 2041(b)(1)(A). The above example is only one of many scenarios which can defeat an estate plan by disregarding the rules for powers of appointment.
Bruce Alan Danford is a Colorado attorney and former Illinois CPA, with an LLM in Taxation, practicing in Broomfield, Colorado. Mr. Danford can be reached at (303) 410-2900 or via e-mail at BADanford@DanfordLawFirm.com.