Posts Tagged ‘joint revocable trust’

Exercise of a Power of Appointment Should Follow the Document

JUNE 29, 2015 VOLUME 22 NUMBER 24

Clients are often unfamiliar with the concept of a “power of appointment.” If they don’t know what it is, they can be excused for not knowing whether they have one, or how to use it.

Suppose Thomas leaves $10,000 to charities in his trust, but gives his brother Richard the authority to choose which charities. What Richard has is a power of appointment. Because Thomas says that only charities qualify, Richard’s power of appointment is said to be “limited” — in this case, limited to charitable organizations.

Now suppose that another portion of Thomas’s trust says that his other brother (you knew he would be named, Harold, didn’t you?) can decide how to distribute $10,000. Harold’s power of appointment could go to anyone — including to Harold himself. It is a “general” power of appointment.

As you can imagine, it would be good for Thomas to spell out what Richard and Harold have to say, or sign, in order to let the trustee know whom they have selected to receive their respective gifts. Since Thomas had his trust prepared by a capable lawyer (with a sense of whimsy), it says that “the power specified herein may be exercised by Richard delivering a signed, notarized document on blue paper to the trustee on a Wednesday before noon, Mountain Standard time.” Harold’s power of appointment is identical, except that it specifies green paper and afternoon delivery.

Can Thomas impose those (silly) requirements on the proper exercise of the powers of appointment he is giving to his two brothers? Of course he can — nothing in the law of trusts requires sober, businesslike language. The signer of a trust has considerable leeway to impose pretty much any technical requirements he (or she — or they) wish.

That’s the principle involved in a recent Arizona appellate decision. It involves a trust established by a husband and wife, and a power of appointment given to whichever spouse survived the other.

William and Mary Quick signed a joint, revocable trust in 1985. As is often the case, the trust was for their own benefit so long as both lived, and continued to be for the benefit of the survivor upon the death of the first spouse. One unusual provision was included in the trust, though: upon the death of the first spouse, the entire trust would become irrevocable, assuring that the couple’s two sons would receive everything upon the second spouse’s death.

The opinion does not explain whether William and Mary’s two sons were to receive equal shares under the trust’s default terms, but let us assume that they were. One thing the trust did provide, though, was that the surviving spouse would have a limited power of appointment, and could change the shares of the two sons after the first spouse’s death. The only requirement for exercise of the limited power of appointment was that it had to be done by a will, and that the will had to make specific reference to the power of appointment.

Mary died in 2003. A year later, William apparently decided that he wanted to change his sons’ shares of the trust. How did he do that? He signed a new trust document — a “restatement” of the trust — which altered the distribution shares upon his death. William lived for several years after the trust restatement was signed, but no further changes were made before his death, and he did not refer to his power of appointment in his will.

William was the sole trustee of the trust after Mary’s death. Assuming all assets were community property (which we don’t actually know to be true), half of the trust’s assets came from “his” share of the community. We can also reasonably assume that the trust permitted him, as trustee, to dip into the trust’s principal and distribute it to himself, at least in some circumstances. So was his failure to refer to the power of appointment in his will a problem?

One of the couple’s sons thought so, and a legal dispute was inevitable. Both brothers joined in asking the probate court for instructions: was William’s apparent exercise of his power of appointment valid? Should the trustee make distributions between them based on William and Mary’s original scheme, or rely on William’s restated trust document from after Mary’s death?

The probate court decided that what William had done was ineffective. Since the original trust became irrevocable on Mary’s death, and it required William to make any changes in his will, that was what was required. The original division between the two sons would be upheld.

The Arizona Court of Appeals agreed. It was not good enough that William almost did it right. Nor was it sufficient that William had the authority, and his wishes were clear. The trust required that the limited power of appointment must be exercised in William’s will, and that the will specifically refer to the power itself. William’s will did not exercise the power of appointment, or even refer to the original trust (or, for that matter, the restated version). Quisling v. Quisling, June 16, 2015.

Assuming, for the sake of education, that William really did mean to change the distribution shares of his two sons, what should he have done? The easy answer is that he should have followed the trust’s instructions: he could make the change by simply referring to the trust in his will, and no change needed to be made in the trust document itself.

Under Arizona law, though, that probably was not his only choice. William might have been able to “decant” the irrevocable trust into a new trust. He might have been able to withdraw some, most or even all of the trust’s principal and put it into his own name (and, subsequently, a new trust). He might have been able to avoid disputes by entering into an agreement with his two sons about how to handle the trust for the rest of his life and even after his death. But by simply restating the trust, without more, he failed to accomplish his goals. The lesson: exercise of a power of appointment must follow any instructions given with the power itself.

Does Your Existing Trust Split Into Two Shares On a Spouse’s Death?


A letter from a reader asks: “My husband and I set up a revocable trust which will divide our assets in half when one of us dies. This was to avoid estate taxes.  Now that estate taxes are no longer a problem, are there still benefits to splitting our assets when one of us has died?”

What a great question!

The short answer: if your combined estate is well under the $5.43 million threshold for estate taxes (in 2015), there is probably no tax reason for splitting the trust on the first death. If your combined estate is less than two times that figure, the answer is probably the same. But that’s not to say that there’s no reason to provide for a split of the trust — it’s just not a tax reason.

Here are some circumstances in which you might still want to split your trust — not necessarily in half, but into two shares — on the first spouse’s death:

  • You might worry about what will happen with the surviving spouse after one spouse dies. Will he or she remarry? Become infirm and susceptible to influence from people outside the family? Begin to favor one child over the others, or disfavor one child? If you feel strongly that “your” share of the estate (and here we’re talking as much about a “moral share”, if you will, as a legal share) needs to be locked down if you die first, then you might still want to provide for a trust split on the first death. Let us talk — and by “us” I mean you, your husband and your lawyer, all together.
  • You might feel like some of the assets are really yours, not your spouse’s. Did you receive a substantial inheritance that you have kept separate? Did you bring more assets to the marriage? Is there a particular asset (your home, or a summer cottage where your children spent every summer, or stock in a family business, or something similar) that you feel particularly strongly about passing to your children? Time for us to talk.
  • Is this a second marriage, with children from prior marriages? We should probably discuss how the two of you feel about the likely connection the surviving spouse will maintain with stepchildren.
  • Does your spouse have a problem managing money, or completely different ideas from yours about how to invest or maintain assets? Guess what — we need to talk.
  • Do either (or both) of you own real property in another state? Because the estate tax answers might be different.

Note a common thread here: there are no easy, pat answers. Each consideration means we need to talk through what’s important to you and to your spouse, and what is legally possible — and efficient.

There are some downsides to splitting the trust on the first death. For one, it probably increases the cost of managing the trust. It certainly increases the responsibility of the surviving spouse to account to the children, and maybe (depending on your trust’s terms) even grandchildren or others. It might (but probably won’t — we don’t want to alarm you unnecessarily) actually increase income taxes. It probably will mean that the surviving spouse has some limitations in how they deal with the portion of the trust that becomes irrevocable on the first death — and that can be emotionally troubling. And remember that what’s sauce for the goose — well, you know the rest of that aphorism.

Incidentally, the same answers apply to a couple who never did set up a trust that splits on the first death. Even though taxes may not compel such a split, it might be a choice that makes the couple feel more comfortable about what will happen after the first death.

Here’s a thought experiment for you: we find that it’s relatively easy for married couples to imagine what life would be like if one spouse died (though it may not be pleasant to contemplate). What’s more challenging is to imagine what life will be like ten, or fifteen, or twenty years after your spouse dies — or (harder still) what life will be like for your spouse twenty years after you die.

The same client goes on:

“Is the second trust still vulnerable to nursing home expenses?”

Another good question. It takes a little explaining, but the journey should be worth it.

If you set up a trust for yourself (let’s assume you are single for a moment) and then enter a nursing home, your assets will probably not be protected from the cost of the nursing home. That’s an overgeneralization — there are actually some kinds of trusts that might protect your assets from long-term care costs. But they will usually have been in place for five years, and be very restrictive. For the moment, let’s just go with “no, the trust you create for yourself is not safe from nursing home costs”.

If your spouse dies and leaves his or her entire estate to you outright, then the trust you set up will look the same. Even if you and your spouse set up a joint trust and then he or she dies, leaving you with the power to revoke the whole trust, that will be the same as the trust you set up with your own assets. So no, the trust that does not split into two shares on the first death will not (usually) protect against nursing home costs.

But if your joint revocable trust splits into a revocable and an irrevocable share on the first death, the answer may be different. If that seems like a likely scenario, or you particularly want to pursue protection from long-term care costs, then that may be another reason for considering a split on the first death — even though there is still no estate tax reason to make the split.

This client keeps asking really good questions:

“What if my husband decides to make large gifts out of the second trust. Can he do that ?”

Sorry to be a lawyer here, but the answer is: “it depends”. Mostly it depends on the language of the trust.

Of course there’s another reality. If the surviving spouse is the trustee of the trust, and the trust terms say “whatever else he/she does, he/she is not to give a single cent to my worthless brother Arnold,” and the surviving spouse gives a few thousand dollars to Arnold, who is going to enforce the trust’s terms? The children? They likely won’t find out about it until well after it happens, and you know how likely Arnold is to pay the money back, right?

Once again, this question needs to be the subject of more discussion with your lawyer. But what excellent questions.

Important note: These off-the-cuff answers are just that, and they really should encourage you to discuss the questions with your lawyer in some depth. If you are not an Arizonan, they may not be correct at all. If we are not your lawyers, you might get a different answer, or at least different emphasis. These are actually hard questions.

Assets Not Held As Part of Trust Pass to Different Successors


From time to time we see appellate court decisions dealing with a common estate planning problem: after creation of a trust, changing title to assets is an essential element of completing the estate plan. Once in a while, as appears to be the case in this week’s court decision, the failure to “fund” the trust may actually be intentional. But the point is still valid. Assets not titled to (or left to) a trust will not be affected by the trust’s terms.

Actually, before we lay out the facts in this week’s case, we want to make two other points supported by the decision. First: to the extent that probate avoidance is an important part of your estate planning, just signing a trust document is not enough. But that doesn’t mean that assets not transferred to the trust will necessarily need to be probated — there are other probate avoidance choices available, whether you have signed a trust or not. Second: heirs need to look at the larger picture, not just the language of one document — be that a trust, a will, a power of attorney or a handwritten note from a now-deceased family member.

Let’s look at the facts of an Arizona Court of Appeals case issued late last week. Fred and Elena Dominguez (not their real names) had been married for years, but had no children together. Elena had four children from her first marriage. Fred and Elena created a joint revocable living trust and transferred three parcels of real property into the trust’s name in 1998.

Late in 2003 Fred and Elena sold part of their real property for $910,000. They received about a third of the sale price in cash, and took back a note for the remaining value of the property. A month later they opened an account at a local bank; that account was titled in their names as individuals, not as trustees, and Sarah, one of Elena’s daughters, was named as a joint owner.

Elena died a little more than a year after the account was opened. Shortly after that, her name was taken off the account so that it was held by Fred and Sarah as joint owners — and not as trustees.

Upon Elena’s death, the trust was divided into two shares and both became irrevocable. It wasn’t until four years later that Fred hired a Phoenix attorney to make the calculations and complete the division; the attorney incorrectly listed the joint account as a part of one of the trusts. The trust division was completed as to the remaining assets, but it took Fred two more years to notice that the listing improperly included the bank account as an asset of the divided trust. In 2011 an amended allocation of trust assets was completed by the same attorney, and approved by Fred and the then-current trustees of the trusts.

Fred himself died shortly after the amended trust division was completed. Elena’s two sons requested an accounting from the trustees; they sent a preliminary accounting and copies of some account documents. Elena’s sons filed a complaint with the probate court arguing that the trustees had failed to discharge their fiduciary duties by not collecting the assets in the joint bank account, and that the accounting did not show the proceeds of the note from the sale of the trust’s real estate.

The probate court held a three-day hearing on Elena’s sons’ complaint. Ultimately, the judge ruled that (a) the joint bank account passed to Sarah outside of the trust and outside of probate proceedings, (b) the receipt of payments on the note was not the responsibility of the trustees and did not need to be accounted for, and (c) the accounting provided by the trustees was both accurate and adequate.

The Arizona Court of Appeals affirmed the probate court decision. The appellate judges noted that it was apparent that Fred and Elena intentionally took the proceeds from sale of the real estate out of the trust — which they were entitled to do while they were both alive — and set up the joint account. Elena’s sons had not shown that there was any mistake or misunderstanding about the transaction. Just because the underlying real estate was once owned as part of the trust it did not follow that they had to keep it in the trust after the sale.

Similarly, the trustees had no duty to account for note payments received by Fred and Elena before their deaths (and before the trustees even took over the trust). The trust terms echoed general trust law: the successor trustees were permitted to accept trust assets as they stood at the time they took over as trustees, and no evidence had shown that any improper transfers had occurred.

One interesting side fact: the two successor trustees were the two husbands of Elena’s daughters. One of those daughters, of course, had received a large bank account outside of the trust. Her brothers argued that the trustees had breached their duty of impartiality by not pursuing Sarah for the bank account, and by communicating with Sarah’s lawyers and strategizing about how to present their case. Not so, ruled the Court of Appeals. The property passed outside the trust, and the trustees were permitted to discuss the case with Sarah and her attorneys — Sarah would be a key witness in the case, after all.

Finally, the Court of Appeals approved the accountings provided by the successor trustees. They demonstrated that “trust assets were accounted for and intact.” That was all that was required of the trustees, and they met their obligations. In the Matter of the Dobyns Family Trust, December 11, 2014.

It appears as if Fred and Elena intended to change the distribution of their assets by creating the joint account outside the trust. They could have accomplished the same result by amending the trust — which they would have had the authority to do at the time of the sale of trust assets (or earlier, for that matter). That might have avoided the later challenge, but of course it might not have done so, either.

Much more often, we see cases in which changes like those Fred and Elena worked are inadvertent. “Funding” of a trust is an important part of the plan, but just as important is maintaining the funding status so that you do not accidentally change your estate plan. Of course, if you intend to make a change your lawyers will be happy to counsel and assist.

How Increased Estate Tax Exemptions Affect Existing Trusts


A lot has changed in American estate planning in the last decade (as you may have already heard). Estate tax thresholds have increased to (as of 2014) $5.34 million. On top of that figure, there is a relatively new concept of “portability” of the estate tax exemption, so that married couples can (more or less) double that exemption amount in most cases. Meanwhile, Arizona has eliminated its estate and gift tax regimens altogether.

It goes without saying, but we can’t avoid saying it: if you haven’t updated your estate plan in the past decade, you should contact your attorney right away about getting that process started. You probably can get by with a simpler estate plan than you needed before, and you can probably make most or all of your decisions on the basis of what you’d like to do with your money, rather than the tax consequences.

Meanwhile, we see a lot of estate plans that have not been updated. Some of those belong to people who have died with their aging wills and trusts in place. We also see a fair number of trusts for people who died years ago, and for whom estate tax liabilities turned out to be unimportant. Is there anything that can be shed to fix tax-driven complications that are no longer needed?

Yes, as it turns out. We do have a couple caveats that need to be mentioned as we open this discussion, though:

  1. We are writing about Arizona tax and estate law, not other states’. If you live in another state, or if your trust is set up in another state, you probably ought to speak with someone familiar with that state’s laws. Keep in mind, though, that the governing law might not be obvious; if your mother wrote a trust in, say, Florida, and died in Tennessee naming a California daughter as trustee, do you know which state’s law applies? Neither do we — the answer is going to be very fact-driven, and so the first question you might want to address with a lawyer is whether you’re even talking to a lawyer in the right state.
  2. Even if Arizona law applies, or the principles we describe here are the same for the state governing the trust, be very careful about generalizing the points we raise here. Discuss them with an attorney, and be alert for the possibility that seemingly small changes in facts can yield entirely different answers.

Disclaimers in mind, we can proceed to discuss what has to be done, and what can be done, with tax-driven estate plans that have not been updated to modern tax concerns. Here are a few examples of what we see:

  • Mr. and Mrs. Johnson created a joint revocable trust in 1995. It provided that on the first spouse’s death, the trust would be divided into two separate trusts. One is called the “decedent’s” trust, and it consists of the separate property of the first spouse to die, plus that spouse’s one-half interest in community property. Since Mr. and Mrs. Johnson are only worth about $1 million, they probably didn’t need such a two-trust arrangement at all — but Mr. Johnson has now died. Mrs. Johnson doesn’t want to go through the bother of dividing assets and, knowing that the estate tax exemption is now several times their combined net worth, she wonders if she can just skip the two-trust part.
  • Mr. and Mrs. Gonzales had a very similar trust. Mrs. Gonzales died in 1999, and Mr. Gonzales actually made the division into two trusts. The “decedent’s” trust is now worth about $1 million, and Mr. Gonzales is tired of paying the annual cost of preparing income tax reports for the trust and providing accounting information to his children (they say they don’t want him to have to do that, anyway). Can he just terminate the decedent’s trust?
  • Mr. and Mrs. Lee have a very similar trust. Mr. Lee is very ill, and Mrs. Lee has been handling their trust for the past several years. The Lees are worth about $6 million. Is there anything Mrs. Lee should be doing with their trust? Assuming Mr. Lee dies before Mrs. Lee, is there anything she should watch out for?
  • Mr. and Mrs. Jorgensen also created their two-trust arrangement in the late 1990s. A very large part of their estate is in Mr. Jorgensen’s 401(k), which names the trust as beneficiary. Is there anything they ought to be thinking about?

Of course the Johnsons, Gonzales’, and Lees could have made changes to their estate plans if both spouses were alive and able to understand and sign changes in each case. But since that didn’t happen, they may be stuck with their estate plans — unless either there is language in the trust or something in Arizona law allowing changes. The Jorgensens are in a little bit different situation, as the decision to name the trust as beneficiary of Mr. Jorgensen’s 401(k) was probably driven by tax considerations that no longer apply.

Let’s deal with the authority to make changes first. We have a couple suggestions for Mrs. Lee, Mr. Gonzales and Mrs. Johnson:

  1. Read the trust. Read it again. It may be hard to parse all the rules, but it will be a productive session. Look for things like the discretion to make distributions of principal, the authority to amend the trust, and any authority the trustee (or the surviving spouse) might have to modify the trust’s terms. Nothing there? Don’t panic. But you can’t just choose to ignore the parts you don’t like.
  2. Talk to a lawyer about Arizona’s law on modification of trusts. Ask specifically about three words: modification, reformation and decanting. Arizona law now makes it easy to change trust provisions in some circumstances — but note that you may well have an obligation not to hurt the interests of the remainder beneficiaries (children, step-children or whoever receives property on the death of the surviving spouse). Know that Arizona’s trust law has changed dramatically in the past few years, and so even if you got advice that nothing could be changed a decade ago, the answer today might be different.
  3. Check with the remainder beneficiaries. They might even agree with you that modification or termination of the trust might be a good idea. Just to be safe, though, talk with your lawyer first; she (or he) might give you a specific idea to discuss with them, or might want to initiate the discussion herself.

Mr. Jorgensen: get in to your lawyer’s office and discuss beneficiary designations. While naming a trust as beneficiary of a retirement account is not necessarily bad, it is usually dangerous and should only be done when you understand exactly what you are trying to accomplish.

Our takeaway: get good legal advice before you just decide to make changes. But don’t despair, as it might be possible to modify old estate plans, even after death.

Home Refinance Can Foul Up Estate Planning

MAY 19, 2014 VOLUME 21 NUMBER 18

When our clients consider creating a revocable living trust, we usually explain that there are several benefits to that estate planning device. Chief among those benefits for most people: avoidance of probate on the death of the client. For married couples, there is usually no probate required on the first death anyway, so a living trust mostly protects against having a probate on the second death.

A few of our clients also see other benefits from living trusts. They may make it easier to minimize estate taxes on the death of the second spouse (though, frankly, current estate tax rules for Arizona residents make this a benefit for a very, very small portion of the population). They may make it easier to control the use of funds for heirs — though many clients are uninterested in imposing any restrictions on the inheritances they leave to children or others.

The living trust may have benefits beyond probate avoidance for a small number of our clients, based on their family situation, type of assets or the size of their estate. But for every client who decides on a living trust, the same two drawbacks need to be weighed against the benefits in their circumstances. First, a living trust is a more expensive estate planning option (how much more expensive? That will depend on individual circumstances, but typically between $1,000 and $2,000 more for most of our clients). Second, and the subject of this week’s cautionary story, is this: if you have a living trust, you need to keep that in mind for the rest of your life, and make sure that your assets get transferred to, and remain titled to, your living trust.

We were reminded of this issue by a typical client story we heard last month. A couple who have been long-time clients — we’ll call them Dick and Jane — created their joint revocable living trust a few years ago. They did it for the usual reason (to avoid probate on the second death), but also for a less-common reason — Dick had been diagnosed with early dementia, and the trust would make it easier for Jane to manage their joint assets as his capacity began to diminish.

After they created their trust, that’s exactly what happened. Dick became less and less able to make decisions, and more and more reliant on assistance with activities of daily living. In fact, Jane found that she had to hire help to take care of Dick in their home. Fortunately, she had a durable power of attorney and the living trust in place — she was able to take care of their finances and marshal them for Dick’s care needs.

Jane figured out that it would make sense for them to refinance their home mortgage. That might have been true just because of the current historically low interest rates — in Dick and Jane’s case, it also made sense to take out some additional principal from their home equity, so that Jane would have sufficient reserve to cover Dick’s growing care costs. It was a good thing that their home had been transferred to their joint trust, since Dick had lost the ability to sign refinancing documents. Because she was the sole trustee, Jane would be able to handle the refinancing by herself.

You might know where this story is going next. If Jane had called us, we could have warned her about the problem that was likely to arise. We don’t expect our clients to call us before making major financial decisions, but in this case it would have been good to hear from Jane. Why? Because the title insurance company insisted that Dick and Jane’s home had to be transferred out of the trust before the refinancing could be completed. And (possibly because the title company was based in Kansas, not Arizona) there was another problem in the documents: the title company’s attempt to create a joint tenancy between Dick and Jane did not comply with Arizona’s requirements. That meant that when Dick died a year later, his one-half interest in the family home had to go through the probate process.

To be clear, that result was not nearly as tragic as Dick’s medical and mental decline and ultimate death. In the scheme of things, the need for a probate proceeding — especially in a state, like Arizona, where probate is a relatively simple process — is more properly characterized as “nuisance” than “tragedy”. But the irony of Dick and Jane’s experience was that they intended to simplify things, and to save money for their heirs — and, despite their best efforts, the result was that Jane actually had to go through extra legal proceedings (since their home was originally in joint tenancy, there would not have been a probate on Dick’s death but for the refinancing following the trust). To be sure, if they had not created the trust and signed powers of attorney, Jane probably could not have refinanced the home at all without a court proceeding to establish authority over Dick’s share of the home, so the net effect was probably beneficial. But the disconnect between the estate plan and the title company’s odd insistence on taking the home out of the trust meant that Dick and Jane missed an opportunity to have their plan work perfectly.

Why do title companies insist on taking homes out of trust for refinancing? This has always puzzled us, too. Apparently, they think that the record is unclear about whether the trustees of a trust have the right to encumber the home with a mortgage — but they are not at all troubled about the trustees’ right to transfer the house outright. Why don’t the title companies then transfer the home back into trust? This one puzzles us, too. Until a decade or so ago, they would do so upon request. Now they typically fail to mention it to their clients at all. And why would a Kansas title company try to practice law in Arizona, creating a defective joint tenancy deed? We have no answer for this one.

Here’s the moral of the Dick and Jane story (or at least this tiny slice of their story — their real story is far, far richer than this one small glitch): if you have established a revocable living trust, be very cautious about titles to your property. Your home, your bank and brokerage accounts, and most of your other assets should probably be titled to the trust (talk to your lawyer — this is not always the case). Once things are titled to the trust, you have to be mindful of any changes you might precipitate, even (especially?) if you did not intend to make any change.

Tax Issues for Trusts — Simplified

JULY 29, 2013 VOLUME 20 NUMBER 28

Judging from the questions and comments we get here, taxation of trusts is one of the most confusing issues we regularly write about. We’re going to try to collect the most important rules here for your convenience. Note that we will not try (in this summary) to touch on every exception, every caveat — we want to try to spell out some of the major categories of trusts and of taxation, and see if we can help you figure out what tax issues you have to face. We will try to give very concise answers, a little explanation and a warning about some of the more common or important exceptions in each category.

Do I need to get an EIN for my revocable living trust?

Short answer: no.

More detail: if you created a trust, put your money in it, and retained the right to revoke it — the IRS doesn’t think of it as a trust at all. It is not a separate taxpaying entity. Not only do you not need to get an Employer Identification Number, you can’t get one. A revocable living trust is always a grantor trust, and it does not file its own tax return.

Important exception: if you are trustee of a revocable living trust created by someone else, you can get an EIN but you are not required to do so. Even if you do get an EIN, the trust does not file a separate trust tax return.

I am setting up a special needs trust for my child, who has a disability. I plan on leaving his share of my estate to the trust. Does it need an EIN?

Short answer: probably not — yet.

More detail: while you are still alive you probably will be the “grantor” of the trust for tax purposes — and that may even be true if the trust is irrevocable. Probably you will pay the taxes on any income the trust receives (note: your contributions to the trust are not “income” for tax purposes). But probably this is not important — you really are probably asking about what happens when you die and your estate flows to this trust. THEN it will need an EIN and it will file its own tax returns. Probably it will be what the IRS calls a “complex” trust.

Important exception: if the trust is both irrevocable and immediately funded, it probably does need an EIN even before you die and leave a larger share of your estate to it.

My daughter’s special needs trust was funded with money from a personal injury settlement. Does it need an EIN?

Short answer: almost certainly not.

More detail: even though it is irrevocable, and even though your daughter is not her own trustee, this trust is almost unquestionably going to be a grantor trust for tax purposes. That means it does not need to have a separate EIN; it uses your daughter’s Social Security number as its taxpayer identification number.

Important exception: although it does not have to get an EIN, this kind of trust may get an EIN. But even if it does, the trust does not file a separate income tax return — all the trust’s income gets reported on your daughter’s individual return.

My father established a revocable living trust to avoid probate, and he died earlier this year. Do I need to get an EIN for his trust? Can I just keep using his Social Security number?

Short answer: Yes, you do. No, you can’t.

More detail: With your father’s death his trust became a different entity. It is no longer a “grantor” trust, so should be filing its own income tax returns for the rest of the calendar year of his death and for the future (if the trust continues).

Important exception: While the trust should have its own EIN, it will only have to file a return if it earns $600 in income in any one year after his death. So if the trust gets resolved fairly quickly, and/or does not hold any income-producing property, it may not need a tax return. In that case, and that case only, it may also not need to have a separate EIN.

As a separate exception to the general rule, note that there are some limited circumstances in which your father’s trust may not have to use a calendar year. That can have significant favorable income tax consequences, so be sure to discuss the tax issues with your accountant and/or attorney.

My wife and I created a joint revocable living trust. She died two years ago, and I was simply too busy dealing with everything to do anything about the trust. Are there tax issues I need to resolve, or am I going to get into trouble for not doing anything quickly?

Short answer: You probably are not in any serious trouble, but you should talk with an accountant and/or attorney soon. Don’t continue to put it off, please.

More detail: It may be that nothing needs to be done regarding your trust. It may be that your trust was supposed to be divided into two shares upon the first death. It may be that such a division no longer makes tax sense — but it might still be necessary to deal with it. It’s too hard to generalize about all those possibilities, and your lawyer needs to look at the trust document AND know how assets are titled. Make an appointment and start gathering information. If you don’t do anything before your own death, your children (or whomever you have named as ultimate beneficiaries) will have a much more complicated time dealing with it than you do now. Incidentally, in our experience it is fairly rare that a surviving spouse does not want to make any changes whatsoever — even if all you want to do is to accelerate the pace at which your children receive your estate, it is a good idea to meet with your attorney.

Important exception: If you are certain that your trust does not require division into separate shares on the first spouse’s death, AND you still want the same people to administer your estate, AND you still want everything divided the same way as the original document provides, then it may not be necessary to make any changes. Most lawyers will tell you that it still makes sense to update powers of attorney and your will to remove your late wife’s name (just so your back-up agent doesn’t have to produce a death certificate before banks and doctors will talk with her), but it may not be critical to do so. Still, talking with lawyers is kinda fun, and almost everyone should do it more often.

There you have it. Our most-asked-about trust taxation questions, with simplified answers. Please be careful about this information, though — there is a lot of nuance we have glossed over. Talk to your accountant and your lawyer to confirm what we have told you here before relying on it. Our goal is to give you a bit of a roadmap, not to answer complex legal questions with oversimplified generic answers. But we hope we have helped.

Step-Children and Disinherited Children Might Have Rights — It Depends

A prospective client asks: “Can my mother cut me out of her will after my father dies? His will leaves everything to the children after her death.” That deceptively simple question comes in a number of variations (like: “My mother’s will left everything to her children, but her estate was not probated. After her husband, my stepfather, died, we learned that everything went to his children from a prior marriage. Can we do anything about that?” Or: “Our father and stepmother had a joint trust leaving everything to all of their children — my siblings and my step-siblings — when the second one of them died. After my father’s death, my stepmother changed the trust to go only to her children. What rights do I have?”

To each of those questions the answer is almost certainly the same: “It depends.” That’s the classic lawyer’s answer, but it reflects a reality that we deal with whenever we talk to a new client or prospective client. We almost never have enough information to give a definitive answer after the initial consultation, and that is particularly true with these questions.

What does it depend on? State law, sometimes. The actual wording of documents, in most cases. Titling of the property, pretty often. The cost of pursuing the issue weighed against the value of the “lost” inheritance, almost every time.

Please remember that what we describe here is based on Arizona law. It’s what we know; we don’t know enough about other states’ laws to do more than speculate about whether the same answer would be true in another state. Heck, sometimes we don’t know enough to determine whether Arizona or some other state’s laws even apply to the question. So check these answers with a qualified lawyer in your state (or the state where your parent(s)/step-parent lived and died).

Disclaimers aside, let’s look at some of the more-common scenarios:

1. Herb and Vonda signed identical wills, leaving everything to one another and, on the second death, to their three children in equal shares. Herb died. No probate was even filed, since everything was owned as joint tenants with right of survivorship. All Vonda had to do was distribute Herb’s death certificate and everything was transferred to her name. Five years later Vonda changed her will to leave everything to one of the three children.

Vonda’s will might be subject to challenge based on undue influence or lack of testamentary capacity, but it is unlikely to be set aside based on Herb’s intention that his property be divided equally among his children. He left everything to Vonda — both in his will and by the joint tenancy designations. She was probably free to do what she wanted with what then became her own property.

Herb and Vonda might have signed an agreement to keep their wills the same. Their wills might have even included a provision that promised the survivor would not change her will after the first spouse died. But such a provision would be rare (not unheard of, but rare). Even if there was such a provision it’s not completely clear that it would apply in these circumstances, since Vonda did not acquire Herb’s interest in the jointly held property by his will — she got it by operation of the joint tenancy arrangement.

2. Richard and Fern signed a joint revocable trust. It provided that on the first spouse’s death, the survivor would have complete control over the trust and the property in the trust — including the right to amend the trust. If the trust was not amended, it would leave everything to Richard and Fern’s only son, Ralph. All their assets were transferred into the trust.

After Fern died, Richard amended the trust to leave everything to a neighbor. At least that’s what Ralph suspects. The neighbor is named as trustee and refuses to even give Ralph a copy of the amended trust. Ralph wants to know if he has a right to at least Fern’s half of the joint estate, and how he can find out about the circumstances of any amendment. He has a copy of the old trust showing him as beneficiary (though the copy he has does not show that it was actually signed). The lawyer who prepared that draft trust won’t return his phone calls.

Can Ralph get a copy of the new trust? Not necessarily. If he has been completely eliminated from the trust, the trustee is under no obligation to give him anything. How does he know if that’s the case? He doesn’t. He could bring a court case to have the Judge interpret the validity of the suspected amendment, but if it is as the neighbor says he will probably lose — he probably won’t get a copy of the trust document and he may end up paying the neighbor’s legal fees in addition to his own.

To be clear, if the neighbor consulted us we would advise that it’s easier to show Ralph the amended trust and be done with it. But we would also tell him (assuming Ralph has been excluded and the document appears to have been properly prepared) that he is not obligated to do so. Ralph is likely to get further by being reasonable and friendly than by being confrontational. Oh, and he is probably not entitled to any portion of “Fern’s estate,” since she appears to have left it all to Richard.

3. Grant and Julia were each married once before they got together. Grant has two children from the first marriage, Julia has three and the two of them had one child together. They signed a joint revocable living trust and transferred all their assets into the trust’s name. It provided that on the death of one of them, the entire trust estate was to be divided into two shares — with half of the combined assets assigned to each share.

One share of the trust would continue to be completely under the control of the surviving spouse (the trust refers to this as the “Survivor’s Trust Share”). The other (the “Decedent’s Trust Share”) is held in trust for the benefit of the surviving spouse (he or she is entitled to all the income and, if he or she needs it, principal of this trust share). On the death of the second spouse, according to the trust document, the “Decedent’s Trust Share” is to be divided equally among all six children. The surviving spouse is named as trustee of the Decedent’s Trust Share, but has no power to modify or amend it.

After Grant died, Julia continued to administer both halves of the trust. She never provided any accountings to any of the children, though her oldest daughter did help her keep bank records and took documents to the accountant for tax preparation every year. None of the children wanted to confront her about how she was handling the money, and so no one every challenged her.

When Julia died (more than a decade after Grant’s death), it turned out that the Decedent’s Trust Share was empty. Julia had withdrawn most of the money in the last five years of her life, and had used it to fix up her house (it was titled to the Survivor’s Trust Share) and to make substantial gifts to two of her children (including the one helping out with the accounting). She had also incurred significant medical bills, and had even paid for in-home care for most of her last two years. Most of the children — and especially Grant’s children — felt like she should have moved into an assisted living facility to save money during that period.

When Grant’s oldest son asked for more information, Julia’s daughter (who, it turned out, had been named as successor Trustee) blew up at him and accused him of just being about the money — not caring what his father would want or what his step-mother needed. He wants to know now what he is entitled to.

Can he get account information? Almost certainly — especially for the Decedent’s Trust Share. Is he entitled to information about the Survivor’s Trust Share? Maybe, if he is still a beneficiary (or if the finances of the Survivor’s Trust Share would affect what Julia had needed from the Decedent’s Trust Share).

We always encourage clients to ask themselves one more question, though: will Grant’s son be happy with any likely outcome? Probably not. The cost of pursuing his step-mother’s estate and his step-sister will likely be high, and the resolution will not give him everything he is entitled to receive. Depending on the size of the estate and the portion at issue, it might be financially worth pursuing. Basically: “it depends.”

Tax Identification Numbers for Trusts After Death of Spouse

MARCH 26, 2012 VOLUME 19 NUMBER 12
Here at Fleming & Curti, PLC, we keep tabs on what brings people to our website. We look at referring pages, at search terms and at a variety of other items. We are intrigued by what persistently tops the search-engine list. The most common search? It’s some variation of: “do I need a new tax ID number for my living trust?” (For those keeping score, the second-most-common question seems to be “can I leave my IRA to a living trust?“)

Why the enduring interest? Because the question is so much less complicated than people think it is. There is a surprising paucity of clear information about when you need to have a new tax ID number (an EIN, if you want to use the correct acronym). And much of the information out there is contradictory.

We have written about the question several times before. In 2009 we asked and answered the question: “Do you need a new tax ID number for your living trust?” Just last year we reviewed the question, along with some other reader questions, and provided a little more detail on when your trust needs an EIN. Since those two explanations the rules haven’t really changed — but your questions have gotten a little bit more sophisticated.

Several of those questions deal with the same basic scenario: what happens when a husband and wife have a joint trust, using one spouse’s Social Security number, and then that spouse dies? The answer will depend on what the trust provides.

First, a word about joint trusts for spouses: they are common in community property states (like Arizona), not as common in those states where community property principles do not apply. Remember, please, that we are Arizona lawyers, and so we write here about Arizona rules. Attorneys from other states are more than free to add their comments; we will post them as we receive them — but we are not vouching for the accuracy of their advice in states other than Arizona.

Let’s set up a scenario, drawn from our common experience: Husband and wife created a joint revocable trust, and their bank accounts, brokerage accounts, insurance — all of their assets, in fact — listed the husband’s Social Security number. They could do that because, as with a joint account outside of a trust, tax rules allow one owner’s identifying number to be used rather than having to use all owners’ numbers. But now the husband has died. What should the (surviving) wife do about the TIN (Taxpayer Identification Number)?

Before we answer, we need to know what happens to the trust on the death of the first spouse. Let’s assume, for a moment, that it remains in one trust, that the wife now has the power to amend or revoke it in its entirety, and that she is the sole trustee. In that case, the direction is easy: tell the bank, the brokerage house and the insurance company to change the name of the trustee from the couple to the wife, and to change the TIN to the wife’s Social Security number. How do you do that? Send them a death certificate and a letter instructing them to make the changes. Assume, incidentally, that they won’t — it will often take you two or three tries, several phone calls, and some wheedling to get the task done. But that’s what should happen.

What if the wife is not the sole trustee? Let’s say, for a moment, that the oldest daughter now becomes co-trustee with her mother, but that the trust remains revocable and amendable by the wife. In that situation, we have the same answer: switch to the wife’s Social Security number.

What if the wife has the power to revoke or amend the trust, but she is now incapacitated? The oldest daughter is the sole trustee, and isn’t sure what to tell the financial institutions. The answer is still the same: the trust is still revocable (even though there may be no practical way to revoke it if the only person with power to do so is incapacitated), and the wife’s Social Security number is the trust’s TIN (expect to have an argument with the financial institutions over this one). Is a bank trust department the successor trustee instead? Same answer — but with the ironic twist that the argument between trustee and financial institution will now occur between two branches of the same organization.

Sometimes a joint revocable trust becomes irrevocable on the death of one spouse. More commonly it splits into two (or sometimes three) portions, one (or two) of which are irrevocable. What happens then? The answer, as you might expect, is a little bit more complicated — and may not be the same in every case.

Generally speaking, an irrevocable trust that does not contain the assets originally belonging to the beneficiary is likely to need its own EIN. That may mean that one (sometimes two) of the trusts resulting from the death of one spouse needs a new EIN, and one just uses the surviving spouse’s Social Security number.

Let’s use a specific example: in our earlier scenario, after the death of the husband the joint revocable trust splits into a “Decedent’s” (sometimes “bypass”) share and a “Survivor’s” share. The Decedent’s Trust is irrevocable. Wife is the trustee, and she is entitled to all the income from the trust. She may even have the ability to distribute trust principal to herself, or to decide how the Trust is divided among the couple’s children at her death. But this trust is not  “grantor” trust — it gets taxed as a separate entity. Hence, it needs its own EIN, and it files its own tax returns.

Mechanically, the process of dividing the trust is a little more complicated than in our earlier scenario. An estate tax return may be required (although it may not). A division of trust assets needs to be completed (the assistance of a competent lawyer and a good accountant is essential here). The share to be assigned to the Decedent’s Trust needs to be identified, and then physically transferred into a new account — often titled something like “The Jones Family Trust — Decedent’s Trust” (yeah, we know — your name isn’t Jones. Stick with us anyway). And that new account needs to use the Decedent’s Trust’s new EIN.

Note that we said that the assets need to be transferred into the new account. Most financial institutions will insist on opening a new account, with a new account number, rather than simply changing the name on an existing account. But when the process is completed — however you and the financial institution get there — the Decedent’s Trust should be physically separated from the Survivor’s Trust, it will have its own EIN, and it will need to file tax returns. Note: it probably will not pay any tax as a separate entity — all its income will  probably be imputed to the surviving spouse.

Meanwhile, the remaining trust assets in our example will continue to use the wife’s Social Security number. It may not be crucial to change the name on that account to “The Jones Family Trust — Survivor’s Trust” (those Joneses — they end up will all the money anyway). If you long for clarity, we would certainly support a transfer of the Surivor’s Trust share into a new account, titled as part of that sub-trust, and bearing the wife’s Social Security number — even if it is not required.

Recall, please, that there are lots of variations on this basic scenario. Be careful about generalizing from this information to your precise circumstances. Our goal here is to give you some general notions about what needs to be done — we do not think of ourselves as a substitute for good, personalized legal advice. We think, in fact, that you should get some of that, because your situation might well be more complicated than you think it is. But we hope we’ve given you some idea of what your attorney will be asking you, and what he or she is likely to tell you.

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