Funding and Administering Your Trust

People have various reasons for creating trusts, the most common of which are: (a) to avoid a probate administration on death or in the event of lifetime disability; (b) to obtain favorable estate tax consequences; (c) to provide for asset management; and (d) to provide for the distribution of assets during the administration of the trust and at its termination.

As trustee, you will be most concerned with the administration of the trust. If estate taxes are to be reduced or eliminated, it will be the terms of the trust instrument which will obtain this benefit. If probate avoidance is the goal, it will be obtained by the transfer of assets to the trustee upon creation of the trust and as additional assets are acquired by you.

As creator (settlor) of the trust, you will want to understand the process of transferring assets. This is essential if probate is to be avoided. In effect, the settlor of a trust is transferring property while he/she is capable of doing so rather than leaving assets in his/her name to be cleared through a probate administration at his/her death. Under present Arizona probate procedures, it is much easier for a living individual to transfer his/her own property than for a personal representative to do so after death. A living individual has freedom to act with his/her own property; a personal representative or administrator is limited by a will, if any, by statute, by court procedures and by the taxing authorities.

These guidelines are designed to explain the transfer process and to be of assistance to the individual trustee in administering a trust.

Funding the Trust

Properly funding the trust is crucial. The trustee can only work with the assets which have been transferred to the trust. In addition, a probate administration can be avoided with regards to all assets which are in the trustee's name at your death or in the event of a disability which would otherwise require a supervised conservatorship by the probate court. To the extent that any assets in your name are overlooked and are not transferred to the trustee prior to your death or disability, those assets will be subject to a probate administration of your estate and be distributed pursuant to your will. Your attorney can handle most or all of the initial transfer of assets for you. Nevertheless, you should be familiar with the transfer process, especially since assets acquired after the date the trust is created must be placed in trust.

The discussion which follows covers various methods of funding or entrusting the types of assets most commonly owned by settlors, pointing out the advantages and disadvantages of each approach.

Securities. Where all of the active trustees are individuals (i.e., there is no bank involved), and when it is not expected that the registered securities held in the trust will be traded actively, the most common method of funding registered securities is to place them in the name of the trustees as trustees of the specific trust.

Registration or re-registration of securities in this manner is not difficult, but there may be some delay upon transfer of a security so registered while the requirements of the stock transfer agent are satisfied. This delay postpones receipt of the proceeds of sale, and in a changing market, may result in a smaller gain or a larger loss than you anticipated. While steps are being taken nationally to ease transfer requirements where trusts are involved, transfer agents still proceed with caution in such cases. Although it is not usually required, it may be necessary to provide the transfer agent with a copy of your trust agreement. Sometimes a transfer agent will accept in lieu of the trust a synopsis of the key trust provisions, a Certificate of Trust Existence and Authority.

If significant transfers of registered securities are anticipated, and speed of transfer will be critical, it may be preferable to create a separate partnership to hold title to the securities. The partnership agreement is prepared in addition to the trust agreement for the sole purpose of holding the title to trust assets. The Trustees may also be the partners in such a partnership, which can greatly simplify the ease of transferring properties. Generally, all of the trust assets can be registered in the name of the partnership. Operation through two entities (i.e., a partnership and a trust) may be confusing to the uninitiated, and you should not hesitate to us.

Still another method of holding securities is the broker's street name account if there is considerable trading activity. This is the simplest approach of all those discussed. However, this device is available only when the trust maintains sufficient trading activity from the broker's viewpoint to justify the street name account, and very few trusts qualify. Please remember that stock held in a street name account can be used by the stock broker for its own use, thus exposing your assets to greater liability. For this reason alone, you may wish to avoid the use of a street name account.

Unregistered securities — i.e., those in bearer form — present no particular transfer problems, and obviously there are no registration problems. A short form of assignment from the settlor to the trustee of the specific trust should be executed. This assignment should describe the property with some specificity to adequately evidence the settlor's intent that it be considered a trust asset.

Real Estate. Conveying real estate to trustees leads to many of the same problems encountered in entrusting securities. One reason is that the trust agreement defines the limits of the trustees' power to deal with the real estate, and a prudent purchaser, lessee, etc. may demand proof of the trustees' powers, which proof might include recording a copy of the trust agreement.

A workable solution which is commonly adopted is to prepare and record a Certificate, to be signed by the settlor, which contains pertinent excerpts from the trust agreement, including the identity of the settlor, trustee and successor trustee, a description of the mechanism by which the designated successor trustee becomes active, a statement of the trust's revocability, a listing of powers given the trustee, particularly the power to sell, mortgage and make improvements and leases with respect to real estate, and finally, a recitation of any exculpatory provisions in the trust agreement designed to protect purchasers.

When the Certificate has been recorded, the settlor may then deed the real estate to the trustee in his/her capacity as such. Another approach involves creation of a partnership to hold title to real estate on behalf of the trustees. The advantages of this approach were discussed previously.

Out-of-state real estate poses a special problem, since in many cases a corporate (i.e., a bank) trustee or successor trustee from the state of the settlor's residence will not be empowered to act in the state in which the real estate is located. This may preclude a conveyance to the trustees and necessitate use of the partnership. However, a provision which is included in your trust allows the trustee to appoint an out-of-state trustee to manage such property which will alleviate this problem.

Any transfer of real property from the settlor to the trust must meet various requirements of common law. This is especially true if your property is held in joint tenancy with right of survivorship and should be done by a person with knowledge and experience in real estate transactions.

Any interest in real estate less than absolute ownership, such as an Agreement of Sale or a lessee's interest, may also be assigned to the trust. The terms of the Agreement of Sale, lease or other relevant document should of course be reviewed to assure that assignment is permitted.

Prior to any transfer of real property, any and all encumbrances should be reviewed to ensure that the transfer will not violate their provisions or trigger a due on sale clause. This also applies if the interest is pursuant an Agreement of Sale, or a lease, which may prohibit the transfer of the property.

Tangible Personal Property. Since tangible personal property, such as household furniture and furnishings, jewelry, etc., is without any recognized documentation of title, funding of this property is approached in the same manner utilized in funding bearer securities, i.e., a simple assignment from the settlors to the trustees. However, since this property changes constantly, and continuous additional assignments would be impractical, the initial assignment should cover "any and all tangible personal property now owned or hereafter acquired."

Bank Accounts. A checking account will need to be opened in the name of the trust. All income and expenses for the trust should be deposited in or paid from this account so that the check register will be a complete accounting record of all transactions of the trust. Time certificates of deposit and long-term savings accounts can be registered in the name of the trust or the partnership.

Life Insurance. In the usual case, insurance on the settlors' lives will be made payable to the trust. If the settlors are the owners of the insurance, no changes other than the change of beneficiary need be made, and the settlors retain all ownership rights.

Retirement Benefits. The "guaranteed" portion of any retirement benefits, as opposed to benefits terminating at the settlor's death, may be made payable to the trustees in the same manner as life insurance. There are two methods to name the trust as recipient of retirement benefits, depending upon the terms of the extension trust. The trust is named either in the insurance policy, if one exists, or by completing a document called a Designation of Beneficiary Form. Designating your trust as a beneficiary of your retirement benefits, however, may preclude the use of various income tax elections to defer, or reduce the income tax liability to the recipient. Therefore, before naming the trust as your beneficiary, you should consult with your accountant or attorney. This also applies to individual retirement accounts.

Identifying the Trust for Tax Purposes

The IRS exempts your trust from filing all income tax returns so long as you report all income, gains, and losses on your personal return. The trust is not treated as a separate taxable entity, and you will not lose any income tax advantages by holding assets in the name of the trust. For example, the transfer is non-taxable, your basis in the property is not affected, and the exclusion of $500,000.00 of gain (if you file a joint tax return) on the sale of your residence is still available if you otherwise quality.

Upon the death of a settlor, the trust will become a separate taxable entity and will be required to file fiduciary income tax returns.

Protecting Trust Assets

Once the trust agreement has been signed and assets have been transferred to the trust, the trust agreement is fully operative as to those assets. At this point, there are certain basic steps to be taken by the trustee.

Any assets that have been transferred to the trust which should be covered by insurance should be so protected. If insurance is already covering a trust asset, the insurance policy should be revised to add the trustees as named insured on the policy. This can usually be done at no additional cost. If personal property, a residence or an automobile has been transferred to the trust, the trustee should make sure that such assets are covered by insurance and that the trustee is a named insured.

Assets such as stocks and bonds which have been transferred to the trust should be placed in a safe place, such as a safe deposit box. If the safe deposit box holds only trust assets and is in the name of the trustees, there will be no problem in identifying bearer bonds or unregistered securities as trust assets. There will be a problem if the box is taken out in the settlor's name alone. If the settlor successfully transfers all of his/her assets to his/her trust, he/she will have no probate estate and will, therefore, have no Personal Representative. However, on his/her death or disability there will also be no one who has immediate authority to enter the safe deposit box. To facilitate identification of trust assets and to permit easy access to the safe deposit box on the settlor's death or in the event of his/her disability, the box should be held in the name of other members of the settlor's family as well as in the name of settlor.

Administering the Trust

As the trustee, you are the legal owner of the trust assets. If more than one trustee is acting, the trustees own the trust assets with survivorship rights similar to those of joint tenants. Property held in the name of trustees will pass to the surviving trustees and any successor trustees upon the death of a trustee. If more than one trustee is acting, the trustees must act together unless expressly provided to the contrary by the trust agreement. As trustee you are not acting as the agent of the beneficiaries of the trust. Your actions are your own and you are responsible for them.

Of critical importance in the creation of a trust is the trust agreement. This is the instrument which instructs you, as the trustee, how to manage, administer and dispose of the assets which are transferred to the trust. These guidelines are directed primarily at the revocable trust situation, where the trust was created by you primarily to avoid probate, and you are the trustee or co-trustee (often with your spouse or another family member), and are also the primary beneficiary during your lifetime.

The settlor of this type of trust has much of the freedom in dealing with his/her assets after they are transferred to the trust as he/she had before the transfer. As settlor and trustee of this type of trust, your wishes as to the management and disposition of the trust assets will control during-your lifetime. Nevertheless, there are certain basic obligations, such as the duties to keep records and to segregate trust property, and to file any required tax returns. The exercise of these functions reflects the fact that the settlor intends the assets to be part of a trust arrangement under which other parties have interests.

Record Keeping. Even where the settlor is the trustee of a trust for the settlor's benefit, a trust cannot be set up and funded and then forgotten. The trustee has a responsibility to keep accurate records concerning the trust assets. Books should be set up, with the help of an accountant if necessary, to identify (1) income received, (2) income paid out, (3) additions to principal, (4) deductions from principal, (5) principal on hand, and (6) changes in trust investments.

All transactions involving trust assets should be carefully documented. When the trust books are originally set up, the cost basis of all assets transferred to the trust should be determined. It is much easier to obtain this information while the settlor is alive and his/her records available than to try to track down such information at such time as assets are sold or otherwise transferred.

In addition to satisfying the trustee's legal responsibilities, accurate books and records will make the successor trustee's job much easier. A trustee should not feel burdened by accounting responsibilities which he/she is unable to handle. An accountant should be retained when required, or the settlor may consider utilizing the services of a bank, which may be the successor trustee, or custodian (as opposed to trustee) of the assets.

Segregation of Trust Property. The trustee has an obligation to segregate trust property. If trust property is commingled with the trustee's own property, the duty will be on the trustee to prove that which is his/her own. Any doubt will be resolved in favor of the trust.

Summary

In the creation and funding of a trust, you have adopted a sophisticated estate plan. A great deal of thought and effort were devoted to the creation and funding of your trust. If at this point you simply forget about the trust, many of the benefits which it would otherwise afford you will be lost. A trust does not require a great deal of continued attention, but it does require periodic review and monitoring.

If you familiarize yourself with the requirements and guidelines set forth above, you should be able to maintain the full effectiveness of the trust with minimum effort. However, questions may arise from time to time which you are unable to answer, and in this event, you should not hesitate to call upon us.

Hoopes, Adams & Alexander, PLC, is a Chandler, Arizona, law firm offering services to Phoenix-area clients in the areas of estate planning, entity formation, commercial and real estate transactions, and civil litigation.