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Trustee's Duties
Duties of a Trustee when Administering
a California Irrevocable Trust
Creating an Irrevocable Trust in California
The Trustee's Initial Duties
The Trustee's Legal Obligations
Determine the Value and Distribute the Trust's Assets
Making Payments from a Trust
Trust Investments
Accounting and Record Keeping
Taxation
In Summary
Duties of a Trustee when Administering a California Irrevocable
Trust
Whoever acts as the trustee of an irrevocable
trust in California acts as a "fiduciary" and
is responsible for performing the legal duties of a trustee
as prescribed by law. If the trustee fails to do so properly
and is challenged in court, he or she may be liable for any
loss the trust incurs. Additionally, the trustee may be liable
for punitive damages claimed by one or more of the trust's beneficiaries
and have to pay all court costs involved in the settling the
case, including the legal fees for both sides.
If challenged in court, the trustee will have to prove
that his or her actions were proper and were done for
the benefit of the trust and its beneficiary or beneficiaries.
By its nature, an irrevocable trust can only be changed
or amended by a court order, one that is extremely difficult
to receive. The trustee of an irrevocable trust can
still invest the trust's assets, which can be sold or
purchased, and make payments to the trust's beneficiary
or beneficiaries in accordance with the trust's provisions,
but little else.
Blood relationships do not exempt the trustee from
the legal responsibilities, and it is not unusual for
a child or children to sue a parent they feel has mismanaged
a trust. Nor is it uncommon for siblings to sue each
other. The children who are set to receive the proceeds
of an irrevocable living trust retain legal rights,
even if the trustee is the sole surviving parent. They
may demand an accounting of the trust and its activities,
they may inquire as to the nature of any investments,
and question payments of principal made from the trust
for the surviving spouse's health or support. They may
even claim mismanagement of the trust and bring legal
proceedings against the surviving spouse.
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Creating an Irrevocable Trust in California
Since living trusts in California are considered revocable
unless the documents establishing the trust specify otherwise,
it is necessary to specify that the trust is irrevocable
when it is created. This can be done when the trust is
first established as a living trust or when a "springing
trust" is formed as part of the will of someone who
dies. Both the living trust and the "testamentary
trust" impose on the trustee the same duties and
responsibilities.
Irrevocable trusts can be any of the following:
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1. Either a "B" or "C" trust that
results from the death of the first spouse of a couple
who established a living trust.
2. An "A" and "B" trust, or "A,""B,"
and "C" trusts, that are created when the surviving
spouse dies.
3. A trust that is created following the death of a single
person.
4. A charitable remainder trust, which is a trust that
provides payments to someone during his or her life with
the assets going to a charity or charities when that person
dies.
5. A trust initially created as an irrevocable trust,
such as for children or grandchildren. |
A husband and wife often establish a living trust to avoid probate
and estate taxes. When the first spouse dies, the trust is split
into subtrusts, typically called Trust A and Trust B, or trusts
A, B, and C. Trust A most often continues as a revocable trust
for the benefit and use of the surviving spouse, and Trust B,
or B and C, are irrevocable trusts. In many trust documents
these subtrusts have different names such as survivor's trust
or marital trust for Trust A, family trust or exemption trust
for Trust B, or qualified
terminable interest trust (QTIP) for Trust
C. The types, nature, and functions of trusts are the same,
regardless of the name.
When both spouses die, all of their trusts become irrevocable.
This occurs even if the trusts are scheduled to terminate
and have their assets distributed to the couple's children,
a process that can take anywhere from six months to
several years to conclude. During this time the trusts
continue to require administration by a trustee or trustees.
The couple who establishes the living trust may have
set it up to continue after their deaths and benefit
a child, children, or grandchildren. They may have done
so by specifying the trust continue for a period of
time or that it will last for someone's lifetime. Trusts
of this kind are also irrevocable.
To avoid probate on his or her assets, a single person
may have set up a living trust. After this person's
death and until all of its assets have been distributed,
this trust becomes irrevocable. If the trust was designed
so that it continues for a period of time after the
person's death, either whole or in part, the trust or
trusts will also be irrevocable.
A couple may also establish an irrevocable trust as a way to
make gifts to their children or grandchildren, or establish
an irrevocable charitable remainder trust to save taxes and
benefit a charity. They may also create an irrevocable trust
to hold the proceeds of a life
insurance policy to pay estate taxes on the policy that
will be due following their deaths. To accomplish any of these
goals, the trust must have been irrevocable from the time it
was established.
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The Trustee's Initial Duties
Even though someone is named in the trust agreement to
act as the successor trustee, he or she is under no legal
obligation to do so and cannot be forced to act as trustee.
Anyone named as the successor trustee may legally decline
to act, in which case the next named trustee will take
over administration of the trust. If no one who is named
as successor wishes to serve, the local Superior Court
can be petitioned to appoint a bank or individual to fill
the role.
After agreeing to act as trustee, that person, although
he or she may resign, may not be replaced or relieved
until the next named trustee takes over. The person
taking over may be one who was named in the trust documents
or may be appointed by the court.
The new trustee should start by carefully reading the
trust documents, including the trust agreement and any
mention of the trust in the will. Particular care should
be taken to see what duties are assigned to the trustee,
and what actions must be performed by him or her. The
new trustee should immediately determine what assets
are currently in the trust and which may be coming into
it through probate or as the beneficiary of a life insurance
policy or retirement plan.
The trustee must be prepared to notify certain people, as
follows:
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1. If, because of someone's death, the trust becomes
irrevocable, the trustee is required to provide a specific
notice to anyone who has, or may have, an interest in
the trust as well as to all the heirs at law of the deceased.
This notice, whose language is specified by law, must
advise the recipients that they have 120 days to contest
the trust by court action and that they may request a
copy of the trust and any amendments that have been made
to it. If the trustee fails to issue this notification,
he or she may be liable for legal actions and costs.
2. If the trust was previously irrevocable and the only
change is that of the trustee, then a notice must be sent
to all trust beneficiaries and anyone who may have a future
interest in the trust notifying them of the name and address
of the new trustee. |
A special notice must be sent to the county assessor
for every parcel of real estate that is owned by the
trust. This notice must alert the assessor of the change
of trust ownership and notify the assessor if the property
is subject to reassessment for California real estate
taxes or not.
The assets in the trust must be quickly reregistered
in the trustee's name as trustee. Once done, the assets
should show a registration of "Joe Smith, Trustee
of the Ann B. Smith Living Trust, dated January 16,
2004." If the trust, until now, was in one of the
originating spouse's Social Security Number, the trustee
must complete Internal Revenue Service form SS-4 to
obtain a Tax Identification Number for the trust. This
form must be sent to the local Internal Revenue Service
Center, who will issue the number. The tax identification
number, once received, will be used instead of the Social
Security Number for all assets contained in the trust
and for all trust income tax returns.
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The Trustee's Legal Obligations
The general legal duties for a trustee are set forth in the
California Probate code,
sections 16000-16042. These duties include:
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1. Administer the trust in accordance with the trust's
provisions.
2. Administer the trust solely for the benefit of the
beneficiaries or beneficiary of the trust.
3. Deal impartially with the beneficiaries if there are
two or more.
4. Avoid using any asset that is the property of the trust
for the trustee's benefit or profit.
5. Avoid becoming a trustee of another trust that has
adverse or conflicting interests with the current trust.
6. Keeping trust assets registered in the name of the
trust and separate from any assets the trustee may own.
7. Avoid delegating to others the trustee's duties.
8. Take reasonable steps to preserve and control trust
property.
9. Use his or her skill in running the trust.
10. If there are co-trustees, to participate with them
jointly and not to turn over administration of the trust
to them. |
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Determine the Value and Distribute
the Trust's Assets
When the creators of the trust have died and the trust
has become irrevocable as a result, its assets are subject
to federal estate or "death" tax. The trustee
must determine the value of all the trust's assets as
of the date of death and also if a federal estate tax
return is due. If a return is due, the trustee has nine
months from the date of date to file it, and if more time
is needed, may apply for an extension of up to six additional
months.
If the trust, previously, was irrevocable and all that's
changed is the name of the trustee, then the new trustee
must obtain income tax information on the current value
of the assets and their cost basis.
If the trust is set to terminate and its assets distributed
to several people, unless the provisions of the trust
prohibit it, the trustee is allowed under California
law to distribute different assets to different people,
all based on the asset's current fair market value.
Thus, if the assets are set to go to three children,
it is not necessary to divide each asset by three and
give each child one-third. The trustee may, instead,
give all of one asset to one child, all to another,
and so forth, as long as the current value of the assets
received by each child is equal.
If the trust had a provision to be separated into separate
subtrusts, one for each child, for instance, then the
trustee must divide the assets accordingly and register
them properly. As an example, the assets for Elizabeth
Smith, child of John and Ann Smith who originated the
trust, would be registered in the name of "Joe
Smith, Trustee of the Ann B. Smith Living Trust, dated
January 16, 2004 f/b/o Elizabeth Smith." The f/b/o
used here stands "for the benefit of" and
is followed by the beneficiary's name. Each individual
trust will require its own, separate records, and a
separate tax identification number must be obtained
for each subtrust and used on trust tax returns if they
are required.
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Making Payments from a Trust
Payments are often made to the trust beneficiary or beneficiaries
if the trust continues after the death of the originator.
These payments can be of several types. The trustee can
issue discretionary payments for the "health, support,
and education" of the beneficiary, or the beneficiary
can receive the income from the trust while the trustee
issues payments from the principal for those three purposes.
The interest, dividends, and net rental income generated
by the assets in a trust make up its income. The principal
includes the trust assets along with any gain or loss
that resulted from the sale of any of the trust's assets.
Any capital gain that results from the sale of an asset
held in an irrevocable trust normally remains in the
trust, which is taxed for the gain. California's Principal
and Income Act has several provisions that define what
is "income" and what is "principal."
The law also defines how unusual assets, such as oil
royalties, and unproductive assets, such as real estate
that was held for several years and later sold but that
never produced any income, should be treated.
Effective January 1, 2000, California law allows a
trustee, under certain circumstances, to adjust a trust's
income by increasing or decreasing the amount paid to
a trust beneficiary or beneficiaries. If the trustee
wishes to adjust a trust's income this way, he or she
must notify all the parties who would be affected by
the change at least thirty days before the adjustment
is made. If anyone objects to the proposed change, no
adjustment can be made without court approval.
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Trust Investments
How the trustee can invest the assets of a California
trust is determined, in part, by the "California
Uniform Prudent Investor Act." This act states that
the trustee "shall invest and manage trust assets
as a prudent investor would, by considering the purpose,
terms, distribution requirements, and other circumstances
of the trust," and then issues several guidelines.
A trustee needs to invest while diversifying the assets,
and needs to balance the income with the future growth
of the assets. He or she may not invest totally for asset
growth, or wholly for income, unless such a course is
specified in the trust document. Depending on individual
circumstances, the assets may be split 60-40 or 40-60
between growth and income.
An investment counselor may be hired by the trustee
to manage the investments. If certain requirements are
met, the trustee, in such a case, is not liable to the
trust beneficiary or beneficiaries for the decisions
made regarding investments, nor for any action taken
in that regard.
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Accounting and Record Keeping
The trustee has the responsibility to keep detailed records
of the trust and to provide an accounting to the trust
beneficiary or beneficiaries. This accounting is usually
done every year, but is not required if the trust document
waives it, if the trust beneficiary or beneficiaries has
waived it, or where the trustee and the beneficiary are
the same person, or if the trust is revocable.
Nor is an annual accounting required if the living
trust was created by a trust agreement or declaration
prior to July 1, 1987 or if a testamentary trust was
created by a will that was signed before that date.
Other than those exceptions, the trustee must provide an accounting
of the trust at least annually. He or she must also provide
an accounting to each trust beneficiary who will receive income
or principal from the trust when it is terminated. This annual
accounting must include the following items:
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1. A statement of any receipts and disbursements.
2. A statement of assets and liabilities.
3. A list of any agents hired by the trustee, their relationship
to the trustee, and the amount of their compensation.
4. The trustee's compensation for the year.
5. A statement notifying all recipients of the accounting
that they may petition the court for a review of the acts
of the trustee and of this accounting.
6. A statement that all recipients have three years after
receiving the accounting in which to file a claim. |
The trustee must keep detailed records of trust income
in addition to providing the annual accounting. The
trust income records will include every dividend, every
interest payment, and every item of income received.
The trustee must also record the sale and purchase of
any trust asset and any payments made from the trust,
including tax payments, other payments, and the compensation
the trustee has received. In case any payments are questioned,
statements of payments should be retained.
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Taxation
To prepare annual income tax returns for the trust, an
accountant, tax preparer or enrolled agent needs to be
employed.
There will be an estate tax return due when the trustor,
who originated the trust, dies. This return is due within
nine months of the date of death, but an extension is
available.
Both federal (Form 1040) and California (541) trust
income tax returns must be filed by April 15 for the
previous year ending December 31. These returns must
report all taxable income received by the trust in the
form of interest, dividends, rents, capital gains and
losses, and all other taxable income. The return should
also include any allowable deductions for such things
as interest paid, California income taxes for the Federal
return, real estate taxes, trustee's and accountant's
fees, tax preparation fees, and other deductible expenses.
If the income is received by the trust and then paid
out to a trust beneficiary, the trust income tax return
will list the payment as a deduction and the payment
is taxed to the beneficiary. These payments are listed
on form K-1, which is attached to the trust's tax return,
and a separate form is used for each trust beneficiary.
Each Form K-1 will show the name of the beneficiary,
his or her address and Social Security Number, and will
include any taxable income the beneficiary received
from the trust. A copy of the form will be given to
each beneficiary so the income can be included on his
or her own personal tax return.
The trust, if it owes tax, may be subject to estimated
taxes that have to be paid during the year. If the trust
has been broken into several subtrusts, each with its
own Tax Identification Number, a separate return is
required for each one.
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In Summary
The trustee of an irrevocable trust is a position that
requires a great attention to detail and a lot of hard
work. The trustee must carefully attend to all legal and
tax rules regarding the trust as well as any conditions
imposed by the trust documents. If the trustee violates,
misses, or ignores any of these rules, however innocently
or well intentioned, the trustee may be held personally
liable for any monetary loss that occurs.
To avoid any potential problems, anyone assuming the role of
trustee should carefully select a qualified and experienced
estate planning attorney
as well as an accountant or tax preparation specialist familiar
with trust taxation. The trustee must relate well with the trust
beneficiary or beneficiaries, prudently invest the trust's assets,
and follow a maze of legal requirements, and must do so to the
satisfaction of everyone involved.
THE MAMOLA LAW FIRM, APC is conveniently located throughout Orange County. For additional information, please contact us at (949) 333-6543.
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