LECTURE NOTES CHAPTER 13 I. Scope of the Chapter A. Various kinds of trusts, including living trusts, are identified and discussed. B. The classification of trusts and an examination of a private lead to a detailed discussion of the living trust. C. The steps necessary for drafting trusts, including the accumulation of data through appropriate checklists, are outlined. II. Classification of Trusts A. All trusts are either express or implied. 1. An express trust is created or declared in explicit terms for specific purposes and is represented by a written document or an oral declaration. a. Express trusts fall into the following subcategories. (1) Private or public (charitable) trusts (2) Active or passive trusts (3) Inter vivos or living trusts b. The most common types of express trusts are testamentary and living trusts. 2. Implied trusts are created not by the ’s express terms but by the presumed intent of the settlor or by a decree of the court. B. Express Trusts—Private versus Public (Charitable) 1. A private trust is created expressly either orally or in writing between a settlor and a (s) who holds legal title to property for the financial benefit of a . a. It is one of the most common types of trusts. b. The essential elements of an express private trust are as follows. (1) The settlor must intend to create a private trust. (2) A trustee must be named to administer the trust. (3) A beneficiary must be named to enforce the trust. (4) The settlor must transfer sufficiently identified property to the trust. 2. A public or charitable trust is an express trust established for the purpose of accomplishing social benefit for the public or the community. a. The beneficiary does not always have to be the general public. b. The trust must be designated either for the benefit of the general public or a reasonably large, indefinite class of persons within the public who may be personally unknown to the settlor. c. In the majority of states, the true test for creation of a valid public trust is not the indefiniteness of the persons aided by the trust but rather the amount of social benefit that accrues to the public. d. The purpose of the charitable trust must not include profit-making by the settlor, trustee, or other persons. e. The essential elements of an express public or charitable trust are as follows. • The settlor must intend to create a public trust. • A trustee must be named to administer the trust. • Property must be transferred to the trust. • A charitable purpose must be expressly designated. • The general public must be benefited. • An indefinite class of persons must be named beneficiaries. 3. The doctrine of cy-pres means that where a or settlor makes a to or for a charitable purpose and it subsequently becomes impossible or impractical to apply the gift to that particular charity, the court may order the gift applied to another charity “as near as possible” to the one designated by the settlor, and no contrary intent by the settlor is apparent. a. The doctrine is only applied to public charitable trusts. b. The rationale is to continue the operation of charitable trusts so as not to terminate public benefits. c. For the doctrine to apply, the settlor’s intent must be broad and general and not restricted to one specific objective or to one particular method of accomplishing the purpose of the trust. C. Express Trusts—Active versus Passive 1. The features that distinguish active trusts from passive trusts are the obligations of management and administration that active trusts impose on the trustee. a. Express trusts are active trusts. b. Implied trusts are passive trusts. 2. An express private active trust must give oral or written affirmative powers and duties to a trustee to perform discretionary acts of management or administration for the benefit of named beneficiaries. 3. For a passive trust, the trustee has no responsibilities or discretionary duties to perform. a. The mere holding of the trust property for the beneficiary with no obligations or powers to administer the trust indicates that the trust is passive. b. Passive trusts result from the failure of the settlor to create an active trust, either accidentally or deliberately. D. Express Trusts—Inter Vivos (Living) versus Testamentary 1. The most common types of express trusts are living trusts and testamentary trusts. 2. The criterion for whether a trust is living or testamentary will be the time the trust became effective. 3. Both types of trusts are often used to conserve property for the benefit of a surviving spouse and children or for the children of a single parent. 4. An inter vivos trust allows the settlor to see how well the trust operates while he/she is still alive. 5. Testamentary trusts are probated; living trusts are not probated. E. Rule Against Perpetuities 1. The rule places a term (time limitation) on how long a private, noncharitable trust may exist. 2. An interest in property must take effect no later than 21 years, plus the period of gestation, after some life or lives in being at the time of the creation of the interest. 3. Charitable trusts have an unlimited duration. F. Implied Trusts—Resulting and Constructive 1. Implied trusts are passive trusts imposed on property by the courts when trust intent is lacking. 2. Implied trusts are created by operation of . 3. Resulting trusts are created because of inferred or presumed intent of a property owner, generally in three types of situations. a. The purchase-money . When one person’s money has paid for land or personal property, but the legal title is conveyed to another person, the law presumes that a purchase-money resulting trust has been created for the benefit of the person who paid the money. (1) The person who paid the money received equitable title to the property. (2) The person to whom the property was conveyed is considered the trustee. (3) Since it is created by implication and operation of law, a purchase-money resulting trust need not be evidenced by writing. (4) The must be clear and convincing for the court to establish a resulting trust, and the burden of proof rests on the party seeking to establish the resulting trust. (5) The court allows parol evidence to be used in these cases. (6) The grounds for the court’s presuming a purchase-money resulting trust are that a person who furnishes consideration for a conveyance to another probably does so for reasons other than gift giving. (7) Several states have abolished or modified purchase-money resulting trusts. b. The failed trust. When a settlor creates an express private trust gratuitously and the trust fails or is declared void for any reason except that it has an illegal objective, a resulting trust arises for the benefit of the settlor or his/her successors. (1) If the private express trust was created for an illegal purpose, then the court generally does not decree a resulting trust but instead declares the trust void. (2) When a charitable trust fails and the court cannot apply the cy-pres doctrine, the property is held by the trustee for the benefit of the original settlor or the settlor’s successors in a resulting trust. c. The excessive endowment trust. When the property of a private express trust exceeds what is needed for the purpose intended by the settlor, or some part of the trust property remains after the trust has ended, the court may establish a resulting trust for the benefit of the settlor or his/her successors. 4. A is a creation of the court and is established for the purpose of rectifying a serious wrong such as , duress, unconscionable conduct, or preventing unjust enrichment of the wrongdoer. a. When someone acquires title by unlawful or unfair means or by breach of duty as trustee, the court will construct a trust for the benefit of the person rightfully entitled to the property. (1) The wrongdoer holds the property as a constructive trustee. (2) The constructive trustee has no administrative duty other than the obligation to transfer the title and possession to the proper person. —TEACHING SUGGESTION: Review the major types of trusts to ensure student comprehension (Exhibit 13.2). G. Miscellaneous Trusts 1. A is created to provide a fund for the maintenance of a beneficiary while safeguarding the fund against the beneficiary’s own extravagance or inexperience in spending money. a. Only a certain portion of the total amount of the funds is given to the spendthrift beneficiary at any one time. b. The trust provides that the beneficiary cannot assign to anyone the right to receive future payments of income or principal from the trust. c. The settlor declares that creditors of the spendthrift cannot reach the trust benefits by obtaining a court order awarding them to the creditors. d. The protection of the spendthrift trust ends once the beneficiary actually receives the distribution of the trust income. e. Some states allow creditors to reach the beneficiary’s interest despite the spendthrift clause if they have supplied “necessities” to the beneficiary. 2. A , also called a payable- or pay-on-death (POD) account, is a savings account in which money is deposited in the depositor’s name as trustee for another person named as beneficiary. a. Such deposits permit the depositor-trustee to withdraw money while alive and allow any remaining balance to be transferred to the beneficiary after the depositor’s death. b. If the beneficiary dies before the depositor, the trust terminates, and the money belongs to the depositor, not the beneficiary’s estate. c. Some courts hold that the depositor may revoke the trust by withdrawing the entire fund or changing the form of the account. d. The requirements for the creation and distribution of funds in such trusts vary from state to state. e. The money in a Totten trust is a nonprobate asset. 3. A sprinkling trust gives the trustee the authority and power to accumulate or distribute the income of the trust or the principal, or both, among the beneficiaries in varying amounts. a. Advantages to a sprinkling trust are as follows. • The trustee has the opportunity to change distributions to meet the needs of the beneficiaries. • The trust funds are more difficult for creditors of the beneficiaries to reach since the trustee alone decides how much to give each beneficiary. • Such trusts may help to reduce estate taxes. b. A disadvantage is that if the trust is intended to qualify for the marital deduction on the decedent’s estate tax return, the surviving spouse must receive all the income during the spouse’s lifetime. c. The settlor must select a trustee known to be reliable, experienced, and reasonable. III. The Purposes of Trusts A. A trust can be created for any lawful purpose, but it must not contravene common or statutory law. 1. Most trusts are to distribute the income from the trust property and/or to preserve the trust property for later distribution on termination of the trust. 2. A trust is a practical way to manage and transfer property in the best interests of a beneficiary. B. Advantages of trusts are numerous and the settlor can provide the following: • Funds for the support of dependent family members • Funds for the college education of children • Professional financial management for those inexperienced in handling large sums of money, which relieves a spouse or children from this responsibility and spares a settlor the burden of property management • A method to avoid • A public, charitable trust C. There are some legal restrictions on purposes of trusts. 1. There are restrictions on purposes contrary to public policy, such as imposing total restraint on marriage or attempting to encourage divorce. 2. Some restrictions are statutory and generally framed, requiring judicial interpretation, while others contain further restrictions, usually in the area of real property trusts. 3. Some restrictions are imposed on private noncharitable trusts by the Rule Against Perpetuities, which prohibits indefinite accumulations of wealth or property. 4. A valid trust cannot be formed if it is based on an illegal or agreement. 5. A trust cannot violate public policy such as imposing total restraint of marriage, of having children or a normal family life; cannot restrain one from communicating or having social relations with other family members; and cannot induce the beneficiary to change his/her religious faith. 6. Courts have upheld trusts containing “reasonable restraints” that provide that the beneficiary will lose his/her interest if he/she • marries a particular person. • marries before reaching majority. • marries before reaching majority without the consent of the trustee (or someone else). • marries a person of a particular religious faith. • marries a person of a faith different from that of the beneficiary. IV. Informal and Incomplete Creation of a Trust A. Some of the major mistakes made in an improperly drafted trust instrument are as follows. • A testator-settlor, in a hand-drawn will, indicates that he/she wants certain objectives accomplished but expresses this using precatory words such as hope, desire, request, or wish rather than expressing it as a mandate. • The trust document does not sufficiently identify the beneficiary or fails to name a beneficiary. • The trust instrument fails to name a trustee or fails to name a successor when the named trustee does not want to serve. • The document names the trustee and describes the beneficiaries but does not specify the duties of the trustee. • Although the trust instrument purports to be transferring legal title, the trust terms are not specified, or they have only been implied in an informal oral agreement. B. To create an express trust, the court must be satisfied that the settlor manifested an intention to impose enforceable duties on the trustee to manage the property for the benefit of others. 1. When precatory words are used to devise property, the court must determine whether the settlor intended it as an absolute gift or as a trust. 2. Some courts hold that the use of precatory words does not create a trust and that the intent to create a trust must be proven by other sections of the trust instrument or by extrinsic circumstances. Other courts hold that precatory words create a precatory trust and allow the trust to be performed. 3. When drafting wills and trusts, it is best to avoid these precatory words. C. When the trust fails to name a beneficiary, a few cases give the trustee absolute ownership, but the general rule is that a “resulting trust” arises in favor of the decedent’s estate if the instrument was testamentary; if a living trust is created and it fails to name a beneficiary, the attempt to create a trust fails. D. A valid trust will not fail for want of a trustee or successor trustee. 1. Lack of a trustee may occur as follows. • If the settlor does not name a trustee in the trust instrument or fails to name a successor trustee to resolve the problem of the original trustee’s death, resignation, or nonacceptance • If the named trustee does not qualify or is refused confirmation of the office by the court because of incompetence • If the named trustee does not have legal capacity to hold property in trust • If the named trustee is removed or resigns after the effective date of the trust 2. The courts will preserve trusts and appoint a new trustee as long as the trust is otherwise valid. 3. Where a trustee is needed to execute and manage a trust, state statutes authorize the court to appoint one. a. An original trustee, where the trust document or will creating the trust has not nominated a trustee or the nominee is unable or unwilling to serve b. A successor trustee, when the original trustee has ceased to act and a replacement is required to finish the administration of the trust 4. The trust will only fail if it can be shown that the settlor intended that only the named person and no one else could be the trustee. 5. Co- generally hold title to trust property as joint tenants with the right of survivorship even in those few states that prohibit joint tenancies. V. Living (Inter Vivos) Trusts A. A living trust is created by a settlor and operates during the settlor’s lifetime. 1. The trust property is a nonprobate asset; therefore, it is not part of the decedent’s probate estate and is not under the jurisdiction of the probate court. 2. A living trust can be created in two ways. a. A declaration of trust in which the settlor retains the legal title to the trust property and is, therefore, also the trustee and, thereafter, names another person to be the beneficiary. It must be signed by the settlor and at least two witnesses or notarized. b. In a trust agreement, the settlor transfers legal title to another party, the trustee, who manages the property for the beneficiary who holds the equitable title and receives the benefits of the trust. B. In a revocable trust, the settlor reserves the right to amend, revoke, or cancel the trust while living. 1. Upon the death of the settlor, the living trust becomes irrevocable and the trust property is disposed of according to the terms of the trust. 2. Since revocable trusts avoid the need for and cost of probate, they are commonly used in . 3. Only an irrevocable trust offers the tax benefit of reducing estate taxes. 4. Many people use a revocable living trust as a substitute for a will because it allows them to transfer their entire estate to the trust, manage and control the trust, receive the income from the trust during their lifetime, distribute the trust property to the named beneficiaries after they die, and avoid the often substantial costs and delays of probate. 5. Generally, the settlor will name himself/herself trustee, or, if married, the settlor and spouse will act as co-trustees, which grants either spouse the legal authority to act as trustee. a. If one spouse becomes disabled or dies, the other automatically has control of the trust if he/she has been named co-trustee. b. As trustee, the settlor retains complete control of the property and avoids paying management fees. 6. If the settlor appoints someone else trustee, the trust agreement usually provides that the trustee is to manage and invest the trust property for the benefit of the settlor-beneficiary for life, and pay to the settlor-beneficiary all the income and as much of the principal of the trust as the trustee determines to be required for the settlor’s care. C. If a revocable living trust is to act as a will substitute, all assets owned by the settlor or in which he/she has or acquires an interest must be transferred to the trust. 1. Title to real property is changed to the trustee by quitclaim deed or a deed of trust that changes the title from the owner to the trustee; it is a change of title, not a transfer of title. 2. Title to personal property, including checking and savings accounts, stocks, bonds, certificates of deposit, mutual funds, cars, boats, and any other titled property, must be changed to the name of the trustee. 3. Untitled personal property can be transferred into a trust more easily by making a list of the items and stating that they are to be added to the trust; the list should be signed by the settlor and notarized. 4. All property that allows the settlor to name a beneficiary should be changed so that the beneficiary is the name of the revocable living trust. a. Although the items that name a beneficiary already avoid probate, changing the beneficiary to the revocable living trust consolidates these assets and avoids the possible dilemma if the current owner and beneficiary die in a common accident. b. A settlor may wish to continue to list an individual beneficiary but the trust could be added as the successor or secondary beneficiary to the policy or plans. c. Title or ownership of all retirement benefits and all the other retirement plans must not be changed or transferred to the living trust but should remain in the settlor’s name. D. Advantages of a Revocable Living Trust as a Substitute for a Will 1. It avoids probate since trust property is a nonprobate asset, and it avoids probate expense. 2. It avoids the lengthy delays often associated with estate administration—even if a testamentary trust is included in a decedent’s will, it takes time to have a trustee appointed whenever beneficiaries of the will are minors, disabled, or incompetent persons. 3. It can diminish the cost and delays caused by will contests or invalid creditors’ claims. a. A trust can be contested but not as easily as a will. b. Since the settlor creates the trust while living, it is in operation while the settlor can personally alter it; thus reflecting the settlor’s true wishes, and the court would be reluctant to change it. 4. It avoids publicity; the will, its contents, and the probate file and documents are public records. 5. It is not under the control or supervision of the probate court. 6. It also affords the settlor, while living, an opportunity to view the operation of the trust, verify its performance, and make necessary and appropriate changes, such as granting more or less power to trustees, changing beneficiaries, or selling and giving away trust property, or even canceling the revocable trust. 7. It provides lifetime or longer management of trust assets by experienced professional corporate trustees for the benefit of the settlor, the settlor’s spouse and family, or other named beneficiaries. 8. It allows the settlor who owns real estate in other states to avoid the time and expense of the . 9. It avoids the need, expense, and delay of appointing a guardian or conservator required should the settlor become disabled or be declared incompetent. 10. It also eliminates the need, expense, and delay for court-appointed guardians for minors or conservators for dependents with special needs due to physical or mental incapacity. 11. It may allow the settlor to save on death taxes, but only if it is an irrevocable living trust; however, wills containing testamentary trusts may also limit these taxes. E. Disadvantages of a Revocable Living Trust 1. It may be more costly to create the trust than to draft a will depending on the amount of assets the settlor-testator owns or the complexity of the estate, and the trustee’s management and administration fees are a continual expense throughout the life of the trust. 2. It does not provide for or establish a time limit on the length of time creditors have to present their claims after the settlor has died. a. A will establishes a time limit for creditors. b. Some states have statutes that allow a living trust to limit the time for creditors to make their claims. 3. It requires that all of the settlor’s assets be transferred into the living trust by changing titles to the property and beneficiary designations to the name of the trustee of the trust. If the settlor does not do this, the property whose title is unchanged must go through probate. F. A pour-over will ensures that property acquired by the settlor after the revocable living trust was established or property that the settlor forgot to transfer into trust will be distributed according to the terms of the trust rather than pass by intestate succession. As a companion to the revocable living trust, the pour-over will can perform the following important functions. 1. It can dispose of property the testator neglected to add to the trust before death. 2. It can dispose of property acquired through , inheritance, or good fortune shortly before death. 3. It can allow the testator to specifically disinherit family members, which can only be done by a clear and expressed statement in the will. 4. It can allow the testator to name a personal and/or property guardian for minor children. 5. It can allow the testator to name the same person as trustee of the living trust and of the will. G. An irrevocable living trust may not be amended, revoked, or canceled after its creation. 1. Living trusts are irrevocable unless the trust instrument contains a provision stating it is revocable. 2. An irrevocable trust not only avoids probate and its expense, but it also can be used to save taxes. a. The living trust cannot save on a family’s federal income taxes, but it can save on federal estate tax. b. It can save on federal estate tax, in appropriate trusts, by excluding the trust property from the decedent settlor’s gross estate, thereby reducing or avoiding the federal estate tax. This is commonly accomplished using an irrevocable . VI. Drafting a Living Trust A. The drafting of trusts is delegated only to attorneys who are knowledgeable in the area of . 1. The paralegal may be asked to prepare a preliminary draft. 2. The instrument must conform to the Internal Revenue Code and to state law. 3. Before the paralegal prepares the preliminary draft under the attorney’s supervision, there must be a clear understanding of the settlor’s purposes and desires in creating the trust as well as the applicable federal and state tax consequences. B. A checklist is used to gather information necessary for drafting a trust. 1. It reflects details to be included in the prospective trust instrument based on the client’s situation. 2. Checklists must be tailored to each individual client’s wishes and intent. VII. Trust Administration A. Pre-death administration requires the least amount of administration. After the trust is created and funded, its administration includes the following: 1. Managing the trust property 2. Preserving, maintaining, and protecting the trust property 3. Filing the annual individual income tax returns B. Post-death administration requires more administration, including the following: 1. Filing for a federal Employer Identification Number (EIN) 2. Filing a Notice Concerning Fiduciary Relationship 3. Opening a checking account for the trust 4. Transferring funds to the new checking account 5. Notifying beneficiaries of the settlor’s death 6. Collecting, preserving, and valuing the trust property as of the decedent’s date of death 7. Preparing a schedule of property held outside the trust 8. Determining the investment and disbursement of trust property and any other obligations as provided in the trust agreement 9. Pursuing or defending any claims in favor of or against the trust estate 10. Paying creditors’ claims 11. Making income and principal payments as provided in the trust agreement 12. Establishing and funding any additional trusts provided for in the original trust after the death of the settlor 13. Obtaining professional management and investment services 14. Filing the trust (fiduciary) annual income tax return 15. Preparing an annual Schedule K-1 (Form 1041) for each beneficiary who receives a distribution from the trust 16. Paying expenses of the decedent and trust 17. Preparing federal and state income, gift, and death tax returns 18. Apportioning and disbursing the beneficiaries’ shares as provided for in the trust agreement 19. Filing the final trust (fiduciary) income tax return (Form 1041) 20. Requesting discharge as trustee