May 23, 2014

By: Judson M. Stein

Tax Thoughts On Trust Protectors

Despite the frequent assurances practitioners very often hear from their clients that they have a perfect choice of a wholesome, trustworthy, and financially savvy Trustee, it is not uncommon to hear stories about these “ideal” individuals misappropriating or mismanaging funds in some way.

As is such, it may often be advisable to suggest the idea of a “trust protector” provision. The degree of a trust protector’s authority can vary greatly. The overarching purpose of the protector, however, is to place an additional set of checks and balances on an existing or successor trustee and to provide for additional flexibility over uncertain future events.

Although the concept of a trust protector is fairly novel and has not yet been fully hashed out either in common law or by statute, the definition of a protector is evolving, especially as additional jurisdictions pass new domestic or foreign asset protection trust legislation.

Some typical powers given to trust protectors include the ability to veto trust distributions or investment decisions, change the trust situs, consent to the exercise of a power of appointment, or remove, add, and replace trustees. However, as is the case with choosing whom to appoint as a normal trustee, there are important tax concerns that must be addressed when choosing a trust protector and selecting their permissible powers.

If a power is granted to a trust protector (who is acting in a fiduciary capacity) that can be exercised in favor of the protector, his creditors, or the creditors of his estate, or to discharge a legal obligation of support, then the protector will have retained a general power of appointment, unless it is limited by an ascertainable standard, such as “health, education, maintenance, and support.” However, it is of the opinion of some practitioners that, depending upon who is chosen to act as a trust protector, ascertainable standard language may be omitted without causing adverse general power of appointment tax consequences. For example, it may be argued that if a professional, such as an attorney, has been appointed as trust protector with the power to add beneficiaries, that it would not be inferred that the settlor’s intent was to include members of the attorney’s own family within the permitted class of appointees.

A Settlor can be given even greater flexibility and control over the originally appointed parties, including the power to remove and replace a trustee or even a trust protector without estate inclusion.  The scope of this permitted control will depend, however, upon the authority the trustee/protector is given and whether or not the trustee/protector is acting in a fiduciary capacity.

If the protector is acting in a fiduciary capacity and if the powers granted to the protector would cause estate inclusion if held by the grantor, then the grantor can hold a power to remove and replace the protector, if the replacement protector is not related or subordinate (independent person). If the protector is not a fiduciary and the powers granted the protector would cause estate inclusion if held by the grantor, then the grantor should not hold a power to remove and replace, even with a related or subordinate (independent) person. However, if the protector only holds powers that a grantor could also safely hold, then the grantor can have a power to remove and replace the protector, even with a related or subordinate person (non-independent trustee).

Tags: Wealth Transfer Tax PlanningAsset Protection