Trust Administration Series: Part 1 of 3
When a person passes away and leaves behind their spouse and a sizeable estate, it kicks off a chain of activities and requirements on which the trustee must take the reins. The necessary steps for administering a trust are nuanced and complicated and can include significant tax consequences.
If you have been named as a trustee, or if you are creating an estate plan and are debating whom to name as trustee, read on to receive guidance around the duties of a trustee, a roadmap of the process of administering a trust, and the considerations one should make when administering a trust.
The Importance of Trust Administration
The duties of a trustee are not to be taken lightly, by the person appointing the trustee, or by the person acting as trustee. When choosing a trustee, one should have an understanding of what they are asking of that person. The right person for the task should also be carefully considered, including identifying whether it would be necessary to select a neutral trustee to avoid pitting family members against each other, especially in a mixed marriage. It is also helpful in a trust administration to have a detail-oriented, financially-oriented mind and possess the requisite interpersonal skills when dealing with multiple beneficiaries with varying, sometimes conflicting interests.
For a surviving spouse who is also acting as a trustee of the family trust, he or she must wear two different hats: that of a trustee and that of a beneficiary of the family trust. As a trustee, the surviving spouse is a fiduciary who holds title to the assets of the trust and is tasked with managing and administering the trust for the benefit of the beneficiaries of the trust. California law requires trustees to administer trusts with reasonable care, skill, and conduct that a prudent person would exercise in a similar capacity and under similar circumstances. (California Probate Code Section (“CA Prob §”) 16040).
A surviving spouse acting as trustee of the family trust must also balance his or her interest as a beneficiary of the trust and the interests of the remaining beneficiaries of the trust, who may be children of his or her marriage with the deceased spouse, or of the deceased spouse alone from a prior marriage.
Often, the family trust is structured to provide for the surviving spouse as the current beneficiary of the trust during his or her lifetime; and upon the surviving spouse’s death, the children are named as the remainder beneficiaries. For example, consider a trust that provides the surviving spouse with the trust income as necessary for his or her health, education, maintenance and support and the use of the residence during the surviving spouse’s lifetime, and upon the surviving spouse’s death, the remaining balance of the trust would be distributed to the children. The terms of the trust agreement may also provide that the trustee is required to consider the surviving spouse’s other resources before making a distribution of principal from the trust for his or her health, education, maintenance, and support. In this scenario, there is an inherent tension between the surviving spouse whose interest would be to invest in higher income-producing assets and the children whose interest would be to preserve the trust’s principal and invest in higher appreciating assets. The trustee has a fiduciary duty of impartiality to balance the interests of all beneficiaries, and this may be even more difficult if the surviving spouse is both a trustee and current beneficiary of the family trust.
Below is an overview of the fiduciary duties of a trustee of a California trust, which may be found in CA Prob §16000 et seq.
- Duty to Administer Trust. The trustee has a duty to administer a trust according to law and in accordance with the trust instrument. No matter how good the trustee’s intentions, the trustee is not free to administer the trust in some other manner.
- Duty of Loyalty. The trustee has a duty to administer the trust solely in the interest of the beneficiaries and as intended by the grantor of the trust. The trustee cannot use the trust for his or her own personal benefit, other than under the terms of the trust.
- Duty to Deal Impartially with Beneficiaries. If a trust has two or more beneficiaries, the trustee has a duty to deal impartially with them. A trustee cannot favor one beneficiary over another.
- Duty to Avoid Conflict of Interest. The trustee has a duty to avoid conflicts of interest. This prohibits a trustee from entering into transactions with trust property which will result in a profit to the trustee, or in which the trustee’s interest is adverse to the interests of the trust or its beneficiaries.
- Duty to Take Control of and Preserve Trust Property. The trustee has a duty to take affirmative action to take and keep control of trust property and to preserve the property. This includes the trustee’s duty to take title to assets that were intended to be trust property by grantors of the trust.
- Duty to Make Trust Property Productive. The trustee has the duty to make prudent investments and take reasonable care for property to be income-producing.
- Duty to Keep Trust Property Separate and Identified. The trustee has the duty to keep trust property separate from property not subject to the trust, including avoiding the commingling of trust property with the trustee’s personal property.
- Reporting and Accounting Duties. The trustee has the duty to (1) keep beneficiaries informed with respect to matters involving the trust, and (2) provide accountings to beneficiaries unless waived. Even if the beneficiaries regularly waive accountings, the trustee should be sure to keep the records of the trust organized and accessible so that if the need for an accounting arises, the records are readily available for inspection.
The trustee can be relieved of liability for breach of trust by provision in the trust agreement. (CA Prob § 16461(a)). For example, the trust agreement may provide that the trustee will have no liability as long as he or she acted in good faith, or a provision in the trust agreement may relax the standard of care owed by the trustee by providing the trustee with sole and absolute discretionary power. However, exculpatory clauses that relieve the trustee of all accountability are against public policy, and accordingly, a trust agreement may not shield a trustee from liability for acts performed with gross negligence, in bad faith, or with reckless indifference. (CA Prob § 16461(b)).
In addition to applicable California law on trustee liability, the trustee may also be personally liable for any unpaid taxes of the decedent under Internal Revenue Code Section (“IRC §”) 3713(b) and as broadly prescribed under the Federal Claims Priority Act.
Note: When the trustee fails to pay the tax, the Internal Revenue Service also has the option of proceeding against the trust beneficiaries under special lien statutes in IRC §6324 for the collection of any unpaid taxes with respect to distributed property from the trust estate as well as under the general transferee liability provision in IRC §6901.
Trust Administration Checklist
With an understanding of a trustee’s fiduciary duties, the following trust administration checklist may serve as a guide for properly administering a trust.
1. Lodge the decedent’s original will with the county court. The trustee is required by California law to file the decedent’s original will with the superior court of the county where the decedent is domiciled within 30 days from the decedent’s date of death. (CA Prob §8200).
2. Review estate planning documents and other related documents. It is the trustee’s fundamental duty to execute the terms of the trust agreement. (CA Prob § 16000). In executing the terms of the trust agreement, the trustee must also review and execute the terms of other documents that are part of the integrated estate plan. This includes the marital agreement to determine which of the spouses’ assets are community property and separate property, and accordingly, which of the trust assets may fund the subtrusts comprising the deceased spouse’s share of the community property trust estate and separate property trust estate.
3. Record information on assets and liabilities. The trustee must marshal the assets of the trust and gather the necessary information to make a complete inventory of all assets and liabilities associated with the trust assets and the deceased spouse’s estate. The trustee will want to verify the title to assets and take title ownership of assets that belong to the trust. For example, the trustee should record an Affidavit of Change of Trustee to take title to real properties titled under the name of the decedent in their capacity as trustee. If title to certain assets that were expressly declared as assets of the trust are not in the name of the trustee as of the decedent’s death, the trustee may need to file a court petition to confirm that these assets are trust assets (referred to as a “Heggstad Petition”). A trustee would typically have to go through probate in order to transfer an asset to the trust, but California Probate Code Section 850 gives the trustee the ability to avoid a lengthy court probate administration by asking a court to order properties that should have been titled in the name of the trust as trust assets based on supporting evidence reflecting the decedent’s express written declaration that such properties are trust assets.
4. Obtain appraisals and valuations. The trustee must record the value of each asset as of date of death. If an estate tax return will be filed, the value of each asset must be confirmed by a formal appraisal or valuation report. A formal appraisal or valuation report may also be appropriate to make a record of the asset’s stepped-up basis as of date of death even if the filing of an estate tax return may not be necessary. On date of death, the basis of all assets owned by the decedent “steps up” to the fair market value of the asset as of date of death, thereby minimizing the capital gains tax consequences should these assets appreciate and are sold following the decedent’s death.
5. Send notices to heirs and beneficiaries. When a trust or a portion of the trust becomes irrevocable because of the death of one or more of the grantors of the trust, or whenever there is a change of trustee of an irrevocable trust, the trustee has a legal obligation under California Probate Code Section 16061.7 to send a notice to all legal heirs of the decedent and beneficiaries of the trust within 60 days following the irrevocability of the trust. The notification must contain the following information:
(a) The identity of the grantor(s) of the trust and the date of execution of the trust instrument
(b) The name, address, and telephone number of each trustee of the trust
(c) The address of the physical location where the principal place of administration of the trust is located, pursuant to California Probate Code Section 17002
(d) Any additional information that may be expressly required by the terms of the trust instrument
(e) A notification that the recipient is entitled, upon reasonable request to the trustee, to receive from the trustee a true and complete copy of the terms of the trust. The heir or beneficiary has 120 days from the date the notification is served, or 60 days from the date on which a copy of the terms of the trust is delivered to the heir or beneficiary, whichever is later, in which to bring an action to contest the trust.
6. Send notices to taxing authorities and other government authorities. The trustee may need to send a notice to the IRS (IRS Form 56) and the Franchise Tax Board notifying these taxing authorities that a fiduciary relationship exists between the trustee and the decedent’s estate, and between the trustee and the family trust (and the subtrusts created thereunder). The trustee may also need to send notices to the county assessor’s office that the owner of real property located in that county is deceased as well as file a change of ownership when transfers of real property have occurred, or a change in control of legal entities when transfers of ownership interests in entities owning real properties have occurred. If the decedent was receiving Medi-Cal benefits, the trustee must provide a “Notice of Death” to the Director of the Department of Health Care Services within 90 days of the date of the death with a copy of the decedent’s death certificate.
7. Apply for separate taxpayer identification numbers. The trustee may also need to apply for a separate taxpayer identification number for each irrevocable subtrust established under the family trust.
8. File tax returns and pay taxes due. The final individual income tax return for the decedent must be filed. If the decedent’s estate is a taxable estate, or if the surviving spouse wishes to elect for portability of the deceased spouse’s unused estate tax exemption, an estate tax return will also need to be filed (IRS Form 706). The trustee may also be responsible for submitting late filings of gift tax returns (IRS Form 709) for prior gifts made by the decedent for which a gift tax return was not filed. These late-filings of gift tax returns play a crucial role in:
(a) Determining the estate tax exemption available for the decedent’s estate
(b) Determining the generation-skipping transfer tax exemption available or allocated for transfers to beneficiaries who are either (1) unrelated to the grantors and 37 ½ years younger than the grantor or (2) related to the grantors and more than one generation younger than the grantors
(c) Limiting the liability of the trustee and beneficiaries if these returns were not filed
For ongoing administration of irrevocable trusts (i.e., the Marital Trust, Bypass Trust, and Trusts for Children and More Remote Descendants), the trustee is responsible for filing the annual fiduciary income tax returns (IRS Form 1041/CA Form 541) for these trusts.
9. Record tax elections. The trustee may be required to make a QTIP election for assets allocated to the Marital Trust and/or Bypass Trust to qualify such assets for the marital deduction and a stepped-up basis on the surviving spouse’s death if it is prudent and tax efficient to do so. See discussion regarding common subtrust structures and QTIP elections in Part 2 of 3 of this Trust Administration Series. Or, the trustee may be required to make an Internal Revenue Code Section 754 election to adjust the basis of the partnership interest owned by the decedent to minimize the capital gains tax consequences if the partnership interest were sold following date of death.
10. Pay decedent’s debts. The trustee has a duty to administer the trust according to its terms (CA Prob §16000) and many trust instruments require a trustee to pay the claims of the decedent. Even when the trust instrument is silent on the payment of claims, the trust estate is liable to the decedent’s creditors to the extent the decedent’s probate estate is insufficient to satisfy the claims if the trust was revocable by the decedent at the time of death. (CA Prob §19001(a)). However, when there is no probate proceeding to administer a decedent’s estate, the trustee in theory has no duty to the decedent’s creditors to pay claims prior to a court judgment. If there are court judgments during the course of the administration, then the trustee must pay the decedent’s creditors in accordance with these judgments and for the probate administration expenses to the extent the probate estate is insufficient to pay those claims. (CA Prob §19001(a)). Note, however, that if there are no court judgments during the course of the trust administration, and the trustee distributed the decedent’s trust assets to the beneficiaries or to subtrusts, the decedent’s creditors may still pursue their claims against the decedent by taking action against the beneficiaries or trustees of subtrusts, who are the recipients of the decedent’s assets. (CA Prob §13109 and §19400). Creditors must file a claim against the decedent’s estate within one year of the decedent’s death unless the limitations period is tolled or extended under California Civil Procedure Sections 366.2 and 366.3.
11. Make specific distributions to individuals. After reviewing the trust agreement, the trustee should identify any specific gifts of cash or property that need to be distributed to beneficiaries before the remaining assets of the trust (the “residue”) are distributed to the residuary beneficiaries or allocated to continuing subtrusts. These gifts generally are not intended to bear their pro rata share of estate taxes and administration expenses; but absent language in the trust agreement in this regard, they are apportioned their equitable share of estate taxes and administration expenses. Additionally, though a specific gift does not bear interest, if there is net income attributable to such specific gift, then the trustee must also distribute such net income to the beneficiary. The trustee should review the ademption provisions of the trust agreement if the property is no longer an asset of the trust and the abatement provisions if there are insufficient funds in the trust to satisfy the specific cash gifts and how the value of such gifts should be reduced and apportioned among the beneficiaries (if applicable).
12. Distribute Residue to Beneficiaries or Allocate Residue to Subtrusts. After the distribution of specific gifts, the residue may be divided and distributed to the designated residuary beneficiaries or allocated among subtrusts if directed by the terms of the trust agreement. See discussion regarding common subtrust structures used for a family trust in Part 2 of 3 of this Trust Administration Series. When dividing the residue and allocating the assets in the residue to the subtrusts, a dollar value (or “target value”) of the assets must be determined and the target value for each subtrust may need to be adjusted depending on several factors, including but not limited to:
(a) Whether the asset is community property or separate property
(b) Whether the community property may be divided between the surviving spouse and deceased spouse based on the aggregate value of the community property (“aggregate theory”) or based on each item of community property that must be divided equally between the surviving spouse and deceased spouse (“item theory”)
(c) Whether expenses were paid from the surviving spouse’s share of the trust estate or the deceased spouse’s share of the trust estate and whether such expenses were incurred or owed by the deceased spouse or the surviving spouse
(d) Whether the terms of the trust agreement direct a certain allocation formula between the subtrusts for tax purposes. See discussion regarding formula clauses for purposes of allocating assets to subtrusts in Part 3 of 3 of this Trust Administration Series.
13. Retitling of Assets to Effectuate Distribution or Allocation to Subtrusts. When completing an outright distribution of assets to beneficiaries, the trustee must ensure that the ownership title to such distributed asset has been formally changed to the name of the designated beneficiary or to the name of the trustee of the recipient subtrust (for example, a change of title by recorded deed if it’s a distribution of real property, the opening of a new account in the name of the recipient if it’s a distribution of investments or funds, or a change of title by assignment if it’s a distribution of business interest or other intangible asset). The trustee should request from the beneficiary or trustee of the subtrust, whichever is applicable, a signed acknowledgment of receipt of the assets received and an agreement to release the trustee from liability upon completion of such distribution. The trustee should also provide a Distribution and Subtrust Allocation Agreement summarizing and listing the trust assets distributed to beneficiaries and allocated among subtrusts, the values of assets distributed or allocated, and the recipients of these distributions and allocations. The recipients should provide their signed consent to the Distribution and Subtrust Allocation Agreement for purposes of transparency and in accordance with the trustee’s duty to keep beneficiaries reasonably informed under California Probate Code Section 16060. (See also Salter v. Lerner (2009) 176 CA4th 1184, holding that the trustee has a duty to communicate the information reasonably necessary to enable contingent remainder beneficiaries to enforce their rights under the trust or to prevent or redress a breach of trust).
14. Account and Report. The trustee must account “to each beneficiary to whom income or principal is required or authorized in the trustee’s discretion to be currently distributed.” (CA Prob §16062(a)). When the beneficiary is another trust, the person entitled to notice is normally the trustee of the beneficiary trust (i.e., trustee of the subtrust created for a descendant or trustee of the Survivor’s Trust, Marital Trust or Bypass Trust) and not the individual beneficiaries of that trust. (CA Prob §1208(a)). Upon reasonable request of a beneficiary (including a remainder beneficiary), or if periodic accounting is required to be provided to the beneficiary under the terms of the trust agreement, the trustee “shall report to the beneficiary by providing requested information to the beneficiary relating to the administration of the trust relevant to the beneficiary’s interest.” (CA Prob §16061). Probate Code Section 16063(a) specifies that an account to trust beneficiaries must contain the following:
(a) A statement of the receipts and disbursements of principal and income that have occurred during the last complete fiscal year of the trust or since the last account
(b) A statement of the trust’s assets and liabilities as of the end of the last complete fiscal year of the trust or as of the end of the period covered by the account
(c) The trustee’s compensation for the last complete fiscal year of the trust or since the last account
(d) The agents hired by the trustee, their relationship to the trustee, if any, and their compensation for the last complete fiscal year of the trust or since the last account
(e) A statement that the recipient of the account may petition the court under California Probate Code Section 17200 to obtain court review of the account and the trustee’s acts
(f) A statement in 12-point boldface type that claims against the trustee for breach of trust may not be made after the expiration of three years from the date the beneficiary receives an account or report disclosing facts giving rise to the claim (or 180 days if specified in the trust agreement or another period specified in the trust agreement, whichever is longer).
Following this trust administration checklist, as well as fully understanding the duties and liabilities of the trustee, ensures that trust administration after a spouse’s death goes smoothly and covers all of the bases.
Contact Jacqueline Yu to discuss your trust administration checklist by sending an email to [email protected] or calling 310-313-1195.