FLEXIBLE TRUSTS ESTATES F UNCERTAIN TIMES Jerold I. Horn June 21, 2005 CHAPTER 1 INTRODUCTIONCHAPTER 1INTRODUCTION Uncertainty abounds, particularly from the perspective of an owner of property who is addressing the disposition of his or her estate. The uncertainty extends to births and deaths, to marriages, to health, to abilities and personalities, to resources and needs and, not least, to a system of law of which the only constant is unpredictable, and perhaps revolutionary, change. What is the owner to do? Although not a solution, per se, flexibility at least offers the possibility of solutions. The writer suggests and analyzes provisions and systems that are designed to enhance flexibility, and to define its limits, in the planning of trusts and estates. Although subtly in some cases, all of the book relates to flexibility. Some of the forms (e.g., Form 3.1 through Form 3.4) preclude flexibility and are included solely for purposes of comparison. Some (e.g., Form 3.6 and Form 3.7) are formulae that show that flexibility is important even if no one is to possess any discretion. Others (e.g., Form 14.6, Form 14.15 and Form 14.16) are drafted in terms of the outer limits of flexibility and are intended to enhance the ability of a power holder to operate within those limits. 1.01 OBJECTIVES The primary objectives of planning relate to enjoyment, management, protection against creditors, control, tax efficiency and investment efficiency. The objectives are not necessarily consistent. Accomplishment of one or more of them might necessitate the sacrifice of one or more others, in whole or in part. Tensions particularly exist between control and enjoyment, between control and protection against creditors and between control and tax efficiency. The property owner must select the desired balance. *Copyright 2005. Jerold I. Horn. All rights reserved.
The writer expressly disclaims (i) all warranties, express and implied, including, without limitation, of merchantability and fitness for any particular purpose, and (ii) all other responsibility for all consequences of use of this material.
1.01(a) Enjoyment Provide such (and only such) enjoyment as the property owner desires, often, as a practical matter, such enjoyment as a beneficiary desires. 1.01(b) Management Provide management for any beneficiary who needs or wants it. 1.01(c) Protection Against Creditors Avoid claims of creditors, spouses and former spouses. 1.01(d) Tax Efficiency Prevent attribution of property, for transfer tax purposes, to any person except to any extent that the person becomes entitled to receive the property or becomes entitled as a beneficiary to exercise a general power to appoint the property or wants the attribution in order to avoid another, more onerous tax. Prevent attribution of property, for income tax purposes, to any person except to any extent that the person becomes entitled to receive the income or the person wants the attribution in order to avoid recognition or to deflect tax liability from another person. 1.01(e) Control if Maximize control, consistently with the tax objectives, (1) one or more beneficially interested persons, solely by themselves, are to possess any nonfiduciary powers and (2) (a) one or more independent trustees, solely by themselves, are to possess any fiduciary powers (see the illustrations at 1.02, Column A) or (b) one or more beneficially interested persons, solely by themselves, are to possess any fiduciary powers (see the illustrations at 1.02, Column B) or (c) one or more independent trustees, solely by themselves, are to possess any fiduciary powers that beneficially interested persons cannot possess consistently with accomplishment of the tax objectives, and either 3
1.01(f) Investment Strategy (i) one or more independent trustees and one or more beneficially interested persons are to share any fiduciary powers that beneficially interested persons can possess consistently with accomplishment of the tax objectives or (ii) one or more beneficially interested persons, solely by themselves, are to possess any fiduciary powers that beneficially interested persons can possess consistently with accomplishment of the tax objectives (see the illustrations at 1.02, Column C). Accommodate optimal investment strategy. 1.01(f)(1) Challenge to Principal-Income Model Classic applications of the principal-income model include the following: Capital Inurement (i) Land - Crop (ii) Tree - Fruit (iii) House - Use (iv) Bond - Interest (v) Stock - Dividend The purpose and operation of the principal-income model are subject to challenge. According to the challenge, the results of the principal-income model often deviate from the objectives of property owners concerning (i) consumption, (ii) conservation and (iii) total-return concepts of modernportfolio theory. 4
1.01(f)(2) Trust Models Models A, B and C, below, illustrate choices. An ability to enjoy the tax results of B (or, better, the tax and nontax results of C) rather than those of A depends upon the design of the trust. The hypothesis is that the planner should design the trust so that the dispositive provisions will provide for the desired beneficial enjoyment and permit the designed management and control without precluding the optimal method of investment. Model A Pay-All-Income Trust Model B Preferred-Tax- Result Trust Model C Total-Return Trust Principal 100,000* 100,000** 100,000*** Interest & Dividends 5,000 0 1,000 Appreciation 0 5,000 5,000 Tax Rate 40% 20% 23+% * Invested to generate trust-accounting income according to the principal-income model. ** Invested to generate capital appreciation. *** Invested to optimize total return. Ignoring possibly temporary reductions. 5
1.02 ILLUSTRATIONS OF DRAFTING TO APPROACH BENEFITS (BUT NOT BURDENS) OF OUTRIGHT OWNERSHIP A Holder of fiduciary powers is independent trustee 1.a. Mandatory distribution of all income to one person (Form 3.2) Income per discretion of independent trustee, to one person or spray (Form 3.8 and Form 3.9) B Holder of fiduciary powers is beneficially interested trustee 1.a. Mandatory distribution of all income to one person (Form 3.2) Income per ascertainable standard, to one person, no spray (Form 3.14) C Holder of fiduciary powers is beneficially interested trustee and independent trustee 1.a. Mandatory distribution of all income to one person (Form 3.2) Combination of income per discretion of independent trustee, to one person, no spray (Form 3.8), and income per ascertainable standard, to one person, no spray (Form 3.13) b. Principal per discretion of independent trustee, to one person or spray (Form 3.8 and Form 3.9) c. Nonfiduciary 5 + 5 power (Form 3.21) 2.a. Nonfiduciary power to withdraw unitrust percentage (Form 3.31) Mandatory distribution of unitrust amount to one person (Form 3.29) b. Additional payments to unitrust recipient per discretion of independent trustee (Form 3.8) 3. Nonfiduciary, inter vivos, nongeneral power of appointment (Form 3.32) 4. Nonfiduciary, testamentary, nongeneral power of appointment (Form 3.37) b. Principal per ascertainable standard, to one person, no spray (Form 3.14) c. Same as A.1.c. 2.a. Same as A.2.a. b. Additional payments to unitrust recipient per ascertainable standard (Form 3.13) 3. Same as A.3. 4. Same as A.4. 5. "Back-up" systems: a. Diversion from sensitive trustee (Form 14.15 and Form 14.16) b. Addition of independent trustee (Form 14.10) b. Combination of A.1.b. (with one distributee) and B.1.b. (Form 3.17) c. Same as A.1.c. 2.a. Same as A.2.a. b. Combination of A.2.b. and B.2.b. (Form 3.17) 3. Same as A.3. 4. Same as A.4. 5. "Back-up" systems: a. Same as B.5.a. b. Same as B.5.b. 6