Chapter 20. Trust Management

• Author: Jerold I. Horn
• Pages: 608-641

20

Trust Management

PART ONE

GENERAL LIMITATIONS

I. HOW ADMINISTRATIVE PROVISIONS CAN SHIFT

ENJOYMENT

If the exercise of a power permits the power holder to shift beneficial

enjoyment to or from himself or herself, the power can present tax issues,

even if the power is labeled as an administrative power. One concern is that

the mere existence of the power can constitute a general power of

appointment or, for income tax purposes, a power exercisable solely by the

power holder to vest income or corpus in himself or herself. Code § 678(a)

(1); Treas. Reg. §§ 20.2041-1(b)(1), 25.2514-1(b)(1), 20.2056(b)-5(f),

25.2523(e)-1(f). Another concern is that the exercise or lapse of the power

in favor of other than the power holder can produce a taxable gift. Treas.

Reg. § 25.2511-1(g)(2), Code § 2514.

Particularly capable of presenting issues regarding shifts of enjoyment

are powers

i. to retain, dispose, and invest property under circumstances in which

particular types of income are allocated to particular beneficiaries,

i. to retain or invest in unproductive or underproductive property

(especially if the governing instrument waives the application of

state law that otherwise requires adjustments in favor of

income),

ii. to allocate receipts and expenses between income and principal,

iii. to lend without adequate security or interest,

iv. to exchange property with the trustee,

v. to release a trustee or accept the trustee’s account, and

vi. to distribute in nonprorata shares without regard to unrealized

gain for tax purposes.

An administrative power seems not to present any problem unless the

administrative power permits the holder to change the amount that the

holder will receive. The ability of a holder of an administrative power to

use it to this effect depends upon the complexions of both (i) the

administrative power and (ii) the dispositive arrangement.

II. POSSIBLE SOLUTIONS

First, if the administrative power is not coupled with any dispositive

provision that mandates the distribution of income or principal, the drafting

of dispositive powers in accordance with the analysis in Chapter 3 should

eliminate all tax vulnerability. To such extent as an ascertainable standard

limits a dispositive power that is exercisable in favor of a holder of an

administrative power or in favor of another distributee, the ascertainable

standard also limits the extent to which a holder of an administrative power

can use the administrative power to benefit the power holder or the other

person. If all ability to distribute property to the power holder is described

in Code Sections 2041(b)(1)(A) and 2514(c)(1) and all ability to distribute

property to other than the power holder is described in Treasury regulations

section 25.2511-1(g)(2) and the power holder cannot distribute trust

property in discharge of his or her legal obligation, these limitations should

prevent (i) any administrative power from being a general power of

appointment and (ii) the exercise of, or the failure to exercise, any

administrative power from being a taxable gift of the beneficial interest of

the power holder.

Second, if the administrative power is coupled with a dispositive

provision that mandates the distribution of income or principal, the

draftsperson might have to eliminate or limit the administrative power.

Whereas administrative powers that are coupled with discretionary powers

to distribute seem to command orthodox solutions previously discussed, a

power of administration that is coupled with a dispositive provision that

mandates a distribution seems capable, absent sufficient limitation, of being

a dispositive power.

If, for example, the governing instrument requires the trustee to pay

income currently to the power holder or another person, an administrative

power to retain or to invest in unproductive or underproductive property

might enable the power holder, unlimited as provided in Code Sections

2041(b)(1)(A) and 2514(c)(1) and Treasury regulations section 25.2511-

1(g)(2), to increase or reduce the stream of income to the distributee. If the

power holder is the income beneficiary, the concern is that the power holder

might possess and release a general power of appointment over any forgone

income. If the power holder is a remainder person rather than the income

beneficiary and the power holder maximizes income and thus reduces the

potential value of the remainder, the concern is that the power holder might

be deemed to give the forgone value to the income beneficiary.

Similarly, if, for example, as in Form 16.2, the governing instrument

requires the trustee to pay currently to a beneficiary all payments that the

trust receives from an individual retirement account or qualified plan, an

administrative power to withdraw assets from the IRA or qualified plan

might enable the power holder, unlimited as provided in Code Sections

2041(b)(1)(A) and 2514(c)(1), Treasury regulations section 25.2511-1(g)

(2), Code Section 2518(b)(4), and Treasury regulations sections 25.2518-

2(d)(2) and 25.2518-2(e), to increase or reduce the stream of payments to

the distributee. If the power holder is the distributee, the concern is that the

power holder might possess at death, or possess and release during life, a

general power of appointment. If the power holder is a remainder person,

rather than a current distributee, and the power holder reduces the potential

value of the remainder, the concern is that the power holder might be

deemed to give the forgone value to the current distributee. If the power

holder is a disclaimant, the concern is that the power might prevent a

qualified disclaimer.

If each holder of an administrative power has a beneficial interest and

the administrative power is coupled with a dispositive provision that

mandates a distribution, general precautions are appropriate to prevent the

use of the administrative power for dispositive purposes. The governing

instrument clearly should cause all administrative powers to be fiduciary

powers. The draftsperson should design all administrative powers

cautiously and conservatively. The draftsperson should avoid exculpatory

clauses and should eliminate any discretion that arguably is sensitive.

Consider reposing any otherwise-sensitive power jointly in more than one

holder. Code §§ 678(a)(1), 2041(b)(1)(C)(ii), 2514(c)(3)(B).