Estate & Trust Administration
What is Trust & Estate Administration?
The average person has had little experience dealing with trusts and often has many questions upon becoming a trustee for the first time. The purpose of this brochure is to try to anticipate questions by providing a general overview of how trusts work and the duties and responsibilities of the person that is acting as Trustee of a trust or Administrator of an estate after a person dies
A Successor Trustee is a person identified in a revocable trust that is to take over as trustee after the maker of the trust passes away. The person making the revocable trust is called the Settlor. Most revocable trusts become irrevocable & non-changeable after the Settlor dies. The Successor Trustee is charged with carrying out the terms of the trust and following California law during the trust administration process. Just because a person had been named as the Successor Trustee in a decedents trust, does not require them to assume the Trust management responsibilities because there is a right to refuse to act. In that case, you would read the trust document to see who the next person in line as the Successor Trustee nominee.
Estate Administration is created out of the need to administer the assets of a decedent that did not have the assets registered in the name of a trust. This happens when the decedent had a will (or did not have a will) and owned valuable assets that now need to be distributed to the rightful beneficiaries. Estate Administration may take place at the same time that the Successor Trustee is administering a trust because often times the Estate Administrator is the same person as the Successor Trustee. The name frequently associated with a person that died without a will is called passing away, Intestate.
Through our experience in helping people administer trusts and estates, we have found that many individuals have unreasonable expectations concerning the way living trusts operate following a death. It is true that a living trust in many cases drastically reduces the costs and delays involved in passing on assets at death. A living trust accomplishes this feat by avoiding probate. Probate is a is a court case where a judge supervises most actions that take place in the administration of an estate. It can be very expensive and time consuming to be involved in a Probate Case. It is for that reason, that it is popular in the State of California to want to avoid probate by creating a revocable trust and other documents to allow the transfer of assets to beneficiaries without court supervision and procedures. Although having a trust own title to your assets will avoid probate, the court is always an available option to help in the management of a trust, should the need arise.
Sometimes the benefits of having a revocable trust are exaggerated by promoters or simply misunderstood by consumers when learning about and considering estate planning service and estate administration. It is true that trusts can avoid the cost and delays associated with a Probate Case, however there are still many administrative chores that have to be completed, legal documents prepared, assets sold to raise cash for beneficiaries, title of assets transferred to beneficiaries, taxes returns filed, laws to be complied with and other matters that take time and cost money.
TRUSTS IN GENERAL
What is a Trust?
A trust is a legal relationship, usually evidenced by a written document called a “Declaration of Trust” or “Trust Agreement”, whereby one person, called the “Settlor”, transfers property to another person, called the “Trustee”, who holds the property for the benefit of another person, called the “Beneficiary”. The same person may occupy more than one position at a time. For example, in the typical living trust, as long as the Settlor is alive, he or she is also the Trustee and Beneficiary. On the death of the Settlor, a “Successor Trustee” (e.g., child, friend, and bank) takes over as Trustee and follows the Settlor’s instructions, which are set forth in the Trust, concerning the distribution of property and the payment of taxes and expenses.
Living Trusts and Probate Avoidance
Although living trusts have been around for centuries, only recently have they achieved a high degree of popularity among the general public. The reason for this surge in popularity is that living trusts help to avoid probate. You might be wondering, “What is probate, and why is everyone trying so hard to avoid it?” The short answer is that probate is a court-supervised procedure for collecting a deceased person’s assets, paying debts and taxes, and distributing the property to the person’s beneficiaries (either according to the instructions the person set forth in his or her will or as determined by state law if the person died without a will). The probate process usually takes 6 to 12 months to complete, although it may take longer in complicated cases.
Probate is not a tax. When people refer to the high costs of probate, they are usually referring to the fees paid to attorneys and the personal representative. In California, these fees are calculated as a percentage of the gross (not net) value of the assets in the estate. These rates are set out in Probate Code §§10800 and 10810 (4 percent on the first $100,000, 3 percent on the next $100,000, 2 percent on the next $800,000, and so on). For example, let’s say that D, who is not married, dies owning one asset, a house worth $200,000 with a mortgage of $120,000. D has a will that leaves the house to D’s two children, A and B. A is named as executor. The probate fees for this case would be as follows: $7,000 to A’s attorney (plus any “extraordinary fees,” which are billed hourly but subject to court approval) and $7,000 to A (if A decides to take a fee), for a minimum total fee of $14,000. These fees are calculated without regard to the $120,000 mortgage, because the fees are charged on the gross (not net) value of the estate.
One of the reasons living trusts have become so popular in the last 20 years is that real estate prices in California have skyrocketed, leading to much larger estates and, hence, higher probate fees. In states where real estate prices are lower or where attorney fees for probate work are based on an hourly fee schedule rather than a percentage scale, living trusts are less popular than in California.
Living trusts avoid probate with respect to those assets that are transferred into the living trust before death. In other words, living trusts avoid the court procedure otherwise required to transfer assets to a person’s beneficiaries at death. However, as we explain below, even though no court procedure is involved, that does not mean there is nothing to do. The living trust makes administration easier, but it does not do away with administration altogether. For example, assets still have to be collected and managed pending distribution to the beneficiaries, appraisals of assets have to be made, debts and taxes have to be paid, tax returns may be required (living trusts do not avoid estate taxes, as some people have been led to believe), and legal documents must be prepared in connection with the distribution of the trust property to the beneficiaries. These activities are very similar to a probate. The major difference is that, with a living trust, everything is handled privately, without court supervision, which makes for (in most cases) a faster, less expensive administration process.
Thus, although it may come as a surprise to you, you should realize that post death administration of a living trust will take time and cost money, such as legal fees, accounting fees, asset transfer fees, and your own Trustee fees if you decide to accept any. The other beneficiaries of the Trust, if any, will also need to understand that the process may take longer than they anticipated. However, in comparison to probate, these delays and costs are substantially reduced, often resulting in time savings of months and costs savings of 50 to 90 percent.
Assets that are not controlled or managed by the trust.
Retirement plans
Life Insurance Policies
Annuities
Assets not owned by the trust
The reason that these assets are not owned by your trust because the financial institutions use a beneficiary statement that you signed when you acquired the asset. The beneficiary statement controls who receives the assets when you pass away. Sometimes a trust will be named as a beneficiary for this type of assets but there are tax disadvantages for the ultimate beneficiaries.
Court Involvement
There is also a popular misconception that the existence of a living trust avoids all possibility of court involvement. This is true (in part) only if all of the Settlor’s assets were properly funded into the living trust. For example, if assets held outside the trust exceed $100,000 in gross value, a probate will be required for those assets in order for you, as Trustee, to collect those assets and add them to the trust.
Moreover, if at any time a beneficiary of the Trust believes that the Trustee has acted improperly or without regard for the beneficiary’s interests, the beneficiary may file a petition with the court to force the Trustee to make a full report and accounting or to redress an alleged breach of trust, including removal of the Trustee or surcharge against the Trustee.
Finally, circumstances may arise in which there are questions about whether the Trustee should or should not take certain actions (e.g., selling a business interest or real property, commencing litigation). In such cases, it may be advisable for the Trustee to petition the court for instructions whether to proceed in a certain way. The beneficiaries will be given notice of the hearing and will be given a copy of the petition that describes the proposed action. The matter will then be addressed in open court, and the beneficiaries will have an opportunity to appear in court and be heard. By obtaining an order from the court in this manner, the Trustee may be able to cut off the beneficiary’s right to complain about the particular action if he or she fails to appear in court. Such a petition protects the Trustee if there is a fear that the Trustee’s decision will be second-guessed by a beneficiary. Also, if relations between the Trustee and the beneficiaries are hostile, it may be advisable for the Trustee to seek court approval of the Trustee’s accountings to minimize potential arguments with the beneficiaries.
ADMINISTRATION OF THE FAMILY TRUST
After the Settlor’s death, the Trust continues as a management and distribution vehicle that will exist only as long as is necessary to identify and collect trust assets, pay debts and taxes, and distribute the trust assets to the beneficiaries (or in further trust, depending on the terms of the Trust). You might visualize this trust as a funnel through which all of the trust assets will pass to the beneficiaries (with the exceptions of tangible personal property, life insurance proceeds, and other nontrust assets that may pass directly to the beneficiaries outside the Trust). As successor Trustee, it is your job to collect and manage the trust’s assets, appraise trust property, pay all taxes and expenses relating to the administration of the Trust, and distribute the trust property according to the Settlor’s instructions.
POUR-OVER WILLS
In addition to the Trust, the Settlor signed what we call a “pour-over” will. The purpose of the pour-over will is to provide for the distribution of assets that were omitted from the Trust, either intentionally or inadvertently. One of your first tasks will be to determine what assets, if any, were omitted from the Trust. If any such assets exceed $100,000 in gross value, a probate may be required to transfer these assets to the Trust. If these assets do not exceed $100,000 in value, you can collect such assets under a declaration procedure authorized by the Probate Code. At least 40 days must elapse after the date of death before you can use this declaration procedure. Whether or not a probate is required, the original will must be deposited for safe keeping with the County Clerk within 30 days of the date of death.
DISTRIBUTIONS OF PROPERTY TO BENEFICIARIES
Tangible Personal Property
Provided the beneficiaries are in agreement, the distribution of tangible personal property may be handled informally and we need not get involved. If any disagreement develops, however, the division of personal property should be handled in a more formal manner. We recommend that you carefully document and inventory the items of property available for distribution and the disposition of each. One way to document the property on hand is to videotape or photograph the household property before distribution.
Before allowing the distribution of any items of personal property, however, please note that you are responsible for reporting such items on a federal estate tax return, if required (see below). Furthermore, if any items of property (or group of items that constitutes a single collection) have a fair market value of $3,000 or more, these items must be separately appraised for federal estate tax purposes. You should therefore keep careful records of what assets are distributed and to whom, and you should obtain any required appraisals before distributing particularly valuable items.
Other Distributions From the Trust
One of the first questions the Trustee and other beneficiaries usually ask us is, “When will the trust property be distributed?” Many people, having heard that living trusts avoid probate, assume that all estate administration procedures are avoided and that the property in the living trust somehow passes to them automatically. Having read this far, you now understand that this simply is not true. As a result of this misunderstanding, many beneficiaries are disappointed to learn that the trust administration process is often measured in weeks or months (and in some cases longer), rather than in hours or days.
To answer to the question of when distribution will take place, we anticipate that distribution will take place in several stages. Depending on how quickly assets and liability information can be assembled, you may be able to make preliminary distributions of a portion of the trust estate within a few weeks. After we have obtained all appraisals and can project the expected tax liabilities and expenses with more accuracy, you may distribute more of the trust estate, making certain to reserve sufficient funds for payment of estate taxes, income taxes, administrative expenses, attorney and trustee fees, debts and liabilities, etc. However, if any litigation arises concerning the Trust (e.g., a “contest” of the Trust), you may have to withhold distribution until such problems have been completely resolved. (Our office has had cases in which a living trust that provided for distribution “at death” was not actually distributed until more than a year after death because of disagreements among the beneficiaries and the ensuing court procedures.)
Moreover, as noted above, living trusts do not avoid estate or inheritance taxes that are reported on IRS Form 706. If it is determined that estate taxes or fiduciary income taxes are payable in this case, we will recommend that you retain a further reserve in the Trust after payment of such taxes until all audits are completed or until the period for assessment of a tax deficiency passes (3 years). This reserve is for your own protection. Any legal fees, accounting fees, and your own Trustee fees incurred in connection with the audit process, and any tax deficiencies that might be assessed by the IRS, are chargeable to the Trust. If you have already distributed all of the trust assets, you, as Trustee, may have to bear these expenses and taxes yourself if the beneficiaries are unwilling or unable to contribute their fair share. If this situation applies in your case, we will assist you in determining an appropriate amount to hold as a reserve.
TRUSTEE DUTIES, POWERS, AND COMPENSATION
Standard of Trust Management
As Trustee, you will act in a fiduciary capacity. As such, you owe certain legal duties to the beneficiaries, as explained in more detail below. In managing the trust property, you must use at least ordinary business ability. However, if you have special skills, under California law you will be held to a higher standard of care. In any event, your management will be judged in light of the circumstances existing at the time transactions occur, rather than with the benefit of hindsight. If you exceed your trustee powers, you may be held liable for loss or damage to the trust estate.
Source of Trustee Powers
It is important that you understand the rules under which you must operate. These rules are derived from three sources: (1) the Trust itself, (2) statutory law (the “Trust Law” found in the California Probate Code), and (3) decisional law created by the courts.
The principal source of your Trustee powers is the Trust itself. You should therefore read the Trust carefully. In doing so, you will see that the Trust contains two types of provisions: (1) “dispositive provisions” that govern the distribution of property and (2) “administrative provisions” that govern the powers of the Trustee, payment of taxes and expenses, rules for interpreting the trust instrument, and other procedural issues. The bulk of the Trust is made up of these administrative provisions.
In creating a trust, the Settlor may include any lawful provisions that he or she wishes to govern the trust relationship. Because tax considerations are often important in creating a trust, the Trustee’s rights and duties are often limited by the tax results desired by the Settlor. The provisions of a trust may override general provisions of the Trust Law, except when the law expresses a paramount public policy. Whenever the trust instrument does not provide for a given situation, the Trust Law applies.
General Duties of Trustee
Your basic duties as Trustees involve the collection, management, and investment of trust assets and the accumulation and distribution of income and principal under the Trust. Another important set of duties relates to tax matters, which are explained in detail elsewhere in this memo.
It is a fundamental principle of trust law that you must be faithful to the interests of the Trust and its beneficiaries. You occupy a position of trust and confidence and owe a duty of care to the beneficiaries. You have a duty to administer the Trust solely in the interest of the beneficiaries and to deal impartially with them. You cannot use trust property for your own profit or for any non-trust purpose. You must not engage in any transaction that will result in a conflict of interest between you and the Trust or a beneficiary.
You have a duty to take reasonable steps to take and keep control of trust property and to preserve the trust property and make it productive. You must not commingle trust property with your own property under any circumstances. You also have a duty to take reasonable steps to enforce claims of the Trust and to defend lawsuits brought against the Trust.
You must carry out all Trustee activities personally. In other words, you may not delegate your responsibilities to others. However, you may hire attorneys, accountants, investment advisors, and others to consult with you concerning your administration of the Trust. Nevertheless, you will ultimately be held responsible for your acts or omissions.
Whether or not you accept a fee, we strongly recommend that you keep a log or diary of the time you spend on trust matters, including the date, amount of time expended, what you did, and the decisions you made and the basis for the decisions. If you incur miscellaneous expenses for which you expect reimbursement from the Trust, you should carefully record these expenses. This log or diary will not only support your request for trustee’s fees (if you decide to accept a fee), but will also serve as a written record of the actions and your thoughts surrounding those actions in the event your activities are ever questioned by a beneficiary of the Trust.
TAX MATTERS
Taxpayer Identification Number
When a person dies, their Social Security must not be used by banks or financial institutions. For this reason, we obtain a new Taxpayer Identitication Number TIN to be used on all accounts and tax statements. This identification number will be used on all fiduciary income tax returns IRS Form 1041 and on all bank accounts.
Notice Concerning Fiduciary Relationship
Federal and state laws require that the respective taxing authorities be notified of the existence of a new trust or a change in fiduciary relationship. Because the Trust is now irrevocable and has in essence become a separate taxable entity, we must notify the taxing authorities of its existence. This is done by way of a “Notice Concerning Fiduciary Relationship” (IRS Form 56). We will prepare this notice for you.
Income Taxes
People are often surprised when there are issues of income taxation when a trust or estate is being administered after a person dies. Income taxes do not disappear because a person passes away.
Decedent’s Final Returns
Final state and federal personal income tax returns will be required for the period of January 1 through the date of the Settlor’s death. The forms that need to be filed are the traditional IRS Form 1040 & California FTB Form 540. Such income tax returns will include income generated by the assets of the revocable Trust before the date of death. Income generated by the assets in the now irrevocable Trust after the date of death are not reportable on the decedents final IRS Form 1040, CA FTB Form 540.
Fiduciary Income Tax Returns
Income earned after the date of death until the trust or estate is fully liquidated are reported on different tax forms. All irrevocable non-changeable trusts that earn over $600 for the year are required to file fiduciary income tax returns on IRS Form 1041 and the California FTB Form 541. The taxpayer identification number used on these tax forms cannot be the decedent’s Social Security Number. A new taxpayer identification will need to be obtained for tax reporting and also be given to banks and financial institutions where assets are being held
Income Tax Basis
For federal and state income tax purposes, all of the property in the Trust (other than assets which are “income in respect of decedent” or I.R.D.) will receive a new income tax basis equal to the fair market value at the date of death (or the alternate valuation date, as explained above). This new basis is the measuring point for any capital gains in the event you sell any property of the Trust or for any depreciation deductions pending administration.
Income Tax Consequences to Beneficiaries needs to be simplified.
All property received by inheritance, including property distributed from a living trust, is received free of income tax. However, some income tax consequences to the beneficiaries should be noted. One such consequence is that the basis of assets received on distribution will be the date-of-death value (or alternate-valuation-date value), as explained above. The income tax basis of assets received will determine the capital gain a beneficiary will realize if and when the beneficiary sells an inherited asset.
In addition, the beneficiaries of any residuary gift must be aware that the distribution of trust assets will carry out to the beneficiary’s income earned by the Trust during the period of trust administration to the extent of basis, which income will be reportable on the beneficiaries’ own individual tax returns. The Trust will supply the beneficiaries with K‑1s reporting the amount of income passed through to the beneficiaries. Alternatively, before this distribution of income to a residuary beneficiary, the Trustee may make an election under Internal Revenue Code §643(e) to recognize the gain at the trust level, in which case the distribution and basis to the beneficiary are increased to fair market value. If the beneficiaries have already filed their returns for a taxable year before obtaining IRS Form 1041, Schedule K‑1s, they will be required to file amended returns personal tax returns on IRS Form 1040X & State FTB Form 540X. Most beneficiaries to not appreciate being required to file amended tax forms that they previously felt had been completed.