Trust law/The United States
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Trust law in the United States
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[edit] The Trust Industry
Most trust law in the United States is now statutory at the state level. Fiduciary tax law is both federal (see the Internal Revenue Code) and state.
Trustees may be (1) competent individuals or (2) state or federally chartered corporations with trust powers (usually banks). Typically bank trustees will have integrated their fiduciary organization into their investment management or private banking groups.
It is not unusual for an individual to serve as trustee alongside a bank trustee: they are typically called "co-trustees." Both individual and corporate trustees may charge fees for their services, although individual trustees typically serve gratis when part of the settlor's family or the settlor him/herself. The term "co-trustee" may and typically will fool either the bank trust officer or the individual co-trustee into thinking their roles are identical. Both should read the document carefully. If the roles are not further defined in the document, then their roles are legally the same. As a practical matter however, the corporate trustee will nearly always do the custody work and keep the books. But many documents will give the individual co-trustee powers that differ from the corporate trustees. For example, the individual co-trustee's rights and duties may be limited to dealing with discretionary distributions of principal and income, sale of a personal residence held in the trust, or sale of a heartstring asset.
Note: in the context of bank trust organizations, references to the "co-trustee" are nearly always to the individual trustee.
Ever fewer American banks serve as trustee, as litigation costs rise. For most banks trust services are not profitable. For large and effective trust organizations a trust organization properly integrated into a private banking and investment division can be quite profitable.
[edit] Trust laws
The fifty states harbor rich differences in fiduciary law despite on-going efforts to reduce disparities through the Uniform Principal and Income Act and other uniform act efforts. It has been a common practice of American lawyers for the past 150 years or so to choose the law of Massachusetts to govern the disposition of property conveyed in trust. In the absence of a nationally uniform law, their justification was that the courts of Massachusetts ruled on trust questions with far greater experience and authority than any other State (much like choosing corporate law in Delaware for your new firm). Nevertheless, unless the terms of the trust document are incompatible with public policy (creating a trust to advance a criminal enterprise, for example), the governing local law generally allows most trust agreements to be enforced according to their terms.
For example, some states require all trustee fees to be charged equally to principal cash and income cash. If the trust document directs otherwise, however, the law allows document language to prevail. Where a document contains obnoxious, unworkable, impractical, or outdated language, the beneficiaries and trustees have recourse to local courts having general jurisdiction in equity -- most commonly for a declaration or judicial construction or for reformation of the trust to bring it into compliance with the original intent of the settlor, or to deal with circumstances not imaginable by the settlor at the time the trust was created to make the trust cy pres or as close as possible to the original intent.
When the trustee or beneficiary needs interpretation of the trust document (often but not necessarily incident to a dispute) the local probate court judge is the place to get an answer. In the trust business one speaks of "docketing" a trust, i.e. taking it to the judge. When the judge is finished, the trust is then "undocketed."
[edit] Creation
The rule that a trust is not established until it has res, discussed above, creates a problem where there is a "self-declared" trust, i.e. one in which the settlor acts as his own trustee, nothing is accomplished by signing trust documents without assets being retitled in the name of the self-declared trust. Failure to follow through on retitling is one of the great bugaboos of self-declared trusts.
This rule sometimes gives rise to "one-dollar trusts" - trusts holding just one dollar yet still posted to the books of bank trust organizations, awaiting more significant funding from life insurance proceeds or the settlor's decision to fund inter vivos. The bank normally will charge nothing to hold the document and the one dollar until the trust is funded with more than the one dollar. Note: banks typically will not collect the one dollar: Usually one dollar is posted on and off the books to establish the trust's existence.
Many trusts specifically allow for additional deposits (cash, securities, real estate, etc.) at the direction of the settlor or others, provided the trustee is willing to accept those assets. This can be problematical in the case of real estate, where entry into the chain of title will make the trustee liable for the acts of all others in the change of title. Corporate trustees will often not accept certain real assets, especially where real property is compromised by unremediated environmental issues or where the trustee is unable to make a thorough inspection. A corporate trustee without real property expertise will sometimes avoid accepting any real estate.
[edit] Purposes
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- This section lists purposes which are specific to the USA. See also the "Purposes" section above, which lists the generic purposes for which trusts are used.
- As an investment account with the added advantages of a full-service trustee. Typically, the individual will be older and wanting a strong relationship with his/her trust advisor. The trust document often then becomes the platform for the settlor's estate planning when combined with a pour-over will provision, i.e., all probate assets (assets in the name of the decedent) going to the trust post mortem. In such trusts there is typically a large component of services including bill payings, insurance claim filings, working with the settlor's attorney, accountant, and children, and financial planning. The personality and devotion of trust officer will be crucial to such a trust's success.
- Trusts are often created pursuant to an estate plan. The most common example by far is a credit shelter trustee wherein the settlor (by will or as dispositive provisions of a trust created inter vivos) leaves an amount in trust for benefit of a surviving spouse not in excess of the current federal exemption equivalent to the Federal Estate Tax. In 2006 this figure is $2 million. Thus an individual would leave, say, $2 million in trust for his wife (keep the $2 million out of her estate), give his widow the net income and the corpus to his children at her death.
- Trusts are often created as a way to contribute to a charity and retain certain benefits for oneself. A common ploy is to create a charitable remainder unitrust ("CRUT") with, say, $5 million with a percentage of the value at the end of each year coming back to the settlor, 5% say, and the remainder going to the charity at the death of the annuitant/settlor.
- Trusts may be created to protect an individual's welfare or other state benefits. These are typically called "special needs trusts." Typically, an individual has Medicaid and Social Security Supplemental Security Income (SSI) coming in. For such individual to then be given access to funds in excess of, usually, $2,000 ("countable" assets), risks immediate termination of his government benefits. To assure the individual a life of some ease beyond what he can afford from Social Security checks, a family member will place several hundred thousand dollars into a special needs trust for the little extras in life: dinner out, a birthday party, some new clothes, et alia. Such trusts require the expertise of a member of the "elder law" bar and must be administered with great care. It is best to have a family member as a co- or sole trustee. Given the small size of these trusts, they are typically not profitable for a corporate trustee.
- Trusts may be created to get funds to the next generation where there is significant wealth and federal exclusionary gifts have already been used up. The most typical of such vehicle is the grantor retained annuity trust (GRAT). Federal tax law specifically allows for this vehicle. Here the grantor places an asset in the trust -- one he expects will grow rapidly during the term of the trust. The document then requires the trustee to pay to the settlor a specific sum of money (the annuity) at certain intervals during the life of the trust. If there are assets in the trust at the end of the term, those assets go without estate or gift tax to the remaindermen. Here's a typical case: settlor owns large block of low cost basis stock in a publicly traded company. He does not wish to sell the stock and pay capital gains tax. He also has estate tax problems since his net worth when he dies is likely to be $10 million or more. His attorney drafts a GRAT in which he places $2 million of the single company's stock. The document calls for the smallest legal interest rate (published monthly by the Federal Government), which is then paid through the term of the trust. Upon the termination of the trust, the annuity has been paid back to the grantor and the remaining corpus is delivered to the remaindermen (typically children) without tax. Money has now passed from the grantor to his/her children without gift or estate tax. There has been no capital gains tax.
- Some create trusts to protect family members from themselves. It is not unusual to see a will in which four children get funds free of trust or any other encumbrances from their father but a fifth child's funds are all or mostly placed in trust. This is usually for good cause -- drug abuse, demonstrated inability to hold onto money, fear of divorce, criminal activity, a wish to see the funds go to grandchildren rather than one's own children.
[edit] Naming Conventions
While practitioners (bank trustees and fellow traveler trust and estate attorneys) persist in titling trusts as "Tr. u/a" (trusts under agreement a/k/a inter vivos trusts) or "Tr. u/w" (trusts under will), there is little practical difference between the two; it matters little whether a trust was created while the settlor is alive or following his death per terms of his will.
Industry convention is for the settlor's name to appear in the title. In the USA, the name follows a shorthand for the type of instrument. Consider "Tr. u/a John Smith" ("Tr. u/a" stands for "trustee under agreement"). This title indicates that during his lifetime John Smith created a trust. This title conveys no information about revocability and might better be titled "Tr. u/a John Smith Revocable" or "Tr. u/a John Smith Irrevocable". Conventional titles may further indicate the names of one or more beneficiaries in cases where the beneficiary is not the same as the settlor. Hence: "Tr. u/a John Smith FBO Alma Smith" or, if appropriate, "Tr. u/a John Smith FBO Alma Smith irrevocable". Titles also frequently include more information such as the existence of more than one trustee ("Co-tr. u/a John Smith": "co-tr" means co-trustee) or that one or more of the trustees are not the original trustee (Successor Co-Tr. u/a John Smith).
As a practical matter the typical corporate trustee's computer system will have room for a short title (with a limited number of characters: 32 in this writer's experience) and a long title with an unlimited character field. Typically, compromises are made in the short title and serve primarily as a reminder to the trust advisor which account he/she is viewing on the computer screen. Thus a complicated situation might be resolved as follows:
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- SHORT TITLE: John Smith IRREV for Alma
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- LONG TITLE: Successor Co-trustee under the will of John Q. Smith for the benefit of Alma Smith et alia irrevocable dated 5/1/1982 restated 4/11/2003.
In this example the bank trustee is the successor trustee, i.e. not the original trustee. John Q. Smith is the settlor (the creator of the trust). Alma Smith and others are the beneficiaries. The original document was executed on May 1, 1982. That document was completely rewritten, i.e. a new document was substituted for the original, on April 11, 2003.
Because each trust document is potentially different from each other document, a seasoned and capable practitioner will carefully consult actual document language before making any important decisions.
Some settlors insist on trust names that defy industry convention. Thus, aggrieved parents who create a scholarship trust for a deceased daughter may put the following language in their document: "This trust shall be called the Sally Sue Smith Education Trust." Some bank trustees might ignore the legal name of the trust, and refer to the trust, in bank records, as the "John & Jill Smith Education Trust" where John and Jill Smith are the grantors.
[edit] Inadvertent termination of trust
The trustee is said to hold legal title to the corpus, while the beneficiary holds equitable or beneficial title. Generally, a trust cannot exist unless there is at least some "title split" -- that is, the same person cannot generally hold all legal and all equitable title at the same time. If the legal and equitable title merge in the same person, the trust is considered nonexistent. This can happen when a sole trustee becomes the sole beneficiary (see Merger doctrine).
It is common practice for an individual to name himself trustee as well as being settlor and sole beneficiary. In such case the trust exists provided there is also at least one other trustee, but the settlor signs the trust document first as SETTLOR and second as TRUSTEE. In such cases the settlor/trustee/beneficiary files income tax returns to report income from trust property under his own taxpayer ID number -- usually his Social Security number. In such cases the settlor/trustee/beneficiary must be careful during trust administration to sign documents with the correct hat on. For example: The settlor/trustee/beneficiary hires an investment firm (often the purely investment part of a bank). Communication with the bank must be from "John Smith, Trustee" rather than "John Smith, settlor" or "John Smith, beneficiary." In the not unusual event that the self-declared trustee decides to resign in favor of a corporate trustee, he does so as "John Smith, trustee" with the concurrence of "John Smith, beneficiary/settlor." It happens....
[edit] Personal versus institutional
Practitioners typically distinguish personal trusts from institutional trusts: the former being established as a part of one or more individuals' estate and personal financial planning and/or investment needs, and the latter typically by or on behalf of foundations, endowments, and defined benefit and other qualifed pension plans. Most fiduciaries manage these two types of business separately, although it is not uncommon for small institutional accounts to be handled by the personal trust group.
[edit] Terminology
The various names listed above for the creator of a trust are interchangeable -- with "settlor" preferred by the legal community and "grantor" by trust officers and related practitioners. Typically, a trust created by a single individual, in which the settlor retains the ability to remove funds at any time, is called a grantor trust. Such trusts are often created as an investment management vehicle -- at least during the life of the settlor.
The term "grantor trust" also has a special meaning in tax law: a trust in which the Federal income tax consequences of the trust's investment activities are entirely the responsibility of the settlor or another individual who has unfettered power to take out all the assets. Therefore, where "grantor trust" is used, one must inquire which meaning is called for.
[edit] Federal income tax implications
For Federal income tax purposes in the United States, there are several kinds of trusts: grantor trusts whose tax consequences flow directly to the settlor's Form 1040 (U.S. Individual Income Tax Return) and state return, simple trusts in which all the income created must be distributed to one of more beneficiaries and is therefore taxed to the non-settlor beneficiary (e.g. the widow of a trust created by the late husband), whether or not the income is actually distributed (it happens), and complex trusts, which are, in general, all trusts that aren't grantor trusts or simple trusts. Some trusts may alternate between simple and complex under certain conditions. Many but not all trust organizations do their own tax work. This can be highly specialized work.
All simple and complex trusts are irrevocable and in both cases any capital gains realized in the portfolios are taxed to the trust corpus or principal.
