Trust (law)

This page deals with the law of trusts in the USA. For discussion of other jurisdictions, see Trust (law) non-USA.

In common law legal systems, a trust is a relationship in which a person or entity (the trustee) holds legal title to certain property (the trust property or trust corpus), but is bound by a fiduciary duty to exercise that legal control for the benefit of one or more individuals or organizations (the beneficiary), who hold "beneficial" or "equitable" title. The trust is governed by the terms of the (usually) written trust agreement and local law. The entity (one or more individuals, a partnership, or a corporation) that creates the trust is called variously the trustor, settlor, grantor, donor, or creator.

This dual title (legal versus equitable) is frequently called "split title." The "title split" of trust law may be generalized colloquially as follows: legal title involves control, management, and possession, while equitable (beneficial) title involves "benefit," "enjoyment," and "use."

Most trust law in the United States is now statutory at the state level. Fiduciary tax law is both federal (see the Internal Revenue Code) and state.

The trust has been called the most innovative contribution of English legal thinking to the law. It plays an important role in all common law legal systems. Trusts developed out of the English law of equity which has no direct equivalent in civil law jurisdictions. However, since the use of the trust is so widespread, some civil law jurisdictions have incorporated trusts into their civil codes. Civil law systems also have analogous concepts like patrimony of affectation and the foundation that have similar independent patrimonies from their donors that trusts can have from their grantor.

Practitioners commonly distinguish between inter vivos and testamentary trusts. A person who is living at the time the trust is established creates an inter vivos trust. A trust created in an individual's will is called a testamentary trust. Because a will can become effective only upon death, a testamentary trust is generally created at or following the date of the creator's death.

Trustees

Trustees may be (1) competent individuals or (2) state or federally chartered corporations with trust powers (usually banks). Typically bank trustees will have integrated their fiduciary organization into their investment management or private banking groups.

It is not unusual for an individual to serve as trustee alongside a bank trustee: they are typically called "co-trustees." Both individual and corporate trustees may charge fees for their services, although individual trustees typically serve gratis when part of the settlor's family or the settlor him/herself. The term "co-trustee" may and typically will fool either the bank trust officer or the individual co-trustee into thinking their roles are identical. Both should read the document carefully. If the roles are not further defined in the document, then their roles are legally the same. As a practical matter however the corporate trustee will nearly always do the custody work and keep the books. But many documents will give the individual co-trustee powers that differ from the corporate trustees. For example, the individual co-trustee's rights and duties may be limited to dealing with discretionary distributions of principal and income, sale of a personal residence held in the trust, or sales of a heartstring asset.

Note: in the context of bank trust organizations, references to the "co-trustee" are nearly always to the individual trustee.

Ever fewer American banks serve as trustee, as litigation costs rise. For most banks trust services are not profitable. For large and effective trust organizations a trust organization properly integrated into private banking and investment division can be quite profitable.

Trust laws

The fifty states harbor rich differences in fiduciary law despite on-going efforts to reduce disparities through the Uniform Principal and Income Act and other uniform act efforts. Nevertheless, unless the terms of the trust document are incompatible with public policy (creating a trust to advance a criminal enterprise, for example), the governing local law generally allows most trust agreements to be enforced according to their terms.

For example, some states require all trustee fees to be charged equally to principal cash and income cash. If the trust document directs otherwise, however, the law allows document language to prevail. Where a document contains obnoxious, unworkable, impractical, or outdated language, the beneficiaries and trustees have recourse to local probate courts -- most commonly for judicial construction or to deal with circumstances not imaginable by the settlor at the time the trust was created.

When the trustee or beneficary needs interpretation of the trust document (often but no necessarily incident to a disupte) the local probate court judge is the place to get an answer. In the trust business one speaks of "docketing" a trust, i.e. taking it to the judge. When the judge is finished, the trust is then "undocketed."

Creation

In general, a trust is not established until the document is (1) signed AND (2) money or something of value is transferred from the settlor to the trustee. Thus, the signing of trust documents does not in itself create a trust. The trust is established only when money or something of value (i.e. farm land or a home) is transferred to the trustee. In legal parlance, there must be a res (Latin for "thing"; that is, there must be some property) that is the subject of the trust.

Indeed, where there is a "self-declared" trust, i.e. one in which the settlor acts as his own trustee, nothing is accomplished by signing trust documents without assets being retitled in the name of the self-declared trust. Failure to follow through on retitling is one of the great bugaboos of self-declared trusts.

This rule sometimes gives rise to "one-dollar trusts" &mdash: trusts holding justone dollar yet still posted to the books of bank trust organizations, awaiting more significant funding from life insurance proceeds or the settlor's decision to fund inter vivos. The bank normally will charge nothing to hold the document and the one dollar until the trust is funded with more than the one dollar. Note: banks typically will not collect the one dollar: Usually one dollar is posted on and off the books to establish the trust's existence.

Many trusts specifically allow for additional deposits (cash, securities, real estate, etc.) at the direction of the settlor or others, provided the trustee is willing to accept those assets. This can be problematical in the case of real estate, where entry into the chain of title will make the trustee liable for the acts of all others in the change of title. Corporate trustees will often not accept certain real assets, especially where real property is compromised by unremediated environmental issues or where the trustee is unable to make a thorough inspection. A corporate trustee without real property expertise will sometimes avoid accepting any real estate.

The trust document

Typically, a trust is created by one of the following:

written instrument (the trust document) signed by both the settlor (who may be the only beneficiary) and the trustee
the last will and testament of the settlor.

While there are other ways to create a trust, they are atypical and of little practical interest to trust practitioners: true desert islands cases for the most part.

While practitioners (bank trustees and fellow traveler trust and estate attorneys) persist in titling trusts as "Tr. u/a" (trusts under agreement a/k/a inter vivos trusts) or "Tr. u/w" (trusts under will), there is little practical difference between the two; it matters little whether a trust was created while the settlor is alive or following his death per terms of his will.

Industry convention is for the settlor's name to appear in the title after shorthand naming the type of instrument. Consider "Tr. u/a John Smith" ("Tr. u/a" stands for "trustee under agreement"). This title indicates that during his lifetime John Smith created a trust. This title conveys no information about revocability and might better be titled "Tr. u/a John Smith Revocable" or "Tr. u/a John Smith Irrevocable".

Conventional titles may further indicate the names of one or more beneficiaries in cases where the beneficiary is not the same as the settlor. Hence: "Tr. u/a John Smith FBO Alma Smith" or, if appropriate, "Tr. u/a John Smith FBO Alma Smith irrevocable". Titles also frequently include more information such as the existence of more than one trustee ("Co-tr. u/a John Smith": "co-tr" means co-trustee) or that one or more of the trustees are not the original trustee (Successor Co-Tr. u/a John Smith).

As a practical matter the typical corporate trustee's computer system will have room for a short title (with a limited number of characters: 32 in this writer's experience) and a long title with an unlimited character field. Typically, compromises are made in the short title and serve primarily as a reminder the trust advisor which account he/she is viewing on the computer screen. Thus a complicated situation might be resolved as follows:

SHORT TITLE: John Smith IRREV for Alma

LONG TITLE: Successor Co-trustee under the will of John Q. Smith for the benefit of Alma Smith et alia irrevocable dated 5/1/1982 restated 4/11/2003.

In this example the bank trustee is the successor trustee, i.e. not the original trustee. John Q. Smith is the settlor (the creator of the trust). Alma Smith and others are the beneficiaries. The original document was executed on May 1, 1982. That document was completely rewritten, i.e. a new document was substituted for the original, on April 11, 2003.

Because each trust document is potentially different from each other document, a seasoned and capable practitioner will carefully consult actual document language before making any important decisions.

Some settlors insist on trust names that defy industry convention. Thus, aggrieved parents who create a scholarship trust for a deceased daughter may put the following language in their document: "This trust shall be called the Sally Sue Smith Education Trust." Some bank trustees might ignore the legal name of the trust, and refer to the trust, in bank records, as the "John & Jill Smith Education Trust."

Inadvertent termination of trust

The trustee is said to hold legal title to the corpus, while the beneficiary holds equitable or beneficial title. Generally, a trust cannot exist unless there is at least some "title split" -- that is, the same person cannot generally hold all legal and all equitable title at the same time. If the legal and equitable title merge in the same person, the trust is considered nonexistent. This can happen when a sole trustee becomes the sole beneficiary (see Merger doctrine).

It is common practice for an individual to name himself trustee as well as being settlor and sole beneficiary. In such case the trust exists provided there is also at least one other trustee, but the settlor signs the trust document first as SETTLOR and second as TRUSTEE. In such cases the settlor/trustee/beneficiary files income tax returns to report income from trust property under his own taxpayer ID number -- usually his Social Security number. In such cases the settlor/trustee/beneficiary must be careful during trust administration to sign documents with the correct hat on. For example: The settlor/trustee/beneficiary hires an investment firm (often the purely investment part of a bank). Communication with the bank must be from "John Smith, Trustee" rather than "John Smith, settlor" or "John Smith, beneficiary." In the not unusual event that the self-declared trustee decides to resign in favor of a corporate trustee, he does so as "John Smith, trustee" with the concurrence of "John Smith, beneficiary/settlor." It happens....

Personal versus institutional

Practitioners typically distinguish personal trusts from institutional trusts: the former being established as a part of one or more individuals' estate and personal financial planning and/or investment needs, and the latter typically by or on behalf of foundations, endowments, and defined benefit and other qualifed pension plans. Most fiduciaries manage these two types of business separately, although it is not uncommon for small institutional accounts to be handled by the personal trust group.

Terminology

The various names listed above for the creator of a trust are interchangeable -- with "settlor" preferred by the legal community and "grantor" by trust officers and related practitioners. Typically, a trust created by a single individual, in which the settlor retains the ability to remove funds at any time, is called a grantor trust. Such trusts are often created as an investment management vehicle -- at least during the life of the settlor.

The term "grantor trust" also has a special meaning in tax law: a trust in which the Federal income tax consequences of the trust's investment activities are entirely the responsibility of the settlor or another individual who has unfettered power to take out all the assets. Therefore, where "grantor trust" is used, one must inquire which meaning is called for.\

Trustee types

The trustee can be either a natural or a collective legal entity. There can be multiple trustees, in which case the trust should provide a mechanism for the trustees to make decisions. A trust generally will not fail solely for want of a trustee; if there is no trustee, whoever has title to the trust property will be considered the trustee. If the interests of the trust require it, a court of competent jurisdiction may appoint a trustee to ensure the continuing viability of the trust.

Trust property

The trust property can be any form of property, be it real or personal, tangible or intangible. The beneficiary can be a single person, multiple persons, or a defined class or group of persons, including people not yet born at the time of the trust's creation. The trustee can be one of the beneficiaries, so long as the trustee is not the only beneficiary. A trust can also be created with some charitable purpose, as opposed to having a particular person or persons as its beneficiary.

Purposes

Any competent individual may create a trust for any legal purpose. The most common usages are:

as an investment account with the added advantages of a full-service trustee. Typically, the individual will be older and wanting a strong relationship with his/her trust advisor. The trust document often then becomes the platform for the settlor's estate planning when combined with a pour-over will provision, i.e., all probate assets (assets in the name of the decedent) going to the trust post mortem. In such trusts there is typically a large component of services including bill payings, insurance claim filings, working with the settlor's attorney, accountant, and children, and financial planning. The personality and devotion of trust officer will be crucial to such a trust's success.
Trusts are often created pursuant to an estate plan. The most common example by far is a credit shelter trustee wherein the settlor (by will or as dispositive provisions of a trust created inter vivos) leaves an amount in trust for benefit of a surviving spouse not in excess of the current federal exemption equivalent to the Federal Estate Tax. In 2006 this figure is $2 million. Thus an individual would leave, say, $2 million in trust for his wife (keep the $2 million out of her estate), give his widow the net income and the corpus to his children at her death.
Trusts are often created as a way to contribute to a charity and retain certain benefits for oneself. A common ploy is to create a charitable remainder unitrust ("CRUT") with, say, $5 million with a percentage of the value at the end of each coming back to the settlor, 5% say, and the remainder going to the charity at the death of the annuitant/settlor.
Trusts may be created purely for privacy. The terms of a will are public and the terms of a trust are not. In some families this alone makes use of trusts ideal.
Trusts may be used to protect one's self against one's own inability to handle money. It is not unusual for an individual to create an inter vivos trust with a corporate trustee who may then disburse funds only for causes articulated in the trust document. These are especially attractice for spendthrifts. In all cases known to this writer a family member or friend has prevailed upon the spendthrift/settlor to enter into such a relationship.
Trusts may be created to protect an individual's welfare or other state benefits. These are typically called "special needs trusts." Typically, an individual has Medicaid and Social Security Disability coming in. For such individual to then be given access to funds in excess of, usually, $1,500, risks immediate termination of his government benefits. To assure the individual a life of some ease beyond what he can afford from Social Security checks, a family member will place several hundred thousand dollars into a special needs trust for the little extras in life: dinner out, a birthday party, some new clothes, et alia. Such trusts require the expertize of a member of the "elder law" bar and must be administered with great care. It is best to have a family member as a co- or sole trustee. Given the small size of these trusts, they are typically not profitable for a corporate trustee.
Trusts may be created to get funds to the next generation where there is significant wealth and federal exclusionary gifts have already been used up. The most typical of such vehicle is the grantor retained annuity trust (GRAT). Federal tax law specifically allows for this vehicle. Here the grantor places an asset in the trust -- one he expects will grow rapidly during the term of the trust. The document then requires the trustee to pay to the settlor a specific sum of money (the annuity) at certain intervals during the life of the trust. If there are assets in the trust at the end of the term, those assets go without estate or gift tax to the remaindermen. Here's a typical case: settlor owns large block of low cost basis stock in a publically traded company. He does not wish to sell the stock and pay capital gains tax. He also has estate tax problems since he worth $10 million. His attorney drafts a GRAT in which he places $2 million of the single company's stock. The document calls for the smallest legal interest rate (published monthly by the Federal Government), which is then paid through the term of the trust. Upon the termination of the trust, the annuity has been paid back to the grantor and the remaining corpus is delivered to the remaindermen (typically children) without tax. Money has now passed from the grantor to his/her children without gift or estate tax. There has been no capital gains tax.
Some create trusts to protect family members from themselves. It is not unusual to see a will in which four children get funds free of trust or any other encumbrances from their father but a fifth child's funds are all or mostly placed in trust. This is usually for good cause -- drug abuse, demonstrated inability to hold onto money, fear or divorce, criminal activity, a wish to see the funds go to grandchildren rather than one's own children.

Express and implied trusts

Trusts can be classified in a number of ways. One of these ways is by how the trust was created. Most commonly, a classification of trusts as express trusts versus implied trusts (resulting trust) is used. Note however that this terminology is not accepted by all authors.

An express trust is created where one person (the settlor) conveys property to another (the trustee) on the condition that the property will be used for the benefit of a third party or parties (the beneficiaries). The intention of the parties to create the trust must be shown clearly by their language or conduct. For an express trust to exist, there must be certainty to the objects of the trust and the trust property. Statute of Frauds provisions require express trusts to be evidenced in writing if the trust property is above a certain value, or is real estate.

An implied trust (also called a resulting trust) is created where some of the legal requirements for an express trust are not met, but an intention on behalf of the parties to create a trust can be presumed to exist. A resulting trust may be deemed to be present where a trust instrument is not properly drafted and a portion of the equitable title has not been provided for. In such a case, the law may raise a resulting trust for the benefit of the grantor (the creator of the trust). In other words, the grantor may be deemed to be a beneficiary of the portion of the equitable title that was not properly provided for in the trust document.

Constructive trust

Unlike an express or implied trust, a constructive trust is not created by an agreement between a settlor and the trustee. A constructive trust is imposed by the law as an "equitable remedy." This generally occurs due to some wrongdoing, where the wrongdoer has acquired legal title to some property but cannot in good conscience be allowed to benefit from it. For example, in the United Kingdom the Privy Council has held that if a fiduciary accepts bribes or makes an improper profit, a constructive trust is thereby created, by which the fiduciary is deemed to hold the bribes or improper profit as trustee of a constructive trust for the benefit of the principal.

A constructive trust is, essentially, a legal fiction. Where a constructive trust is recognized, the wrongdoer is generally not allowed to continue to hold the subjected assets. For example, a court of equity recognizing a plaintiff's request for the equitable remedy of a constructive trust may decide that a constructive trust has been "raised" and simply order the wrongdoer to transfer the applicable assets to the person who rightfully should have them.

Simple and special trusts

In a simple trust (also called a bare trust) the trustee has no active duty beyond conveying the property to the beneficiary at some future time determined by the trust. In a special trust, however, the trustee has active duties beyond this.

The careful practitioner will be careful to distinguish between a simple trust as used in the above paragraph and the term simple trust as used in trust tax law. A simple trust in Federal income tax law is one in which, under the terms of the trust document, all net income must be distributed on an annual basis.

Private trusts and public trusts

A private trust has one or more particular individuals as its beneficiary. By contrast, a public trust (also called a charitable trust) has some charitable end as its beneficiary. In order to qualify as a charitable trust, the trust must have as its object certain purposes such as alleviating poverty, providing education, carrying out some religious purpose, etc. The permissible objects are generally set out in legislation, but objects not explicitly set out may also be an object of a charitable trust, by analogy. Charitable trusts are entitled to special treatment under the law of trusts and also the law of taxation.

Fixed, discretionary and hybrid trusts

In a fixed trust, the amount of money or other goods or services to be paid to the beneficiaries is fixed by the settlor. An express fixed trust requires a certain degree of certainty regarding who are the beneficiaries and the amounts to be paid to them, so that the trustee has little or no discretion. If this degree of certainty is not met, an implied trust exists instead. In a discretionary trust, the amount of money or other goods or services to be paid to the beneficiaries is up to the trustee, so long as the decision is made based on the beneficiaries best interests. A hybrid trust combines elements of both fixed and discretionary trusts. In a hybrid trust, the trustee must pay a certain amount of the trust property to each beneficiary fixed by the settlor. But the trustee has discretion as to how any remaining trust property, once these fixed amounts have been paid out, is to be paid to the beneficiaries.

Unit trusts and protective trusts

A unit trust is a trust where the beneficiaries (called unitholders) each possess a certain share (called a unitholding) and can direct the trustee to pay money to them out of the trust property according to the number of unitholdings they possess. Unit trusts are primarily used for investment purposes.

A protective trust is a type of trust that was devised for use in estate planning. Often a person, A, wishes to leave property to another person B. A however fears that the property might be claimed by creditors before A dies, and that therefore B would receive none of it. A could establish a trust with B as the beneficiary, but then A would not be entitled to use of the property before they died. Protective trusts were developed as a solution to this situation. A would establish a trust with both A and B as beneficiaries, with the trustee instructed to allow A use of the property until they died, and thereafter to allow its use to B. The property is then safe from being claimed by A's creditors, at least so long as the debt was entered into after the trust's establishment. This use of trusts is similar to life estates and remainders, and are frequently used as alternatives to them.

Federal income tax implications

For Federal income tax purposes in the United States, there are several kinds of trusts: grantor trusts whose tax consequences flow directly to the settlor's Form 1040 (U.S. Individual Income Tax Return) and state return, simple trusts in which all the income created must be distributed to one of more beneficiaries and is therefore taxed to the non-settlor beneficiary (e.g. the widow of a trust created by the late husband), whether or not the income is actually distributed (it happens), and complex trusts, which are, in general, all trusts that aren't grantor trusts or simple trusts. Some trusts may alternate between simple and complex under certain conditions. Many but not all trust organizations do their own tax work. This can be highly specialized work.

All simple and complex trusts are irrevocable and in both cases any capital gains realized in the portfolios are taxed to the trust corpus or principal.

External links

Basic info from the legal perspective of New Zealand