Estate Planner Jul-Aug 1998
The selection of an ideal trustee often presents the most significant obstacle to implementing an estate plan involving inter vivos trusts or testamentary trusts. Should you have one trustee or co-trustees? A corporate trustee, individual trustee or a combination? Too often, people fail to consider the convenience and security of designating their spouses as trustees.
You Can Hire Expertise
You may have doubts about naming your spouse as trustee. Of course, if you feel that your spouse is not financially responsible, you should not consider designating him or her as trustee. More likely, however, the concern is that your spouse is not financially experienced. But remember, expertise can be bought. A spouse acting as trustee can engage a financial advisor on behalf of the trust. Such advisors include money managers, accountants, bookkeepers and attorneys.
Make sure your spouse understands the necessity of selecting qualified advisors with whom he or she can communicate and in whom he or she has confidence. Uncle Joe may be a family friend or relative but will not be a qualified advisor if he doesn’t have the knowledge and experience necessary to protect trust assets and beneficiaries. In the trust agreement, consider naming people or firms in whom you have confidence and who you believe your spouse should consider consulting. Or include guidelines to help your trustee spouse find the needed talent.
Avoiding Inclusion In Spouse’s Estate
You also may hesitate to designate your spouse as trustee because of a concern that the trust assets will be included in your spouse’s taxable estate. This is not necessarily the case. Even if your spouse is a beneficiary of the trust, trust assets will not be included in the spouse’s taxable estate as long as his or her ability to distribute trust income or principal to himself or herself is limited to an ascertainable standard either by the trust agreement or by state law.
Accordingly, the trust agreement should clearly provide for either nondiscretionary, mandatory distributions or discretionary distributions to your spouse based on support, maintenance, educational or health needs. In addition, your spouse should not have the power to satisfy his or her legal obligations with trust assets. If you have minor children, the trust should not permit the spouse to make distributions for their support. Distributions on behalf of children that do not discharge your spouse’s legal obligations may be permissible.
Another potential trap that could cause trust assets to be included in your spouse’s taxable estate may arise in connection with a “step plan.” For example, assume real estate is held by husband and wife in joint tenancy, and, in connection with a plan, they transfer title to the husband and then he transfers that property into a trust with his wife as both trustee and beneficiary. The momentary sole ownership of the property by the husband may not be enough to sever the step, and the wife will be deemed a grantor of one-half of the property. Accordingly, one-half the property could be included in her taxable estate.
Life Insurance Trap
Special concerns arise if the trust is to own life insurance on your spouse’s life or on the joint lives of you and your spouse. In this situation, if your spouse acts as trustee, he or she may have incidents of ownership over trust-owned policies. This could cause the insurance proceeds to be included in your spouse’s taxable estate. Your spouse should generally not even act as a co-trustee unless the trust agreement clearly provides that he or she has no authority or power relating to the insurance policy.
Flexibility Is Key
Appointing your spouse as trustee can increase trust planning flexibility. It may permit you, as the grantor, to retain indirect control of trust assets and have indirect access to trust assets if the spouse is also a beneficiary. Also, consider whether having your spouse as trustee would still be desirable if your marriage should be in difficulty or end in divorce. Designation of your spouse as trustee of a testamentary trust clearly places control of the trust assets in his or her hands and within the framework of the trust agreement may permit greater economic flexibility and tax planning.
We would be pleased to help you decide whether your spouse should be your trustee. Please call us to discuss your estate planning needs.
Income Tax Consequences
A number of factors determine the income tax consequences of a trust when the spouse is the trustee. There are four possibilities: Income can be taxed 1) to the trust, 2) to the grantor, 3) to the spouse or 4) partly to each.
While you, the grantor, are alive, income earned by the trust will be taxed if:
- Your spouse is a beneficiary of the trust (even if not a trustee), or
- If the spouse’s authority as trustee over distributions is not limited by an ascertainable standard.
After you have died, income will be taxed to the trust unless:
- The income is distributed to your spouse,
- Your spouse as trustee has the sole authority to make distributions of income or principal to himself or herself, or
- Trust income is used to fulfill your spouse’s obligation of support.
In addition, because of an income tax rule known as “spousal attribution,” the Internal Revenue Service will deem any power or interest in a trust held by your spouse to be held by you. Accordingly, if you should not act as trustee for income tax purposes, then your spouse should not be trustee. There is no spousal attribution for estate or gift tax purposes.