Q: Barbara wrote last week asking, “Dear Derek: I have been asked to be a trustee on behalf of our family’s assets. Should I accept this offer and what could it entail?”
A: Barbara unless you are a professional trustee, my advice would be to not assume the risks and responsibilities of this role. Being asked to serve as a trustee of a trust may be flattering; however, many factors should be considered in deciding whether to serve as a trustee of a trust. Mistakes can be costly, and trustees can be held liable for breach of fiduciary duty.
The trustee is the legal owner of the trust assets, and the trust beneficiaries are the beneficial owners of the trust assets. The trustee has a fiduciary duty to act solely in the best interests of all beneficiaries (present and future) and in compliance with the terms of the trust document. It is important to read the trust document to see what it says about various issues, including trustee provisions, investments, notices that are required to be sent to beneficiaries, and distributions.
Trustee Provisions
Among other issues, trustee provisions discuss who makes decisions if multiple trustees exist. For example, it could be that majority rules or, alternatively, the trustee may be able to act alone. Trustee provisions will also discuss procedures on how a trustee resigns. For example, on resignation, the trustee may need to file timely notices to other trustees and beneficiaries. Further, on resignation, the trustee might want to obtain a release and indemnification from liability from the other trustees, beneficiaries, and even the grantor/settlor of the trust (i.e., the person who established the trust).
Investment Provisions
Trustees also need to be aware of investment responsibility. How should trust assets be invested? What limitations on investments, if any, does the trust provide? Is the trustee allowed to own closely held assets? Does the trustee have a duty to diversify? Generally, investments should be diversified, unless the trust specifically allows a concentration of certain assets (e.g., closely held family business interests).
Another point trustees should consider is the potential conflict between current and remainder beneficiaries. That is, current beneficiaries may want investments that generate income, while remainder beneficiaries may want investments that generate growth.
If trust investments go bad, beneficiaries may look to the trustee for liability.
Life Insurance Trusts Often, trusts are designed to hold life insurance. These trusts typically have no income (and consequently, no tax return filing requirement) during the life of the insured-grantor. However, significant trustee concerns exist. One concern involves the responsibility for monitoring the quality of the life insurance policy. The trustee will be responsible unless the trust provides otherwise. For instance, if the policy performs poorly and premiums skyrocket or the policy face value decreases dramatically, beneficiaries might sue the trustee for breach of fiduciary duty.
Another concern involves the payment of premiums. Who is responsible for paying the premiums? The grantor? The trustee? What does the trust document say about this? Unless it says otherwise, the trustee is responsible. What if a premium payment is missed and the insured is no longer insurable such that a replacement policy is not possible to obtain? Again, the trustee may be liable.
Withdrawal Notices
Many times, trusts provide that the trustee should send out withdrawal notices (or “Crummey” notices) to beneficiaries. This allows gifts made to the trust to qualify for the $14,000 gift tax annual exclusion for the grantor. Trusts often provide that when the grantor makes a gift to the trust, the trustee is supposed to send out a letter to the beneficiary telling the beneficiary that a gift has been made to the trust and that the beneficiary has a certain amount of time to request withdrawal of the gift amount. However, what if the trustee does not send out the letter? What if the Internal Revenue Service says the gift does not qualify for the annual exclusion? The trustee should understand what the trust provisions say about these notices and the timing of notices, to follow the trust document and to avoid liability.
Dispositive Provisions
What does the trust say about distributions? What are the criteria for distributions? Trusts might require distributions to be made at a certain time in a certain amount. Trusts might give trustees discretion on when and how much to distribute. Sometimes trusts provide a standard that trustees must follow. For example, the trust might say that the trustee can make a distribution for the beneficiary’s health, education, maintenance, or support. What if the trustee makes a distribution to a beneficiary that violates this provision, and the beneficiary squanders the money? Ironically, the beneficiary might sue the trustee asserting that the trustee never should have made the distribution. Trustees should consider getting a release and indemnification for distributions made and trustees should be sure to comply with the dispositive provisions of the trust.
Some trusts require “income” to be distributed to a beneficiary each year. How is trust accounting income calculated? Trust “accounting” income is not necessarily trust “taxable” income. Interest (including tax-exempt interest), dividends, and rents are trust accounting income. Capital gain income is not trust accounting income – it is principal. Corporate/partnership LLC distributions typically trust accounting income. The K-1 items, however, are not usually regarded as trust accounting income. Trust expenses are generally allocated one-half to income and one-half to the principal. Thus, it is important that trustees calculate net trust accounting income correctly where the trust specifically calls for distributions of such income. Otherwise, beneficiaries can be overpaid or underpaid and lawsuits can result.
Tax Returns
If a trust is required to file a tax return, it is the trustee who is responsible. Some trusts are not required to file a tax return (e.g., trusts with no income such as a life insurance trust and trusts that are “grantor” trusts for federal income tax purposes).
Conclusion
It is very important that trustees know what their responsibilities and risks are before agreeing to serve. Trustees should consider numerous factors in order to avoid liability.
