- Trust Agreement. This is the key to all determinations the trustee will make, and the documents to retain as part of the records. Some trusts even have a tax position article that indicates the intended tax status for the trust for income tax (grantor or non-grantor), gift (completed gift or not), state tax situs, etc. Confirm whether such a provision exists and that tax positions you take are consistent, unless actions by the trustee or others has changed these factors. For example, the trust might be formed in state “A” but a trust protector may be given the authority to change the situs and governing law of the trust to any other jurisdiction. The trust protector might terminate a particular trustee and change the situs to a more tax friendly jurisdiction. Traditionally, an irrevocable trust generally remained the same from inception until termination. Today, however, especially with a “modern” trust that incorporates all the flexibility modern trust drafting permits (decanting, trust protector with powers to change, the ability to turn off grantor trust status), the characteristics of an irrevocable trust might change quite dramatically from formation to termination (or perhaps more descriptively, reincarnation).
- Annotated Trust Agreement of Summary. A practical tool that can be helpful to any trustee, but especially a lay-trustee (in contrast to a professional or institutional trustee) is an annotated version of the trust highlighting key provisions that apply to the current administration of the trust. This can be used to focus the trustee on administrative steps to take, etc.
- Fiduciary and Power Holder Actions. Many trusts could be significantly impacted by actions the trustee or other power holders take. Obtain confirmation of any that have occurred. It may also be advantageous to periodically confirm that no actions have been taken. For example, a person (typically the settlor), is given the right to swap or exchange assets for non-trust assets can change the entire nature of the trust. Was such as power exercised? A person may be given the right to loan trust assets to the grantor, or to add a charitable beneficiary. These actions could also have significant impact on the trust. Relevant documentation should be retained.
- Beneficiary Information. Current data on trust beneficiaries including: addresses, Social Security numbers, state of residence, tax bracket, financial needs, and other data may be advisable or even essential to maintain. In some instances the trust records might document the state income tax implications of beneficiary residences, the tax situs of the trust, and what planning may be feasible.
- Disclosures. Consider the terms of the trust and applicable state law. If it is required that disclosures about the trust (e.g., a copy of the trust and a trust balance sheet) be made to certain beneficiaries (e.g., all current beneficiaries over 25 years of age) documentation that the required disclosures have been made should be retained (e.g., copies of the covering letters or emails sending out the required disclosures). If it is not obvious from the terms of the trust which beneficiaries should receive notice, an internal memorandum outlining the applicable law and analysis should be retained.
- Crummey or Annual Demand Powers. If gifts to the trust require notices be issue to qualify for the annual gift tax exclusion, the trust records should include copies of the Crummey notices since the inception of the trust, and that they are properly prepared and acknowledged. Many Crummey powers lapse over a period of time based on the greater of $5,000 or 5% of the trust assets each year (“hanging powers”). For these, it would be ideal to have a chart in the trust records of the remaining hanging powers that have not yet lapsed and to update this each year.
- Trust Assets. Trust records should include the documentation transferring assets into the trust. This might include, for example, an assignment for a partnership interest, a deed for real estate, a stock purchase agreement for stock purchased rather than received by gift (see below), a gift letter confirming a transfer by gift, and a range of other documents depending on the nature of the asset and the manner of transfer.
- Engagement or Retainer Agreements. Trusts regularly retain professionals to provide advice: insurance consultants, wealth managers, attorneys, CPAs, others. Trustees should try to obtain and retain written agreements with professional advisers. It could be important to confirm who the adviser is representing: The trustee, beneficiaries, or the grantor. Too often only a general engagement letter for a client is prepared rather than separate agreements for the client, an entity or trust.
- Investment Policy Statement (“IPS”). A written IPS can be important to clarify the investment intent for the trust. For example, prior to recent tax legislation the general investment objective of many bypass trusts had been to maximize growth outside the surviving spouse’s estate. Under the current tax structure, minimizing unrealized appreciation if there is no opportunity for a basis step-up on the death of the second spouse, might have a significant impact on how those trust funds are invested. If the bypass trust involved has provisions permitting the distribution of highly appreciated -assets out of the trust to the surviving spouse, where they could qualify for a basis step-up that might change the nature of the investment objectives for the same trust. An IPS can address the objectives of an insurance trust, a trust holding interests in a family business, or other assets, not merely one holding marketable securities.
- Split-dollar Life Insurance. If the trust is an insurance trust a split-dollar arrangement may have been entered into to pay for a portion of the insurance costs. For example, mother may loan an ILIT for daughter funds to purchase insurance. That loan may be secured by an interest in the life insurance policy purchased. If the arrangement is a split-dollar loan, a statement may have to be filed with the trust tax return confirming the intent to repay the loan.
- Loan Arrangements. Many trusts lend money to beneficiaries, family entities, or others. Related party loans are too often handled informally or worse. Proper documentation, payment and reporting of interest, etc. is essential for the transfer to be taxed as a loan, to minimize the risk of the loan being used to attack the validity of transaction or even the entity/trust involved.
- Personal Use Assets. If a trust purchases a house for a beneficiary, be certain that property tax and mortgage interest deductions are being properly handled both for the trust and those using the property. Who is entitled to deduct property taxes for a personal property that may be owned by a trust (e.g., the surviving spouse resides in the marital residence now owned by a bypass trust)? Has appropriate trust documentation been completed to support the acquisition of the asset? Which fiduciary must authorize the purchase? Is a personal use asset subject to the discretion of an investment trustee or the general trustee?
- Guarantee. If the family engaged in any intra-family sales (e.g. a note sale to a grantor trust) a trust other than the purchasing trust may have guaranteed a portion of the payments. Determine if guarantee fees are required to be paid, that they were in fact paid, and reported appropriately.
Trust Administration: Trust Records Provide A Roadmap To Proper Trust Management Part 2
This is the second article in a series of three articles intended to help trustees identify steps to be taken, and documents they might consider retaining, as part of the permanent trust records. Proper trust documentation may not only corroborate proper operation of a trust, but create a record to guide trustees and others in trust operation.
Following will be the final article in this series of three to discuss other documents trustees might consider retaining.
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