Serving as a Trustee - Part Five: Distributions to Beneficiaries
Making distributions to beneficiaries is a significant responsibility for a Trustee. Most beneficiaries will have little involvement with a Trustee other than when distributions are made. In most circumstances the Trustee will look just to the trust instrument, including all amendments, for guidance in making distributions. In some cases a Court Order or Distribution Agreement may be relevant and must be reviewed.
The Trustee has a duty to act impartially among the beneficiaries in all actions, including when making distributions. For example, the distribution of all stock to one beneficiary and all real property to another beneficiary may not be considered fair. The best approach is often to distribute proportionate shares of each asset to each beneficiary.
MANDATORY VS. DISCRETIONARY DISTRIBUTIONS
When trusts continue over time, the instrument may provide for both mandatory distributions and discretionary distributions. The mandatory distributions are fairly easy to administer. For example, trusts often provide for all net income to be distributed to one or more beneficiaries.
Discretionary distributions are more complicated and often allow for distributions for “needs”, typically defined as the “health, education, support or maintenance” of the beneficiary. In order to determine the beneficiary’s need, the Trustee often obtains financial information from the individual. Decisions about discretionary distributions can be difficult; this is an area where professional advice may be helpful.
Some trusts provide for withdrawal rights when the beneficiary reaches certain ages (i.e., 25 years, 30 years and 35 years). The Trustee should be aware of the ages of the various beneficiaries so these distributions can be made in a timely manner.
If the trust divides the assets into subtrusts (for example Trusts A, B and Q, or Trusts for children or grandchildren), each of these subtrusts will likely be a separate entity for income tax purposes. Therefore, you should request a taxpayer identification number for each subtrust. This can be done using IRS Form SS-4 (your attorney or accountant can obtain these for you).
You will need to change the ownership records to show that the Trustee of the appropriate trust owns certain assets (i.e., real property, insurance policies, securities, etc.). The listed owner should read something like: “Bill Smith, as Trustee for the Jones Family Trust dated October 6, 1991, as amended, Trust ‘Q’”. Bank accounts should be established in the name of each subtrust; this will help prevent the commingling of funds among the different trusts. Separate accounts will also be helpful in preparing accurate and complete accountings.
With respect to assets such as securities and insurance, a phone call or email to the company will usually reveal the proper method for changing title. Changing ownership of real property will require more inquiry and paperwork, including deeds and, in California, preliminary change of ownership reports. Changing ownership of real property can trigger a reassessment of property taxes. Certain transfers, such as between spouses, and between parents and children, are exempt from property tax reassessment (though documents must be filed with the appropriate Assessor’s Office, in a timely manner, in order to obtain the parent-child exclusion). Also there are special rules which must be complied when a trust owns contaminated property, such as gas stations and mills.
INCOME vs. PRINCIPAL?
Items coming into and going out of the trust should be categorized either as “income” or “principal”. These distinctions are made in the trust accounting records and are important as the beneficiaries may be entitled to distributions of income only.
The trust instrument normally identifies what types of items are allocated to income and what are allocated to principal. To the extent the trust does not so provide, California has adopted the Uniform Principal and Income Act (“UPIA”), which also makes these distinctions. The following is a list of how items are generally characterized. However, you should still review the terms of each trust and the UPIA (Probate Code Sections 16230-16238) for rules applicable to your situation.
* Rent * Capital gains, unless trust provides otherwise
* Interest * Portion of note payment towards principal repayment
* Dividends * Assets set aside for remainder beneficiaries
* Reserve set aside for wasting assets (i.e., oil wells)
NOTIFYING THE BENEFICIARIES
In some circumstances the Trustee must notify beneficiaries when they have a right to withdraw assets from the trust. This usually arises when the trust is a “Crummey” trust, which grants the beneficiary a certain period of time in which to withdraw gifts made to the trust. The trust may also require the Trustee to notify beneficiaries when making adjustments between principal and income under the UPIA.
TAXATION OF DISTRIBUTIONS
Distributions of principal are generally not taxable when received by the beneficiary. Distributions of income are taxed as income to the recipient. Trusts are taxed at a 35% tax rate when their income reaches $11,250, while an individual is not taxed at that rate until his/her income reaches $379,150. As it is likely that the beneficiaries have lower tax rates than the trust, distributing income from the trust to the beneficiaries may produce greater overall tax savings.
KEEP GOOD RECORDS
One of the best ways to avoid pitfalls is to maintain current and accurate records of all trust business. You should keep these records in a safe place and keep them for at least four or five years after the trust has terminated (keep tax returns for seven years). Your attorney or accountant can provide you with a sample trust accounting format to get you off on the right track.
USING COURT SYSTEM FOR HELP
The trust instrument itself should provide the information needed to administer the trust. The Probate Code also includes important directions. If necessary, the Probate Court can provide assistance to the Trustee in performing his/her duties. California law provides a means for Trustees to request instructions from the court when administering a trust (Probate Code Section 17200). Usually this is desirable only when a difficult or controversial decision arises.
OPTION TO RESIGN
If you come to a point where you believe that you are unable to serve as Trustee, most trusts provide that a Trustee may resign for any reason. If the trust does not so provide, you may also seek the court’s approval to resign.
Many trusts provide for the Trustee to be paid for their services. However, the document may provide only a vague reference to “reasonable compensation”. A long standing rule of thumb is a fee of one percent (1%) of principal each year (with the percentage decreasing as the value of assets increases). Trustees can also be compensated on an hourly rate, or on some combination of the two methods. When agents are hired to assist with matters such as property management, the Trustee’s fees is typically reduced accordingly.
Some of the criteria used by courts to determine what is a reasonable fee are: value of trust assets; types of assets under management; gross income of trust; success of administration; special skills or expertise; fidelity of the Trustee; risk or responsibility taken on; time involved; local custom; character of work performed; and the value of the Trustee’s time. In some instances, extraordinary compensation is also warranted. A Trustee should also be reimbursed for reasonable expenses paid out-of-pocket with respect to administering the trust, such as recording fees and postage. Trustees can hire experts such as attorneys and accountants; their fees are paid directly from the trust.
TERMINATING THE TRUST
Eventually the Trustee will be required to terminate the trust. Some trusts terminate shortly after the death of the trustor; in such event all assets can be distributed after the Trustee pays all debts, expenses, and taxes. Sometimes the trust is terminated upon a certain event, as provided for in the trust instrument itself, such as when the beneficiary reaches a certain age. In order to protect the Trustee it is recommended the final distribution occur after the beneficiaries consent, in writing, to the accountings and to the Trustee’s actions.
FEW FINAL WORDS
The role of Trustee is a very important one, involving a wide range of skills and requiring difficult decisions that will affect the lives of the trust beneficiaries. The preceding guidelines should help to see you through most of your duties and obligations. The three most important things to remember are:
- Read the estate planning documents;
- Keep good records; and
- Get help when you need it
Remembering these three things will help make your role as Trustee a satisfying and rewarding experience. We hope this information has been helpful to you.
If you have any questions regarding trust administration that have not been addressed, we would be happy to assist you.
The above information may be helpful when serving as a Trustee. It is designed merely to serve as a guide to those dealing with the administration of a Trust and is not intended to be all-inclusive or to provide legal advice of any sort.