Selecting a trustee
April 19, 2014    Disclosures    POSTED IN  Personal Finance

Eligibility and tax considerations

As the trust’s grantor (the person establishing the trust), you can name any of the following as a trustee: yourself, your spouse, family, friends, the beneficiaries, business associates, professional advisors, a bank, or a trust company.

However, you must investigate carefully before appointing a trustee because the tax consequences can vary widely, depending on whom you name. If the trustee you appoint doesn’t meet state trust law requirements, the trust will be invalid and provide none of the intended tax benefits.

There are a number of situations in which it’s inadvisable to appoint yourself or a beneficiary as trustee:

  • A sole beneficiary cannot be sole trustee–According to state trust law requirements, if the sole beneficiary is the sole trustee, the trust is invalid. A beneficiary can be a trustee only if there are other beneficiaries and/or other trustees.

Example:         If Sue sets up a trust with herself as the sole beneficiary, her trust is invalid if she is also the sole trustee. This is not because she can’t be both grantor and trustee. It’s because she can’t be both sole beneficiary and sole trustee. However, if she appoints Dan, her tax attorney, as co-trustee, or she if adds her niece, Jessie, as another beneficiary, her trust may be valid.

  • Testamentary trusts –It’s inadvisable to name a beneficiary as the trustee of a testamentary trust. If the trust document is drafted with the sole beneficiary as the sole trustee, the trust could be invalidated and the IRS could include the assets in the beneficiaries’ gross estates for estate tax purposes.

Example:         Glenn appoints his spouse, Anna, as the sole trustee of a trust intended to avoid estate taxes at her death. If the trust is not properly drafted, the IRS could include the trust in Anna’s gross estate because she cannot be both sole trustee and sole beneficiary.

  • Irrevocable trusts –If your primary purpose in setting up an irrevocable trust is to avoid federal and state income, estate, or generation-skipping transfer taxes, you should select an independent trustee. You could appoint yourself, but only in certain restricted circumstances and with severely diminished powers. Otherwise, you face the risk that the IRS could include the trust assets in your gross estate.

Example:         Mrs. Dickinson, a widow, sets up an irrevocable trust for her child, and names herself as trustee. If she dies, the IRS could include the trust assets in her gross estate, even though the trust was irrevocable.

  • Revocable trusts –For tax purposes, it doesn’t matter who you name as trustee. You’ll be taxed on the income regardless of whether the trustee is you, your spouse, your family member, your friend, a beneficiary, a business associate, a professional, or a bank or trust company.

Other considerations

A trustee’s responsibilities often span at least one generation and may extend beyond two or three. This should have a significant impact on your choice of trustee or on your decision to appoint co-trustees or successor trustees. You must also weigh and consider many other personal, family, business, investment, and non-tax factors. For example, does your candidate possess the necessary investment, accounting, and tax planning expertise? On the other hand, does he or she know the beneficiaries and will he or she be sensitive to their changing needs?

Combining professionals and nonprofessionals as co-trustees

Combining a professional and a nonprofessional as co-trustees can provide the longevity the role requires, protect against possible adverse tax consequences, and balance the specialized knowledge of a professional trustee with the personal touch of a family member or trusted friend. If your estate is large or the trust provisions complex, you should consider selecting one or more professional trustees.

Laws and trust provisions govern trustee’s conduct

State laws govern a trustee’s conduct. However, you can modify the effect of these laws to some extent through appropriate provisions in the trust document.

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