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Guidelines for the Individual Trustee
Ronald P. Adams
Seminar: See the video highlights from Ron Adams' October
2013 seminar for trustmakers and successor trustees.
Now that you are trustee of your own revocable living trust, you will want to
manage it to maximum advantage. While this is not difficult to do, you should
remember that a trustee cannot always do everything that an individual can do,
particularly after the death of a settlor when a trust has become irrevocable.
This article is intended to give you some general information and guidelines
concerning the management of the trust during a trust's three phases: (1) when
both settlors are living; (2) when only one of the settlors is living; and,
finally, (3) when no settlor is living. This article also covers such diverse
areas as record keeping, tax returns, proper investment and management
procedures, the duties and liabilities of trustees, and allocation of assets
(upon division into separate trusts).
Because each trust document is different and each case has its own special
facts, the general rules set forth in this article will not always be applicable
and this memo cannot substitute for specific advice on specific legal questions
as they arise. Nor can this memo substitute for common sense and caution.
Each trustee must read and be familiar with the terms of his trust, and must
carefully comply with those terms. If questions arise respecting the
interpretation of the trust, record keeping, forms of title, whether or not a
particular investment or sale can be made, etc., your attorney, accountant, or
other advisor should be consulted. While the revocable living trust is a useful
and flexible estate planning tool which, in many instances, can save substantial
estate and income taxes, it demands careful administration if its tax and other
benefits are to be achieved.
Management During Life of Settlors
A revocable living trust commences the moment the trust has been executed
(signed) and funded (see
Funding and Administering Your Trust).
Complete funding of the trust is not necessary to establish it, but transfer of
at least one asset to it is necessary. Different types of assets require
different procedures to effectuate the transfer of title from the names of the
settlors into the name of the trustee, and the length of time necessary to
transfer title to the name of the trustee will vary depending upon the
particular asset involved.
Some assets not initially transferred into the trust may later be transferred
into the trust even at or after the death of a settlor. For example, the
ownership rights in insurance on the life of a settlor (or another person) is
usually not transferred to the trust, instead the proceeds are made payable (by
beneficiary designation) to the trust at the insured's death. No matter when an
asset is transferred into the trust, the trustee must take care to properly
collect the asset, have title registered in the name of the trust (i.e., the
name of the trustee), allocate the asset to the proper account and thereafter
keep proper records of the transactions concerning that asset.
The benefits of a revocable living trust, such as avoidance of probate
proceedings, accrue only to those assets held in the name of the trustee.
Therefore, it is important, as assets are sold and new assets purchased, that
the trustee handle all transactions as trustee and that he be certain that new
assets are registered in trustee's name.
Protecting Trust Assets. Once assets have been transferred to the trust, the
trust agreement is fully operative as to those assets. So long as both settlors
are alive and competent, they may control the manner in which assets are
invested and the manner in which the income and principal of the trust is
distributed. The settlors will have this control even if they are not trustees.
Thus, it is conceivable that the trustee may have no significant
responsibilities during the first phase of the trust, i.e., when both settlors
Nevertheless, any assets which have been transferred to the trust and which
should be covered by insurance should also be protected by insurance while they
are within the trust. If insurance is already in force, the insurance policy
should be amended to add the trustee as an insured party. This can usually be
done at no cost.
Assets such as stocks and bonds should be placed in safekeeping, such as a
separate safe deposit box. This safe deposit box should be used only for trust
assets and should be held in the name of the trustee. In this manner, bearer
securities (such as municipal bonds) can always be identified as trust assets.
The successor trustee, upon presentation of a true copy of the trust, will be
able to obtain access to the safe deposit box.
Actions of the Trustee. The trustee is the legal owner of the trust assets. If
there is more than one trustee, the trustees own the assets with survivorship
rights similar to those of joint tenants. Property held in the name of multiple
trustees will pass to the surviving trustees upon the death of a trustee. If
more than one trustee is acting, the trustees must act together unless the trust
instrument expressly provides to the contrary.
The trustee is not the agent of the beneficiaries; the trustee is an independent
party who is responsible for his own actions. However, when both settlors are
living and directing the actions of another person acting as trustee, this
responsibility is not to persons who might take an interest in the trust in the
future so long as both settlors are living and the trust is revocable. As
indicated below, once a trust becomes irrevocable, future beneficiaries may
obtain enforceable rights and the trustee then may act only after considering
When both settlors are living, the trustee should segregate the trust assets and
keep trust records sufficient to allow the settlors to prepare normal personal
income tax returns.
Identifying the Trust for Tax Purposes. The IRS exempts your trust from filing
all income tax returns, so long as you report all income, gains and losses on
your personal return. The trust is not treated as a separate taxable entity, and
you will not lose any income tax advantages by holding assets in the name of the
For example, the transfer is non-taxable, your basis in the property is not
affected, and the one lifetime exemption of the first $500,000.00 (if married
and filing jointly) of gain on the sale of your home is still available.
Upon the death of a settlor, the trust will become a separate taxable entity and
will be required to file fiduciary income tax returns.
Investments. During the first phase of the trust, investment of trust assets is
handled in the same manner as it would have been handled by the settlors were
there no trust in existence, except that trust transactions should be undertaken
in the name of the trustee and not in the names of the settlors as individuals.
Procedures on Death of a Settlor
When a settlor dies, a portion of the living trust (usually consisting of all or
part of the deceased settlor's separate property and his share of the community
property) will usually become irrevocable. The duties of the trustee then become
more important and his responsibilities become substantially greater.
At the death of a settlor, trust assets must be valued, death tax returns must
be filed, assets must be allocated to the proper accounts or subtrusts,
appropriate books (records) must be established so that the income and principal
receipts of each trust which has become irrevocable can be recorded accurately
and investments must be more carefully made because the trustee is now
responsible to all of the trust's beneficiaries, even if they are not yet born
Normally, the trustee's attorneys or accountants will prepare the federal estate
tax returns necessitated by the death of a settlor. They will also assist the
trustee in collecting assets, valuing them and allocating them between trusts.
The attorneys will, upon request, assist with any questions of trust
administration or interpretation. Most of these items relating to the continuing
management of the trust are discussed in greater detail below.
Management During Lifetime of Surviving Settlor
Upon the death of one of the spouse settlors, the living trust is usually
divided into two separate subtrusts, the Survivor's Trust and the Decedent's
Trust. To the Survivor's Trust is allocated one-half of the settlors' community
property, all of the surviving settlor's separate property, and, in some
instances, a marital deduction share. The balance of the trust property will be
allocated to the Decedent's Trust. Furthermore, your trust may provide for the
creation of a third trust called the Qualified Election Trust which will usually
have all of deceased settlors' separate property and his or her share of the
community property not allocated to the Decedent's Trust.
Because federal law allows the trustee to minimize taxes by valuing the
decedent's share of trust assets both at date of death and six months thereafter
(unless they have been distributed or sold) allocation of assets may need to
occur between the Decedent's Trust, the Survivor's Trust and the Qualified
Election Trust (if applicable). Once the trustee has determined the extent and
value of the assets which are held by the trust, the trustee will allocate those
assets between the Survivor's and Decedent's trusts and the Qualified Trust (if
applicable) in the manner required by the trust document itself.
Most trust documents, however, now allow the trustee to allocate various whole
assets (rather than undivided interests) to each trust -- to achieve better
management, to encourage future estate planning, and to meet the varying needs
of the different beneficiaries. For example, if the home and its contents are
held by the trust it is quite common to allocate them to the Survivor's Trust
(rather than a one-half interest to the Survivor's Trust and a one-half interest
to the Decedent's Trust) so that the surviving spouse has not only their
continued use, but the complete freedom to dispose of them as his or her needs
dictate. It should be remembered that the Survivor's Trust usually remains
subject to revocation by the surviving spouse after the death of the first
settlor to die, or, if it is not revocable, it is almost always subject to a
general power of appointment (the power in the surviving spouse to designate how
the assets of the trust are to be distributed), thus property allocated to the
Survivor's Trust almost always remains subject to the control and disposition by
the surviving settlor.
The actual allocation of the trust assets is usually accomplished by book entry
in the accounting records of the trust rather than by actually registering title
to the assets in the name of the specific subtrust (i.e., Survivor's or
Decedent's Trusts). This allows the assets of the trust to be managed as a unit
for purposes of economy. For example, if 60 shares of certain stock are
allocable to the Decedent's trust and 40 shares of the same stock are allocable
to the Survivor's Trust, the actual certificate will probably be for l00 shares
held in the name of John Doe, trustee, etc. If it becomes appropriate to sell
the shares held by one trust an retain the shares held by the other trust, this
can always be done so long as accurate accounting records are kept.
The mathematical computations governing allocation of trust assets, while not
difficult, are complex because of many factors which may be present. For
example, while the property may be equally allocated to each of the Survivor's
and Decedent's Trusts, death taxes, funeral expenses and expenses of last
illness are usually chargeable only against the Decedent's Trust; debts (i.e.,
unpaid bills outstanding at time of the deceased settlor's death) may be
chargeable equally to both trusts or in varying proportions to the trusts
depending upon the nature of the debt and the amount of separate or community
property available to satisfy the debt. Thus, it is most important when
allocating trust assets for the trustee to consult with attorneys or accountants
skilled in fiduciary accounting (as opposed to business accounting) so that the
all-important "starting figures" for each trust may be determined. The
importance of proper asset allocation and generally getting off to a good start
cannot be overemphasized.
Record Keeping. After the death of one of the spouse settlors the accounting
records for the Survivor's trust are kept in the same fashion as the revocable
living trust records are kept prior to the death of the spouse. However, the
accounting records for the Decedent's Trust and the Qualified Election Trust, if
applicable, must, of necessity, be kept in greater detail and with greater
accuracy. Because the Decedent's Trust and the Qualified Election Trust, if
applicable, are separate taxpaying entities and because the trustee has
responsibilities to both the income beneficiaries [usually the surviving spouse
and sometimes other members of the family, and the remaindermen (those who will
receive the property on termination of the trust)], careful records must be kept
of the transactions of the Decedent's Trust and the Qualified Election Trust, if
applicable, which has become irrevocable.
These records must distinguish between income and principal, receipts and
disbursements. For example, if the trust holds a note received on the sale of an
asset and the note is being paid on an installment basis, each payment most
likely will include both a repayment of the principal portion of the note and
interest. These items must be allocable to the income account while the note
repayment portion is allocable to the principal account. (This treatment may or
may not be the same for income tax purposes since fiduciary accounting and
fiduciary income taxation are not always parallel.)
Similar careful treatment must be accorded expenses allocable to principal and
expenses allocable to income. In some instances, the trustee has the discretion
to determine the manner of allocation as between principal and income or, in
less frequent instances, to make the determination when the allocation is not
clear. When any question of allocation arises, the accountants or attorneys
should be consulted.
Please note that fiduciary record keeping differs substantially from normal
bookkeeping or even from corporate or personal income tax record keeping. A
fiduciary is responsible for every penny which passes through his fingers and
must therefore account to the penny. Thus, the trustee is required to keep a
precise record of every receipt and disbursement, every gain and loss, every
distribution to a beneficiary, and every change in the nature of an asset of the
trust. This is not difficult if good records are kept from the inception of the
Decedent's (or other irrevocable) Trust. However, failure to keep good records
will require time consuming and costly reconstruction of trust records for both
tax and accounting purposes, and will raise adverse inferences against the
trustee should a dispute arise at a later date.
Tax Returns. As indicated above, the Decedent's trust and the Qualified Election
Trust are separate taxable entities. As such, they may select a fiscal year, are
required to obtain their own taxpayer identification number, and are required to
file their own tax return. Even if all of the income of the Decedent's Trust and
the Qualified Election Trust is distributable to the surviving spouse, some
"income" may still be taxable to the Decedent's Trust and the Qualified Election
Trust, and capital gains generated by sales or exchanges of assets held by the
Decedent's Trust and the Qualified Election Trust are almost always taxable to
the Decedent's Trust and the Qualified Election trust, respectively.
Fiduciary income taxation is a highly specialized field and most accountants are
not familiar with its intricacies. Therefore, it is extremely important that an
accountant familiar with fiduciary income taxation be employed to prepare the
Family Trust income tax returns, or that an attorney supervise the accountant in
the preparation of the return. The Survivor's Trust fiduciary income tax return
is prepared in the same manner as the fiduciary income tax return for the
revocable living trust was prepared when both settlors were alive.
Powers of the Trustee. The powers of the trustee are generally set forth in
detail in the trust document. Depending upon the terms of the trust, the powers
given the trustee may be very restricted or almost unlimited. However, even
where he is specifically granted absolute or sole discretion the trustee must
always act in good faith, considering the interests of the income beneficiaries
and the remaindermen. Unless specifically authorized otherwise by the trust,
joint trustees must act unanimously. Sometimes a trustee may delegate powers to
another trustee or to an agent. However, a trustee should be very cautious about
the types of functions which he delegates to a person who is not a trustee. For
example, "ministerial" functions may be delegated, such as the trust accounting
work or management of a farm property or a business. Nevertheless,
notwithstanding the delegation of the authority, the trustee is responsible to
oversee the delegated work and is responsible for the actions of the ministerial
agent. Discretionary powers (for example, determining whether or not to
distribute income or principal) may not be delegated. All decisions concerning
trust distributions should be made by the trustee. Decisions concerning trust
investments should usually be made by the trustee unless the trust expressly
provides for the retention of separate investment counsel or vests the
investment decisions in one particular trustee. However, even then the
delegating trustee probably has the responsibility to see that the delegated
power is used prudently.
Generally, the trustee has broad powers to sell, lease, borrow, pledge, and
otherwise manage the assets of the trust in a businesslike fashion. If a
question arises as to the existence or exercise of a power that is not clear
from the terms of the trust, the attorneys should be contacted. In these cases
where no ready answer is available (whether it concerns trustee's powers or
other terms of the trust) a petition may be filed with the Probate section of
the Superior Court and the matter usually can be resolved within a short time.
Duties of the Trustee. The trustee has an absolute duty of loyalty to the
beneficiaries of the trust. This means that although the trustee is the legal
owner of the trust assets, all actions taken in connection with the
administration of the trust must be with the sole interest of the beneficiaries
in mind. Any self-dealing by the trustee is a breach of trust. The trustee
cannot deal in any way with the trust's assets which would personally benefit
him (as for example buying assets for himself or selling assets to the trust)
even if such action would be advantageous to the beneficiaries, unless
authorized by the trust instrument.
Investments. The trustee has the responsibility for administering the trust in a
manner most beneficial to the beneficiaries in accordance with the terms of the
trust agreement. Normally, the trustee will be given power to invest as would a
"prudent man", namely, to manage the trust funds with regard to their permanent
disposition and considering both the probable income to be earned as well as the
probable safety of the principal. Such a standard recognizes the trustee's duty
not only to the income beneficiaries but also to the remaindermen.
Thus, for example, if the trustee invests in a wasting asset, such as an oil
royalty interest subject to depletion, a portion of the income received must
usually be set aside as a reserve to replace the depleting principal; otherwise,
the interests of the remaindermen would be prejudiced. Conversely, the trustee
may be required by the terms of the trust to establish no reserves or even to
retain certain assets although they produce no income. Thus, you can see that
paying close attention to the terms of the trust is of great importance. If
there are questions, the trustee's attorneys should be contacted without fail.
Record Keeping and Accounting. The trustee is usually required to furnish the
beneficiaries of a trust an annual accounting of his actions. This accounting
shows the starting balance of the trust assets, adds the receipts and gains and
deducts the distributions, losses and disbursements and then shows the remaining
balance on hand at the end of the accounting period. The starting and closing
balances will generally be at the "carrying value" for the trust which is most
often their income tax basis. A good account will also show market values for
the assets so that the investment decisions of the trustee can be more
A trustee must act with the highest good faith towards the
beneficiaries and use ordinary care and diligence whether he is paid for his
services or not. The trustee may not deal with the trust property for his own
profit, or for any purpose not connected with the trust. The trustee may not
obtain any advantage over a beneficiary or take part in any transaction with a
beneficiary unless the beneficiary, with full knowledge of the transaction and
having the legal capacity to enter into the transaction, specifically consents
to this and permits the trustee to do so. Similarly, the trustee may not
commingle his own property with the trust property; thus, separate accounts and
accurate record keeping are an absolute necessity. A trustee always has the duty
Trustee Liabilities. In many ways, the trustee is an insurer. If the trustee is
negligent, he may be surcharged (i.e., fined) for his negligence. Thus,
penalties and interest for failure to file tax returns will normally be borne
personally by the trustee. Moreover, the tax laws make a trustee personally
liable for unpaid death taxes to the extent of the assets held by him. Thus,
most trusts allow the trustee to withhold distribution of trust property until
all death taxes are determined and paid so that the trustee will not be later
required to pay the taxes from his own personal funds. Failure to invest the
trust property will subject the trustee to liability for simple interest on the uninvested funds. If a court were to find that the trustee willfully failed to
invest the trust property, he would be liable for compound interest and perhaps
Fees. trustees are entitled to reasonable compensation for the services
performed to the trust. Often the trust document will specify an amount or a
limitation. If it does not, a trustee is entitled to compensation in the same
manner as would anyone else performing similar management or investment
services. This usually depends upon the time involved, the responsibilities
undertaken, the results achieved, and the magnitude of the problems encountered.
Management of Trust after Death of Both Settlors
The discussion of the activities, duties and liabilities set forth in Section IV
above also applies to the management and distribution of assets after the death
of both settlors. Often the terms of the trust will then require specific
allocation of certain assets to specified beneficiaries or trusts, as, for
example, all of the stock in a family business to those children involved in the
business; or will charge a beneficiary's share with loans previously made to him
or with prior gifts, etc. Obviously, the terms of the trust must be examined
carefully to see that all of the settlors' directions are carried out.
If there are continuing trusts for children or grandchildren, these trusts may
be separate trusts (i.e., separate tax entities each requiring its own tax
return) or separate shares (i.e., one trust with varying interests requiring
only one tax return). Normally, the trust document will specify that separate
trusts are to be used as they are usually most advantageous from an income tax
If at any time trust income has been accumulated (i.e., not distributed but
rather added to principal), the federal and Arizona income tax laws only require
special computations resulting in additional taxes or refunds when the
accumulated income is distributed. These "throwback" rules are quite complex and
accountants or attorneys should be consulted if there are any questions
regarding them. The need to be familiar with and understand the terms of each
trust cannot be overemphasized.
Summary and Conclusion
The revocable living trust is a flexible and useful device for managing property
and, in many instances, saving death and income taxes. However, like a
partnership or corporation, it must have adequate management and record-keeping
Once these procedures are properly established their continued maintenance is
relatively easy. Most trusts can be managed by individual trustees, after they
are successfully under way, with minimal assistance from accountants and
attorneys, thus achieving numerous benefits for the settlors, their children,
and other beneficiaries, at minimal cost.
Nevertheless, being a trustee is a substantial responsibility and a trustee
should not hesitate to seek professional investment, accounting or legal
assistance whenever questions arise. An ounce of prevention is worth a pound of