10.8 Powers of Appointment

• Library: Estate Planning in Virginia (Virginia CLE) (2022 Ed.)

10.8 POWERS OF APPOINTMENT

10.801 Introduction.

A power of appointment offers the estate planner one of the most versatile tools for providing flexibility in an otherwise predetermined estate plan. This versatility provides both tax and non-tax advantages. The estate planner must consider both the creation and the exercise of powers of appointment in the planning process because, even though the client may not want to create a power, he or she may possess a power conferred by another, the exercise of which must be coordinated with the client's own estate planning.

Virginia adopted the Uniform Powers of Appointment Act (UPAA) in 2016. ¹⁸⁰³ The Act governs all aspects of powers of appointment, including the rights of a powerholder's creditor to access appointive property in certain situations. The drafters of the uniform law have stated that the UPAA does not change existing law but is intended to codify it. The statute applies to all powers of appointment, regardless of when created, and to judicial proceedings commenced on or after July 1, 2016, except that a rule of construction or presumption does not apply to any instrument executed before that date if the terms of the instrument itself clearly indicate a contrary intent. ¹⁸⁰⁴

A power of appointment is basically a power given to someone to direct the transfer or disposition of property at such time and upon such terms as the person conferring the power provides in the instrument creating the power. The creator of the power is often referred to as the "donor"; the holder or grantee of the power is called the "donee" under the federal statutes and regulations, but is also referred to as the "powerholder" under the UPAA and the definitional section of the Virginia Act; ¹⁸⁰⁵ and the persons to whom property subject to the power may be transferred are called the "appointees" or "objects" of the power. Persons to whom appointive assets will pass if the power is not exercised are called "takers in default of appointment." There are two types of powers: "limited" and "general."

A. Limited Power.

For federal estate and gift tax purposes, a limited power is one that is not a taxable general power. A limited or special power of appointment is one exercisable in favor of any appointees other than the donee, the donee's estate, or the creditors of the donee or the donee's estate. ¹⁸⁰⁶ At common law, the nontaxable limited power is a hybrid between a general and a limited power of appointment because the class of appointees is so broad as to approximate a general power. The hybrid power is generally used where the donor wants the donee to have the maximum dispositive power over the appointive assets without having them taxed to the donee for federal estate and gift tax purposes.

B. General Power.

A general power is one that may be exercised in favor of anyone, including the donee, the donee's estate, or the creditors of the donee or the donee's estate. For federal estate and gift tax purposes, general powers may include powers that really are not general under common or local law. ¹⁸⁰⁷ The estate planner will consider the general power to give the donee the maximum power of disposition over the appointive assets or to provide for the taxability of the general power to the donee or the donee's estate for federal estate, gift, and generation-skipping tax planning purposes. Under the Virginia statute, a power is presumed to be general unless the terms of the instrument creating it provide otherwise or section 64.2-2710 controls. ¹⁸⁰⁸ A powerholder may not transfer a power of appointment. If the powerholder dies without exercising or releasing the power, it lapses. ¹⁸⁰⁹

C. Creation and Drafting.

A donor usually creates a power of appointment by deed, will, or trust instrument. There are various considerations in creating a power, and there is no substitute for clear drafting. ¹⁸¹⁰

1. Type of Power.

Whether to use a general or limited power depends upon the breadth of discretion the donor wants to give the donee of the power concerning the appointees and upon the estate and gift tax effects of the appointment. As noted, a hybrid power (appointees include anyone other than the donee, his or her estate, or the creditors of either) can achieve the maximum appointive class without taxation.

2. Identity of Donee.

The donee's identity may be a given, depending upon the reason for the power. For example, the donor's spouse must be the donee of a general power to qualify a marital deduction trust for the marital deduction under I.R.C. § 2056(b)(5), where the QTIP or estate trust is not used. Otherwise, the donee should be one in whom the donor places sufficient faith and confidence to allow the donee to alter the donor's dispositive scheme within the parameters of the power of appointment. If such a trusted donee is not available, the donor could consider adding restrictions or conditions on the use of the power to allay the donor's concerns. A donor may not grant a power of appointment to a deceased individual but may grant one to an unborn or unascertained powerholder (subject to the rule against perpetuities). ¹⁸¹¹

3. Class of Appointees.

This consideration applies mainly to limited powers, since general powers are usually exercisable in favor of anyone. But a taxable general power has been defined as one exercisable in favor of the donee, the donee's estate, or the creditors of either the donee or the donee's estate. The United States Tax Court has ruled that the power to exercise in favor of any one of these four classes is a general power, and therefore it is not necessary to give the donee the power to appoint to all of these categories. ¹⁸¹² Thus, the power to appoint only in favor of the creditors of the donee's estate may offer a more "limited" version of a general power sufficient to meet a desired taxability of the power for estate tax purposes, while limiting the power to the extent possible. But if such a general power is limited to the creditors of the donee's estate, although taxable in the donee's estate under I.R.C. § 2041, it is not a sufficient general power for marital deduction purposes under I.R.C. § 2056(b)(5).

For limited powers, the class can be as broad as that used in the above-described hybrid power, or it can be more restricted to suit the donor's goals. A popular limitation restricts the class of appointees to the donor's issue living at the time of the exercise of the power. In describing the class of appointees, the planner should keep in mind that the power is not likely to be exercised until some point in the future, when some objects of the donor's bounty may be deceased. Thus, it is important not to limit the class to one generation. The planner should consider using "issue" instead of "children" or "issue of my father" rather than "my brothers and sisters" to take these changes into account. In describing a class, the donor may want to specifically exclude certain individuals or classes of individuals (such as second marriage spouses or children of a prior marriage of a second spouse). The power should also specify whether it is exercisable in favor of any one or more of the appointees designated in the class (an exclusive power) or whether it must be exercised in favor of all of them (a nonexclusive power). It is generally desirable to allow appointment in favor of "any one or more of" and "in such amounts or proportions" as the donee may determine.

4. Takers in Default.

The donor should specify the takers in default of exercise of the power of appointment or in the event of a partial exercise of a power. If no takers in default are named for a general power, the assets revert to the donor or the donor's estate. In Virginia, naming a taker in default could prevent a life estate coupled with a power of disposition in the life tenant from converting into a fee simple interest under the rule of May v. Joynes. ¹⁸¹³ If no taker in default is named for a limited power, it is presumed that the assets should be distributed in equal shares to the members of the class who could have taken at the time the power could have been exercised by the donee. ¹⁸¹⁴

Under the Virginia UPAA, if there is no gift-in-default clause (or to the extent that such a clause is ineffective), the ineffectively appointed property passes to the powerholder or, if the powerholder is an impermissible appointee or is deceased, to the powerholder's estate, if the estate is a permissible appointee. ¹⁸¹⁵ Virginia did not adopt the Act's provision that would have granted the powerholder the right to appoint in favor of a descendant of a deceased permissible appointee. ¹⁸¹⁶

5. How and When Exercisable.

The power should specify whether it is inter vivos, exercisable by deed or other instrument of the donee during the donee's lifetime, or testamentary, exercisable by the donee's will. Often the donor will require that the donee make specific reference to the document conferring the power of appointment to prevent an inadvertent exercise of the power by the donee. Failure to make the reference will invalidate the exercise. ¹⁸¹⁷ The Virginia Supreme Court denied appointment of a successor trustee when the designating trustee was not actually a trustee at the time the designation was executed, illustrating the importance of specific compliance with the terms of a power. ¹⁸¹⁸

6. Extent of Power.

The donor should specify to which assets the power applies, and whether the power is exercisable in whole or in part. The power should also specify whether it allows the donee to appoint the assets in trust for the benefit of the appointees and whether the donee can create new powers of appointment in the appointees. Section 64.2-2717 of the Virginia Code allows the donee of a limited power to appoint to a trustee for the benefit of one or more objects of the power and to create a general power (lifetime or testamentary) in an object of the original power, unless the instrument creating the...