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Guidelines for the Individual Trustee

Ronald P. Adams

Successor Trustee Seminar


Successor Trustee 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 are living.

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 these rights.

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 trust.

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 and identified.

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 accurately measured.

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 of care.

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 additional surcharge.

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 standpoint.

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 procedures.

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 cure.