The Trustee’s worst nightmare is to be cross-examined by a blood thirsty litigator whose sole goal is to make the Trustee look as bad as possible. The Trustee thwarts the litigator’s attacks by paying close attention to the standards of fiduciary conduct that govern the Trustee’s activities and by creating an organized and detailed record of the Trustee’s deliberations and transactions.
The purpose of this post is to describe the steps the new Trustee should take to get started on the “right foot.” It is based on a publication by LawFirst Publishing entitled “The Trustee’s Guide” and is meant only to provide general guidance. Management of your trusts must take the specific terms of the trusts into account as well as the general principles described in this post.
For previous posts regarding trusts, go here: The Benefits of Trusts and Special Needs Trusts.
A. Background
A settlor (creator of a trust) may form a trust through a will or through a trust instrument. Either way, a trust is a legal device that allows a Trustee, the legal owner of the trust property, to manage the property for the benefit of one or more beneficiaries, the equitable owners of the trust property. The Trustee owes several duties to all the beneficiaries of the trust. Frequently, the beneficiaries of the income are different from the beneficiaries of the principal. This has important ramifications for accounting and investment purposes.
B. Trustee Duties
The Trustee has the duties summarized below:
1. Duty of Loyalty
Except for reasonable compensation for serving as Trustee, a Trustee may not receive a personal benefit from a transaction or decision. The Trustee administers the trust solely in the interest of the beneficiaries. A Trustee may not engage in self-dealing without court approval.
2. Duty to Deal Impartially with Beneficiaries
The Trustee has a duty to treat all beneficiaries impartially except when the terms of the trust provide otherwise. Accordingly, the Trustee should be even-handed in the Trustee’s dealings with all the beneficiaries.
3. Duty to Take Possession and Control of Trust Property
If trust property is in the possession and control of a third party, the Trustee has a duty to take necessary steps to take possession and control.
4. Duty to Keep Trust Property Separated
The Trustee has a duty to keep trust property separate from other property. The Trustee is prohibited from commingling trust property with the Trustee’s own property.
5. Duty to Preserve the Trust Property
The Trustee has a duty to protect the trust property from loss or damage. This will take different forms with different assets: insurance coverage for real and tangible property; safe deposit boxes and custodian arrangements for securities; and climate control for paintings, etc. The Trustee should not engage in speculative investing.
6. Duty to Make Trust Property Productive
The Trustee has a duty to convert unproductive property to productive property unless the terms of the document provide otherwise.
7. Duty to Pay Income to the Income Beneficiary
Unless the terms of the trust provide otherwise (and they frequently do), the Trustee has a duty to distribute income to the trust beneficiaries in reasonable intervals during the term of the trust.
8. Duty to Keep and Render Accounts
The Trustee has a duty to keep clear and accurate accounts showing in detail the nature and value of all the trust property and how the property has been administered. Go here for a sample of a Trustee’s account: Sample Trustee’s Account.
9. Duty to Furnish Information
The Trustee has a duty to satisfy a beneficiary’s reasonable requests for information. See Section F.2. below.
10. Duty to Exercise Reasonable Care and Skill
The Trustee has a duty to exercise the same skill and care that someone with ordinary prudence would exercise with respect to his or her own property. In addition, pursuant to Connecticut law, when investing and managing trust property, the Trustee has a duty to do so in accordance with the “prudent investor standard” as defined in the Connecticut Uniform Prudent Investor Act starting at Section 45a-451 of the Connecticut General Statutes (copy attached). Pursuant to New York law, when investing and managing trust property, the Trustee has a duty to do so in accordance with the “prudent investor standard” as defined in Section 11-2.3 of New York’s Estates, Powers and Trust Law (copy attached).
11. Duty Not to Delegate
The Trustee is personally responsible for exercising his or her judgment as Trustee. The Trustee cannot avoid responsibility by delegating such responsibility. With respect to investment management, however, the Trustee who lacks the skill and experience to manage investments is well-advised to retain competent investment professionals.
12. Duty to Enforce Claims
The Trustee has a duty to use reasonable efforts to enforce the trust’s claims.
13. Duty to Defend Actions
The Trustee has a duty to take reasonable steps to defend the trust property against the claims and actions of others.
C. Initial Set Up of Trust
1. Accept or Decline Appointment
Until you accept your appointment as Trustee, you are under no obligation to administer the trust. You may indicate acceptance in writing or by performing acts as Trustee. To decline appointment, you should complete a simple written statement that notifies the court or appropriate person of your intentions. The remainder of this post presumes that you already have accepted or plan to accept your appointment.
2. Gather Documents
To properly administer the trust, you will need to assemble the following documents shortly after accepting your appointment:
i. The trust instrument, which may take the form of an original of the trust agreement, a certified copy of the will, or a certified copy of a court decree establishing the trust.
ii. The following, if provided under a document other than the trust instrument:
a. An original of your written appointment as trustee.
b. An original of the agreement (if any) concerning your compensation as Trustee.
iii. Contact information for each beneficiary, including full names, Social Security numbers, dates of birth, and home and business addresses, telephone numbers, and fax numbers.
iv. Deeds to real property transferred to the trust.
v. If the trust was created by a will:
a. A certified copy of settlor’s death certificate.
b. A copy of the estate’s federal estate tax return, if any.
c. A copy of the Connecticut estate tax return.
d. A copy of the executor’s final accounting if the trust is established pursuant to a Will.
vi. If you are replacing a prior trustee:
a. An original of the resignation or the removal of prior trustee.
b. A copy of prior trustee’s accounting.
Original documents, and other important documents, should be kept in a lockable fireproof file cabinet or safe. If you keep records on your personal computer, be sure to back up frequently. Many of the documents listed above, including the trust instrument, deeds, tax returns, and contracts with agents should be retained permanently. Insurance policies should be held for at least three years after their expiration date, while approved accountings should be retained until the trust terminates and the final distributions have been made to the beneficiaries and approved either by the interested parties or by the Court having jurisdiction.
3. Apply for a Federal Taxpayer Identification Number (TIN) for the Trust
Use IRS Form SS-4, Application for Taxpayer Identification Number. If you are the Trustee of a trust created by a will, you still must apply for a TIN even though the estate already has its own TIN.
4. Notify the IRS of Your Position as Trustee
Use IRS Form 56, Notice Concerning Fiduciary Relationship. This form notifies the IRS that you are the Trustee and should be receiving communications relating to the trust. At your discretion, you may also file Form 56 with your first federal tax return for the trust. If you are replacing a prior Trustee, it is essential to file Form 56 in a timely manner so that the IRS can direct communications about any prior delinquencies to you. You should file Form 56 again at the end of your term as Trustee to inform the IRS that the trust relationship has ended.
5. Obtain a Bond if Required
A bond protects the trust in the event that you are unable to make good any losses from your negligence, breach of fiduciary duty or criminal acts. Connecticut and New York laws require Trustees of trusts created by a will to obtain a bond, unless the Will waives this requirement.
The bond will not protect the Trustee against personal loss from a breach (negligent or otherwise) of one of the Trustee’s many duties. Individual Trustees will find it difficult to insure against such loss through a fiduciary liability policy because insurers consider non-professional Trustees to be a high risk.
You can decrease your personal exposure by delegating duties to attorneys, investment managers, tax consultants, and others who qualify for professional liability coverage.
6. Create an Investment Policy Statement
An investment policy statement is a written policy that governs the investment process. While not required, we recommend creating one because it can help you explain to beneficiaries or a court that you constructed and followed a suitable investment program.
Although your investment policy statement must conform to the terms of the trust, you have great flexibility in crafting it. At a minimum, it should cover:
i. Goals and objectives.
ii. Time frames.
iii. Acceptable levels of risk.
iv. Liquidity and income needs of beneficiaries.
v. Types of investments.
vi. Asset allocation strategy.
vii. Selection and monitoring of financial advisors.
viii. Procedures for amendment and review of your investment policy.
7. Meet with the Beneficiaries
As soon as is practicable, you should meet with the beneficiaries. A typical meeting should include a discussion of:
i. The terms of the trust, including any restrictions on investment.
ii. The duties of a Trustee.
iii. Fees and other expenses of the trust.
iv. Tax consequences for the trust and the beneficiaries.
v. Beneficiaries’ preferences for communication.
Additionally, there are a few simple things which you may wish to do to make the meeting run smoothly and to avoid misunderstandings. Consider providing each beneficiary with an agenda, an accordion-type folder containing pre-labeled folders for correspondence, statements, copies of documents, and tax information to ensure that they have easy access to all documentation, and a summary of the meeting in a follow-up letter.
D. Managing Trust Income and Principal
Assuming a the trust is either a Connecticut or New York trust, unless the terms of the trust provide otherwise, all Trustees must adhere to the applicable Prudent Investor Act (see the Connecticut Uniform Prudent Investor Act and the New York Prudent Investor Act). Under such acts, Trustees owe the beneficiaries several duties, including the duty to review the trust assets shortly after receiving them to ensure that they comply with the terms of the applicable Act, to invest the trust assets as a prudent investor would, to diversify investments, to act impartially towards beneficiaries, to consider only the interests of the beneficiaries when investing, and to incur only reasonable investment costs. It sets forth specific factors that Trustees must consider when managing trust assets. Actual return on investments is irrelevant; you are only liable to the beneficiaries for failure to follow the standards of conduct set forth in the Act. An Investment Policy Statement, described above, will aid greatly in compliance with the Act.
Trustees also must adhere to the applicable Principal and Income Act. This Act determines which disbursements the Trustee shall make from income and which from principal.
New York’s Act and Connecticut’s Act are quite different in some important respects. For example, in Connecticut, one-half of the Trustee’s compensation and all of the administrative expenses must be paid from income, while estate taxes and payments on the principal of a trust debt must be paid from principal. In New York, one-third of the regular fees of persons providing investment advisory or custodial services and all of the ordinary expenses relating to administration, management or preservation of trust property must be paid from income, while estate taxes and payments on the principal of a trust debt must be paid from principal. Each of the Connecticut Act and the New York Act has several exceptions and different rules for different types of assets, so it is best for you to obtain proper guidance specific to your situation.
E. Distributions
Distributions take the form of required and discretionary distributions. Required distributions are relatively easy to manage: the trust instrument will specify regularly scheduled distributions or distributions after the happening of an event (such as a beneficiary attaining a certain age). Your power to make discretionary distributions is spelled out in the trust instrument. Whether you are responding to a request from a beneficiary or initiating the distribution on your own, you should document the purpose of the distribution, the source of income, and the possible adverse effects on other beneficiaries.
F. Filing Requirements
1. To the Probate Court
a. Inventory
In Connecticut, if the trust is established pursuant to a decedent’s Will, you will need to file an inventory with the Probate Court having jurisdiction over the settlement of the decedent’s estate. An inventory of trust assets includes a description of the trust property, the date received, its adjusted cost basis, and its market value on the date it legally became trust property. You may wish to list assets by category, such as cash, fixed income, common stock, and real estate.
b. Accounting
In Connecticut, if you are the Trustee of a trust created by a Will, you must file an accounting with the Probate Court every three years (unless the will excuses these filings). For other trusts, except for the final accounting, you need only file an accounting with the Probate Court when a beneficiary requests one. In Connecticut, all Trustees of trusts established pursuant to a decedent’s Will must file a final accounting with the Probate Court when the trust terminates. An accounting provides all interested parties with complete transaction information regarding the contents of the trust, including all receipts and disbursements. For a sample of a Trustee’s account, go here: Sample Trustee’s Account.
2. To the Beneficiaries
You have a duty as Trustee to provide a beneficiary with information the beneficiary reasonably requests about the nature and value of the trust property and information needed to enforce the beneficiary’s rights under the terms of the trust. The Trustee is required to satisfy only those requests that are reasonable based on the circumstances.
The terms of the trust frequently include instructions to the Trustee regarding periodic reporting to the beneficiaries of the trust. The Trustee has a duty to follow such instructions.
3. Tax Returns and Taxes
a. On Behalf of the Trust
Trust income is subject to taxation. The Trustee is responsible for filing federal and State income tax returns on a calendar year basis. The Trustee is also responsible for making estimated tax payments.
Keep in mind that the maximum tax bracket for trusts (35%) applies when a trust’s taxable income exceeds a mere $11,200. When computing the taxable income of a trust, the trust is entitled to deductions related to income distributions from the trust. A beneficiary who receives income distributions from a trust is required to report such income on the beneficiary’s income tax return. The Trustee is required to provide this information to the beneficiary and the tax authorities as part of the income tax returns which the Trustee must file.
Tax laws are complex and change frequently. A Trustee who lacks skill and experience in fiduciary income tax matters should retain the services of a tax professional.
b. On Your Own Behalf as Trustee
For tax purposes, a Trustee is a self-employed individual. Therefore, you will have to file Schedule C, Profit or Loss from a Business, with your federal income tax return Form 1040. If you already file Schedule C for a different business, you will need to file a separate Schedule C for your activities as Trustee.
Trustee fees are earned income and as such, they may change your tax bracket or affect your eligibility for Social Security benefits. If your net profit on Schedule C exceeds $400, you will have to file Schedule SE, Self Employment Tax. If you show a net loss on Schedule C, you may be able to offset other income on Form 1040. Again, we recommend that you consult with a tax advisor regarding these issues.
Posted on 9/4/2011 by Richard S. Land, Member, Chipman, Mazzucco, Land & Pennarola, LLC.
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