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Administering a testamentary trust for a child: creating a road map to follow.

For CPAs involved in trust compliance and planning, the key step when any testamentary trust is formed is to have a meeting with the trustee and trust counsel to review the trust and how it should be operated. This meeting is quite different from the analysis given by their attorney when creating a trust. The result of this trust administration meeting should be an annotated trust document that highlights:

* Key provisions relevant to administration

* Decisions that remain to be made

* Elaboration of technical terms and provisions

* Notes on the application of generic trust terms to specific circumstances

* Confirmation of steps that have been taken so that interpreting the trust will have appropriate context

* Assignment of a tax identification number.

Trust Administration Road Map

To illustrate these issues, consider a typical trust formed under a will for an heir, for example, a parent's will setting up a testamentary trust for a child. This situation raises a myriad of planning issues. CPAs can help explain the implications of the trust terms with regard to the proper administration of the trust, including distributions, investments, and other matters with income tax consequences. The following represents a road map to follow for the typical administration of such a trust.

Annual meeting. The participating parties should establish an annual review meeting. Few trusts that are administrated without professional guidance can withstand the scrutiny of professional review. Too often, by the time professional advisers are sought out, costly damage to the administration process has already been done. An annual meeting should review

operations, tax planning with the trust's attorney (who should be engaged by the trustee), CPA, and wealth manager, as well as create an updated compilation of all trust actions and events. Tax returns, investments, and bank account statements should be reviewed. Any changes in circumstances, as well as tax and other laws, should be evaluated.

Name. A trust's name should be agreed upon. If a name was used in filing for the trust tax identification number, that same name should generally be used. Many wills and trusts that create trusts have no particular name assigned to them and become known by the article number that creates them. It is easier for all involved if a trust has a more descriptive name, like "Father Smith Trust f/b/o Son Smith." It is also helpful to include the date of the instrument creating the trust, in case there are multiple trusts for the same settlor and beneficiary.

EIN: An EIN (Employer Identification Number) should be obtained for the trust. This can often be confusing to nontax specialists, who are generally aware of the need to name an estate or revocable trust but not a separate testamentary trust formed under that instrument. Confusion is particularly common when there is only one beneficiary, making the distinction between a deceased-parents living trust and the trust formed under that instrument for the sole surviving child seem inconsequential, when it is not.

Effective date. Confirm the effective date of the trust, whether it be the date of the decedent's death or some other date.

Corpus. Which assets are in the trust, and which assets should be in the trust? CPAs should not assume they are the same without confirmation. Look for all loose ends that need to be addressed to complete the funding process.

Independence. CPAs have a vital role in turning theoretical legal concepts like "fiduciary duty" into concrete fiscal steps. The trustee must understand all relevant concepts, including the following:

* All trust transactions must be handled through separate trust bank, brokerage, and other accounts.

* Nontrust assets may not be deposited into the trust. Neither the trustee nor beneficiary can make gifts into the irrevocable testamentary trust.

* Each trust must file its own income tax returns.

* Each trust must be treated like an independent person.

* Records for every significant decision, event, or transaction, must be maintained.

* Detailed and accurate books and records must be maintained. An independent CPA can play a vital role in protecting a trustee from claims by beneficiaries in this regard.

Funding. A typical inter-vivos trust has a schedule attached that often lists property transferred to the trust. Testamentary trusts do not have this, and may be required to identify assets. An estate tax return may provide some guidance; but as the federal exemption has increased, fewer estates are required to file. In some cases, CPAs will have to identify the transfer documents (e.g., deeds, wire transfers, bills of sale).

Situs/state taxation. CPAs should review the nexus of the trust for various states, the tax consequences in each of the states, and which steps would be needed to establish the trust in a new jurisdiction. For example, the governing instrument might give the trustees the right to exercise the powers to change situs.

Merely exercising a power to change situs might not suffice to terminate tax nexus, if, for example, a state resident remains a trustee. CPAs might recommend that the trustee (and successors) creating the undesired tax nexus resign and have new successor trustees appointed. But be careful removing the people the settlor specifically wished to manage the trust.

Basis. While commentators have focused on the means of increasing tax basis, the mundane fundamentals might be more important. For testamentary trusts, the tax basis of the assets will be the date of death values of the testator. As noted above, this may be difficult to identify. In many cases, wills (revocable trusts or other instruments) pour assets into existing irrevocable trusts. The history of the trust and all prior transfers may have to be analyzed; for example, if old trusts were merged into a testamentary trust, those assets also form the corpus. CPAs may have to go back to old trust records to ascertain income tax basis.

If no federal estate tax return was filed, state inheritance and estate tax returns may provide relevant information.

Gain harvesting. CPAs should review the income tax status of the trust before the end of every year to evaluate whether distributions should be made to reduce overall tax burden. Trusts are subjected to compressed income tax rates. Remember that the trustee can make a distribution within 65 days after year-end and treat the distribution as attributable to the prior tax year.

Investments. CPAs should evaluate investment allocations and asset locations between personal and trust assets. The individual responsible for investment decisions should prepare an investment policy statement (IPS) indicating the investment philosophy and goals for each trust.

CPAs should review the terms of the governing trust instrument to be certain that it is permissible for the trustee to consider an overall asset allocation for all family assets and rather than just one particular trust. If the instrument does not permit sufficient flexibility, perhaps a decanting into a new trust, or a court-ordered modification, may be feasible.

Distributions. CPAs can determine how much each beneficiary is entitled to. Some trusts might permit broad distributions of as much or as little of the income and principal of the trust each year. If a broad, flexible distribution provision is provided for, consider the federal (and state) tax consequences of funds left in the trust, as compared to distribution to a beneficiary. The fact that a trustee can distribute principal does not mean that one should, as it will eliminate the divorce and asset protection benefits of the trust.

Many trusts provide for distributions in accordance with an ascertainable standard, or health, education, maintenance, and support (HEMS). This is approximately analogous to a "standard of living," so that distributions may only be made from the trust for each child in an amount not more than what is necessary to maintain a beneficiary's standard of living. CPAs should discuss with the trustee what this means from a tax perspective, and address the legal implications with counsel.

Finally, consider whether the governing instrument mandates, or even permits, consideration of the beneficiary's other income or resources.

Fiduciaries. CPAs should evaluate whether the named successor trustees are those the testator selected. Even if the beneficiaries do not approve of the trustees, it is up to the trustees to determine whether they wish to serve or not. Often, if family or friend trustees are named and the beneficiaries do not wish them to serve, they will resign. CPAs should be mindful of whom they represent in such discussions.

Some trusts name a beneficiary but mandate that an independent trustee also serve. Other trusts permit the beneficiary to serve alone, but suggest or authorize a beneficiary or trustee to name an independent co-trustee. Some prohibit a beneficiary from serving. It is essential to ascertain what the specific trust provides, and, within those parameters, what might be appropriate under the circumstances.

Powers of appointment Each individual who holds a power of appointment under the trust should amend his will to expressly address this. CPAs should explain the use of the power and the tax implications. The individual's attorney should address revising or drafting a document to effectuate that exercise. One may have to expressly exercise the power, referring specifically to the provision in the trust document by its name and article number.

Form 56. This form should be filed by each trustee to inform the IRS of the existence of a trustee relationship.

Receipts and releases. Counsel should prepare these to be signed by the trustee in favor of the executor or other fiduciary, transferring assets into the testamentary trust. A copy should be retained with the testamentary trust permanent records.

Merger/decanting/restructuring. CPAs should bear in mind that the growing use of decanting, trust protectors, and other such power holders could facilitate restructuring or modifying an even irrevocable trust. Trust counsel should be consulted about the possibility of modifying the governing instrument.

Remember the Basics

A typical trust formed under a will for an heir can raise a myriad of planning issues. CPAs should focus on the basics and not merely the more sophisticated tax decisions. Often, properly identifying and understanding basic trust provisions and facts affecting the administration of that trust is a prerequisite to more sophisticated planning. Having an initial trust meeting to create an annotated trust road map can provide an excellent first step in the planning process.

Martin M. Shenkman, JD, CPA/PFS, AEP, is an attorney at Shenkman Law in Paramus, N.J.
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Title Annotation:Finance: estate & retirement planning
Author:Shenkman, Martin M.
Publication:The CPA Journal
Date:May 1, 2015
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