Trusts & Federal Estate Tax: Trust Administration Issues

Front 1

District Courts and Statutory Probate Courts have concurrent jurisdiction over all proceedings regarding inter vivos trusts and testamentary trusts

Back 1

If an individual trustee, county of trustee's residence or county in which situs (principal office) of trust has been maintained.

2 ore more individual trustees: county in which situs of trust has been maintained.

Hint 1

Corporate trustee: county in which situs (principal office) of trust has been maintained.

Front 2

Trust beneficiaries are entitled to an accounting, on demand, no sooner than 12 months after trust was created; and to successive accountings on demand at same intervals.

Back 2

Settlor can't restrict or eliminate the right to demand an accounting by beneficiaries who at the time of the demand (i) are entitled or permitted to receive distributions from the trust, or (ii) who would receive a distribution if trust terminated then ("first tier" remaindermen).

Hint 2

However, right of any other beneficiary to demand an accounting can be restricted or eliminated.

Front 3

Texas Trustee Powers Act: If a fee simple owner can do it, so can a Texas trustee!

BROADEST trustee provision

Back 3

ex: trustee can give valid 99-yr lease when lease is likely to outlast term of trust. Can sell real property to a third party in exchange for purchaser's unsecured promissory note.

Hint 3

Model answer:

"The TX Trust Code, which applies to all trusts in Texas except to the extent the trustee's powers are expanded or limited by the settlor, gives broad fiduciary powers to trustee. Specifically, Trust Code expressly authorizes a trustee to [].

Exception: 2 situations where answer is NO trustee doesn't have power-- (1) self-dealing; (2) imprudent investment.

Front 4

Powers a trustee may exercise in managing real property held in trust:

Back 4

- sell property at public/private sale
- lease property for any term the trustee deems appropriate
- give a mortgage
- make improvements
- make repairs
- give mineral leases
- partition/subdivide the property

Front 5

"No self-dealing" rule

- can be waived by Settlor as to corporate and individual trustees
- concern that trustee's personal interest in transaction may taint his judgment

Back 5

* - Trustee can't borrow trust funds or use trust assets as collateral for personal loan [exceptions: corporate trustee can make interim deposits of trust funds in its own bank accounts; can authorize corporate trustee to invest in bank's own certificates of deposit as a trust investment]

Hint 5

* Trustee can't buy or sell trust assets to itself

[corporate trustee can be allowed on court order]

Front 6

Trustee can't loan funds to the trust, and any interest earned on such a loan must be returned to the trust. Also, any security received in connection with such a loan is invalid.

Back 6

Trustee can't profit from serving as trustee (except for being compensated), as by taking advantage of confidential information received in his capacity as trustee, or accepting a bonus for investing trust funds in a start-up company.

Hint 6

Corporate trustee can't buy its own stock as trust asset (but can retain such stock when received in trust, if it's a prudent investment)

Front 7

If trustee breaches any fiduciary duty (commits a "breach of trust")- self-dealing, speculative investment or exercises a power not given to the trustee- in addition to bringing action to remove trustee, beneficiary has option:

Back 7

- can ratify the transaction and waive the breach of trust
- can sue for resulting loss. Name of action is surcharge. Moreover, if case involves self-dealing, under the no further inquiry rule- breach of fid duty is automatic wrong. Good faith reasonableness is no defense. Only issue in self-dealing case is measure of damages.

Hint 7

If trustee still has possession of the property, beneficiary can petition for the imposition of a constructive trust.

If trustee borrows trust funds and invests the proceeds, if value of purchased property goes up, beneficiary can 'trace' and claim the property for the trust.

Front 8

4 year SOL doesn't begin to run on action against a fiduciary (trustee, executor, guardian) unless and until he:

Back 8

(i) repudiates the trust (denies existence of trust with respect to the property); (2) dies or resigns, or (3) gives an accounting that makes a full disclosure of the facts upon which action is based

Front 9

** Self-dealing rules also apply to loans or sales to a relative, and to a business entity of which trustee is an officer, director, partner, employee or principal shareholder ("indirect self-dealing")

Back 9

Trustee can loan trust funds to a beneficiary-- subject to general test of prudence

- fair interest rate
- loan must be secured
- reasonable repayment schedule

Front 10

Trustee's duty to protect and preserve trust's assets includes duty to insure them against loss, if a prudent person would insure such assets

Back 10

When 2 or more trustees, majority rules.

Each co-trustee has affirmative duty to prevent a breach of trust by a co-trustee and should attempt to dissuade. if unsuccessful, don't participate in transaction and express dissent in writing pre-action.

Front 11

** Prudence is measured by conduct when the investment decision is made.

NOT measured by hindsight (outcome or performance)

Back 11

Uniform Prudent Investor Act ("UPIA") is based on modern portfolio theory of investing that looks to total return (appreciation and capital gain as well as ordinary income)

Front 12

Under UPIA, Trustee must establish/maintain custom-tailored investment strategy that effectuates settlor's intent as to purposes of particular trust, taking into account factors like

Back 12

- general economic conditions
- poss effect of inflation or deflation
- expected tax consequences of investment decisions or strategies
- role that each investment plays w/in overall trust portfolio

Hint 12

- expected total return from income/capital gain
- needs for liquidity
- asset's special relationship or value to purposes of the trust or a beneficiary, and
- any differing interests of the income beneficiaries and remaindermen

Front 13

Under UPIA, investment returns are measured by appreciation _ total return, as well as capital gains and ordinary income.

Back 13

Under UP & IA, trustee can exercise adjustment power and allocate capital gains to income.

Hint 13

Starting point: Trustee distributes 'income' (interest income, rental income, dividends on common stocks, etc) to income beneficiary. Adds capital gains (part of proceeds on sale of principal asset) to the corpus of the trust. But capital gain/principal can be allocated to income where appropriate.

Front 14

Factors to be considered in exercising adjustment power (power to adjust total return between income and principal, and allocate capital gain and principal to income):

Back 14

- purpose and expected duration of trust
- settlor's intent as to respective interest of beneficiaries
- net amount of ordinary income and capital gain available for allocation
- circumstances of the beneficiaries

Hint 14

- need for liquidity, regularity of income, and preservation/appreciation of capital
- increase/decrease in value of trust assets
- whether trust gives trustee a power to distribute principal
- effect of econ cond and effects of inflation and deflation, and
- anticipated tax consequences of an adjustment

Front 15

*** MEMORIZE THIS FOR POINTS

Under the Uniform Prudent Investor Act, invest for total return, taking into acocunt potential appreciation and capital gain as well as ordinary income...

Back 15

Prudence is measured by conduct at the time the investment decision is made, not by hindsight based on outcome or performance....

Hint 15

Under the Uniform Principal & Income Act, trustee can exercise adjustment power in favor of income beneficiary where appropriate, and can allocate capital gain and principal to income.

Front 16

Trust provides for payment of "income to A for life, and on A's death principal to B"

Back 16

- Interest, rental income, cash dividends on stock --> income

- Eminent domain condemnation award, insurance proceeds for trust property destroyed by fire --> principal

Front 17

Delay rental --> all allocated to income, zero to principal

Royalty, bonus: allocate receipts equitably

Back 17

Allocation is presumed to be equitable if it follows federal income tax depletion allowance (15%). So 15% of bonus to principal to cover depletion, and rest to income.

Front 18

Before enactment of UP&IA (Jan 2004), allocation rule under Trust Code was 27.5% to principal to cover depletion and 72.5% to income.

Back 18

Trustees permitted to continue this allocation if they wish to do so.

Front 19

For pension plans, annuities and IRAs that name a trust as beneficiary, distributions are allocated to income until payments equal 4% of plan's or IRAs value at the beginning of the accounting period. Any excess over 4% allocated to principal.

Back 19

For receipts from "liquidating assets" (patents, copyrights, book royalties) that decline in value over time, allocate 10% to income and 90% to principal.

Hint 19

All money received from an entity (corporation, partnership, etc.) is allocated to income (unless receipt characterized as capital gain for federal income tax purposes).

All receipts from an entity other than money (e.g., stock dividends) are allocated to principal.

Front 20

Expenses: Trustee's commissions, expenses for accountings, judicial proceedings:

Half charged against income; half charged against principal.

Back 20

Ordinary expenses: come up every year; charged against income. Property taxes, casualty insurance premiums, ordinary repairs, mortgage interest payments.

Hint 20

Capital expenditures are charged against principal- capital improvements, expenses relating to environmental matters, estate taxes, mortgage principal payments.

Front 21

Can Trustee retain stock without duty to diversify?

Back 21

Under prudent investor rule, trustee can't keep or put all investment eggs in one basket (absent contrary provision).

Front 22

All provisions of TX Trust Code are "default" rules and apply absent contrary provision by Settlor. Settlor can "write own rules" and modify otherwise applicable provisions.

Back 22

Only rules settlor can' waive:

- Can't limit req that trust can't be created for an illegal purpose, or require trustee to commit a criminal or tortious act or act contrary to public policy
- can't exculpate trustee from liability for breach of trust committed in bad faith, intentionally, or w/reckless indiff to interest of a beneficiary

Hint 22

- can't limit SOL for commending judicial proceeding
- can't limit trustee duty to respond to demand for accounting by primary beneficiaries, to act in good faith ;
- can't limited court's power to exercise jursidiction to modify/terminate truste, remove a trustee, req fiduciary bond, or deny a trustee's compensation

Front 23

Trust Code says that trustee is personally liable on CONTRACTS unless contract excludes personal liability

Back 23

BUT addition of words "trust" or "as trustee" is prima facie evidence of intent to exclude personal liability

Hint 23

Actual rule: Trustee not personally liable on a K unless she fails to disclose her representative capacity (that she is a trustee)

Compare: Executor or administrator (of decedent's estate) IS personally liable on K unelss K stipulates no personal liability-- signing "as executor" doesn't by itself relieve of liability

Front 24

Trustee is personally liable for TORTS committed by itself and its agents (that's why a prudent trustee will always take out liability insurance immediately); but trustee is entitled to reimbursement from trust estate if tort was common incident of the business activity in which trustee was properly engaged when tort was commtited

Back 24

Suit is against trustee in his individual capacity, not against the trust

Front 25

If trust contains an exculpatory clause that purports to relieve liability for acts done in bad faith, gross negligence or fraud is unenforceable.

Exculpatory clauses are strictly construed.

Back 25

While self-dealing rules can be waived, an exculpatory clause, by itself, does not authorize self-dealing.

Hint 25

Beneficiary can't bring direct action against 3d party who causes injury to trust property, bc trustee holds legal title. He's the one who has responsibility to sue.

Exception: trustee unable/unwilling to bring action; or third part participated w/trustee in committing breach of trust.