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Louis A. Mezzullo, Editor / Beverly R. Budin, Assistant Editor / © The American College of Trust and Estate Counsel 2002
Table of Contents
Volume 28, No. 2, Fall 2002
President’s Message . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
Editor’s Page . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76
The 2002 Annual Joseph Trachtman Memorial Lecture:
Some Thoughts on Philanthropy and Net Worth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77
William H. Gates, Sr.
Hackl Debacle: Are the Annual Exclusion and Discounts Mutually Exclusive for Gifts of Closely-Held
Business Interests? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83
Jerome A. Deener
This article analyzes the recent Hackl decision and recommends ways to avoid loss of annual exclusions for gifts of
limited partner/limited liability interests.
Adversity After Bosch . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88
Shirley L. Kovar
This article discusses how the Bosch decision and its progeny affect the ability of taxpayers to settle controversies as
to the meaning of wills and trusts and to correct mistakes in such documents without adverse tax consequences.
Punctilio of an Honor—A Trustee’s Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .101
Robert J. Rosepink
This article provides a comprehensive review of the duties of a trustee, including commentary on the Uniform Trust
Code and Restatement of the Law (Second) of Trusts.
Total Return Unitrusts: Is This a Solution in Search of a Problem? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .121
Alvin J. Golden
This article critiques the total return unitrust concept and offers alternative solutions to the mandatory income trust.
Washington Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150
John M. Bixler and Ronald D. Aucutt
Foundation News . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
John A. Wallace
Spotlight on Attorneys’ Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155
Martin A. Heckscher
New Developments in Construction and Instruction Case Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
John F. Meck
ACTech Talk: Tips for Technophobes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160
Robert B. Fleming
New Developments in Malpractice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163
Keith Bradoc Gallant and Sharon B. Gardner
Calendar of Events; In Memoriam . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .C1
ACTEC Journal 73
President’s Message
by Carlyn S. McCaffrey
New York, New York
The practice of trusts and
estates law seems to many
of us to be one of the most
enjoyable and rewarding
practice areas in the legal
profession. Those of us
who practice in this area
enjoy the challenge of problem solving, the pleasure of
meeting and working with a
wide variety of individual
clients, the reward of establishing long-term relationships with many of them, and the satisfaction of helping them make informed and educated decisions about
matters of great importance to them and to their
For the past 52 years, ACTEC has been an organization of trusts and estates lawyers recognized for its
commitment to excellence in the trusts and estates
field. Membership in ACTEC gives each of us an
opportunity to enjoy the company and dialogue of
experienced trusts and estates lawyers from across the
country, each of whom is keenly interested in the
development of the legal rules that are the tools of our
practice. That interest spurs us not only to master
those rules and to retain that mastery through the constant process of legislative, judicial and regulatory
changes but also, when appropriate, to play a role in
the development of those changes.
ACTEC provides us with several forums, real and
virtual, for sharing our professional experiences,
including our national meetings, which take place
three times each year. The most recent one was held in
Tucson in October at the La Paloma Resort. More than
610 of you and your guests attended. Based on the
comments I heard from those of you who were there,
all of you had an enjoyable and stimulating experience.
We had two full mornings of professional seminars,
our usual challenging committee meetings, a chance to
socialize at two outdoor parties, and an opportunity to
enjoy the beautiful desert and mountains that surround
the resort. Our next annual meeting will take place at
El Conquistador Resort in Puerto Rico from March 5
through March 10. A preliminary schedule and a hotel
reservation form, along with a cover letter, were
mailed to you on October 25. I hope to see many of
you there.
Regional and state meetings provide additional
opportunities for learning from each other. These are
ACTEC Journal 74
particularly helpful for those of you who are unable to
attend our national meetings. Each region, and many
individual states, have at least one meeting each year,
often with a format that follows our national meetings’
familiar mix of learning and social opportunities.
Check with your state chair or with the national office
to find out when your next regional or state meeting
will be held.
ACTEC has two virtual forums—our list services
and our Web site. All of us can take advantage of these
forums on a daily basis. There are two major list services open to all members of the College, ACTECGEN and ACTEC-PRAC. ACTEC-GEN allows us to
share recent developments affecting our practice and to
ask for help with particular problems. ACTEC-PRAC
is devoted to practice issues. To find out more about
the list services, go to the private side of the ACTEC
Web site, left click on the “Email and Discussion
Forums” button on the left hand side of the page and
follow the instructions.
The Web site is full of interesting, helpful
resources. All of the issues of the ACTEC Journal,
from Fall 1994 through the present, can be accessed by
left clicking the “College Publications” button on the
left hand side of the Web site page. You can search by
key words and phrases through all of the issues from
Winter 1995 through the current issue. For example, a
search for “Bosch” will refer you to eight different
articles that mention that case. When you access an
article that cites Bosch, another search will help you
locate the references within the article to the Bosch
case. Bill Crawford, our systems administrator, has
been working to enhance the Web versions of the Journal articles by including (to the greatest extent possible) links to online texts of cases mentioned in the articles. Take a look at any of the articles in this issue of
the Journal to see what this feature is about. Other
materials available under the College Publications button include ACTEC’s Commentaries on the Model
Rules, ACTEC’s forms of engagement letters, and
ACTEC’s studies of state laws.
We’ve recently expanded the scope of the materials
available on the site by adding CLE materials from
recent national meetings. All of the outlines prepared
for the national meetings from 1999 through the present
are now accessible on the site. Those of you who need
more shelf space can discard your blue meeting binders
and rely on the Web for access to these important materials. Web access to CLE materials that are two or more
years old is free to all ACTEC members. CLE materials from more recent meetings are available free to
those members who attended the meetings and are
available at a small charge to all other members.
Finally, there are the links. Left click on the
“Toolbox & Topical Links” button, and you’ll find a
wonderful array of links to outside resources as well as
to materials produced by College committees and
ACTEC’s Web site is the result of many years of
hard work by College members and staff, including
Stan Foster and Joe Hodges, who dragged the College
into the computer age in the early days when many of
us lacked the foresight to understand what an important tool it would be. More recent contributors include
our tireless systems administrator, Bill Crawford, and
our Web Oversight Group members, Don Kelley,
Bjarne Johnson, and Bob Kunes. We owe them all a
deep debt of gratitude.
ACTEC’s future as the preeminent association of
trusts and estates attorneys requires a continuing flow
of new members. We are counting on each of you to
help identify prospective new members within your
community. We are looking for experienced and capa-
ble trusts and estates lawyers whose commitment to
our field has manifested itself in their writings, lectures
and bar association activities. When you’re considering likely candidates, keep in mind that ACTEC admits
not only attorneys whose practice is centered on estate
and transfer tax planning and probate practice, but also
those who focus on fiduciary litigation, elder law, and
employee benefits and charitable planning for individuals. Each of these practice areas adds to the richness
of the ACTEC experience. ACTEC’s national Membership Selection Committee will consider the admission of new members at its meeting at ACTEC’s annual meeting in March in Puerto Rico. If you have a candidate to suggest, please complete the nomination
form and send it to your state chair no later than
January 3, 2003. A nomination form and a copy of the
Requirements and Procedures for the Election of Fellows were sent to you in the October 25 mailing. You
may also print out the nomination form from ACTEC’s
Web site or request one from the College’s office.
ACTEC Journal 75
Editor’s Page
by Louis A. Mezzullo
Richmond, Virginia
The contents of this issue reflect several trends that
I hope continue in the future. First, we have excellent
articles on very relevant topics. Second, we have a
number of articles on nontax subjects. While the Trachtman Lecture given by Bill Gates, Sr. deals with
some aspects of the repeal of the estate and generation
skipping transfer taxes, it is also a commentary on
philanthropy in our country. For those of you who
were not fortunate enough to hear Mr. Gates’ lecture in
La Quinta, you will find his remarks not only interesting, but also very meaningful to the Fellows and the
role we play in helping our clients dispose of their
wealth in a responsible manner.
We are fortunate to have two articles dealing with
nontax aspects of trusts. Bob Rosepink’s comprehensive discussion of the duties of trustees, which is an
updated version of the outline provided in connection
with the program that he and Bob Goldman presented
at the Annual Meeting in La Quinta, is must reading
for Fellows who serve as or advise trustees. We also
are fortunate to have Al Golden’s discussion on total
return trusts, taking a somewhat contrarian view to that
popular concept. Again, Al’s article is an update of the
materials submitted for the program that he and Bob
Wolf presented at the Annual Meeting on total return
trusts. [An earlier version of Bob’s article on the same
topic appeared in ACTEC Notes in 1997.] Both of
these articles will be of great practical use by all Fellows. Shirley Kovar’s article on adversity after Bosch
does deal with tax issues, specifically the effect of state
law on federal transfer tax issues. Finally, Jerry Deener provides us with insights about the effects of the Tax
Court’s holding in the Hackl case.
ACTEC Journal 76
So far, I have not received any comments from the
Fellows concerning the suggestions that Beverly Budin
and I proposed for improving the Journal. However, the
Editorial Board will be considering permanently adopting the criteria Beverly drafted concerning submission
of articles for publication in the Journal. In addition,
the practice of assigning editors for proposed articles
has proven to be very successful, with the author and
editor working together to provide a better product. For
example, Jere McGaffey provided suggestions for Jerry
Deener’s article. Please let us know if you are willing to
serve as an editor of articles on a particular topic.
For those of you who have already sent the last
issue to storage, I am repeating the guidelines that
Beverly drafted for accepting articles for publication:
1. Content. The basic criterion for an article’s
publication in the ACTEC Journal is that the article
makes a contribution to the literature of trusts and
estates, and is not a regurgitation of material readily
available elsewhere. The following kinds of material
meet the content criterion:
a. Original analysis:
i. Particular area of the law.
ii. Particular case, regulation, ruling, etc.
b. Practical approach to problem, including
drafting techniques.
c. Comprehensive review of area of the law
(Example: comparison of the law in different states).
d. Summary/analysis of area related to
estates and trusts (Example: article on hedge funds).
e. Review of literature in the area.
2. Quality of writing. Material should be wellorganized and well-written.
The 2002 Annual Joseph Trachtman
Memorial Lecture:
Some Thoughts on Philanthropy and Net Worth
by William H. Gates, Sr.
Seattle, Washington*
I have to admit that I was pleased when I learned
that my conversation with you today was being billed as
a lecture. You see, as the father of two daughters and a
son, I’ve had more than a few occasions to give lectures.
Those lectures were reasonably well attended, particularly if they took place where food was being served.
However, one of my children, my son, Bill
acquired the rather irritating habit of reading during
my lectures. That’s right, he read, most every night at
the dinner table! Of course, the alternative was
worse—if there was a full moon or he was feeling
argumentative, it was like being back in court.
I can’t say that I noticed then that he particularly
had a “legal” mind, although I feel confident in saying
that he does now. But you know, as I think of that, I’m
sure that many lawyers dream of having a firm where
they have their name on the door and where their son
comes to work every day. I, on the other hand, go to an
office every day where my son never comes to work
and his name’s on the door. So this has been a long
way around of saying that I’m enthused about the
prospect of giving a lecture that might finally be listened to.
It’s like coming home to be in a room mostly full
of attorneys. A large part of my life has been spent
with the law. My work involved in part doing the same
things you do, helping solve the same complex and
thoroughly human puzzles, and I found great satisfaction in that.
Now I have a second career. It came to me unbidden and quite unexpected. When my son and his wife
decided to establish their foundation, they asked me if
I’d help and I said “yes.” So instead of booking cruises
to the Galapagos or sitting on a beach in Hawaii, I’m
spending my “golden years” traveling to places like
Bangladesh and Mozambique. In those places, I’ve
watched dedicated medical people working in remote
clinics and crowded city hospitals administering lifesaving vaccines and other medical therapies to the
world’s children.
Looking back, my experience with volunteering
and philanthropy and the law was valuable—but insufficient—preparation for my second career. I had no
idea how difficult the cause of improving global health
could be, or how important it is to succeed. Still, in
hindsight, I know my “yes” to Bill and Melinda was a
good decision. I’ve had an opportunity to meet people
who are living gallant lives under the most difficult circumstances imaginable, to see their countries with new
understanding and to see my own country—and the
concept of philanthropy—with fresh eyes. My remarks
today will be colored by all those experiences.
I have only a few answers, and many questions.
There are many ambiguities and some seeming contradictions I have observed. I can confirm, for example,
that Americans, as individuals, are—as expected—
among the most generous peoples on Earth. Oxford
University, for example, raises more money in the
United States than it does in the United Kingdom.
But I’ve also discovered that America, as a nation,
is surprisingly parsimonious. In 1999, the latest year
for which figures are available, we gave only 0.1 percent of our gross national product to official foreign
development, a budget category that excludes defense
and that includes items I think of as helping provide
poor nations with an opportunity to improve their situation. Denmark gave 10 times that, Japan and Germany about 3 times that amount and Portugal gave 31 ⁄2
times as much.
I have a table that lists 23 nations in this world in
order of their relative contributions to poor countries;
the United States ranks 23rd. Another example of those
ambiguities and contradictions I’ve observed is that I
know beyond any doubt that our society offers more
choices, greater freedoms, richer opportunities and
greater protections to its citizens than most other countries. But I also have learned how easy it is to take all
that for granted, to imagine our unique society as a
given—a birthright of sorts—and to suppose that it is
cheap to maintain.
* The 2002 Joseph Trachtman Memorial Lecture was presented at the 2002 ACTEC Annual Meeting in La Quinta, California, on March 1, 2002. Copyright 2002. William H. Gates, Sr. All
rights reserved. William H. Gates, Sr., is the Co-chair and CEO of
the Bill & Melinda Gates Foundation.
ACTEC Journal 77
Searching for clarity in the face of these disconnects, I’ve looked at the history of philanthropy, and
I’ve concluded that giving to others is central to our
nature. I believe that we extend help to each other partly for reasons that are altruistic and spiritual in nature.
I also suspect that the impulse toward social behavior
and helping one another may be hard-wired into our
species—a key to our survival. Social scientists speculate that evolution is less a story of the fittest having
survived than it is of the cooperation and nurturing
from others that allowed them to do so.
Think of our distant ancestors who found themselves in a wilderness, frail compared with the wild
creatures around them with neither fang nor claw, but
possessing two other gifts that proved even better, that
is, communication and cooperation. I remember hearing once that teams of paleontologists, working in
Kenya with Dr. Richard Leakey studying the migration
patterns of early primates, observed what they thought
were indications of those very human characteristics.
They said they knew they were looking at a different
kind of creature when they found bones that had been
broken and then given the opportunity to heal.
They said this indicated that when a member of
this species was injured, he or she had not been left
behind to die. Instead others had stayed to tend to and
protect the injured members, until he was physically
able to move on. They saw that as a sign of caring and
cooperation that was not in evidence among the bones
of other primates.
In the book The Fragile Species, Dr. Lewis
Thomas, a former chairman of the Department of
Pathology and dean at Yale Medical School, wrote, “it
goes too far to say that we have genes for liking each
other, but we tend in that direction because of being a
biologically social species. We are more compulsively
social, more interdependent and more inextricably
attached to each other than any of the celebrated social
Whatever the reasons for it, it’s clear that humans
were social animals, from the beginning, who could
reason and act together to achieve common goals.
Over time, we used those powers to build complex
social structures and systems. Many of those early
institutions formalized the social imperative. Governments levied taxes to pay for security, permit trade and
assure continuity. And, even in the most ancient civilizations there were individual mechanisms created
through which people provided private support to the
widowed, aged and orphaned.
Religions introduced the concept of tithing—suggesting that a portion of what is ours should be set
aside for community needs. Well, there are various
forms of tithing being encouraged in the secular realm,
today. There’s a relatively new organization in Min-
ACTEC Journal 78
nesota called the One Percent Club. It encourages people to give one per cent of their net worth each year to
charitable causes.
There’s also a fellow named Claud Rosenberg
who’s promoted a standard he calls “the new tithing,”
aimed at getting the well-to-do to substantially
increase their levels of giving. He doesn’t suggest a set
percentage. His system uses a table, which sets forth
income on one axis and investment assets on the other.
Where your income line meets your investment assets
line is the suggested new tithing amount.
So both tithing and taxes have historically given
us the means to accomplish together things we could
not have accomplished alone. Another of those interesting contradictions I cited earlier that I’ve observed
is that in modern times—in the United States, where
the concept of private ownership of property is nourished and highly valued—so is the concept of the common good.
In fact, the French social observer Alexis de Tocqueville wrote about those conflicting values way back
in the 1830s. Evidence of our concern for the common
good is in the fact that Americans invented many associations and mechanisms for giving including the United Way concept, which is now being adopted in other
places around the world while it is being passed down
to a new generation of Americans.
There’s been some apprehension in donor circles
as to whether or not the young “techies” who have
recently earned wealth would become significant charitable givers. My observation is that they’re definitely
picking up where their parents left off, and they’re
doing more than their share. United Way is a typical
example. In Seattle, we have a Million Dollar Roundtable that was just started a few years ago. The minimum gift is a million dollars. The club now has 47
members, including many young entrepreneurs. These
young people are also creating new mechanisms for
giving. We have one in our area called Social Venture
Partners, the express purpose of which is to move technology wealth toward good causes.
Of course, as counselors, you deal with individuals
who have accumulated considerable wealth—and if
your experience is similar to mine, you seldom, if ever,
find yourselves creating an interest in charitable
bequests where no such inclination already existed. On
the other hand, in my practice, I was surprised by the
number of instances when, in discussing a will, the
interest in some charitable giving was expressed, without, however, any particular conviction about what that
charitable giving should be. So counselors have an
opportunity to provide some input and counsel that is
very constructive.
I have also had the experience of being asked to
evaluate some cause or direction in which the client
has expressed an initial interest. In that case, the
sophisticated counselor can perform a service of great
value to a donor who, at least initially, wishes to
remain anonymous.
Frequently clients are looking to add funds to an
existing endowment or foundation. Here, the counselor
has a heavy responsibility to understand how endowments work and to become well informed about that
which has the client’s interest. Such things as the statement of purposes, investment policies, rate of payout,
power to invade and power to amend are items the
client needs to be informed about.
And then there is, always, the “perpetual” question. Forever is really quite a long time. If you want to
have some fun with idle speculation try and think
about what people might be doing with the billions of
dollars that exist in endowment funds, today and 1,000
years from now in 3002.
All of which asks, very loudly, how long should one
commit funds when the ultimate use of them is
unknown? Should the plan include the forever time element? This is a question still being asked in our family.
Anyone who spends any appreciable time counseling in this area should be aware that there is wide and
constructive literature discussing these kinds of questions in considerable detail. The counselor could do
well to read some of this work and would surely find
some clients who would relish doing some reading of
their own. And of course, this leads directly to the subject of the family foundation.
Family foundations fall into two broad categories.
One of those I call the improvement category. It’s
characterized by interests that one might call general
good citizen types of support, such as helping build a
new symphony hall or helping contribute to some other
community enterprise.
The other category I call the reform category. If
your client is interested in this category then he or she
has cut out a piece of work to do. More on that in a
In this regard, I think you will find interesting the
approach Warren Buffet has in mind for the long-term
management of his foundation. His scheme is one in
which there are never more than a very few trustees. He
believes that foundations should be devoted to reform,
which requires boldness. His conviction is that a large
board is unlikely to act with the requisite boldness.
As long as we are talking about foundations, let’s
talk for a moment about the Bill & Melinda Gates
Foundation and my experience with it over the period
of the last six or seven years. We clearly started in the
improvement category. We had no particular goals in
mind. In our case, that may not have been critical
because the benefactor was and is still very much alive
to give direction.
Any foundation of appreciable size needs to be
fairly clear about what its interests are and similarly
clear about the fact it is not going to spend time considering projects outside of those interests. We spent
time responding to a lot of proposals that might never
have come in, had we been clearer about our goals
from the start.
Let me share some of the requests we received. We
got a letter from a guy who wanted us to fund a ballroom dancing TV channel. He thought if everybody in
this country learned the same steps, then people on the
East coast could dance with people on the West coast.
We could solve a lot of society’s problems, if we just
got everybody dancing!
Then there was the guy who wanted us to help him
jump his funny car over the Grand Canyon. And speaking of natural wonders, we got a request from a guy
who had clearly become anxious watching the Discovery Channel. He wrote, urgently asking us if we would
mind “venting” the so-called magma chamber of the
Yellowstone volcano. He said, “I know this is going to
take ‘big bucks.’ But then you have those.”
A major directional shift occurred for us when Bill
and Melinda read an article in The New York Times
about the number of people around the world, especially children, still dying of diseases that have long
been eradicated in this country. As a result of that and
their trips over seas, they became concerned about the
problem of global health.
As Bill and Melinda’s enthusiasm for global health
grew, they made a series of very substantial additions
to the corpus of the foundation. Our venture into global health provides the perfect example of what I meant
when I said that if you were beginning to consider giving that fell into the category of reform, you needed to
realize you’re getting into a very involved project. You
have to prepare for a process of trial and error, for
extensive study and for hiring experts.
Because now the problem becomes one of analysis
and insight: What is the cause of this problem? What
can be done, by whom, to effectively change the etiology? Now my son has started reading everything he
can find on the subject of global health. Fortunately
he’s not reading quite as much as he used to at the dinner table. Because with such book titles as The Coming
Plague and Overcoming Microbial Resistance, his
reading selections are becoming increasingly unappetizing.
They say that the fellow who articulated the initial
strategy for John D. Rockefeller’s philanthropy, Frederick Gates, read a thousand books in the process. I
believe it.
On the subject of global health, in one of his books
the historian Arnold Toynbee predicted that the 20th
century would be seen as the age where it became pos-
ACTEC Journal 79
sible for the whole world to have good health. But he
was overly optimistic. In the poorest places of the
world today, especially in the tropics, the average life
span is 47 years of age and dropping. With AIDS, in
some places it’s dropping down into the 30s. The
600,000 women who die each year of pregnancy-related causes may not even live that long.
That’s right. Although the risk in the United States
of a mother dying in childbirth or of pregnancy-related
causes is only one in 3,500, in India, it’s one in 37. In
Africa, it’s one in 16.
One hundred fifty million children are deficient in
vitamin A. This deficiency, when complicated by diseases like measles, leaves half a million of them blind
and costs another one to two million their lives. People
in the developing world are still dying from ancient ills
such as malaria and tuberculosis. One and a half million die each year from a form of tuberculosis which
can be cured for as little as $20. Three million children
a year die from illnesses that vaccines prevent our children from ever experiencing.
Of course, statistics get at the breadth of the problem, but not its human impact. In order to communicate impact, I have to ask you a question: “Is the loss of
a child less tragic in one place on the planet than
another?” I think we would like to think that, but it is
not true. I think it also gives one some perspective to
realize that just a century ago, children in New York
City were dying of some of the same ailments that take
the lives of children of the developing world today.
Now, whether one’s cause is the health of the
world’s children, or any other cause in philanthropy,
there’s never enough money to go around. So at our
foundation, we try to find the things that we can afford
to do that will have the greatest impact. In global
health, the bulk of our work falls under the category of
prevention, which is something vaccines accomplish
so efficiently. For many diseases one administration of
a vaccine can protect a child for a lifetime.
Prevention is also the focus of our work in the fight
against AIDS. And we’re into something called
“micronutrients.” They prevent illnesses and deaths
caused by a lack, for example, of vitamin A, or iodine.
There have been enormous improvements made to the
lives of children already through the use of micronutrients.
As daunting as all those statistics are, very positive
changes have already been achieved in every one of the
areas that I’ve mentioned by, in many cases, a handful
of people with their hearts in the right place.
Even in recent history we have seen some remarkable progress:
• there are countries like Kenya and Thailand
where the birth rate has been reduced to nearly the
reproduction rate, meaning that the population simply
ACTEC Journal 80
replaces itself from generation to generation;
• we managed to eliminate smallpox from the
world a couple decades ago and we are within a couple
of years of completely eliminating polio;
• the new tetanus vaccine has drastically
reduced deaths from this killer, which took 200,000
lives four years ago.
We know that those accomplishments have been
made possible largely by the achievements of those
who came before us. The Rockefellers, for example,
have been supporting the study of diseases such as the
ones I’ve mentioned today for as far back as 100 years.
In fact, they played a leadership role in establishing
medical research as a full time pursuit rather than
something physicians did in their free time.
And in terms of philanthropy in general, they, the
Carnegies and others of that era are credited with
changing philanthropy from an endeavor that simply
responded to human suffering to one that attempted to
eliminate the root causes of that suffering. They found
the causes. They changed the etiology. They eliminated the problem. They succeeded at reform.
These people I’ve mentioned and so many more
realized long before we did that there are huge gaps
that exist between the way that we live and the way the
poor people of the world live. That’s why, as we talk
today about wealth and the sharing of it, it’s important
to reflect on where wealth comes from.
If one wants to become wealthy, being smart helps.
Being energetic and lucky play a role. But as Warren
Buffet suggests, probably the most important piece of
luck a person can have is to win what he calls “the
ovarian lottery”: being born in this country.
Let me tell you a fable that this point. The story
begins where God is perplexed. He has a problem to
solve. His problem is that his total assets have been in
serious decline and he needs to pump up his bottom
line. So He calls two about-to-be-born fetuses into his
office. And he explains to them the fact that he has sort
of a financial problem and he’s going to need some
input of capital over time.
He’s figured out the way to do it, and it’s this: “I
have one spot in the United States, and one spot in
another part of the world,” he says. “I’m going to auction off the United States spot. I’m going to hand each
of you a piece of paper. I want you to write down on it
the percentage of your net worth that you’re willing to
leave to my treasury when you die. And the one of you
who writes down the highest number is going to be
born in the United States.” Do you think either of them
would be so stupid as to write down a number as low as
55 percent? My point is, what is it worth to be an
Now I speak for myself on a personal note and not
as an official of the Foundation.
One of the things that rankles me about our national discourse around the repeal of the estate tax is how
thoroughly we ignore the criticality of the place of
I’ve always liked thinking that when we make a
gift we are giving something of benefit back to someone or something that benefited us. I think most people
grasp that concept when they make a contribution to
their college or university. They sense they owe something to the institution that made a contribution to their
lives, an institution nurtured and subsidized by others.
It’s a very obvious connection. And this is why so very
many people with high net worth make large gifts to
their colleges.
What’s not always as readily seen by these folks is
that they owe a debt to a system that goes far beyond
that university, and without which that university
wouldn’t even exist: our American system. That system has provided them with security, public education,
law enforcement, a working court system, an orderly
economy with orderly markets, and the ability to expect
that basic conditions tomorrow and the next year will
be pretty much as they are today. Any American entrepreneur would do well to reflect on the influence that
things like patent protections, enforceable contracts,
limited liability systems, property records and so many
other legal guarantees of our system might have had on
his ability to run a viable business and make a profit.
The accumulation of large net worth is much more
a product of the order that exists in this wonderful place
than it is a product of personal talent and effort. I
believe that not only provides the rationale for a system
of estate taxation, but also is indeed the principle that
makes the repeal of estate taxation an affront to rational
public policy. People who have been able to spend a
large portion of their lives with virtually unlimited discretion about what they buy, where they go, how they
get there, are indeed very privileged persons.
Consider with me for just a moment the pleasure
and convenience that attends having enough money to
own and travel in your own jet airplane. Now compare
that to the sometimes exhaustive planning, crowds,
delays and security restrictions confronting the bulk of
Americans who must fly commercially.
Should a society, through its Congress, guarantee a
person who has known such extraordinary privilege,
who has been able to exercise his discretion about
almost every element of living, the ability to pass on, at
the end of his life, free of any public impost, all of the
power to live in that manner to his or her offspring?
That question leads to another important principle.
Leon Bostein, president of Bard College and conductor of the American Symphony Orchestra, suggests
that throughout the 20th century, Americans tolerated
inequalities in wealth because there was a partial trans-
fer of wealth from private hands to the public sector
that happened with the passing of each generation. He
goes on to say that the dream of rags to riches has been
sustained as believable, in part, because of the dilution
of wealth at death.
Teddy Roosevelt, in promoting the estate tax in
1907 wrote: “Our aim is to realize what Lincoln pointed out: the fact that there are some respects in which
men are obviously not equal; but also, to insist that
there should be an equality of self respect and of mutual respect, an equality before the law, and at least an
approximate equality in the conditions under which
each man obtains the chance to show the stuff that is in
him when compared to his fellows.”
It’s also been said that, in defending the Constitution, James Madison admitted that he believed the
overriding purpose of government was to protect the
unequal acquisition of property. There are just two
goals for America: 1) a prosperous society, and 2) a
just society.
We have succeeded with number one. We are a
long way from, and losing ground, in achieving number two. Warren Buffet compares the repeal of the
estate tax with choosing the 2020 Olympic team by
naming the eldest sons of the gold medal winners in
the 2000 Olympics—ridiculous.
Oh, we hear talk about how the repeal of the estate
tax puts family farms and small family companies out
of business. But an Iowa state economist named Neil
Harl, whose job it is to know these things, said that he
had searched far and wide and found the demise of
family farms due to the estate tax to be a myth. The tax
reform act of 1997 went a long way towards addressing the estate planning needs of family-owned farms
and businesses. I think we may need to fix certain
aspects of the estate tax by strengthening family enterprise protections and raising individual exemptions,
but I do not believe that we should repeal it. What will
the repeal of the estate tax cost us?
The estate tax currently brings in revenue—some
$28 billion dollars in 1999. That’s about the same
amount as what the government spends for housing
and urban development. And the dollar cost of repealing the estate tax is only going to become greater as the
greatest transfer of wealth in history begins to occur.
Last year the poorest person on the Forbes magazine list of our country’s 400 richest citizens had a net
worth of $725 million. When this list originated in
1982 the net worth of number 400 was $75 million.
Just think what those numbers imply for estate tax collections over the next decade or two. Recognize that
under those 400 fortunate, there is this huge pyramid
of extremely wealthy individuals. How many $50 millionaires would you suppose?
And there is another point made by this prodigious
ACTEC Journal 81
growth in the number of people who are really
wealthy. We can readily increase exemptions dramatically. These were $225,000 in 1982 and are now just
$1 million. Larger exemptions and some tinkering with
special provisions should largely release the difficulties in giving closely held businesses to children.
Some level of taxation is a requirement if government is to provide whatever level of services is agreed
upon. If the estate tax is removed, then something, no
doubt higher income tax rates, will be required to provide those services. There is no free lunch.
Right here, I’d like to take a moment to highlight
the connection between the social achievements we
accomplish through our system of government and
those which we pursue privately, through the medium
of philanthropy.
Achieving the social goals deemed in keeping with
a civil society has required and will continue to require
the joint efforts of both private philanthropy and public
They play complementary roles. Something we’ve
seen in our own philanthropy is that if private giving
can demonstrate that a particular undertaking is
achievable, governments will very often follow this
lead and commit resources to it.
John D. Rockefeller, for example, observed that
our country’s medical education standards were not up
to par with those of Europe. And he initiated a successful effort to change that, an effort that was ultimately embraced and pursued by our government. Private philanthropists and volunteers have initiated
reform movements such as civil rights and women’s
rights, and the environmental movement, all of which
were ultimately taken up by government.
Conversely, government often launches endeavors
that philanthropy then begins to support. For example,
right now in global health, our foundation is, in many
cases, carrying forward decades of hard work done by
government agencies such as USAID and the World
Health Organization.
In the domestic arena, an example that comes to
my mind is the enormous amount of basic scientific
research our government has supported that has not
only stimulated so much private enterprise, but that has
been continually used to solve painful human problems that touch the lives of every one of our families.
For instance who but government would have, 20
or 30 years ago, supported an obscure medical
research scientist at the University of Washington who
wanted to study how baker’s yeast cells divide, a
researcher who just recently, this past December, carried away a Nobel Prize.
ACTEC Journal 82
That scientist, Dr. Lee Hartwell, now director of
the Fred Hutchinson Cancer Research Center in Seattle, an institution I and others support, was cited as
having provided pioneering work in the field of cancer
research. Dr. Hartwell and his work wouldn’t be there
for individual citizens to support through private philanthropy if it weren’t for the sustained support he was
given by our government.
His example speaks not only to the role government plays in serving the common good but also to the
role it plays in giving individuals inclined toward high
achievement the encouragement and sustenance they
need to succeed.
And so you see, in my view, all these elements that
define the American condition, that condition that
resides at the very heart of our ability to live the way
we do, are indeed community resources. Community
resources that include both assets that are the investments of government and assets that are a product of
philanthropy. It is this condition, the American condition, that made possible Dr. Hartwell’s Nobel Prize,
and put young Bill Gates and his 399 friends on the
Forbes 400.
Now, I know not all of us picture the world just this
way. And so not everyone would agree with me. But
that’s another one of the extraordinary characteristics
of our American system: it provides a climate for
debate and dissent that allows us to air issues like this
one in a way that leads us to further reflection and ultimately yields improvements.
I made a comment earlier about an observation
made by paleontologists who worked in Kenya with
Dr. Richard Leakey, studying the remains of our
ancient ancestors. Now I’d like to mention an observation made by Richard Leakey’s wife, Dr. Mary
Leakey. She said in studying ancient sediments and
the actual footprints of early humans she had often
in those footsteps detected a sign of hesitation. She
said it happened enough to convince her that from
the very beginning, doubt had been built into our
I like to think that her observation suggests the
prehistoric existence of an attribute Harry Truman said
was an essential quality of any American president and
Mark Twain called “the surest sign of intelligence”: an
open mind.
As long as Americans and our American system go
on prizing that quality, I believe that in similar manner
to those who left those ancient footprints, we may
never fully arrive, but we will be ever journeying forward, consistently advancing in the direction of a more
just society.
Hackl Debacle: Are the Annual Exclusion and
Discounts Mutually Exclusive for Gifts of
Closely-Held Business Interests?
by Jerome A. Deener*
Hackensack, New Jersey
Despite the Internal Revenue Service's attempts to
ignore the family limited partnership or limited liability
company in its entirety, or to reduce discounts by arguing the applicability of Sections 2703 or 2704, the courts
continue to uphold the validity of these entities, and recognize that discounts are appropriate. See, e.g., Strangi,
115 T.C. 478 (2000)(31%); Knight, 115 T.C. 506
(2000)(15%); Jones, 116 T.C. 121 (2001)(8%/44%);
Church, unpublished (5th Cir. 7/18/2001)(63%); Adams,
2001-2 U.S.T.C. Par. 60,418 (N.D. Tex. 2001)(54%);
Dailey, 82 T.C.M. 70 (2001)(40%). The viability of the
taxpayer's business appraisal is an important aspect of
substantiating the appropriate discount.
To achieve the discount, the partnership agreement
should be carefully drafted to include restrictions upon
limited partners' rights to partnership assets. The following types of provisions generally contained in a
limited partnership agreement or a limited liability
company operating agreement can favorably impact
the discount available for the limited partnership or
membership interests:
(1) restrictions on sale or other transfer;
(2) restrictions on ability to dissolve the entity;
(3) restrictions on rights to withdraw capital; and
(4) discretion vested solely in the general partner/manager to distribute income.
The discount is often supported by an appraiser's
opinion. The appraiser will consider the various
restrictions in the agreement, and relevant capital market evidence, when rendering an opinion.
Impact of Restrictions on Annual Exclusion.
Under the recent Tax Court case of Hackl v. Comm'r, 118 T. C. No. 14 (3/27/02), an LLC containing
these restrictions caused the loss of the annual exclusion for gifts of membership interests. The tension
between the availability of discounts and the qualification for the annual exclusion is explored in this article.
The Hackl decision may significantly affect the
availability of the gift tax annual exclusion for gifts of
interests in closely-held businesses. In that case, the
Tax Court disallowed the annual exclusion for gifts of
limited liability membership interests because it deter* Copyright 2002. Jerome A. Deener. All rights reserved.
mined that they were not "present interests," finding
that the donees did not have the immediate benefit of
the property received. The very restrictions that created the valuation discount caused the court to disallow
the annual exclusion.
In December 1995, father and mother formed a
limited liability company ("LLC") under Indiana state
law to conduct a new family business, consisting of
tree farming operations. This involved the purchase of
land with little or no existing timber, because it was
significantly cheaper, and because their goal was longterm growth. Father purchased land and contributed it
to the LLC. Subsequently, father and mother contributed cash and securities to the LLC. In exchange
for their contributions, father and mother received voting and non-voting membership units in the LLC.
The LLC operating agreement provided that management of the LLC business was "exclusively vested
in the manager," that such manager "shall perform
[his] duties in good faith, in a manner … reasonably
believed to be in the best interests of the company" and
with the care of "an ordinarily prudent person." Thus,
a standard for the manager's decision making was
established. Father was named as the initial manager
for life, or until his resignation, removal or incapacity.
The operating agreement also provided that the
manager controlled the distributions of cash. Further,
the agreement provided that no member had a right to
withdraw his capital contribution, except with the
manager's approval, and that the members waived the
right to have LLC property partitioned. No member
could withdraw from the LLC without prior consent of
the manager. However, a member could offer his units
to the LLC, with the manager having complete authority to accept or reject the offer and negotiate the terms.
No member could transfer his units, except with the
manager's consent, which could be withheld as the
manager determined in his sole discretion.
Members did have the following rights: to vote on
removal and replacement of the manager by majority
vote; to amend the operating agreement by an 80%
majority vote; to access the LLC books and records; to
decide to continue the business after an event of disso-
ACTEC Journal 83
lution; and, after father was no longer the manager, to
vote to dissolve the LLC by an 80% majority vote.
The stated purpose of the business was to acquire
and manage the properties for long-term income and
appreciation, rather than to produce immediate
income. In fact, the taxpayers anticipated that the LLC
would operate at a loss for a number of years. Therefore, they did not expect the LLC to make any distributions to members during those years. In fact, the LLC
reported losses for 1995 through 1998. The LLC never
generated any profits nor made any distributions of
cash or other property.
Within a month of formation of the LLC, father
and mother made gifts of voting and non-voting units
to their eight children and their respective spouses. In
March of 1996, father and mother made similar gifts to
the children and children-in-law, and also made gifts of
units to trusts for the benefit of their 25 grandchildren.
All of the gifts were reported on timely-filed gift tax
returns and annual exclusions were claimed for all the
gifts. The annual exclusions for gifts on the 1995 and
1996 tax returns were disallowed by the IRS, and were
the subject of this case. The valuation discount was
stipulated (although its magnitude was not revealed),
and was not an issue in the opinion.
Review of the Law.
To qualify for the gift tax annual exclusion under
Code Section 2503(a), the gift must be of a "present
interest." The regulations under Section 2503 define a
present interest in part as "an unrestricted right to the
immediate use, possession, or enjoyment of property
or the income from property (such as a life estate or
term certain) …" .
The taxpayers argued that the gifts of membership
interests were outright gifts of a present interest, equal
to the bundle of property rights conferred by the LLC
membership interests. The IRS argued that the restrictions in the operating agreement were insufficient to
confer the necessary immediate rights.
The Tax Court first agreed with the taxpayers that
the "property" at issue here is the LLC unit, rather than
an indirect gift of the underlying LLC property represented by that unit ("an ownership interest in the entity
itself, rather than an indirect gift in property contributed to the entity"). The court recognized that the
LLC was duly organized under state law as an LLC,
the units of which are "personal property separate and
distinct from the LLC's assets." These conclusions
apparently were intended to clarify issues that the IRS
has brought up in recent cases on the discounts for limited partnership interests.
The Tax Court then held that the body of case law
ACTEC Journal 84
involving indirect gifts, usually through trusts, was
also applicable here. These cases have held that a present interest only exists where the donee receives a
substantial present economic benefit. Thus, where the
use, possession, or enjoyment is postponed until a contingent or future event occurs, such as the exercise of
discretion by a trustee or joint action of the interest
holders, or where there is no history of a steady flow of
cash from the trust or entity, the gift has not qualified
as a present interest. The timing of the rights, as well
as the existence of the rights, is relevant. Therefore,
the Tax Court rejected the idea that the mere fact that a
gift was made outright qualifies it for the annual exclusion, without any analysis of the benefits conferred
Although the Tax Court held that the indirect gift
cases are "the relevant body of Federal authority," it is
difficult to see their relevance once it has been accepted that the gifted property is the LLC unit and not the
LLC's underlying assets. The donee's rights to the
underlying assets or income therefrom should not be
the criteria to judge enjoyment of the LLC unit.
Nevertheless, the Tax Court concluded that, to
qualify for the annual exclusion, the law requires that
the donee receive "an unrestricted and noncontingent
right to the immediate use, possession, or enjoyment
(1) of property or (2) of income from property, both of
which alternatives in turn demand that such immediate
use, possession, or enjoyment be of a nature that substantial economic benefit is derived therefrom." Note
that this is a disjunctive test, and so the right can be to
the property or to the income therefrom.
As to Property Rights.
The LLC operating agreement was considered to
be most relevant in determining the rights conferred by
the units. The restrictive agreement was found to deny
the members "the ability to presently access any substantial economic or financial benefit that might be
represented by the ownership units." The court found
that the lack of rights discussed above (namely, (1) no
withdrawal rights, except as approved by manager; (2)
no rights to transfer units, except with consent of manager (which consent was totally discretionary); (3) no
dissolution rights; and (4) "put" right, subject to manager negotiation of terms) meant that some contingency (generally, the consent of the manger) prevented
a member from receiving the economic benefit of his
The court summarily dismissed the argument that
the right of a donee to assign his interest constituted a
present interest: the possibility of making sales in vio-
lation [of manager approval], to a transferee who
would then have no right to become a member or to
participate in the business, can hardly be seen as a sufficient source of substantial economic benefit.
However, it is not clear why the ability of a donee
to confer assignee status on a third party was insufficient to constitute a "present interest." Although an
assignee interest is worth less than a full membership
interest, it is still a property right with value to the purchaser and immediate economic benefit to the seller.
As to Income Distributions.
The member had no right to the income from the
units, because income was unlikely to be received in
the near future, and distributions were discretionary
with the manager. The court said that a three-pronged
income test must be satisfied: (1) that the entity will
receive income; (2) that some portion of the income
will flow steadily to the holder of the interest; and (3)
that the portion of the income flowing to the interest
holder can be ascertained. Because the business goal
was for long-term income and appreciation, and
specifically not for immediate income, the court found
that even the first part of the income test had not been
met. Moreover, even if there had been a history of
income earned, no income would be distributed to the
members unless the manager exercised his discretion.
Since the timing and amount of any distributions were
speculative, the court found that no current economic
benefit of the income from the property was received
by the donees. It appears that, even if income were
actually earned and distributed by the partnership, the
court would not find the requisite current economic
benefit of the income because under the agreement the
distributions were discretionary with the manager.
The court did not clearly address the relevance of
a fiduciary standard upon the manager's discretion. As
indicated above, the manager was required to act in the
best interests of the company and with the care of an
ordinarily prudent person. In two relatively recent
Technical Advice Memoranda, however, the existence
of a fiduciary standard seemed to be a key factor in
allowing the annual exclusion.
In TAM 9751003, which dealt with the identical
issue of whether the annual exclusion was available
for gifts of limited partnership interests, the Internal
Revenue Service focused on the lack of a fiduciary
standard in the partnership agreement, where the general partner had complete discretion over the distribution of income and could retain income "for any reason whatsoever." The Internal Revenue Service held
that this provision eliminated the fiduciary duty normally imposed on a general partner and gave him the
authority to withhold income for reasons unrelated to
the partnership. The TAM did not disclose the amount
of cash flow or whether distributions were actually
made. The Internal Revenue Service applied the same
tests as the Tax Court later used in Hackl, and concluded that, since it was uncertain at the time of the gifts
whether any income would be distributed to the limited partners, the income test failed. Therefore, the limited partnership interests did not qualify for the annual
exclusion. Although the partnership in the TAM
owned income-producing commercial real estate, as
well as other realty, the Internal Revenue Service did
not focus on the entity's ability to distribute income in
reaching its conclusion.
In TAM 199944003, the Internal Revenue Service
again addressed the issue of the annual exclusion for
gifts of limited partnership interests. Again, the timing and amount of any distribution of income was in
the sole discretion of the general partner. However, in
this situation, where the partnership agreement specifically imposed a "strict fiduciary duty toward the limited partners and the partnership," the Internal Revenue Service distinguished the cases where a trustee
has total discretion over distributions. Instead, it
pointed out that the general partner's powers were consistent with those possessed in most limited partnerships and those granted under state law. Moreover,
due to the fiduciary standard imposed under the agreement, the limited partners "may expect the highest
standard of conduct from the general partners in their
management of the partnership." Accordingly, the
gifts qualified for the annual exclusion. The TAM did
not discuss the type of assets held by the partnership or
the cash flow therefrom.
In each TAM, there were also restrictions on the
limited partners' rights to transfer their interests, withdraw from the partnership and withdraw capital contributions. In the first TAM discussed above, the Internal
Revenue Service concluded that these restrictions precluded the economic benefits required for a present
interest. However, in the more recent TAM, the limited partners' rights were deemed to entitle the donees to
current economic benefits. Since the main distinction
between the facts in the TAMs was the lack of a fiduciary duty in the first case, that would seem to be the
relevant focus. However, the Tax Court did not discuss whether the language of the Hackl agreement
imposed a sufficient fiduciary duty on the manager.
Therefore, contrary to the conclusion derived from a
close reading of the TAMs, under the Hackl case, the
imposition of a fiduciary standard on the discretion of
the manager/general partner appears to be insufficient
to create a present economic benefit of the income.
First, although the Hackl case involved an LLC, it
should be pointed out that the court's analysis would
ACTEC Journal 85
apply equally to family limited partnerships and to
closely-held S and C corporations. This case turns primarily on the lack of income-producing objectives,
total discretion in making income distributions, as
well as the near total control by the manager, and the
very restrictive operating agreement provisions on
transfers and withdrawals of capital. The type of
assets held by the LLC in Hackl were not currently
income producing and were specifically not intended
to produce income for quite some time.
Since the Hackl test is disjunctive (i.e., a right to
the property or the income therefrom), an entity holding securities or income-producing real estate should
be viewed differently than one holding non-incomeproducing assets, such as vacant land for which development is not planned for quite some time. Also, a
partnership that has a history of distributions should be
viewed differently than one that never distributed cash
flow. However, the decision appears to indicate that
for an income-producing entity, the mere actual distribution of income is insufficient, and the entity agreement must be drafted to require a distribution of
income (or a portion thereof).
Thus, the recommendations are different for
income-producing entities and non-income producing
entities. Also, the planner and client should focus on
the ultimate objective of the planning. If the planning
is to gift (or sell) at a discount a significant portion of
the units (for example, to use the client's gift tax
exemption equivalent), the use of the greatest permissible legal restrictions will be helpful to achieve the
highest discount possible. The Hackl decision implicitly embraces the usual taxpayers' arguments that a
significant discount should apply to a limited partnership interest with restrictions. On the other hand, if
the client will merely be giving annual exclusion
amounts each year, then the restrictions should be tailored to obtain a discount while still qualifying for a
present interest within the Hackl parameters.
In dealing with the recommendations, the attorney
should be careful to discuss with a qualified business
appraiser, in advance, how the restrictions (or lack
thereof) would affect the discount. A draft of the entity agreement should be submitted to the appraiser in
advance for comment.
1. For an entity with marketable securities or
other income-producing property, clients with existing
entities should be advised to make pro rata distributions of income, at least equal to the income taxes that
the members will pay on the entity income. In addition, the entity agreement should state that the distribution of income is in the discretion of the
manager/general partner, but that at least a certain percent of net income (e.g., 45% of taxable income,
which should be sufficient to cover the partners'
ACTEC Journal 86
income taxes on their pro rata share of income) must
be distributed annually. The right to receive a stated
percentage of income may be sufficient, without further removal of other restrictions, to produce the
required present economic benefit to sustain the annual exclusion. For an entity with a low yield on marketable securities, for example, the requirement to distribute 45% of net income should have a minimal
impact, if any, on the discounts. However, if the entity
has significant cash flow relative to its asset value, the
negative impact on discounts could be large. For
instance, in a partnership with a steady income stream,
a 50% partner's interest was denied a minority discount. See Godley, 80 T.C.M. 158 (2000).
In an informal discussion with Robert P. Oliver,
President of Management Planning, Inc., a well-recognized valuation firm, he indicated that the entity's
ability to distribute income is considered in determining the size of minority and marketability discounts.
Entities with high cash flow, such as income-producing real estate entities, will still warrant a significant
discount, even if the agreement requires a certain
amount of income to be distributed. Certainly, in the
case of a marketable securities partnership, where the
dividend yield may be less than 3%, a requirement to
distribute (say) 45% of such income will have no
impact on the valuation discounts.
2. The agreement should state that units can be
sold to a third party, subject to a right of first refusal by
the manager/general partner at "fair market value",
and that gift transfers to related parties are permitted
without consent. The right of first refusal is very common in family entity agreements and, according to Mr.
Oliver, will have no impact on the valuation discount.
3. For an entity with non-income-producing
property (such as vacant land or a young tree farm), or
where the requirement of a stated distribution may
have an impact on the discount, to further buttress the
taxpayer's argument for the existence of a present
interest, clients should also be advised to consider a
"put" right, whereby the members/limited partners can
sell their units to the entity for a limited period after
receipt (say, 60 days) at the "fair market value." The
agreement can provide that "fair market value" should
be determined as if the "put" right did not exist (i.e., at
a discounted value, assuming that there is little marketability for the units). The put right is similar to a
Crummey power used in trusts to achieve a present
interest. The put right should dispel any IRS argument
that a right of first refusal is illusory if a market is
lacking. According to Mr. Oliver, the use of a fair
market value standard should preserve the discount,
because it is a price to be negotiated. According to
Mr. Oliver, a put right, as described above, has no
impact on valuation discounts. However, if a stated
price is defined in a way that deviates from a fair market value standard, normal valuation discounts may
not apply.
The Hackl case will be appealed, according to the
taxpayers' attorneys. There are grounds to believe that
favorable arguments exist to overturn the Tax Court
decision. For example, the court did not analyze the
significance of the right of a donee, without the consent of the manager, to sell his membership units to a
"mere assignee," who would have limited rights in the
LLC. The mere assignee would not rise to the level of
a member. However, the membership units transferred
to the assignee would possess immediate economic
benefits. Furthermore, the court ignored the fact that
the agreement in Hackl did impose a good faith standard on the managing member with regard to his
duties, which would include the distribution of
income. Even though no income was anticipated for a
number of years, the fact that a good faith standard
existed may be sufficiently persuasive to the appellate
court to overturn the Tax Court decision. The Tax
Court decision implicitly confirms that the provisions
of the LLC in Hackl, most of which are fairly conventional and consistent with provisions seen in commercial transactions, do significantly reduce the value of
LLC membership interests.
Nevertheless, until the appeal is decided, when the
use of the annual exclusion is important in the planning, practitioners will consider drafting agreements
to avoid the result in Hackl. A dialogue with the
appraiser will be important, to confirm that a right to
income distributions, a put right and a right of first
refusal will not materially reduce the normal valuation
discounts that are available.
ACTEC Journal 87
Adversity After Bosch
by Shirley L. Kovar*
San Diego, California
I. FRAMING THE ISSUE . . . . . . . . . . . . . . . .89
A. There Is No Federal Property Law . . . . . . .89
B. The Goal: Settle Controversies Without
Adverse Tax Consequences . . . . . . . . . . . .89
1. Property Rights . . . . . . . . . . . . . . . . . .89
2. Favorable Tax Results . . . . . . . . . . . . .89
COLLUSION? . . . . . . . . . . . . . . . . . . . . . . .90
A. Complete Deference to State
Court Judgment . . . . . . . . . . . . . . . . . . . .90
B. Non-collusive Standard for State
Court Judgments . . . . . . . . . . . . . . . . . . . .90
1. Freuler v. Commissioner of
Internal Revenue . . . . . . . . . . . . . . . . .90
2. Blair v. Commissioner of
Internal Revenue . . . . . . . . . . . . . . . . .90
3. Conflict Among the Circuits . . . . . . . .90
III. ESTATE OF BOSCH . . . . . . . . . . . . . . . . . .90
A. The Issue in Bosch . . . . . . . . . . . . . . . . . .90
B. Narrow Holding: No Binding Deference
to State Trial Court Order . . . . . . . . . . . . .90
C. Bosch Involved Two Federal Estate
Tax Controversies . . . . . . . . . . . . . . . . . . . .91
1. Validity of Release of General Power
of Appointment . . . . . . . . . . . . . . . . . .91
2. Negation of State Proration of
Taxes Statute . . . . . . . . . . . . . . . . . . . .91
3. Three Positions Over Past Thirty Years .91
4. Supreme Court: “We look at the
problem differently.” . . . . . . . . . . . . . .91
5. Proper Regard Serves
Three Objectives. . . . . . . . . . . . . . . . . .91
D. There Were Extensive Dissenting Opinions. 92
1. Dissent by Justice Douglas . . . . . . . . .92
a. Precedent for Comity to Lower
State Court Decisions . . . . . . . . . .92
b. Invalid Premise of Tax-Driven
Judgments . . . . . . . . . . . . . . . . . . .92
c. Unfairness to Taxpayer . . . . . . . . .92
2. Justice Harlan Dissented, Joined by
Justice Fortas . . . . . . . . . . . . . . . . . . . .92
a. Genuinely Adversary
Proceeding . . . . . . . . . . . . . . . . . . .92
b. Justice Douglas’ Approach Unfair
to Government . . . . . . . . . . . . . . . .92
c. Majority Approach Is Unworkable .92
* Copyright 2002. Shirley L. Kovar. All rights reserved.
ACTEC Journal 88
3. Justice Fortas Wrote His Own
Separate Dissent. . . . . . . . . . . . . . . . . .92
A. The IRS Will Rarely Be a Party in
the Lower Court Proceeding. . . . . . . . . . . .92
1. Service Cannot Be Forced
to Participate. . . . . . . . . . . . . . . . . . . . .92
2. Policy of Service Not to Participate . .92
B. Federal Court Practice: “Proper Regard”
Is “No Regard” . . . . . . . . . . . . . . . . . . . . . .92
1. “No regard” . . . . . . . . . . . . . . . . . . . . .93
2. De Novo Review . . . . . . . . . . . . . . . . .93
3. Law or Fact . . . . . . . . . . . . . . . . . . . . .93
C. Catch-22 for the IRS? . . . . . . . . . . . . . . . .93
1. Highest State Courts Approve
Tax-Driven Cases . . . . . . . . . . . . . . . . .93
2. Highest Court of State Granted
Reformation to Reduce Taxes . . . . . . .93
3. Highest Court of State
Dismisses Case. . . . . . . . . . . . . . . . . . .93
D. Service Sees Gloss on Bosch: State’s
Highest Court Decision Not Always
Binding: G.C.M. 39183 (1984) . . . . . . . . .93
E. “Having Your Cake…”: Service Says
State Court Decision Bars Relitigation. . . .93
V. THE SCOPE OF BOSCH . . . . . . . . . . . . . .93
A. Settlement Agreements: Good Faith
and Good Law . . . . . . . . . . . . . . . . . . . . . .93
1. Pre-Bosch: Standard of Good Faith . . .93
2. Ahmanson: Bosch Requires Good
Law, Not Just Good Faith . . . . . . . . . .93
3. Enforceable Right Is Essential . . . . . . .94
B. Does Bosch Apply Only to Federal
Estate Tax Cases? . . . . . . . . . . . . . . . . . . . .94
VI. ADVERSITY AFTER BOSCH . . . . . . . . . . .94
A. Justice Harlan Dissent in Bosch . . . . . . . .94
B. Despite Bosch, Many Federal Courts
Focus on Adversity . . . . . . . . . . . . . . . . . . .94
1. After Bosch, Four Circuits, and Certain
Other Courts Focus on Adversity . . . .94
2. The First Circuit:
Estate of Abely v. Commissioner
of Internal Revenue . . . . . . . . . . . . . . .94
3. The Second Circuit:
Lemle v. United States of America . . . .94
4. The Fifth Circuit . . . . . . . . . . . . . . . . .94
a. Bath v. United States of America .94
b. Brown v. United States of America .94
c. Estate of Warren v. Commissioner
of Internal Revenue . . . . . . . . . . . .95
d. Robinson v. Commissioner of
Internal Revenue . . . . . . . . . . . . .96
e. Estate of Delaune v. United States .96
5. The Seventh Circuit:
Estate of Greene v. United States
of America . . . . . . . . . . . . . . . . . . . . . .96
6. Other courts . . . . . . . . . . . . . . . . . . . . .96
a. Burke v. United States . . . . . . . . . .96
b. Estate of Bennett v.
Commissioner . . . . . . . . . . . . . . . .96
c. Estate of Simpson v. Commissioner
of Internal Revenue . . . . . . . . . . . .96
C. More from the Service Regarding
Adversity . . . . . . . . . . . . . . . . . . . . . . . . . .97
1. The Argument of the Service in Bosch .97
2. Focus on Adversity: a Disclaimer Case:
Estate of Goree v. Commissioner . . . . .97
a. Factual Background . . . . . . . . . . .97
b. The IRS in Tax Court . . . . . . . . . .97
c. The Tax Court decision . . . . . . . . .97
d. The AOD . . . . . . . . . . . . . . . . . . . .97
D. The General Rule for Reformation/
Modification: The Completed
Transaction Doctrine . . . . . . . . . . . . . . . . .97
1. The “Completed Transaction” Rule . . .97
2. AFTER the Taxable Event . . . . . . . . . .97
3. BEFORE the Taxable Event at Issue . .98
4. WHEN is the Taxable Event? . . . . . . .98
5. PLR 200033015: Even the Service
Approves This Retroactive
Reformation . . . . . . . . . . . . . . . . . . . . .98
VI. PRACTICE THOUGHTS . . . . . . . . . . . . . .99
A. Potential Disadvantages of Disclaimers . . .99
1. Friendly Family Situation . . . . . . . . . .99
2. Adversarial Situation . . . . . . . . . . . . . .99
B. Try to Avoid De Novo Review of Probate
Court Order by the Service and/or
Federal Court . . . . . . . . . . . . . . . . . . . . . . .99
C. Development of the Case in General . . . . .99
D. Preparation of Settlement Agreement . . . .99
E. Attorney-Prepared Orders . . . . . . . . . . . .100
“But under Bosch we may accord ‘proper regard’
to the decree, whatever that means.”1
A. There Is No Federal Property Law
There is no federal property law. As a result,
the federal transfer tax system looks to state law to
determine whether property has been transferred in a
manner that is subject to tax under the federal estate,
gift, or generation-skipping transfer tax. Morgan v.
Commissioner of Internal Revenue, 309 U.S. 78, 80
Although state law is determinative for federal
transfer tax purposes, in many cases it is difficult to
decide what the appropriate result is under state law
even if a state court has actually ruled how state law
should apply for local law purposes. The problem
stems from the Supreme Court’s decision in Commissioner of Internal Revenue v. Estate of Bosch, 387 U.S.
456 (1967). In that case, the Supreme Court held that
“Where the federal tax liability turns upon the character of a property interest held and transferred by the
decedent under state law, federal authorities are not
bound by the determination made of such property
interest by a state trial court.” Id. at 457.
B. The Goal: Settle Controversies Without
Adverse Tax Consequences
This outline discusses how the Bosch decision
and its progeny affect the ability of taxpayers to settle
controversies as to the meaning of wills and trusts and
to correct mistakes in such documents without adverse
tax consequences.
Caution! The preferable path to desired property
rights at the state court level may conflict with the
complex maze required to achieve favorable federal
tax results.
1. Property Rights:
The preferable approach to resolving
property rights is probate court approval of your
client’s uncontested petition, or at worst, a petition followed by a settlement agreement among the interested
parties and a consent decree from the probate court.
2. Favorable Tax Results:
Favorable tax results may require proof of
an adversarial proceeding, despite the rejection of
adversity as an appropriate test in Estate of Bosch,
Lake Shore Nat’l Bank v. Coyle, 296 F. Supp. 412, 418 (N.D. Ill. 1968), rev’d on other grounds, 419 F. 2d 958 (7th Cir. 1969).
ACTEC Journal 89
A. Complete Deference to State Court Judgment
1. The Supreme Court in 1916 in Uterhart v.
United States, 240 U.S. 598 (1916) gave complete deference to a state trial court decree in later federal tax
litigation regarding the “succession taxes” paid by
appellants under the act of June 13, 1898.
2. “[O]ne of the executors brought suit in the
Supreme Court of the State of New York [the state trial
court] against his co-executors and the beneficiaries
for a judicial construction of the will, and a decree was
made on the date mentioned….” Id. at 602. “It is very
properly admitted by the Government that the New
York decree is in this proceeding binding with respect
to the meaning and effect of the will.” Id. at 603.
B. Non-Collusive Standard for State Court Judgments
1. In the 1930s, the Court applied a “non-collusive” test in two income tax cases, Freuler v. Commissioner of Internal Revenue, 291 U.S. 35 (1934) and
Blair v. Commissioner of Internal Revenue, 300 U.S. 5
a. In Freuler, the trustee filed fiduciary
income tax returns, which deducted from gross income
an amount for depreciation, but the trustee did not
deduct the depreciation amount from income distributed to the beneficiaries. The Commissioner determined a deficiency on a beneficiary’s return. The beneficiary appealed to the Board of Tax Appeals.
b. While the case was pending before
the Board, the trustee obtained an order from a California lower court, which found the trustee had overpaid income to the beneficiaries and ordered the
beneficiaries to repay the overpayment to the trust.
The Board of Tax Appeals reversed the Commissioner, holding the state court’s judgment conclusive
that the Trustee had overpaid the income to the beneficiaries.
c. The Circuit Court of Appeals reversed
the Board, upholding the Commissioner’s ruling. The
Supreme Court granted certiorari and reversed the Circuit Court of Appeals.
d. The Supreme Court accepted the
lower court’s judgment a statement of the law of the
state: “Moreover, the decision of that court, until
reversed or overruled, establishes the law of California
respecting distribution of the trust estate. It is nonetheless a declaration of the law of the State because not
based on a statute, or earlier decisions. The rights of
the beneficiaries are property rights and the court has
adjudicated them. What the law as announced by that
court adjudges distributable is, we think, to be so considered… .” Id. at 641, 642.
e. The Supreme Court also rejected the
ACTEC Journal 90
Commissioner’s argument that the state court proceeding was “a collusive one—collusive in the sense
that all the parties joined in a submission of the issues
and sought a decision which would adversely affect
the Government’s right to additional income tax.” Id.
at 642.
f. The Court described the “usual” procedure of the lower court leading up to the lower
court’s order, apparently equating “collusive” with a
non-adversarial proceeding. The Court concluded
“[t]he decree purports to decide issues regularly submitted and not to be in any sense a consent decree.” In
apparent support of this conclusion the Court noted
that “[t]he court ruled against the remaindermen on
one point and in their favor on another…but refused to
surcharge the trustee, for reasons stated … .” Id.
2. In Blair, the Supreme Court determined
that whether assignments of income from a trust were
valid depended on whether the trust was or was not a
spendthrift trust under local law.
a. The Court upheld the order of the
“intermediate appellate court” that the trust was not a
spendthrift trust and the assignments were valid.
b. The Supreme Court rejected the allegation that the decree was “collusive.” The Court gave
no definition of “collusive” or any set of criteria for
assessing whether the decree was “collusive.” The
Court simply recited that “[t]he trustees were entitled to
seek the instructions of the court having jurisdiction of
the trust” and that the appellate court had “reviewed the
decisions of the Supreme Court of the State and
reached a deliberate conclusion.” Id. at 469, 470.
3. Conflict Among the Circuits
a. The courts spent the next thirty years
attempting to frame a workable definition of “collusion.” Some courts used collusion to mean “fraud.”
Other courts equated collusive with “non-adversary.”
The result was a confusing history of the application
of the collusive standard in the pre-Bosch era. Caron,
The Federal Tax Implications of Bush v. Gore, Univ.
of Cincinnati Public Law Research Paper No. 01-1,
Working Papers ( at 7, 8.
b. The Supreme Court noted the “widespread conflict among the circuits” and granted certiorari in Estate of Bosch, supra.
A. The Issue in Bosch
“Whether a federal court or agency in a federal
estate tax controversy is conclusively bound by a state
trial court adjudication of property rights or characterization of property interests when the United States is
not made a party to such a proceeding.” Id. at 456, 457.
B. Narrow Holding: No Binding Deference to
State Trial Court Order
“We hold that where the federal estate
tax liability turns upon the character
of a property interest held and transferred by the decedent under state law,
federal authorities are not bound by
the determination made of such property interest by a state trial court.” Id.
at 457.
C. Bosch Involved Two Federal Estate Tax Controversies
1. Validity of Release of General Power of
a. In one case, the decedent had created
a revocable trust that provided the decedent’s wife with
income for her lifetime and a general power of
appointment. The wife subsequently signed a document purporting to release the general power and convert it to a special power.
b. The ensuing controversy was whether
or not the release was valid. If the release was valid,
there would be no marital deduction.
c. The state court determined the release
was invalid. The Tax Court accepted the state court
judgment. The Court of Appeals affirmed. The
Supreme Court reversed and remanded.
2. Negation of State Proration of Taxes
a. State Court Allowed Marital Deduction
In the second case, the decedent’s will
provided that ‘the provisions of any statute requiring
the apportionment or proration of such [death] taxes
among the beneficiaries of this will…shall be without
effect in the settlement of my estate.’ The state court
determined that this language was not sufficient to
negate proration and allocated the entire federal estate
tax against the non-marital trust. Id. at 460. This
determination “allowed the widow a marital deduction
of some $3,600,000 clear of all federal estate tax.”
Id. at 461.
b. State Court Ruling Is Not Binding
The Commissioner determined the
Probate Court ruling was in error, not binding on him,
and assessed a deficiency. The District Court and
Appellate Courts both agreed that the State Court ruling was not binding.
3. Three Positions Over Past Thirty Years
The Court gave a brief history of “what
effect must be given a state trial court decree where
the matter decided there is determinative of federal
estate tax consequences ….” Id. at 462, quoting
Gallagher v. Smith, 223 F.2d 218, 225.
a. The Court observed that three positions had evolved over the past thirty years: The first
position was that ‘if the question at issue is fairly pre-
sented to the state court for its independent decision
and is so decided by the court the resulting judgment if
binding upon the parties under the state law is conclusive as to their property rights in the federal tax
case….’ Id. at 463.
b. The second “opposite view” is similar
to the approach of Erie Railroad Co. v. Tompkins, 304
U.S. 64 (1938) “in that the federal court will consider
itself bound by the state court decree only after independent examination of the state law as determined by
the highest court of the State.” Id.
c. The Government urged a third “intermediate position”: a state trial court decree should be
binding “only when the judgment is the result of an
adversary proceeding in the state court.” Id.
4. Supreme Court: “We look at the problem
a. Applying Federal Tax Statute: Legislative History
i. The Court pointed out that it was
being asked to apply a federal taxing statute. As a
result, the Court explained it was necessary to review
the legislative history of that statute. Id. at 463.
ii. Accordingly the Court noted that
the report of the Senate Finance Committee that recommended enactment of the marital deduction stated
that “proper regard” and not “finality” should be given
to state court judgments. Id. at 464.
iii. Congress intended the marital
deduction to be “strictly construed and applied.”
b. Deference Owed to Highest Court of
the State
The Court relied on Erie v. Tompkins in rendering
its opinion that “the underlying substantive rule
involved is based on state law and the State’s highest
court is the best authority on its own law.” Id. at 465.
c. ‘Proper Regard’ is Standard for Trial
Court Judgments
If there is no decision by the state’s
highest court, “then federal authorities must apply
what they find to be the state law after giving ‘proper
regard’ to relevant rulings of other courts of the State.
In this respect, it may be said to be, in effect, sitting as
a state court.” Id.
5. Proper Regard Serves Three Objectives
The Court said in conclusion that the standard of “proper regard” would carry out three objectives (Id. at 465):
a. That “proper regard” would “avoid
much of the uncertainty that would result from the
‘non-adversary’ approach”;
b. That “proper regard” would be “fair to
the taxpayer”; and
c. That “proper regard” would “protect
the federal revenue as well.”
ACTEC Journal 91
D. There Were Extensive Dissenting Opinions
1. Dissent by Justice Douglas
Douglas concluded that absent a consent
decree, collusion or fraud, “the federal court should
consider the [state court] decision to be an exposition
of the controlling state law… . ” Id. at 471.
a. Precedent for Comity to Lower State
Court Decisions
In diversity cases “we have never suggested that the federal court may ignore a relevant state
court decision because it was not entered by the highest state court.” Id. at 466. To the contrary, Justice
Douglas cited cases to the effect that “the federal court
is obligated to follow the decision of a lower state
court in the absence of decisions of the State Supreme
Court showing that the state law is other than
announced by the lower court.” Id.
b. Invalid Premise of Tax-Driven Judgments
Justice Douglas asserted that the lack
of respect for state court decisions are based on the
invalid premise “that such proceedings are brought
solely to avoid federal taxes.” Justice Douglas
explained that there are “many instances in which the
parties desire a determination of their rights for other
than tax reasons.” Id. at 470.
c. Unfairness to Taxpayer
Justice Douglas also pointed out that a
federal court decision contrary to a state court decision
would be unfair to the taxpayer if a federal court judgment imposes a tax on the taxpayer for a benefit that
the taxpayer did not receive under state law. An example is explained in Blair v. Comm., supra, “where the
Government attempted to tax the taxpayer for income
to which he had no right under state law.” Id.
2. Justice Harlan dissented, Joined by Justice
a. Genuinely adversary proceeding
i. Harlan framed his holding as follows: “in cases in which state-adjudicated property
rights are contended to have federal tax consequences,
federal courts must attribute conclusiveness to the
judgment of a state court, of whatever level in the state
procedural system, unless the litigation from which the
judgment resulted does not bear the indicia of a genuinely adversary proceeding.” Id. at 481.
ii. Justice Harlan concluded that “the
federal interest requires only that the Commissioner be
permitted to obtain from the federal courts a considered adjudication of the relevant state law issues in
cases in which…the state courts have not already provided such an adjudication.” Harlan said that a state
court has made such a judgment if the state court “has
had the benefit of reasoned argument from parties
holding genuinely inconsistent interests.” [emphasis
ACTEC Journal 92
added.] Id.
b. Justice Douglas’ Approach Unfair to
Justice Douglas would, Justice Harlan
says, “create excessive risks that federal taxation will
be evaded through…judgments from lower state
courts…not to resolve truly conflicting interests
among the parties but rather as a predicate for gaining
foreseeable tax advantages, and in which the point of
view of the United States had never been presented or
considered.” Id. at 480.
c. Majority Approach Is Unworkable
On the other hand, Justice Harlan
believed the majority approach is unworkable: “. . .
absent a judgment of the State’s highest court, federal
courts must under this rule reexamine and, if they
deem it appropriate, disregard the previous judgment
of a state court on precisely the identical question of
state law.” This, Harlan says, “ . . . might be widely
destructive both of the proper relationship between
state and federal law and of the uniformity of the
administration of law within a state.” Id.
3. Justice Fortas wrote his own separate dissent.
A. The IRS Will Rarely Be a Party in the Lower
Court Proceeding.
There is agreement that res judicata does not apply
where the IRS is not a party in the lower court
proceeding. See Estate of Bosch, supra, at 463;
Douglas, (dissenting on other grounds), at 466.
1. Service Cannot Be Forced to Participate.
As a practical matter, the IRS will rarely
be a party in the lower court proceeding. “[E]fforts
through the years subsequent to the Bosch decision to
bring the government into such cases have been fruitless. The United States as sovereign, and the Service
as an agency of the United States, are immune from
suit in state court. This sovereign immunity may be
waived only by Congress. In state property disputes
that have federal tax consequences, the Service cannot
be forced to participate.” Bruce, Bosch and Other
Dilemmas: Binding the Parties and the Tax Consequences in Trust Dispute Resolution, Institute on
Estate Planning, 9-1, 9-23 (1984).
2. Policy of Service Not to Participate
If an attempt is made to make the Service
a party to a lower state court proceeding, the policy of
the Service is to refuse to participate. Typically, a government representative would make a special appearance for the purpose of obtaining a dismissal of the
action. Id.
B. Federal Court Practice: “Proper
Regard” Is “No Regard”
1. “No regard”
Sixty percent (60%) of federal courts from
1967-2001 “have refused to follow the state court’s
interpretation of state law in the federal tax proceeding.” Caron, Federal Tax Implications, at 17, 18.
2. De Novo Review
“At best, they give mere lip service to the
Bosch ‘proper regard’ standard. In most cases, they
engage in de novo review of state law without giving
any weight to the state court decision.” Id. at 23, 24.
3. Law or Fact
Very few decisions involved pure questions of law subject to de novo review. Most cases
involved factual issues or mixed issues of fact and law.
Id. at 45.
C. Catch-22 for the IRS?
1. Highest State Courts Approve Tax-Driven
Bosch is usually interpreted to mean that
federal authorities must give binding deference to the
decisions of the highest court of the state and to state
statutes. Where a decision of the highest court is for the
purpose of giving effect to the parties’ agreement to
achieve a specific result for tax purposes, Bosch actually helps bring about the kind of tax objectives that
Bosch explicitly disapproves. See the discussion in
Gans, “Federal Transfer Taxation and the Role of State
Law: Does the Marital Deduction Strike the Proper Balance?” 48 Emory Law Journal 871 (Summer, 1999).
2. See e.g., Simches v. Simches, 671 N.E.2d
1226 (1996) (Highest court of the State granted decree
for reformation that reduced taxes.)
But see, Kirchick v. Guerry, 706 N.E.
2d 702 (1999). The issue in Kirchick was what was
the date the power of appointment was created. The
court determined there was no state law duty or issue at
stake. The court said the only reason for the suit was to
obtain a ruling that could be used in a pending federal
tax case. The court dismissed the suit.
D. Service Sees Gloss on Bosch: State’s Highest
Court Decision Not Always Binding: G.C.M. 39183
1. “[T]he Estate Tax Attorney asserts that
[the cited supreme court case] was a ‘carefully orchestrated, nonadversary lawsuit in state court designed
only to obtain federal estate tax relief….’” Id. at 8.
2. “[T]he Bosch court did not intend for the
federal courts and agencies to give binding effect to
nonadversary state Supreme Court proceeding… .” Id.
at 30.
A. Settlement Agreements: Good Faith and Good
1. Pre-Bosch: Standard of Good Faith
a. In pre-Bosch Revenue Ruling 66-139
(1966-1 C.B. 225) the Service determined that the
amount given to a surviving spouse pursuant to a goodfaith settlement agreement qualified for the marital
b. The Service relied on Lyeth v. Hoey,
305 U.S. 188 (1938), an income tax case, where the
taxpayer argued that the amount he received in the settlement of a will contest should be excludible from
income as an inheritance.
c. The Court in Lyeth agreed with the
taxpayer that the amount received by the taxpayer as a
settlement was excludible from income as an inheritance.
2. Ahmanson: Bosch Requires Good Law,
Not Just Good Faith.
a. In Ahmanson Foundation v. United
States, 674 F. 2d 761 (1981) the Ninth Circuit extended Bosch to settlement agreements.
b. The court explained that the majority
in Bosch concluded that “the test of ‘passing’ for estate
tax purposes should be whether the interest reaches the
spouse pursuant to state law, correctly interpreted-not
whether it reached the spouse as a result of a good faith
adversary confrontation.” Id. at 774.
c. In Ahmanson, the surviving wife was
entitled to the benefit of a marital trust valued at
$5,000,000. Mrs. Ahmanson also received $750,000
from the estate in settlement of certain claims against
the will. The government argued the estate was not
entitled to a marital deduction for the settlement of the
wife’s claim of the $750,000 payment.
d. The court determined that it could not
“square” Rev. Ruling 66-139 with Bosch: “Bosch
would require that the interest be enforceable; the revenue ruling appears only to require that the state law
claim be sufficiently plausible to support good faith
arm’s length settlement. For this reason the revenue
ruling, which predates Bosch, is of no effect.” Id.
Spivey, “Completed Transactions, Qualified Reformation
and Bosch: When Does the IRS Care about State Law of Trust
Reformation?” ACTEC Notes, V. 26, No. 4, (Spring, 2001) 346,
n.2, citing Levy v. U.S., 776 F. Supp. 831 (DNY 1991) (res judicata) and Baily v. U.S., 350 F. Supp. 1205 (D PA 1972) (collateral
E. “Having Your Cake….”2 Service Says State
Court Decision Bars Relitigation.
But the Service may (in some states) assert res
judicata “to bar a taxpayer from relitigating a property
law issue decided adversely to the taxpayer in a state
court proceeding.”
ACTEC Journal 93
3. Enforceable Right Is Essential
a. The Service relied on Bosch and
Ahmanson in the Estate of Brandon, 828 F. 2d 493 (8th
Cir.1987), persuading the Eighth Circuit that “under
even the most narrow reading of Bosch, either a good
faith settlement or a judgment of a lower state court
must be based on an enforceable right, under state law
properly interpreted, in order to qualify as ‘passing’
pursuant to the estate tax marital deduction.” Id. at
499, citing Ahmanson, supra, at 775.
b Subsequent rulings of the Service
conform to the Bosch-Ahmanson view that an essential, if not sufficient, component of a settlement agreement is a legally enforceable claim under state law.
See e.g., Revenue Ruling 83-107 (“clarifying” Revenue Ruling 66-139 “to emphasize that only good faith
negotiated settlements based on a surviving spouse’s
enforceable rights to a deductible interest, under properly interpreted state law, will be recognized for purposes of section 2056….”[emphasis added]); PLR
200127038 (“In view of Ahmanson, property passing
pursuant to the settlement of a claim asserted by a
spouse will be treated as passing from the decedent, to
the extent the compromise is a bona fide settlement of
a legally enforceable claim.” [emphasis added] Id. at
20.); PLR 200004014 (“… the interests to be received
by the parties (both as to the nature of the interests and
their economic value) are consistent with the relative
merit of the claims asserted by the parties.”[emphasis
added] Id. at 16, 17.)
B. Does Bosch Apply Only to Federal Estate Tax
Cases (or Even Only to Marital Deduction Cases) and
Not to Income Tax Cases?
The argument could be made that Bosch
should be limited to the marital deduction. Bosch
resolved marital deduction issues, not other federal
estate tax issues. Bosch focused on the legislative history of the marital deduction and borrowed the term
“proper regard” from that legislative history.
The Fifth Circuit has declined to apply Bosch
in the context of the amount of the charitable deduction. Estate of Warren v. Commissioner, 981 F. 2d 776
(5th Cir. 1993).
However, other courts and the Service have
relied on Bosch beyond the marital deduction. See
cases cited in Gans, supra, note 101, including, e.g.,
Dancy v. Commissioner, 872 F. 2d 84, 85 (4th Cir.
1989) (validity of disclaimer); United States v. White,
853 F. 2d 107 (2d Cir. 1988) (deductibility of administration expenses); PLR 9528012 (grandfathered generation-skipping trust);PLR 9308032 (taxable gift).
Lyeth in Income Tax and Ahmanson in Transfer Tax
In general, since Ahmanson, courts have
applied Lyeth, supra, in the income tax context and
ACTEC Journal 94
Bosch where transfer taxes are at issue.
This “bifurcated approach” has resulted in greater
deference being shown to settlement agreements and
lower court decisions involving income tax than cases
deciding transfer tax issues, where the Bosch standard
is applied. See Gans, supra, at 896 and 897.
A. Justice Harlan, Dissent in Bosch
See discussion above at III. D. 2.
B. Despite Bosch, Many Federal Courts Focus on
1. After Bosch, four circuits, and certain
other courts, notwithstanding rejection of the adversity
test in Bosch, have focused on the presence or absence
of adversity in the lower state court proceeding. See
cases cited in Caron, Federal Tax Implications, supra
at 24, n.86. The following cases are examples of
courts that have focused on adversity after Bosch.
2. The First Circuit: Estate of Abely v. Commissioner of Internal Revenue, 489 F. 2d 1327 (1st Cir.
In Estate of Abely, the court affirmed the
Tax Court judgment that the award of a family
allowance to the surviving spouse was contingent and
did not qualify for the marital deduction. According to
the court, “[w]hatever the motives of the heirs in perhaps assenting to, and in any event not appealing from
a probate decree conspicuously outside of the scope of
the statutory provision, the taxing powers of the government are not to be avoided by private arrangements
contrary to the will even though they receive the gloss
of a probate court decree.” Id. at 1328.
3. The Second Circuit: Lemle v. United
States of America, 579 F. 2d 185 (2nd Cir. 1978)
The Second Circuit affirmed the District
Court’s judgment rejecting plaintiff’s claim to recover
income tax paid on distributions from her husband’s
estate. The court observed that “[n]o such private
agreement should foreclose the government from collection of its taxes. Courts ‘will not be bound by the
parties’ self-serving characterization of the settled
claim’.” [citations omitted.] Id. at 188.
4. The Fifth Circuit
a. Bath v. United States of America, 480
F. 2d 289 (5th Cir.1973)
i. In Bath, the issue was “whether a
payment received by taxpayer from his mother’s estate
was a tax-free bequest or taxable compensation for services performed during his mother’s life.” Id. at 290.
ii. “Especially suspect are characterizations, such as we have here, not the result of bona
fide adversary proceedings.” Id. at 289 citing the dissent of Justice Douglas in Bosch, supra, at 471.
b. Brown v. United States of America,
890 F. 2d 1329 (5th Cir. 1989)
i. In Brown, the issue was whether a
probate estate was unduly prolonged, resulting in the
payment of federal income tax by the estate, rather
than the beneficiary. The Fifth Circuit affirmed the
District Court’s decision granting of summary judgment to the government. The Fifth Circuit held that
the government properly assessed income tax against
the beneficiary rather than the executor.
ii. The key issue was “what degree of
deference the district court should have accorded [the]
state judgment.” The executor, after receiving a notice
of deficiency (as beneficiary) petitioned the probate
court to “find that the Estates required ongoing management and administration.” Id. at 1341. The probate
court “entered an order authorizing [the executor] to
continue to manage the assets of the Estates as independent executor until such time as he determined ‘in his
sole discretion’ that it would be in the best interest of
the beneficiaries to terminate the Estates.” Id.
iii. The Fifth Circuit concluded that
“[t]he relevance of a state court’s judgment to the resolution of a federal tax question will vary, depending on
the particular tax statute involved as well as the nature
of the state proceeding that produced the judgment.”
Id. at 1342. The Fifth Circuit determined that the tax
statute involved was section 641 (a)(3) of the Internal
Revenue Code and that “the issue of whether administration has been unduly prolonged for purposes of section 641 (a)(3) of the Code is ultimately one of federal,
not state, law.” Id. Next, the Fifth Circuit concluded
“the judgment had no practical consequences apart
from this federal tax controversy….” Id. This was true
for two reasons: (1) The Court first focused on the
non-adversary nature of the state court proceeding; and
(2) second, under Texas law, the executor did not need
an order from the probate court to continue estate
administration: “An independent executor…has
authority to determine when to terminate the administration of an estate free of any court intervention; and
therefore…the judgment had no practical consequences apart from this federal tax controversy….” Id.
c. Estate of Warren v. Commissioner of
Internal Revenue, 981 F. 2d 776 (5th Cir. 1993)
i. In Warren, the issue was whether the
IRS was bound by a probate court judgment approving
a settlement, which allocated the larger portion of
estate administration expenses against the residuary
postmortem income rather than residuary corpus. The
Tax Court upheld the deficiency asserted by the IRS,
which determined that it was not bound by the probate
court judgment. The Fifth Circuit reversed, holding
that the Tax Court erred in failing to give effect to the
state probate court judgment.
ii. The decedent’s will left the major-
ity of her estate in two residuary charitable lead trusts,
which would terminate in favor of the decedent’s children and grandchildren. The will provided that “[a]ll
of my just debts, funeral expense, administration and
testamentary expenses, and all estate, inheritance,
transfer, and succession taxes…shall be paid out of my
residuary estate…without apportionment.” The “residuary estate” was to ‘consist of my entire testamentary
estate after satisfaction of any gifts under Article IV
hereof, and after payment of those debts, expenses, and
taxes referred to in Article III hereof.’ Id. at 777. The
charities brought suit in the probate court, alleging that
the administration expenses should be paid from residuary postmortem income rather than residuary corpus.
iii. The charities’ suit was one of sixteen suits brought against the estate during the probate.
Parties to most of the suits, including the administrators, the charitable trust beneficiaries and most
claimants against the estate entered into an “omnibus
settlement,” which included a provision that the will
“would be restated to allocate payment of all administrative expenses out of the residuary postmortem
income, not out of the residuary corpus.” Id. at 778.
An agreed final judgment was entered by the probate
court, which modified and approved the settlement.
The probate court order provided that 271 ⁄2 % of the
administrative expenses would be charged against the
residuary corpus and the balance against postmortem
residuary income.
iv. After a review of Bosch and other
authorities, the Fifth Circuit adopted the test in Brown,
supra, that ‘the relevance of a state court’s judgment to
the resolution of a federal tax question will vary,
depending on the particular tax statute involved as well
as the nature of the state proceeding that produced the
judgment.’ Id. at 781. The court pointed out that there
was no legislative history for the estate tax charitable
deduction comparable to that for the estate tax marital
deduction. The court did note, however, that it had
been frequently recognized that Congress had sought
to “encourage gifts to charity” by its enactment of the
charitable deduction in Internal Code section 2055 and
prior statutes. Further, citing Flanagan, the court
observed that in upholding charitable deductions based
on court approved bona fide settlements of adversarial
positions, the decisions have stressed that ‘the deduction is sought for the actual benefit passing to the charitable foundation.’ Id. at 782.
v. The court emphasized that Texas
law “has long recognized the ‘family settlement doctrine’” which is an “alternative method of administration in Texas that is a favorite of the law.” Id. Because
Texas probate law vests the decedent’s estate immediately in the beneficiaries, they are “free to arrange
among themselves for the distribution of the estate and
ACTEC Journal 95
for the payment of expenses from that estate.” [citation
omitted]. Id.
vi. The court rejected the Commissioner’s argument that the settlement as to the allocation of administrative expenses, “…was collusive and
designed simply to avoid payment of taxes… .” Id. at
783. Instead, the Court concluded that “[it] is indisputably clear that the litigation, and its settlement,
were to resolve adversarial, non-tax, bona fide disputes.” Id. at 783.
d. Robinson v. Commissioner of Internal
Revenue, 70 F.3d 34 (5th Cir. 1995)
In Robinson, the Fifth Circuit
reversed the portion of a lower court judgment that
determined that certain settlement proceeds were
excludable from gross income. The court explained
that “[i]n the case at bar…the Tax Court found that the
allocation was not entered in a bona fide adversary
proceeding. Further, it found that the state trial court
simply ‘rubber stamped’ a judgment drafted by
the…attorneys.” Id. at 37.
e. Estate of Delaune v. United States,
143 F. 3d 995 (5th Cir. 1998), cert. denied, 525 U.S.
1072 (1999)
In Delaune, the Fifth Circuit, in
reversing a district court decision, held that a disclaimer by a deceased heir’s heirs was valid under
Louisiana law and was a valid disclaimer under Internal Revenue Code section 2518.
However, based on Bosch, the Fifth
Circuit relied on “this circuit’s longstanding interpretation of the rather ambivalent majority opinion in
Bosch. Accordingly, if “the state court adjudication
arises out of a manifestly non-adversarial proceeding
and the relevant federal tax statute indicates no preference for the sanctity of the state court’s ruling, we need
accord no particular deference, and must conduct our
own investigation of the relevant state law as declared
by the state’s highest court.” Id. at 1002.
5. The Seventh Circuit: Estate of Greene v.
United States of America, 476 F. 2d 116 (7th Cir. 1973)
In Greene, the Seventh Circuit affirmed
the District Court’s order supporting the IRS determination that estate tax should be paid from property
passing to the widow. “The district court may have
also determined that the state court decision was not
tempered by a ‘genuinely adversary proceeding’…for
appellant did not contest the government’s representation on this appeal that no appearance was entered for
the sons in the state probate court proceeding.” Id. at
119, 120.
6. Other Courts
a. Burke v. United States, 994 F. 2d 1576
(Fed. Cir), cert denied, 510 U.S. 990 (1993)
“In the case at bar, there was no bona
ACTEC Journal 96
fide adversarial proceeding leading to
the Florida probate court’s decision to
allow payment of administrative
expenses out of post-mortem income.
Therefore, even assuming that Bosch is
limited to non-adversarial situations, it
is applicable to this case…. Further,
the decision in Warren would allow an
agreement between the beneficiaries
under a will to dictate federal estate tax
law. While the settlement in Warren
was undoubtedly the result of adversarial proceedings, it is hard to imagine
that reducing federal estate tax consequences was not at least one aspect of
the settlement agreement. Decreasing
the amount of taxes owed would
increase the overall post-tax amount of
money which could be divided by both
of the negotiating parties.” Id. at 1583,
b. Estate of Bennett v. Commissioner,
100 T.C. 42 (1993)
“While we do not suggest that the
Trustees and the beneficiaries in the
present case engaged in improper collusion with the Kansas probate court
to obtain approval of the Rules and
By-laws and the disclaimers, nonetheless that proceeding was nonadversarial and was instituted for the sole purpose of obtaining a marital deduction
that was not otherwise available under
the original terms of the will and Trust
Agreement.” Id. at 60.
c. Estate of Simpson v. Commissioner of
Internal Revenue, 67 T.C.M. (CCH) 3062 (1994)
“Taxpayers can achieve favorable but
collusive results from State court proceedings in which the Commissioner
has not been made a party or which
appear to have been pursued for the
purpose of affecting a Federal tax liability. Collusion does not imply fraudulent or improper conduct; rather, it
implies that the parties have joined in
submission of the issues such that
there was no genuine issue of law or
fact as to a beneficiary’s rights to or
property interest in an estate.” [citations omitted] Id. at 17, 18.
“The circuit court proceeding was neither a genuine and active contest nor adversarial in
nature. We conclude that the circuit court did not pass
upon the facts upon which the marital deduction
depends. The settlement agreement was similarly not
a good faith compromise of a bona fide dispute. Consequently, [her] receipt of her elective share in decedent’s estate was not a bona fide recognition of her
right to it.” Id. at 20.
C. More from the Service Regarding Adversity
1. The Argument of the Service in Bosch
a. In its brief to the Supreme court in
Bosch, the Service urged the Court to adopt the test of
adversity in the state court proceeding as the way to
balance the competing interests of revenue and comity.
Petitioner’s Brief, Commissioner v. Estate of Bosch
(No. 673) cited in Caron, Federal Tax Implications,
supra, at 12.
b. The Service urged that failure to give
effect to a state court decision only in the case of fraud
was too narrow a test, and that this approach would not
give sufficient weight to the revenue interest of the
government. Id. at 11.
c On the other hand, the Service argued
that if a federal court could impose a tax on a property
right denied to the taxpayer under state law, that would
be “too broad” and would give too much power to the
federal courts. Id. at 12.
d. The Service proposed that a federal
court should review a state court judgment only when
it was the result of a non-adversary state court proceeding. Id.
2. Focus on Adversity: A Disclaimer Case:
Estate of Goree v. Commissioner, 68 T.C.M. (CCH)
123 (1994)
a. Factual background
i. According to the state law of
intestacy, decedent’s estate would pass one-half to the
decedent’s wife and one-half to their three children.
The distribution to the children would generate significant estate tax liability.
ii. The wife, as conservator for the
children, requested the Court to approve a disclaimer
by each of the three children, which would avoid the
anticipated estate tax. Each child would accept
$200,000 from the decedent’s estate, and disclaim any
interest in the decedent’s estate above that amount. The
result would be to use the decedent’s $600,000 unified
credit for the distribution to the children and the disclaimer would cause the balance of the decedent’s
estate to pass to the wife by intestacy, thereby deferring
federal estate tax as a result of the marital deduction.
iii. A guardian ad litem was appointed for the children. After a favorable recommendation
by the guardian, the Court approved the disclaimers.
b. The IRS in Tax Court
i. In the Tax Court trial, the Service
refused to recognize the validity of the disclaimers,
arguing that the probate judge erred as a matter of state
law in the decree approving the disclaimers.
ii. The Service proposed, contrary to
Bosch, that the Tax Court should give no weight to the
decision of the probate court. The Service urged the
Tax Court to engage in a de novo review and make an
independent judgment whether the disclaimers were in
the best interests of the children under state law.
iii. The Service argued that it could
not be in the best interest of the children to forego their
intestate rights for no consideration. The Service
therefore concluded that the wife’s request for
approval of the disclaimers was solely to avoid adverse
tax consequences.
c. The Tax Court Decision
i. The Tax Court used the same standard of review that the State supreme court would
apply to a lower court decision. Therefore, the Tax
Court would decide whether the state court decision
was “plainly and palpably erroneous.”
ii. The Tax Court determined that
there were considerations in addition to reduction of
taxes, including the desire to keep the stock of a closely-held corporation within the family and the probability that other elderly family members would leave
large bequests to the children.
iii. The Tax Court held that the probate court ruling that the disclaimers were in the best
interests of the children was not “plainly and palpably
erroneous” bequests to the children.
d. The AOD
i. The Service issued a non-acquiescence in the Estate of Goree, 1996-1 C.B.1, 1996-10
I.R.B.4 (I.R.S.).
ii. The Service states that the Tax
Court should have reviewed the state court judgment
de novo, rather than applying an appellate standard of
iii. “The utilization of the palpably
erroneous standard for review of factual findings in a
non-adversarial situation is inconsistent with the rationale for the palpably erroneous standard, which
assumes a vigorously contested lower court hearing.”
Id. at 3.
D. The General Rule for Reformation/Modification: The Completed Transaction Doctrine
1. The “completed transaction” rule does not
apply to “qualified reformations” pursuant to the Internal Revenue Code.
2. AFTER the Taxable Event at Issue (not
including qualified reformations)
ACTEC Journal 97
In Rev. Rul. 93-79, 1993-2 C.B. 269, the
Service determined that a state court order reforming a
trust to meet the requirements of a qualified subchapter
S Trust was not effective retroactively, although the
Service would recognize the validity of the order for
future years. The ruling cites, inter alia, American
Nurseryman Publishing Company v. Commissioner, 75
T.C. 271, 276-277 (1980), aff’d without published
opinion, 673 F. 2d 1333 (7th Cir. 1982); Estate of Hill
v. Commissioner, 64 T.C. 867 (1975), aff’d without
published opinion, 568 F. 2d 1365 (5th Cir. 1978).
In PLR 199922045, the Service declined
to give retroactive effect to a reformation of a trust by
the probate court.
Certain courts have made exceptions to
the completed transaction rule. Flitcroft v. Commissioner of Internal Revenue, 328 F.2d 449 (9th Cir.
1964) (state court reformation changing revocable
trusts was valid for federal estate tax purposes.)
Another case not explained by the completed transaction rule is Estate of Kraus v. Commissioner of Internal
Revenue, 875 F. 2d 597 (7th Cir. 1989) (retroactive
reformation where scrivener’s error proved by clear
and convincing evidence).
3. BEFORE the Taxable Event at Issue
In Rev. Rul. 73-142, 1973-1 C.B. 405, the
Service distinguished Bosch regarding the effect of
state law as announced by the highest court of the state
where the lower state court decree is contrary to the
law as stated by the highest court of the state.
In this ruling, “[t]he decedent made substantial gifts of property in trust for the benefit of his
wife and children.” In the Trust instrument the decedent retained the “unrestricted power to remove or discharge the trustee at any time and appoint a new
trustee, with no express limitation on so appointing
himself.” The Trust also gave the Trustee an “unrestricted power to withhold distribution of income or
principal and to apportion income and principal….”
Id. at 1.
Prior to his death the decedent, in 1965,
petitioned and obtained an order in lower state court
proceedings to construe the trust instrument as follows:
(i) That the decedent “had reserved the
right to remove and appoint a trustee only once….”
(ii) “[T]hat this power did not include the
right to appoint himself . . . .”
(iii) “[T]hat once having exercised that
power, decedent would have exhausted his reserved
powers….” Id. at 1, 2.
The Service determined that the lower
court decree was effective for purposes of the federal
estate tax, and that section 2036 and 2038 of the IRC
did not require inclusion of the trust assets in the dece-
ACTEC Journal 98
dent’s gross estate for federal estate tax purposes.
The Service explained that in Bosch
the decree in question was rendered after the date of
death of the decedent:
“Unlike the situation in Bosch, the
decree in this case was handed down
before the time of the event giving rise
to the tax (that is, the date of the
grantor’s death). Thus, while the
decree would not be binding on the
Government as to questions relating to
the grantor’s power to appoint himself
as trustee prior to the date of the
decree, it is controlling after such date
since the decree, in and of itself, effectively extinguished the power. In
other words, while there may have
been a question whether the grantor
had such power prior to the decree,
there is no question that he did not
have the power thereafter.” Id. at 5.
For a recent ruling, see PLR 200127042
(analyzing a irrevocable life insurance trust reformed
after the death of the husband but before death of the
wife to avoid inclusion of trust proceeds in the estate
of the wife.)
4. WHEN Is the Taxable Event?
The government has argued that the
appropriate measuring date is the date of the testator’s
death. See e.g., Estate of Rapp v. Commissioner of
Internal Revenue, 140 F. 3d 1211 (1998) and cases
cited there by the court; Jackson v. United States, 376
U.S. 503, 505 (1964); Estate of Heim v. Commissioner
of Internal Revenue, 914 F. 2d 1322, 1327 (9th Cir.
With respect to the QTIP election, the
court in the Estate of Rapp, supra, at 1218, noted that
“three circuits have held that the correct ‘measuring
date’ for determining whether a particular asset is considered part of a QTIP trust is the date of QTIP election, not the date of the testator’s death. See Estate of
Spencer v. Commissioner of Internal Revenue, 43 F. 3d
226 (6th Cir. 1995); Estate of Robertson v. Commissioner of Internal Revenue, 15 F. 3d 779 (8th Cir.
1994); Estate of Clayton v. Commissioner of Internal
Revenue, 976 F. 2d 1486 (5th Cir. 1992).”
5. PLR 200033015: Even the Service
Approves This Retroactive Reformation
In this Private Letter Ruling, the Service
determined that a non-adversarial reformation by a
state trial court did not have adverse income tax and
gift tax consequences. The Service accepted the reformation as a correction of the irrevocable trust (Trust
#1) to reflect trustor’s original intent and determined
that the reformation would not generate any income
tax or gift tax.
The taxpayer had created two irrevocable
trusts for the taxpayer’s five children (income beneficiaries) and grandchildren (remaindermen). Trust #1
recited that the word “child” and “grandchild” “shall
not include descendants by adoption.” Id. at 5. One of
the trustor’s children then adopted a child who would
not qualify as a remainderman under Trust #1. The
trustor claimed that she did not intend to exclude
minor children as remaindermen, and that she only
wanted to exclude any person who was an adult at the
time of the adoption. The trustor’s attorney corroborated the trustor’s claims regarding the original intent
of the trustor.
Prior to the submission of the ruling
request, the parties to Trust #1 agreed to the reformation. The agreement was followed by a petition to the
court requesting reformation of Trust #1 that the terms
“child” and “grandchild” would include “descendants
by birth and any adopted person who lived while a
minor (either before or after the adoption) as a regular
member of the household of the adopting descendantby-birth.” Id. at 8.
The ruling recited that Bosch determined
that (1) “a decision of a state trial court as to an underlying issue of state law should not be controlling when
applied to a federal statute…;” (2) “the highest court of
the state is the best authority on the underlying…federal matter” and (3) “If there is no decision by that court
then the federal authority must apply what it finds to
be state law after giving ‘proper regard’ to the state
trial court’s determination and to relevant rulings of
other courts of the state.” Id. at 15 and 16.
After citing lower court California cases
regarding California law, the ruling concluded that
“the reformation of Trust 1 is consistent with applicable California law as it would be applied by the highest court of California.” Id. at 17. The Service took the
position that “the reformation based on a mistake in
drafting does not change any of the beneficial interests
in Trust 1, and, accordingly, the reformation will not
give rise to gift tax liability for any party.” Id.
The ruling concluded that the reformation
did not arise “by reason of the Agreement.” Id.
Rather, “the parties merely acknowledge Settlor’s original intent and state that they will not object to the
reformation so long as they do not personally incur any
gift tax or income tax liability….” Id.
A. Potential Disadvantages of Disclaimers
1. Friendly Family Situation
In a friendly family situation, if the court
has approved a disclaimer by a minor child, the Service may claim there was no adversarial proceeding
for approval of the disclaimers and therefore request a
federal court to conduct a de novo review of the validity of the disclaimer under state law. In the proceedings
regarding the disclaimer for a minor child, determine if
there is any definition of the “best interests” of the
minor child. In a proceeding relating to modification
or termination, California Probate Code section 15405
provides that the court may consider the “general family benefit accruing to living members of the beneficiary’s family, as a basis for approving a modification or
termination of the trust.”
2. Adversarial Situation
a. In a more adversarial situation, it may
be impossible to elicit a disclaimer from the adverse
beneficiaries because the existence of consideration
will invalidate the disclaimer for federal tax purposes.
b. In adversarial situations the adverse
party may require a guarantee of tax consequences,
which, again is not possible because this would constitute consideration and invalidate the disclaimer.
3. Instead, if possible, prove there was a mistake in drafting.
B. Try to Avoid De Novo Review of Probate
Court Order by the Service and/or Federal Court. (The
Service Will Want to See Signs of an Adversarial Proceeding)
1. Appoint a guardian ad litem for a minor
child. The guardian should provide written, explicit
2. Conduct a factual investigation.
3. The opposing party should file objections.
C. Development of the Case in General
1. Rely on the strongest theory under state
law that supports your client’s claim and also achieves
favorable tax results. There may be multiple theories
to support the client’s claim.
2. Unless the highest court of the state
approves the probate court judgment or there is a state
statute for tax minimization regarding the matter at
issue, avoid tax reduction or tax deferral arguments.
3. Leave a paper trail of arm’s length negotiations or adversarial court proceedings.
4. Document the method used to calculate
the value of your client’s claim.
5. Any settlement should reflect as closely as
possible the actual economic value of the parties’
respective claims.
6. Leave searches for sympathy to the telephone or court chambers.
D. Preparation of Settlement Agreement
1. Make extensive recitals of fact; avoid tax
avoidance or tax deferral recitals.
2. Emphasize the factual basis of the claims.
ACTEC Journal 99
3. Rely on and cite decisions of the highest
court of the state or state statutes.
4. Depending upon the relationship of the
parties, it may not be possible to avoid allocation of the
risk of tax consequences.
E. Attorney-Prepared Orders
1. Include extensive, detailed findings of fact
that track the factual requirements under decisions of
ACTEC Journal 100
the highest court of the state or state statutes.
2. Emphasize the factual basis of the claims.
3. Ask the court to issue a ruling that
includes findings of fact and conclusions of law.
4. Track the court ruling carefully in the
attorney-prepared order.
5. Be sure the order provides it is retroactive
to operative date (date of death, if possible).
Punctilio of an Honor—A Trustee’s Duties
by Robert J. Rosepink*
Scottsdale, Arizona
I. INTRODUCTION . . . . . . . . . . . . . . . . . . . .102
A. Under the Trust Instrument . . . . . . . . . . . .102
B. Under Federal Law or Administrative
Agency Regulation . . . . . . . . . . . . . . . . . .102
C. Under State Statute . . . . . . . . . . . . . . . . . .102
D. At Common Law . . . . . . . . . . . . . . . . . . .102
E. Other Sources . . . . . . . . . . . . . . . . . . . . . .102
THE UTC . . . . . . . . . . . . . . . . . . . . . . . . .103
A. Duty to Administer Trust . . . . . . . . . . . . .103
B. Duty of Loyalty . . . . . . . . . . . . . . . . . . . .103
C. Impartiality . . . . . . . . . . . . . . . . . . . . . . . .104
D. Prudent Administration . . . . . . . . . . . . . . .104
E. Costs of Administration . . . . . . . . . . . . . .104
F. Trustee’s Skills . . . . . . . . . . . . . . . . . . . . .104
G. Delegation by Trustee . . . . . . . . . . . . . . . .104
H. Powers to Direct . . . . . . . . . . . . . . . . . . . .104
I. Control and Protection of Trust Property. .105
J. Record Keeping and Identification of
Trust Property . . . . . . . . . . . . . . . . . . . . . .105
K. Enforcement and Defense of Claims . . . .105
L. Collecting Trust Property . . . . . . . . . . . . .105
M. Duty to Inform and Report . . . . . . . . . . . .105
THE RESTATEMENT . . . . . . . . . . . . . . . .106
A. Duty to Administer the Trust . . . . . . . . . .106
B. Duty of Loyalty . . . . . . . . . . . . . . . . . . . .106
C. Duty with Respect to Delegation . . . . . . .106
D. Duty to Keep and Render Accounts . . . . .107
E. Duty to Furnish Information . . . . . . . . . . .108
F. Duty to Exercise Reasonable Care
and Skill . . . . . . . . . . . . . . . . . . . . . . . . . .108
G. Duty to Take and Keep Control . . . . . . . .108
H. Duty to Preserve the Trust Property . . . . .109
I. Duty to Enforce Claims . . . . . . . . . . . . . .109
J. Duty to Defend Actions . . . . . . . . . . . . . .109
K. Duty to Keep Trust Property Separate . . .109
L. Duty with Respect to Bank Deposits . . . .110
M. Duty to Make the Trust
Property Productive . . . . . . . . . . . . . . . . .110
N. Duty to Pay Income to Beneficiary . . . . .111
* Copyright 2002. Robert J. Rosepink. All rights reserved.
O. Duty to Deal Impartially with
Beneficiaries . . . . . . . . . . . . . . . . . . . . . . .111
P. Duty with Respect to Co-Trustees . . . . . .111
Q. Duty with Respect to Person Holding
Power of Control . . . . . . . . . . . . . . . . . . .111
V. EXCULPATORY PROVISIONS . . . . . . . .112
A. In General . . . . . . . . . . . . . . . . . . . . . . . . .112
B. UTC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .112
C. Restatement . . . . . . . . . . . . . . . . . . . . . . .113
VI. FIDUCIARY BONDS . . . . . . . . . . . . . . . . .113
A. In General . . . . . . . . . . . . . . . . . . . . . . . . .113
B. UTC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .113
C. Restatement . . . . . . . . . . . . . . . . . . . . . . .113
VII. TYPES OF LIABILITY . . . . . . . . . . . . . .113
A. Personal Liability . . . . . . . . . . . . . . . . . . .113
B. Liability in a Representative Capacity . . .113
FROM THE TRUST ESTATE . . . . . . . . .113
A. General Rules . . . . . . . . . . . . . . . . . . . . . .113
B. Indemnity for Contractual Liability . . . . .114
C. Indemnity for Tort Liability . . . . . . . . . . .115
D. Indemnity for Liability as a Title Holder
of Property . . . . . . . . . . . . . . . . . . . . . . . .115
E. Indemnity Where Trust Estate
Is Insufficient . . . . . . . . . . . . . . . . . . . . . .115
TO THIRD PERSONS . . . . . . . . . . . . . . . .116
A. Personal Liability to Third Persons . . . .116
B. Contract Liability . . . . . . . . . . . . . . . . . . .116
C. Tort Liability . . . . . . . . . . . . . . . . . . . . . . .116
D. Property Liability . . . . . . . . . . . . . . . . . . .116
BENEFICIARIES . . . . . . . . . . . . . . . . . . . .118
A. Breach of Trust . . . . . . . . . . . . . . . . . . . . .118
B. Nonliability for Loss in the Absence
of a Breach of Trust . . . . . . . . . . . . . . . . .118
C. Trustee’s Liability in Case of Breach
of Trust . . . . . . . . . . . . . . . . . . . . . . . . . . .118
A. Successor Trustee . . . . . . . . . . . . . . . . . . .118
B. Breach of Trust by Co-Trustee . . . . . . . . .119
C. Acts of Agents . . . . . . . . . . . . . . . . . . . . .119
D. Payments or Conveyances Made to Persons
other than the beneficiary. . . . . . . . . . . . .119
ACTEC Journal 101
A. “Many forms of conduct permissible in a
workaday world for those acting at arm’s length, are
forbidden to those bound by fiduciary ties. A trustee is
held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an
honor most sensitive, is then the standard of behavior.
As to this there has developed a tradition that is
unbending and inveterate. Uncompromising rigidity
has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the
‘disintegrating erosion’ of particular exceptions. Only
thus has the level of conduct for fiduciaries been kept at
a level higher than that trodden by the crowd.” Meinhard v. Salmon, 249 NY 458, 164 NE 545, 564 (1928).
B. “For as a trust is an office necessary in the
concerns between man and man, and which, if faithfully discharged, is attended with no small degree of trouble, and anxiety, it is an act of great kindness to accept
it.” Lord Chancellor Hardwicke in Knight v. Earl of
Plymouth, 21 Eng Rep 214, 216 (1747).
C. The title of this outline is intended to remind
the reader at the outset that the standard of conduct to
which a trustee is held under the law is significantly
higher than anywhere else in the marketplace. Yet our
clients routinely consider appointing as trustee of
trusts with complicated dispositive or tax provisions
one or more family members or acquaintances whose
background, education, experience, and perspicacity
rarely qualify them to understand, let alone properly
execute the duties of the trustee.
D. Although the powers of a trustee are often set
forth in the trust instrument, the trustee’s duties usually
are not.
E. In addition, this outline discusses a trustee’s liability for breaches of trust–failure to perform the required
duties according to the accepted standard of conduct.
F. Although executors, administrators, and personal representatives (collectively, “PRs”) are clearly
fiduciaries, probate is entirely a statutory process. The
laws governing probate, including those determining
the duties and liabilities of PRs, vary greatly from state
to state. Although some of the duties and potential liability to which PRs are subject may be similar to those
of a trustee, this outline does not discuss a PR’s duties.
A. Under the trust instrument.
B. Under federal law or administrative agency
1. Federal law imposes various direct and
indirect duties on trustees. The best-known duties of a
trustee under federal law are to pay various taxes.
However, ERISA also imposes reporting requirements
and increases trustee liability.
ACTEC Journal 102
2. Treasury regulations impose numerous
duties in connection with a trustee’s duties to pay
income and transfer taxes.
3. The Office of the Comptroller of the Currency (“OCC”) imposes various duties on trustees subject to its jurisdiction–viz., national banks. See 12
CFR Parts 9 and 19. [A full discussion of Regulation 9
is beyond the scope of this outline.]
C. Under state statute.
1. The nature and extent of statutes concerning a trustee’s duties vary widely from state to state.
Some states have an extensive statutory scheme dealing
with a trustee’s duties, while other states have almost
no law on the subject. However, the Uniform Trust
Code [hereinafter cited as “UTC”], which was adopted
by the National Conference of Commissioners on Uniform State Laws in August 2000, “is the first effort by
the Uniform Law Commissioners to provide the states
with a comprehensive model for codifying the law of
trusts.” English, David M., “The Uniform Trust Code
(2000),” ACTEC 2000 Summer Meeting at 1.
2. As it enacted in more jurisdictions, the
UTC will begin to create more uniformity from state to
state. Although the UTC stands as the most up-to-date
and thorough analysis of a trustee’s duties, there are as
yet no cases analyzing its provisions. However, as
Professor English, Reporter for the UTC points out:
“The Uniform Trust Code was drafted in close coordination with the revision of the Restatement [(Second)
of Trusts]. This coordination has hopefully made both
into better products. The UTC offers the benefit of
certain rules. The Restatement provides a wealth of
background materials for interpreting the language of
the UTC.” Id at 7.
D. At common law. Where the duties of a trustee
are not set forth in the trust instrument, trustees are
subject to whatever duties are imposed on them by
statute or which have “evolved by courts of equity for
the governing of the conduct of trustees.” Scott, A.W.
& W.F. Fratcher, The Law of Trusts § 164 (4th ed 1987)
[hereinafter cited as “Scott”]. The Restatement of the
Law (Second) Trusts, adopted and promulgated by the
American Law Institute in 1959 [hereinafter cited as
“Restatement”] describes seventeen separate duties
imposed upon a trustee by common law (see IV. infra).
The text and comment of several of the sections
describing those duties (viz., sections 170, 171, 181,
183, and 184) were revised as part of the Restatement
of the Law (Third) Trusts (Prudent Investor Rule)
adopted and promulgated by the American Law Institute in 1990 [hereinafter cited as “Restatement 3d”].
E. Other sources. ACTEC Fellows should be
familiar with the “Guide for ACTEC Fellows Serving
as Trustees” which represents a “consensus of suggestions and considerations” dealing with trusteeships.
A. Duty to administer trust. UTC § 801. [UTC
text is quoted in bold.]
1. Upon acceptance of a trusteeship, the
trustee shall administer the trust in good faith, in
accordance with its terms and purposes and the
interests of the beneficiaries, and in accordance
with this [Code].
2. This section is very similar to Restatement
§ 169.
B. Duty of loyalty. UTC § 802.
1. (a) A trustee shall administer the trust
solely in the interest of the beneficiaries.
(b) Subject to the rights of persons
dealing with or assisting the trustee as provided in
Section 1012 [Protection of Person Dealing With
Trustee], a sale, encumbrance, or other transaction
involving the investment or management of trust
property entered into by the trustee for the
trustee’s own personal account or which is otherwise affected by a conflict between the trustee’s
fiduciary and personal interests is voidable by a
beneficiary affected by the transaction unless:
(1) the transaction was authorized
by the terms of the trust;
(2) the transaction was approved
by the court;
(3) the beneficiary did not commence a judicial proceeding within the time
allowed by Section 1005 [Limitation of Action
Against Trustee];
(4) the beneficiary consented to the
trustee’s conduct, ratified the transaction, or
released the trustee in compliance with Section
1009 [Beneficiary’s Consent, Release, or Ratification]; or
(5) the transaction involves a contract entered into or claim acquired by the trustee
before the person became or contemplated becoming trustee.
(c) A sale, encumbrance, or other
transaction involving the investment or management of trust property is presumed to be affected
with a conflict between personal and fiduciary
interests if it is entered into by the trustee with:
(1) the trustee’s spouse;
(2) the trustee’s dependents, siblings, parents, or their spouses;
(3) an agent or attorney of the
trustee; or
(4) a corporation or other person or
enterprise in which the trustee, or a person that owns
a significant interest in the trustee, has an interest
that might affect the trustee’s best judgment.
(d) A transaction between a trustee and
a beneficiary that does not concern trust property
but that occurs during the existence of the trust or
while the trustee retains significant influence over
the beneficiary and from which the trustee obtains
an advantage is voidable by the beneficiary unless
the trustee establishes that the transaction was fair
to the beneficiary.
(e) A transaction not concerning trust
property in which the trustee engages in the
trustee’s individual capacity involves a conflict
between personal and fiduciary interests if the
transaction concerns an opportunity properly
belonging to the trust.
(f) An investment by a trustee in securities of an investment company or investment trust to
which the trustee, or its affiliate, provides services in
a capacity other than as trustee is not presumed to be
affected by a conflict between personal and fiduciary
interests if the investment complies with the prudent
investor rule of [Article] 9. The trustee may be compensated by the investment company or investment
trust for providing those services out of fees charged
to the trustee if the trustee at least annually notifies
the person entitled under Section 813 [Duty to
Inform and Report] to receive a copy of the trustee’s
annual report of the rate and method by which the
compensation was determined.
(g) In voting shares of stock or in exercising powers of control over similar interests in
other forms of enterprise, the trustee shall act in the
best interests of the beneficiaries. If the trust is the
sole owner of a corporation or other form of enterprise, the trustee shall elect or appoint directors or
managers who will manage the corporation or
enterprise in the best interests of the beneficiaries.
(h) This section does not preclude the
following transactions, if fair to the beneficiaries:
(1) an agreement between a trustee
and a beneficiary relating to the appointment or
compensation of the trustee;
(2) payment of reasonable compensation to the trustee;
(3) a transaction between a trust
and another trust, decedent’s estate, or [conservatorship] of which the trustee is a fiduciary or in
which a beneficiary has an interest;
(4) a deposit of trust money in a
regulated financial-service institution operated by
the trustee; or
(5) an advance by the trustee of
money for the protection of the trust.
(i) The court may appoint a special
fiduciary to make a decision with respect to any
proposed transaction that might violate this section
if entered into by the trustee.
ACTEC Journal 103
2. This section is far more extensive than
Restatement 3d § 170, which also imposes the duty of
loyalty on a trustee. In general, this section of the
UTC codifies the Restatement 3d Comments, with one
important exception. Under UTC section 802, a corporate trustee may invest trust funds in a regulated
mutual fund which it operates if doing so is “fair to the
C. Impartiality. UTC § 803.
1. If a trust has two or more beneficiaries,
the trustee shall act impartially in investing, managing, and distributing the trust property, giving
due regard to the beneficiaries’ respective interests.
2. Presumably, just as with Restatement 3d
section 183, this duty will apply whether the beneficiaries’ interests are simultaneous or successive.
3. “Due regard” will continue to pose a challenge for the trustee in selecting trust investments. An
income beneficiary will favor investment in assets that
tend to maximize current income, and a remainder
beneficiary will favor investment in assets that tend to
maximize the value of the trust principal over time,
even if such assets produce less current income.
D. Prudent Administration. UTC § 804.
1. A trustee shall administer the trust as a
prudent person would, by considering the purposes,
terms, distributional requirements, and other circumstances of the trust. In satisfying this standard,
the trustee shall exercise reasonable care, skill, and
2. This section, while similar to Restatement
section 174, does not relate the hypothetical prudent
person to dealing with his own property (or, as under
Uniform Probate Code (hereinafter “UPC”) section 7302, the property of another).
E. Costs of Administration. UTC § 805.
1. In administering a trust, the trustee
may incur only costs that are reasonable in relation
to the trust property, the purposes of the trust, and
the skills of the trustee.
2. Although this section is included with others imposing duties on the trustee, it really expresses a
power of the trustee. It is similar to Restatement section 188, Power to Incur Expenses.
F. Trustee’s Skills. UTC § 806.
1. A trustee who has special skills or
expertise, or is named trustee in reliance upon the
trustee’s representation that the trustee has special
skills or expertise, shall use those special skills or
2. This duty is expressed as part of Restatement section 174.
G. Delegation by Trustee. UTC § 807.
1. (a) A trustee may delegate duties and
powers that a prudent trustee of comparable skills
ACTEC Journal 104
could properly delegate under the circumstances.
The trustee shall exercise reasonable care, skill, and
caution in:
(1) selecting an agent;
(2) establishing the scope and terms
of the delegation, consistent with the purposes and
terms of the trust; and
(3) periodically reviewing the
agent’s actions in order to monitor the agent’s performance and compliance with the terms of the delegation.
(b) In performing a delegated function,
an agent owes a duty to the trust to exercise reasonable care to comply with the terms of the delegation.
(c) A trustee who complies with subsection (a) is not liable to the beneficiaries or to the
trust for an action of the agent to whom the function was delegated.
(d) By accepting a delegation of powers
or duties from the trustee of a trust that is subject
to the law of this State, an agent submits to the
jurisdiction of the courts of this State.
2. This section is consistent with the
approach to delegation adopted by Restatement 3d section 171.
3. Exculpation of the trustee for actions of
agents under subsection (c) is similar to Restatement
section 225 (see IX.C. infra).
H. Powers to Direct. UTC § 808.
1. (a) While a trust is revocable, the
trustee may follow a direction of the settlor that is
contrary to the terms of the trust.
(b) If the terms of a trust confer upon a
person other than the settlor of a revocable trust
power to direct certain actions of the trustee, the
trustee shall act in accordance with an exercise of
the power unless the attempted exercise is manifestly contrary to the terms of the trust or the trustee
knows the attempted exercise would constitute a
serious breach of a fiduciary duty that the person
holding the power owes to the beneficiaries of the
(c) The terms of a trust may confer
upon a trustee or other person a power to direct the
modification or termination of the trust.
(d) A person, other than a beneficiary,
who holds a power to direct is presumptively a fiduciary who, as such, is required to act in good faith
with regard to the purposes of the trust and the
interests of the beneficiaries. The holder of a power
to direct is liable for any loss that results from
breach of a fiduciary duty.
2. This section, while similar to Restatement
section 185, features several important additions.
a. First, subsection (a) makes it clear
that, with respect to a revocable trust, the trustee may
follow instructions of the settlor that are contrary to the
terms of the trust instrument.
b. Second, subsection (c) authorizes
modification or termination of the trust by the trustee
or another person, who presumably needs have no
other relation to the trust. Query: how can the power to
modify or terminate a trust be exercised “in good faith
with regard to the purposes of the trust and the interests of the beneficiaries”? Should lawyers be drafting
purpose clauses in all trusts? Unless the trust has a
stated purpose or purposes, how can the power holder
begin to determine whether any exercise of the power
to modify or terminate is in good faith with respect to
the purposes of the trust?
c. Third, subsection (d) creates a statutory presumption that a person who has a power to direct
the trustee holds such power in a fiduciary (not personal) capacity.
I. Control and Protection of Trust Property. UTC
§ 809.
1. A trustee shall take reasonable steps to
take control of and protect the trust property.
2. This provision consolidates in one section
the duties imposed separately by Restatement sections
175 and 176.
J. Record Keeping and Identification of Trust
Property. UTC § 810.
1. (a) A trustee shall keep adequate
records of the administration of the trust.
(b) A trustee shall keep trust property
separate from the trustee’s own property.
(c) Except as otherwise provided in
subsection (d), a trustee shall cause the trust property to be designated so that the interest of the trust, to
the extent feasible, appears in records maintained
by a party other than a trustee or beneficiary.
(d) If the trustee maintains records
clearly indicating the respective interests, a trustee
may invest as a whole the property of two or more
separate trusts.
2. The duty to maintain adequate records
imposed by subsection (a) is similar to that imposed by
Restatement section 172.
3. The duty to keep trust property separate
imposed by subsection (b) is similar to that imposed by
Restatement section 179.
4. Subsection (d) authorizes commingling of
the property of several trusts, which is generally prohibited by Restatement section 179.
K. Enforcement and Defense of Claims. UTC
§ 811.
1. A trustee shall take reasonable steps to
enforce claims of the trust and to defend claims
against the trust.
2. This section consolidates in one place the
separate duties imposed by Restatement sections 177
and 178.
L. Collecting Trust Property. UTC § 812.
1. A trustee shall take reasonable steps to
compel a former trustee or other person to deliver
trust property to the trustee, and to redress a
breach of trust known to the trustee to have been
committed by a former trustee.
2. The Restatement does not articulate this
duty separately. However, it is contemplated by the
Comments as part of the trustee’s duty to enforce
claims under Restatement section 177.
M. Duty to Inform and Report. UTC § 813.
1. (a) A trustee shall keep the qualified
beneficiaries of the trust reasonably informed
about the administration of the trust and of the
material facts necessary for them to protect their
interests. Unless unreasonable under the circumstances, a trustee shall promptly respond to a beneficiary’s request for information related to the administration of the trust.
(b) A trustee:
(1) upon request of a beneficiary,
shall promptly furnish to the beneficiary a copy of
the trust instrument;
(2) within 60 days after accepting a
trusteeship, shall notify the qualified beneficiaries
of the acceptance and of the trustee’s name,
address, and telephone number;
(3) within 60 days after the date the
trustee acquires knowledge of the creation of an
irrevocable trust, or the date the trustee acquires
knowledge that a formerly revocable trust has
become irrevocable, whether by the death of the
settlor or otherwise, shall notify the qualified beneficiaries of the trust’s existence, of the identity of
the settlor or settlors, of the right to request a copy
of the trust instrument, and of the right to a
trustee’s report as provided in subsection (c); and
(4) shall notify the qualified beneficiaries in advance of any change in the method or
rate of the trustee’s compensation.
(c) A trustee shall send to the distributees or permissible distributees of trust income or
principal, and to other qualified or nonqualified
beneficiaries who request it, at least annually and at
the termination of the trust, a report of the trust
property, liabilities, receipts, and disbursements,
including the source and amount of the trustee’s
compensation, a listing of the trust assets and, if
feasible, their respective market values. Upon a
vacancy in a trusteeship, unless a cotrustee remains
in office, a report must be sent to the qualified ben-
ACTEC Journal 105
eficiaries by the former trustee. A personal representative, [conservator], or [guardian] may send
the qualified beneficiaries a report on behalf of a
deceased or incapacitated trustee.
(d) A beneficiary may waive the right to
a trustee’s report or other information otherwise
required to be furnished under this section. A beneficiary, with respect to future reports and other information, may withdraw a waiver previously given.
2. UTC section 103(12) defines “qualified
beneficiary” as “a beneficiary who, on the date the
beneficiary’s qualification is determined: (A) is a distributee or permissible distributee of trust income or
principal; (B) would be a distributee or permissible
distributee of trust income or principal if the interests
of the distributees described in subparagraph (A) terminated on that date; or (C) would be a distributee or
permissible distributee of trust income or principal if
the trust terminated on that date.”
3. Several of Professor English’s insights on
this section are worthy of replication here:
Philosophy. Section 813 of the UTC
fills out and adds detail to the trustee’s duty to keep the
beneficiaries informed of administration. When in
doubt, the UTC favors disclosure to beneficiaries as
the better policy.
Specific Notice Requirements. The
drafting committee rejected the more limited approach
of letting the trustee decide which provisions are material to the beneficiary’s interest; the trustee’s version of
what is material may differ markedly from what the
beneficiary might find relevant.
The Waiver Issue. The most discussed
issued in the drafting of the UTC and subsequent to its
approval is the extent to which the settlor may waive
the requirements of Section 813. This issue is currently addressed in Section 105(b)(8)-(9). Most of the specific notice requirements are waivable. Not waivable
is the trustee’s obligation to notify the qualified beneficiaries age 25 or older of the existence of the trust.
With respect to any beneficiary regardless of age, the
trustee [settlor?] also may not waive the trustee’s
obligation to respond to a request for trustee’s report
and other information reasonably related to the trust’s
administration. In other words, if a beneficiary finds
out about the trust and makes a request for information, the trustee must respond to the request even if the
trustee was not obligated to inform the beneficiary
about the trust in the first instance.1
English, David M., “The Uniform Trust Code (2000),” ACTEC
2000 Summer Meeting at 31.
ACTEC Journal 106
A. Duty to administer the trust. Restatement
§ 169. [Restatement text (but not Comments) throughout this outline is quoted in small capital letters.]
2. This section seems not to have attracted
much attention from the courts. However, as both the
Restatement Comment and Scott point out, this section
prohibits a trustee from disclaiming his office after
acceptance. Further, a trustee can only resign with the
permission of the court or by the consent of all the beneficiaries, unless the terms of the trust provide otherwise.
Scott § 169 at 311. Moreover, after acceptance, the
trustee is bound to administer the trust even if he is to
receive no compensation. However, this section makes it
clear that a trustee’s duties are not contractual in nature.
B. Duty of loyalty. Restatement 3d § 170.
2. It is probably fair to say that more has
been written about this duty of the trustee, both by the
courts and by commentators, than any other. This is
due to the fact that “The most fundamental duty owed
by the trustee to the beneficiaries of the trust is the duty
of loyalty.” Scott § 170 at 311. Implicit in the duty of
loyalty is the duty not to self- deal.
3. In cases involving a breach of the duty of
loyalty, it is typically immaterial that the trustee acted
in good faith or that the particular transaction was fair
and reasonable in all respects.
4. Prior court approval of a self-dealing
transaction can avoid a breach of the duty of loyalty.
Also, acquiescence or consent by the beneficiaries to a
self-dealing transaction may constitute a defense if the
beneficiaries were aware of all of the facts.
C. Duty with respect to delegation. Restatement
3d § 171.
2. This section was substantially revised from
Restatement section 171, which generally frowned on
delegation. However, some delegation was permitted.
As Comment d to former Restatement section 171 stated:
A trustee can properly delegate the
performance of acts which it is unreasonable to require him personally to
perform. There is no clear-cut line
dividing the acts which a trustee can
properly delegate from those which he
cannot properly delegate. In considering what acts a trustee can properly
delegate the following circumstances,
among others, may be of importance:
(1) the amount of discretion involved,
(2) the value and character of the property involved, (3) whether the property
is income or principal, (4) the proximity or remoteness of the subject matter
of the trust; (5) the character of the act
as one involving professional skill or
facilities possessed or not possessed
by the trustee himself.
3. The philosophy of Restatement 3d section
171 is expressed in Comment f:
Delegation of authority to do particular acts. Although the administration
of a trust may not be delegated in full,
a trustee may for many purposes delegate fiduciary authority to properly
selected and supervised agents.
Delegation is not limited to the
performance of ministerial acts. In
appropriate circumstances delegation
may extend, for example, to discretionary acts, to the selection of trust
investments or the management of
specialized investment programs, and
to other activities of administration
involving significant judgment.
In considering whether and under
what circumstances and conditions a
particular delegation of fiduciary
authority is proper, the following circumstances, among others, may be of
importance to the trustee or to a
reviewing court: (1) the nature and
degree of discretion involved; (2) the
amount of funds or the value and character of the property involved; (3) efficiency, convenience, and cost considerations in light of the situs of the
property or activities involved; (4) the
relationship of the act or activities
involved to the professional skills or
facilities possessed by the trustee; and
(5) the fairness and appropriateness of
the responsibilities in question to the
burdens and compensation of the
trustee (see § 188, Comment c).
4. The terms of the trust instrument may
authorize delegations of authority by the trustee that
would otherwise be improper. Comment i.
D. Duty to keep and render accounts. Restatement § 172.
2. Scott observes that a trustee’s “accounts
should show what he has received and what he has
expended. They should show what gains have accrued
and what losses have been incurred on changes of
investments. If the trust is created for beneficiaries in
succession, the accounts should show what receipts
and what expenditures are allocated to principal and
what are allocated to income.” Scott § 172 at 452.
3. Not only must the trustee maintain accurate records. This section also imposes on a trustee the
duty to provide an accounting at reasonable times
when requested by the beneficiaries.
a. The general rule is that a beneficiary
who has only a future or contingent interest in the trust
may still exercise the right to compel an accounting.
However, several recent cases have held to the contrary. Chicago City Bank & Trust Co v. Lesman, 186
Ill App 3d 697, 134 Ill Dec 478, 542 NE 2d 1067
(1989); Schlosser v. Schlosser, 247 Ill App 3d 1044,
187 Ill Dec 769, 618 NE 2d 360, appeal denied, 152 Ill
2d 580, 190 Ill Dec 910, 622 NE 2d 1227 (1993).
b. If only one beneficiary wants an
accounting and the other beneficiaries object because
of the cost to the trust, courts have held that the beneficiary requesting the accounting must indemnify the
trust against the expense. In re New England Mutual
Life Ins Co Litigation, 841 F Supp 345 (WD Wash
1994), aff’d mem, 54 F 3d 786 (9th Cir 1995); Bryan v.
Seiffert, 185 Okla 496, 94 P 2d 526 (1939); Pollock v.
Manufacturers & Traders Trust Co, 154 Misc 67, 276
NYS 363 (1934).
4. This duty is regulated by statute in many
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E. Duty to furnish information. Restatement
§ 173.
2. This duty requires a trustee to provide
complete and accurate information regarding the
administration of the trust. “The beneficiaries are entitled to know what the trust property is and how the
trustee has dealt with it.” Scott § 173 at 462-464.
3. This topic generated considerable traffic
on the ACTEC-GEN list-serve during November 2001.
Fellows were interested in whether and how they
might assist clients who preferred to keep the terms of
a trust, or even its very existence, from being known by
the beneficiaries.
a. One Fellow mentioned that he was
involved in a case where the trustees were accused of
concealing the fact that a person was a potential beneficiary of the trust. Despite extraordinarily good
investment performance, the remoteness of any possibility that a distribution would be made to the person
involved, and no finding of bad faith, the trial court
removed one corporate trustee and surcharged both the
corporate and individual trustees. (Apparently the case
is on appeal.)
b. Also, in Karpf v. Karpf, 240 Neb 302,
481 NW 2d 891 (1992), where a statute mandated disclosure of the trust’s existence to the beneficiaries, the
trustee’s failure to do so was held to be a breach of
c. Fellows seemed to conclude that the
only way to keep a trust’s existence and terms from
being known by the beneficiary is by using an offshore
trust, the governing law of which might permit complete withholding of information.
4. According to Comment b, “The trustee is
privileged to refrain from communicating to the beneficiary information acquired by the trustee at his own
expense and for his own protection. Thus, he is privileged to refrain from communicating to the beneficiary
opinions of counsel obtained by him at his own
expense and for his own protection.”
a. In Moeller v. Superior Court (Sanwa
Bank), 947 P2d 279 (Cal 1997), the attorney-client
privilege for confidential communications between a
predecessor trustee and its counsel passed to the successor trustee. The court suggested that a trustee can
avoid any problem resulting from such disclosure by
retaining and paying counsel with his own funds for
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legal advice that is personal in nature.
b. However, in Wells Fargo Bank, NA v.
Superior Court, 990 P 2d 591 (Cal 2000), the court
held that a trustee was not required to produce privileged communications on the subjects of trust administration and possible misconduct in order to fulfill its
duties to report to the beneficiaries on the trust and its
administration. The fact that the legal advice had been
paid for by the trust apparently had no effect on the
court’s decision.
c. See generally, Report of the Special
Study Committee on Professional Responsibility,
Counseling the Fiduciary, 28 Real Prop, Prob & Trust J
825, 848-855 (1994); Hamel, Louis H., Jr., “Trustee’s
Privileged Counsel: A Rebuttal,” 21 ACTEC Notes 156
(1995); Gibbs, Charles F. & Cindy D. Hanson, “The
Fiduciary Exception to a Trustee’s Attorney/Client
Privilege,” 21 ACTEC Notes 236 (1995); Gibbs,
Charles F., “The Attorney/Client Privilege and the
Fiduciary Exception–The Latest Word,” 21 ACTEC
Notes 307 (1996); and Reid, Rust E., William R.
Mureiko & D’Ana H. Mikeska, “Privilege and Confidentiality Issues When a Lawyer Represents a Fiduciary,” 30 Real Prop, Prob & Trust J 541 (Winter 1996).
F. Duty to exercise reasonable care and skill.
Restatement § 174.
2. Note that the Restatement standard is that
of a prudent person dealing with his own property. In
many states that standard has been changed by statute
to that of a prudent person dealing with the property of
another. (UPC § 7-302 requires a trustee to observe
the standards that would be observed by a prudent man
dealing with the property of another.)
3. If a trustee has greater skills that those of
an ordinary prudent person, he is under a duty to use
those skills and will be liable for a loss resulting from
a failure to use those skills.
4. Comment b states: “Whether the trustee is
prudent in the doing of an act depends on the circumstances as they reasonably appear to him at the time
when he does the act and not at some subsequent time
when his conduct is called in question.”
G. Duty to take and keep control. Restatement
§ 175.
2. A trustee is ordinarily under a duty to take
and keep possession of tangible personal property
owned by the trust.
a. This duty is sometimes ignored or
overlooked when tangible personal property located in
a residence, such as artwork, continues to remain in
the residence occupied by the beneficiary.
b. Proper drafting can make sure that the
trustee’s duty to take and keep control of tangibles is
waived for items the settlor intends for the beneficiary
to use and enjoy.
3. This duty can lead to potential liability for
the trustee, as under CERCLA.
4. Where reasonable to do so, the trustee
may entrust possession of trust property to the
trustee’s attorney, broker, banker, or other agent.
Comment e.
5. This duty also includes the responsibility
to designate property as trust property.
H. Duty to preserve the trust property. Restatement § 176.
2. Consistent with his duty to use appropriate care and skill, it is a trustee’s duty to protect the
trust property from loss, damage, or other diminution
in value. Examples include:
a. Physical loss of trust property, such as
loss of a stock certificate.
b. Failure to procure appropriate insurance against casualty loss.
c. Legal loss of trust property from failure to pay taxes or a mortgage. On the subject of a
trustee’s duties to minimize taxes, see Ascher, Mark
L., “The Fiduciary Duty to Minimize Taxes,” 20 Real
Prop, Prob & Trust J 663 (1985).
d. Loss in value from failure to make
repairs necessary to preserve property.
3. If there are insufficient funds in the trust
estate with which to pay expenses necessary to preserve the trust property, the trustee may:
a. Raise the funds from the trust property by mortgage, sale, or otherwise; or,
b. Notify the beneficiaries in order to
give them the chance to advance the money.
I. Duty to enforce claims. Restatement § 177.
2. This duty applies to:
a. Claims against any predecessor
b. Claims against the executor or personal representative of a decedent/trustor;
c. Tort claims; and,
d. Contract claims.
3. If a claim cannot be collected in full or it
appears doubtful that it is enforceable, the trustee can
compromise the claim or submit it to arbitration.
4. If it appears reasonable to do so, the
trustee need not file suit or appeal an adverse lower
court decision.
J. Duty to defend actions. Restatement § 178.
2. A trustee is obligated to appeal an adverse
decision to a higher court, unless under all the circumstances it is unreasonable not to appeal.
3. A trustee can properly compromise or
arbitrate claims against the trust if it appears to be for
the benefit of the beneficiary.
4. A trustee can properly pay a claim, even
though it appears not to be enforceable, if the cost and
risk incurred in defending the claim are unreasonable.
5. Also, “It is the duty of the trustee to the
beneficiaries of the trust to prevent the destruction of
the trust. Thus, where the settlor or his successors in
interest seek to rescind the trust on the ground that the
settlor was induced by undue influence or mistake to
create the trust, it is the duty of the trustee to defend
the trust and resist the proceeding to the extent to
which it is reasonable to require him to do so.” Scott §
178 at 496.
K. Duty to keep trust property separate. Restatement § 179.
2. This duty requires that the trustee:
a. Keep the trust property separate from
his own property;
b. Keep the trust property separate from
property held upon other trusts; and,
c. Earmark the trust property as property
of the trust.
3. Comment d states:
The trust property should be ordinarily so earmarked as to indicate not
only that it is trust property but that it
is property of the particular trust
upon which it is held. Thus, it is
ordinarily not sufficient that the
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trustee should take title to the property in the name of the trustee “as
trustee” without indicating the particular trust upon which it is held. It
should be taken in the name of the
trustee as “trustee under the will of”
the settlor, or “as trustee under a certain deed of trust” or “as trustee for”
certain beneficiaries.
4. However, the terms of the trust instrument
may authorize the trustee to hold the trust property in
his own name without designating the particular trust
or even that it is held in trust at all. Therefore, absent
statutory authority (which now exists in most states), if
securities are to be held in street name with a brokerage
house, the trust instrument must permit the trustee to
hold trust property in the name of a third person and to
register trust securities in the name of a nominee.
5. Commingling assets of various trusts is
generally impermissible under this section.
L. Duty with respect to bank deposits. Restatement § 180.
2. Scott observes that “A trustee cannot
properly lend trust money without security. In a sense
a deposit in a bank is a loan to the bank of the money
deposited.” Scott § 180 at 526. However, if a deposit
is insured by a federal agency, it is not improper as an
unsecured loan. Id at 539. (See Note, “The Responsibilities of a Lawyer or Fiduciary with Respect to
Estate Funds over the Amount Insured by the FDIC,” 7
Conn Prob LJ 183 (1992).)
3. Nevertheless, a trustee can deposit funds
in a bank, subject to the trustee’s responsibility to
exercise reasonable care and skill. Those responsibilities extend to selection of the bank, earmarking any
deposits, not leaving funds uninvested for too long,
and not precluding withdrawals.
M. Duty to make the trust property productive.
Restatement 3d § 181.
2. Comment a to this revised section states:
Productivity generally. A trustee is
normally under a duty to manage trust
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property so that the trust estate can
reasonably be expected to produce a
total return that is consistent with
objectives of caution and impartiality
as appropriate to the particular trust
and its purposes, requirements, and
The objectives of total return encompass not only income productivity but
also returns to principal, with these
competing interests being balanced in
a way that is appropriate to the particular trust. The principal objectives
involve preservation of the corpus,
which normally includes a general
goal of protecting its purchasing
power (that is, protection of real rather
than merely dollar value). In some
trusts these objectives may even support a goal of enhancing real value.
Fulfillment of a trust’s combination of
income and principal objectives, of
course, need not be assured by the
trustee’s investment program. The
ability to realize these dual objectives
will be particularly uncertain over any
given period of time, and most
notably with respect to principal
objectives. Thus, the duties of the
trustee require a careful balancing of
objectives and uncertainties, taking
account of the particular trust’s tolerance for volatility and other risks and
after giving due consideration to the
goals and circumstances of that trust.
3. The cited Comment makes it clear that
productivity applies not only to income but also to
principal. Moreover, productivity involves the concept of total return. Also, preservation of the value of
principal now involves protecting the trust’s purchasing power in real terms.
4. Land. Formerly, a trustee was normally
required to lease land or manage it to produce income.
However, under Restatement 3d section 181, “Questions of income productivity and impartiality are properly judged on the basis of the trust estate as a whole
rather than asset by asset.” Comment b. Thus, the
manner in which and the degree to which land must be
made productive depends on the purposes for which
the property is held. “Similarly, the existence, extent,
and nature of the trustee’s duty with respect to produc-
tivity of land are affected by whether the land is
improved and, if not, by the prospects of its being
leased or otherwise used productively in light of the
trustee’s possible authority to make improvements and
the realistic prospect of those improvements being
made.” Id.
5. Chattels. Unless the trust instrument
requires the trustee to preserve, distribute, or utilize
chattels (as in a business), the trustee has a duty to sell
or lease chattels. However, it may be proper for the
trustee to hold tangibles as part of the trust’s investment portfolio. Comment c.
6. Money. A trustee is normally required to
invest money so that it will produce income. However, reasonable delays in investing are permitted. Comment d.
N. Duty to pay income to beneficiary. Restatement § 182.
2. “The trustee can properly withhold a reasonable amount of the income to meet present or anticipated expenses which are properly chargeable to
income.” Comment a. “In order to equalize the
income from year to year he may estimate in advance
probable expenditures and build up a reserve to meet
such expenditures.” Scott § 182 at 551.
3. Trust provisions mandating accumulation
of income for a period longer than any applicable rule
against perpetuities are invalid. Restatement § 62,
Comment t.
4. Beneficiary under an incapacity. Scott §
182 at 552-555.
a. The trustee’s duty depends on the
terms of the trust instrument. If the trust instrument
requires payment of income, it is the trustee’s duty to
pay the income to the beneficiary’s guardian or conservator or to the court. (However, if the trustee
applies the income for the support of the beneficiary,
he will be entitled to credit in his accounting, because
otherwise the beneficiary would be unjustly enriched.)
b. If the trust instrument authorizes the
trustee to apply the income for the benefit of the incapacitated beneficiary, the trustee can do so without
paying the income to the beneficiary’s guardian.
c. If the trustee is directed to apply the
income for the benefit of an incapacitated beneficiary,
he may not pay the income to the beneficiary’s
guardian, because that would be an improper delegation of the trustee’s duties.
d. But see UTC section 816(21), which
gives the trustee the authority to pay any amount dis-
tributable to a beneficiary who is under a legal disability by paying it directly, applying it for the beneficiary’s benefit, by paying it to the beneficiary’s conservator (or, if none, guardian), a custodian under the Uniform Transfers to Minors Act or custodial trustee
under the Uniform Custodial Trust Act (and for such
purpose to create either one), an adult relative or other
person who has physical custody of the beneficiary, or
by managing it as a separate fund.
O. Duty to deal impartially with beneficiaries.
Restatement 3d § 183.
2. This duty applies whether the interests of
the beneficiaries are simultaneous or successive.
Comment a.
3. The trust instrument may authorize the
trustee to favor the interests of one beneficiary over
another. Id.
P. Duty with respect to co-trustees. Restatement
3d § 184.
2. Generally, it is improper for one trustee to
allow a co-trustee to have such control of the trust
property as would enable that co-trustee to misappropriate it. Comment a. That is why, unless it is proper
to hold securities in the name of a nominee, trust property should be titled or registered in the names of all of
the trustees.
3. “Where there are several trustees, unless
the terms of the trust or of an applicable statute provide otherwise, action by all of them is necessary to
the exercise of powers conferred upon them.” Comment b. (See Uniform Trustee Powers Act.)
4. The trust instrument may authorize one or
more (but fewer than all) trustees to have possession or
control of trust property or to perform specific functions.
Q. Duty with respect to person holding power of
control. Restatement § 185.
2. The person holding the power to control
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the actions of the trustee may be a co- trustee, a beneficiary, the settlor, or a third person otherwise unconnected with the trust.
3. The trustee’s duty under this section
depends on whether the person who possesses the
power holds it in a purely personal capacity or in a
fiduciary capacity.
a. Power held personally. “Where the
holder of the power holds it solely for his own benefit,
the trustee can properly comply and is under a duty to
comply with his directions, provided that the attempted exercise of the power does not violate the terms of
the trust.” Scott § 185 at 574.
b. Power held as a fiduciary. “But where
the holder of the power holds it as a fiduciary, the
trustee is not justified in complying with his directions
if the trustee knows or ought to know that the holder of
the power is violating his duty to the beneficiaries as
fiduciary in giving the directions.” Id. The trustee is
under a duty to take reasonable steps to inquire
whether the power holder is violating his fiduciary
duty to the beneficiaries.
c. See discussion of UTC § 808(b) supra.
A. In general.
1. Exculpatory clauses are also sometimes
referred to as “immunity” clauses.
2. Professor Bogert describes two types of
exculpatory clauses:
a. “One provides that the trustee is not to
be accountable to anyone for his actions. This type of
clause is not upheld.” Bogert, George Gleason &
George Taylor Bogert, The Law of Trusts and Trustees
§ 542 (2d ed 1979) at 188.
b. “The second type of exculpatory
clause provides that the trustee is not to be liable for
specified acts or certain conduct.” Id. at 189.
3. Professor Bogert also observes that “It
would doubtless be regarded as against public policy to
excuse a trustee from liability for the consequences of
willful negligence or default, or bad faith or gross negligence.” [Footnote omitted.] Id. at 208.
4. Exculpatory clauses are strictly construed
by the courts. In Re Trusteeship of Williams, 591 NW
2d 743 (Minn Ct App 1999).
1. Exculpation of Trustee. UTC § 1008.
(a) A term of the trust relieving the
trustee of liability for breach of trust is unenforceable to the extent that it:
(1) relieves the trustee of liability
for breach of trust committed in bad faith or with
reckless indifference to the purposes of the trust or
the interests of the beneficiaries; or
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(2) was inserted as the result of an
abuse by the trustee of a fiduciary or confidential
relationship to the settlor.
(b) An exculpatory term drafted or
caused to be drafted by the trustee is invalid as an
abuse of a fiduciary or confidential relationship
unless the trustee proves that the exculpatory term
is fair under the circumstances and that its existence and contents were adequately communicated
to the settlor.
2. Note, however, that under UTC section
105(10), the terms of the trust instrument cannot prevail over the effect of an exculpatory term under this
3. Whether an exculpatory term has been
“drafted or caused to be drafted by the trustee” is sure
to spawn litigation.
a. If a professional fiduciary refers a
prospective trust customer to an estate planning attorney who drafts a trust, has any exculpatory term in the
trust instrument been “caused to be drafted by the
b. Regardless of how the client comes to
the estate planning lawyer, if that lawyer uses the professional fiduciary’s trust form and the trust instrument
names as trustee the professional fiduciary whose form
was used, was any exculpatory provision “caused to be
drafted by the trustee”?
4. How will a trustee ever prove that an
exculpatory term is “fair under the circumstances”?
a. “Fair” to whom? Presumably, it will
be fairness to the beneficiaries that will be the test.
That presents a serious problem for any trustee,
because it would seem that an exculpatory provision
would never be fair to the beneficiaries if the alternative is that the beneficiaries would have a cause of
action against the trustee for breach of trust.
b. What “circumstances”? When are the
circumstances to be determined? Are they the circumstances at the time the trust is created? Or are they the
circumstances at the time when what would otherwise
be a breach of trust occurs?
5. How will the trustee ever prove that the
“existence and contents” of an exculpatory provision
were adequately communicated to the settlor?
a. Should exculpatory provisions be separately identified and initialed by the settlor?
b. What is the drafting attorney’s responsibility to the trustee, if any, for ensuring that the existence and contents of an exculpatory term were adequately disclosed?
6. Note also that UTC section 1106 contemplates that the UTC will apply to all trusts created
before, on, or after enactment in a particular state. It is
not clear if and how the limited exceptions to retroac-
tivity might apply to exculpatory clauses and acts performed in reliance thereon.
C. Restatement.
1. In general, the trustee can be relieved of
liability for a breach of trust by use of an exculpatory
provision in the trust instrument. Restatement § 222.
2. However, an exculpatory provision cannot
relieve the trustee of liability:
a. For a breach of trust committed in bad
b. For a breach of trust committed intentionally;
c. For a breach of trust committed with
reckless indifference to the interest of the beneficiary;
d. For any profit which the trustee
derives from a breach of trust. Id.
3. An exculpatory provision is ineffective to
the extent inserted in the instrument as the result of the
trustee’s abuse of a fiduciary or confidential relationship to the settlor. Id.
4. Furthermore, exculpatory provisions are
strictly construed. Id., Comment a.
A. In general.
1. “A fiduciary bond is a signed promise to
be personally responsible for carrying out certain
obligations. It neither increases nor decreases the
trustee’s general fiduciary responsibility nor does it
affect the trustee’s liability. … It may be appropriate
to have a surety on the bond. A surety is either an individual or a company who agrees to be responsible (up
to the dollar limits specified in the bond) in the event
the beneficiary cannot be made whole in an action
against the trustee. Surety fees are a proper trust
expense generally charged to trust income.” [Footnote
omitted.] Rounds, Charles E., Jr., Loring A Trustee’s
Handbook (1999 ed., Panel Publishers) § at 73.
2. Most states now have statutes that obviate
the need for a trustee to file a bond. See Bogert,
George Gleason & George Taylor Bogert, The Law of
Trusts and Trustees § 151 (2d ed 1979).
1. Trustee’s Bond. UTC § 702.
(a) A trustee shall give bond to secure
performance of the trustee’s duties only if the court
finds that a bond is needed to protect the interests
of the beneficiaries or is required by the terms of
the trust and the court has not dispensed with the
(b) The court may specify the amount
of a bond, its liabilities, and whether sureties are
necessary. The court may modify or terminate a
bond at any time.
[(c) A regulated financial-service institution qualified to do business in this State need not
give bond, even if required by the terms of the trust.]
2. Thus, if the trust instrument is silent on the
issue, under the UTC no bond is required of the trustee
unless the court finds it necessary to protect the interests of the beneficiaries. Query: if the trust instrument
is silent on the issue of bond, does a new trustee have
any duty to bring the issue to the attention of a court of
competent jurisdiction?
C. Restatement. The Restatement is essentially
silent on the subject of a fidelity bond. Its only reference is in Comment b to § 107 where a trustee’s refusal
to give bond, if required, is grounds for removal.
A. Personal liability. “A person is subject to personal liability if an action can be maintained against
him as an individual and his individual property can be
subjected by judicial proceedings to the satisfaction of
a judgment entered therein.” Restatement § 261, Comment a.
B. Liability in a representative capacity. “If a
person is subject to liability only in a representative
capacity, an action cannot be maintained against him
as an individual and his individual property cannot be
reached by judicial process, but only such property as
he holds in his representative capacity can be reached.”
A. General rules.
Restatement § 244.
a. The right to indemnity applies to
expenses incurred in:
(1) Defending suits to set aside the
trust, to terminate the trust prematurely, and to remove
the trustee without justification.
(2) Defending or prosecuting actions
for the benefit of the trust, where the litigation is not
the trustee’s fault.
(3) Obtaining the advice of counsel to
aid in the administration of the trust, where such
advice is not required as a result of the trustee’s own
(4) Making repairs or improvements
to trust property or paying commissions in connection
with the sale of trust property.
(5) Employing agents. Scott § 244 at
b. A trustee’s right to indemnity may
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take the form of exoneration or reimbursement.
Restatement § 244, Comment b.
What is the right of indemnity? I
apprehend that in equity, at all events,
it is not a right of the trustee to be
indemnified only after he has made
the necessary payments…but that he
is entitled to be indemnified, not
merely against the payments actually
made, but against his liability…. It
seems to me, therefore, that a trustee
has a right to resort in the first
instance to the trust estate to enable
him to make the necessary payments
to the person whom he employs to
assist him in the administration of the
trust estate; that he is not bound in the
first instance to pay those persons out
of his own pocket, and then recoup
himself out of the trust estate, but that
he can properly in the first instance
resort to the trust estate, and pay those
persons whom he has properly
employed the proper remuneration out
of the trust estate.
In re Blundell, 40 Ch D 370, 376
(1888), 44 Ch D 1 (1889); cited at Scott § 244 at 32728.
(1) Exoneration is the use of trust
property to discharge the liability in the first instance
so that the trustee will not be forced to use his individual property. Restatement § 244, Comment b.
(2) Reimbursement is repayment of
the trustee for use of his personal funds to discharge a
liability. Id.
c. The trustee has a security interest in
the trust property to the extent he is entitled to indemnity. Id., Comment c.
d. The rule applies even to spendthrift
trusts. Id., Comment d.
e. Any liability of the trustee for breach
of trust can be set off against the amount to which he
would otherwise be entitled for indemnity. Id., Comment e.
2. With the exceptions described below, the
trustee is not entitled to indemnity for his expenses
from the trust if those expenses were not properly
incurred. Restatement § 245.
a. The trustee is not entitled to indemnity for expenses in employing an agent to perform acts
which the trustee ought to perform personally. Id.,
Comment b.
b. The terms of the trust may permit the
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trustee to be indemnified by the trust estate for expenses incurred in good faith even though he is not empowered to incur such expenses. The expenses, however,
must not have been incurred in bad faith or with reckless indifference to the interest of the beneficiary. Id.,
Comment c.
3. “The trustee is entitled to indemnity for
expenses not properly incurred by him if and to the
extent to which he has thereby in good faith benefitted
the trust estate.” Scott § 245.1 at 338.
a. This exception requires that the
trustee act in good faith and that there be a benefit to
the trust estate.
(1) However, under certain circumstances it may be inequitable to the beneficiary to permit the trustee to be indemnified. Those circumstances
(a) “[W]hether the trustee acted
in bad faith in incurring the expense.
(b) “[W]hether the trustee in
incurring the expense knew that he was not empowered to incur it.
(c) “[W]hether in incurring the
expense he reasonably believed that it was necessary to
do so for the preservation of the trust estate.
(d) “[W]hether the benefit has
been or can be realized in the form of money.
(e) “[W]hether indemnity can be
allowed without defeating or impairing the purposes of
the trust.” Restatement § 245, Comment g.
(2) Such benefit to the trust estate
may take the form of an increase in rental value or
sales value of the trust property. Id., Comment e.
(3) A benefit may also result from
preservation of value that would otherwise have been
diminished. Id, Comment f.
(4) The trustee may have to wait for
indemnity until the benefit he conferred has been realized. Id., Comment g.
b. “If such indemnity were not allowed,
the beneficiary would be unjustly enriched at the
expense of the trustee.” Id., Comment d.
4. “If the trustee exceeds his powers in incurring an expense, with the result that the trust estate is
benefitted thereby, but in such a manner that the beneficiaries are in a position to accept or reject the benefit,
the trustee is entitled to indemnity for the amount of
expense incurred if, but only if, the beneficiaries
accept the benefit.” Scott § 245.2 at 344. If the beneficiaries decline the benefit, the trustee is not entitled to
indemnity but is entitled to take the benefit. Restatement § 245, Comment i.
B. Indemnity for contractual liability.
1. The general rules discussed above with
respect to indemnity of the trustee apply in the area of
contractual liability. Restatement § 246. Thus, if a
contractual liability is properly incurred by the trustee
in the administration of the trust, the trustee is entitled
to indemnity. If the expense is not properly incurred,
the rules under Restatement § 245 apply.
2. “Although the trustee breaks a contract
properly made by him in the administration of the trust
and thereby incurs a liability for breach of contract, he
is entitled to indemnity to the extent to which he thereby benefitted the trust estate.” Restatement § 246,
Comment c.
C. Indemnity for tort liability.
1. The general rules discussed above with
respect to indemnity of the trustee also apply in the
area of liability in tort. Restatement § 247.
a. If a tort liability occurs in the proper
administration of the trust, and the trustee was not personally at fault in incurring the liability, the trustee is
entitled to indemnity. Id., Comment a.
b. Where tort liability to a third person
results from the act of the trustee’s properly employed
agent, the trustee is entitled to indemnity so long as the
trustee was not personally at fault. Id.
c. “If the trustee was at fault in incurring
the liability, he is not entitled to indemnity.” Id., Comment d.
2. If by failing to obtain liability insurance
the trustee has committed a breach of trust, he is not
entitled to indemnity to the extent the insurance he
should have obtained would have discharged the liability. Id., Comment e.
3. A trustee may be entitled to indemnity
from the trust estate for liability incurred from commission of an intentional tort. Id., Comment g.
a. The trustee must have intended that
the intentional tort would benefit the trust estate. Id.
b. The intentional tort must have actually
benefitted the trust estate. Id.
c. The trustee’s claim of indemnity is
still limited by the amount of benefit conferred upon
the trust estate, and indemnity must not be inequitable
under the circumstances. Id., Restatement § 245(2).
D. Indemnity for liability as a title holder of property.
1. The general rules discussed above with respect
to indemnity of the trustee apply by reason of holding
title to the trust property. Restatement § 248.
2. “If the trustee in breach of trust acquires or
holds property, he is not entitled to indemnity for liabilities incurred by him as holder of the title, unless the
beneficiary elects to take the property.” Id., Comment d.
“Thus if a trustee of shares of stock improperly takes the
shares in his individual name so that he becomes individually liable to pay calls or assessments with respect
to the shares, he is entitled to indemnity, since the ulti-
mate result would have been the same even if he had
properly taken the shares in his name as trustee. But if
the trustee purchases shares that he is not authorized to
purchase, and as a result he is compelled to pay an
assessment or call upon the shares, the beneficiary may
reject the shares and the trustee is not entitled to indemnity. But if the beneficiary accepts the shares he must
accept the burdens with the benefits and the trustee will
be entitled to indemnity.” Scott § 248 at 351.
E. Indemnity where trust estate is insufficient.
1. “In the case of a testamentary trust and
ordinarily in the case of a trust created inter vivos, the
trustee is not entitled to indemnity from the beneficiary personally in the absence of an agreement to the
contrary.” Restatement § 249, Comment a.
2. However, there are two exceptions to this
a. If there was an agreement between the
trustee and the beneficiary that the beneficiary would
indemnify the trustee, then the trustee is entitled to
indemnity from the beneficiary personally. Restatement § 249, Comment b.
(1) Such agreement can be expressed
in specific terms or may be inferred from all the circumstances. Id.
(2) Circumstances among those that
may tend to evidence such an agreement are:
(a) “[T]hat the settlor is also the
sole beneficiary or one of the beneficiaries,
(b) “[T]he duty of the trustee was
not merely to care for the trust property but to conduct
a business involving considerable risk on the part of
the trustee, and
(c) “[T]hat the trust property was
shares of stock involving a possibility of calls or
assessments which might exceed the value of the
shares.” Id.
(d) An agreement regarding
indemnity between the beneficiary and the trustee is
normally interpreted as applying only to liabilities
incurred in the proper administration of the trust. Id.
b. Likewise, if the trustee has distributed property to the beneficiary without deducting
the amount to which he is entitled as indemnity, he is
entitled to indemnity from the beneficiary personally
to the extent of the property so conveyed. Restatement
§ 249(2).
(1) This rule does not apply if the
trustee has indicated his intent to forego any claim to
indemnity. Id.
(2) Nor does this rule apply if the
beneficiary has so changed his position that it is
inequitable to require him to indemnify the trustee. Id.
(3) Although neither the Restatement nor Scott speaks to this point, it would appear that
ACTEC Journal 115
the trustee’s delay in seeking indemnity from the beneficiaries personally could result in his being estopped
from making a claim for indemnity. Similarly, delay
by the trustee is the single factor most likely to allow
the beneficiary to change his position, thereby rendering indemnification inequitable. Query: is a refunding
provision incorporated in a trustee’s instrument of distribution or the beneficiary’s receipt and release sufficient to preserve the trustee’s right to indemnity from
the beneficiary personally, despite the passage of what
otherwise would be considered an inordinate time?
(4) “If the trust property would be
insufficient to indemnify the trustee, he is not under a
duty to incur a liability unless the beneficiaries are
willing to indemnify him.” Scott § 249.1 at 358.
A. Personal liability to third persons. THE
Restatement § 261.
1. The rule applies to the three typical ways
(listed below) in which obligations to third persons
generally arise in the administration of a trust. However, it also applies to other liabilities incurred in the
administration of the trust. Id., Comment c.
a. Contracts made by the trustee.
b. Torts committed by the trustee.
c. Ownership of the property held in
2. “Although the trustee is personally liable
to third persons on obligations incurred by him in the
administration of the trust, he is entitled to indemnity
out of the trust estate if the liability was properly
incurred by him.” Restatement § 261, Comment b.
3. Note, however, that this general rule may
be limited or negated by statute. See UPC § 7-306.
B. Contract liability. EXCEPT AS STATED IN § 263,
1. “Where a trustee in the administration of
the trust makes a contract with a third person, the
trustee is personally liable on the contract in the
absence of a stipulation in the contract relieving him
from personal liability.” Scott § 262 at 418. “Thus,
even if the third party knows that the contract was
made by the trustee in the administration and for the
benefit of the trust, the trustee is personally liable.” Id.
at 420-21.
2. This rule applies whether or not the trustee
is properly performing his duties when he enters into
ACTEC Journal 116
the contract. Restatement § 262, Comment a.
3. The trustee’s personal liability does not
depend on whether the existence of the trust or the
names of the beneficiaries are known to the third party.
4. If the liability was properly incurred by
the trustee in the administration of the trust, he is entitled to indemnity from the trust. Restatement § 246.
However, the trustee remains personally liable even if
the trust estate is insufficient to indemnify him, unless
the contract expressly or impliedly provides otherwise.
Restatement § 262, Comment b.
5. UPC section 7-306(a) significantly limits
the trustee’s liability in contract: “Unless otherwise
provided in the contract, a trustee is not personally
liable on contracts properly entered into in his fiduciary capacity in the course of administration of the trust
estate unless he fails to reveal his representative capacity and identify the trust estate in the contract. The
Comment to UPC section 7-306 indicates that the purpose of the section is to make the liability of the trust
and the trustee the same as that of a decedent’s estate
and its personal representative.
1. This rule applies regardless of whether the
tort was intentional or negligent or whether the trustee
was without fault, whether his conduct was an action
or inaction, and whether or not he violated any duty as
trustee. Id., Comment a.
2. The principle of respondeat superior
applies to torts committed by agents or employees of
the trustee. Restatement § 264, Comment b.
3. If the liability was properly incurred by
the trustee in the administration of the trust, he is entitled to indemnity from the trust. Restatement § 247.
However, the trustee remains personally liable even if
the trust estate is insufficient to indemnify him.
Restatement § 264, Comment c.
4. It is possible that breach of fiduciary duty
may itself become an independent tort. See Hartlove
v. Maryland School for the Blind, 111 Md App 310,
681 A 2d 584 (1996), citing the Restatement of the Law
(Second) Torts § 874.
5. UPC section 7-306(b) significantly limits
the trustee’s liability in tort: “A trustee is personally
liable…for torts committed in the course of administration of the trust estate only if he is personally at
D. Property liability. WHERE A LIABILITY TO THIRD
1. Unless and to the extent otherwise provided by the trust instrument, a trustee is entitled to
indemnity from the trust property for expenses properly incurred in the administration of the trust. Restatement § 244. Liabilities incurred by reason of the
trustee’s holding title to property are within the scope
of the right to indemnity. Restatement § 248.
2. However, unlike the unlimited personal
liability to third parties for the trustee’s contracts and
torts, the trustee’s liability to third parties arising from
holding title to trust property is generally limited to the
extent to which the trust estate is sufficient to indemnify him. Restatement § 265, Comment a.
a. This rule applies to property taxes.
Restatement § 265, Comment b.
b. It also applies to assessments on
shareholders, if the shares are registered in the name of
the person as trustee. Restatement § 265, Comment c.
c. The most financially devastating area
in which this type of liability is not limited to the value
of the trust estate has recently arisen is environmental
liability under the Comprehensive Environmental
Response, Compensation, and Liability Act of 1980,
42 USC §§ 9601 et seq. (“CERCLA”). See generally
Packer, Thomas A. & James W. Miller, Jr., “Inheritance of Contaminated Property: Blessing or Curse?,”
10 Prob & Prop 13 (Oct/Nov. 1996) [hereinafter cited
as “Packer”]; Note, “The Expansive Reach of CERCLA Liability: Potential Liability of Executors of
Wills and Inter Vivos and Testamentary Trustees,” 55
Albany L Rev. 143 (1991).
(1) Under CERCLA § 9607(a), liability is imposed on four classes of persons:
(a) Current owners or operators
of contaminated property;
(b) Owners or operators of the
property at the time when hazardous waste disposal
(c) Persons who arrange for disposal or treatment of hazardous substances at the property; and,
(d) Persons who accepted hazardous substances for transport to the property.
(2) “Just as an executor or conservator’s CERCLA liability is typically limited to estate
assets, a trustee’s liability is typically limited to trust
assets. See Restatement §§ 264, 265. The trustee’s
personal liability will turn on whether the trustee is a
‘responsible person’ under 42 United States Code section 9607(a). Some courts have required no more than
a confirmation that the trust assets include contaminated property to impose liability. Other courts have
sought more significant indicia of ownership, such as
control of the contaminated property. A review of
trustee cases reveals that trustee liability under CERCLA appears to be expanding.” Packer at 17-18, followed by analysis of cases arising from trustee status
and on indicia of ownership.
d. In September 1996 Congress limited a
trustee’s personal liability under CERCLA by enacting
the Asset Conservation, Lender Liability, and Deposit
Insurance Protection Act of 1996, §§ 2501-2505 of the
Omnibus Consolidated Appropriations Act, Pub L
104-208, 110 Stat 3009.
(1) Under current law, a trustee’s personal liability under CERCLA is limited to the value
of the assets in the trust estate.
(2) A trustee may still be personally
liable under CERCLA to the extent that the trustee’s
own negligence caused a release of a hazardous substance. Environmental case law highlights the difficulty of identifying the scope of the trustee’s liability
caused by his own negligence. See discussion in Matter of Bell Petroleum Services, Inc., 3 F 3d 889 (5th Cir
(3) The new negligence standard fails
to clarify the extent to which a trustee must investigate,
discover, and remediate suspected contamination of
trust property to be relieved from personal liability.
Under 42 United States Code section 9607(n)(4), there
are safe harbors which will protect the fiduciary from
personal liability:
(a) Undertaking or directing
another person to undertake a cleanup.
(b) Responding to an agency
enforcement order.
(c) Terminating the fiduciary
d) Incorporating special environmental provisions (including indemnification of the
fiduciary) into the trust agreement.
(e) Inspecting the trust property.
(f) Providing financial or other
advice to the trust grantor or beneficiaries.
(g) Administering trust property
which was contaminated before the fiduciary relationship began.
(h) Declining to take any action
listed in 42 United States Code section 9607(n)(4).
3. UPC section 7-306(b) significantly limits
the trustee’s liability arising from ownership of property: “A trustee is personally liable for obligations arising from ownership of property of the trust estate…in
the course of administration of the trust estate only if
he is personally at fault.”
ACTEC Journal 117
A. Breach of trust. A trustee is liable to beneficiaries for any loss to the trust estate resulting from a
breach of trust committed by the trustee. Scott § 201.
1. A breach of trust is a violation by the
trustee of any duty which as trustee he owes to the beneficiary. Restatement § 201.
a. A breach of trust normally results if
the trustee intentionally or negligently does what he
ought not to do or fails to do what he ought to do. Id,
Comment a. “In the world of trusts, an intentional
breach is usually two breaches: a breach of the duty of
loyalty coupled with some other breach…. The breach
of the duty of loyalty never travels alone…. Like the
intentional breach, the negligent breach is actually two
or more breaches: a breach of the duty to be generally
prudent in conducting the affairs of the trust couple
with some other breach.” Rounds, Charles E., Jr., Loring A Trustee’s Handbook (1999 ed, Panel Publishers)
§§ 7.2.1 and 7.2.2 at 215.
b. However, if a trustee acts under a mistake of law or fact, a breach of trust can occur even
where the trustee is not personally at fault. Id.
(1) A trustee commits a breach of
trust where he violates a duty resulting from his mistake regarding the extent of his duties and powers. Id.,
Comment b.
(a) Neither the trustee’s good
faith nor advice of counsel is a defense. Id.
(b) Liability regarding the extent
of the trustee’s duties and powers is avoided by submitting the matter to the advisory jurisdiction of the
court. Scott § 201 at 221.
(2) A breach of trust can also be committed as a result of mistake of fact or law concerning
the exercise of the trustee’s powers or performance of
his duties. Restatement § 201, Comment c. Here,
however, negligence is required to subject the trustee
to liability for breach of trust. Proper care and caution
in the exercise of powers or performance of duties
avoid liability. Id.
B. Nonliability for loss in the absence of a breach
of trust.
2. “A trustee is not a guarantor of the value
of the trust property. He is not liable unless he has violated some duty owed by him to the beneficiaries. If a
loss to the trust estate is not due to his failure to exercise reasonable care and skill to preserve the trust
property or to some other breach of trust, he is not subject to a surcharge.” Scott § 204 at 234.
ACTEC Journal 118
a. This rule applies in the case of the
trustee’s investment in property which depreciates in
value, if the trustee did not commit a breach of trust in
making or in continuing to hold the investment. Id.
b. It also applies to the trustee’s failure to
make a profit. Scott § 205.
C. Trustee’s liability in case of breach of trust.
1. A trustee who commits a breach of trust is:
TRUST (SEE § 206). Id.
3. The beneficiary’s remedies are alternative
in that the beneficiary has the option of affirming the
transaction or surcharging the trustee. Id., Comment a.
4. If the beneficiary is under an incapacity,
the court will enforce the remedy which in its opinion
is the most advantageous to the beneficiary and most
likely to accomplish the purposes of the trust. Restatement 3d § 205, Comment b.
5. This rule applies to trust income as well as
to principal. “Thus, if the trustee in breach of trust
fails to make the trust property productive he is liable
for the amount of income which he would have
received if he had not committed the breach of trust
(see § 207).” Restatement 3d § 205, Comment i.
A. Successor trustee.
1. The general rule is that a successor trustee
is not liable for a breach of trust committed by a predecessor trustee. Restatement § 223.
2. However, a successor is liable for a predecessor’s breach of trust if he:
3. A successor trustee must take proper steps
to compel the predecessor to redress a breach of trust
(Continued on page 119)
Calendar of Events
2002 Regional and State Meetings
Florida Fellows Meeting
Hyatt Regency
Orlando, Florida
Carlyn S. McCaffrey
ACTEC President
Western Regional Meeting
Hilton La Jolla Torrey Pines
La Jolla, California
Robert J. Durham, Jr.
ACTEC Immediate
Past President
Mid-Atlantic Regional Meeting
Atlantic Sands Hotel
Rehoboth Beach, Delaware
Ronald D. Aucutt
ACTEC President-Elect
Quad State Regional Meeting
Sheraton Suites on the Plaza
Kansas City, Missouri
Robert J. Rosepink
ACTEC Vice President
September 25
Hawaii Fellows Meeting
Plaza Club
Honolulu, Hawaii
Southeast Regional Meeting
The Inn at Harbour Town
Hilton Head, South Carolina
Carlyn S. McCaffrey
ACTEC President
Ohio ACTEC Fellows Meeting
Hyatt Hotel
Cleveland, Ohio
Judith W. McCue
ACTEC Treasurer
November 25
Hawaii Fellows Meeting
Plaza Club
Honolulu, Hawaii
December 4
Iowa Fellows Annual Luncheon
Des Moines Club
Des Moines, Iowa
Carlyn S. McCaffrey
ACTEC President
December 13
New Orleans Fellows Dinner
New Orleans, Louisiana
In Memoriam
C. Henry Glovsky
Beverly, Massachusetts
Mannes F. Greenberg
Baltimore, Maryland
Any gift to the ACTEC Foundation made in the memory of a deceased Fellow will be acknowledged to the family.
ACTEC Journal C1
2003 Annual Meeting
Tuesday, March 4 through
Monday, March 10
El Conquistador Resort
and Country Club
Las Croabas, Puerto Rico
March 4
Committee meetings—
as scheduled in the afternoon
March 7
Committee meetings—
as scheduled in the afternoon
Open evening
March 8
Seminars, symposium, computer workshops, athletic events and tours
Dinner for 2002-2003 committee members
and their spouses/guests
March 5
March 6
President’s Welcome Reception
For registered Fellows and registered
Committee meetings—
as scheduled in the afternoon
Cocktail Reception and Dinner Dance
March 9
Seminars, Hot Topics, athletic events
and tours
State Chairs Meeting
Dinner for 2002-2003 Regents,
State Chairs and Past Presidents
and their spouses/guests
March 10
Board of Regents Meeting
Opening Breakfast and Annual
Business Meeting
Seminars, symposium, athletic events
and tours
Committee meetings—
as scheduled in the afternoon
Committee meetings—
as scheduled throughout the day
Athletic events and tours
Theme Party
ACTEC Journal C2
Seminars, Trachtman Lecture, computer
workshops, athletic events and tours
2003 Summer Meeting
The 2003 Summer Meeting will be held in Saint
Paul, Minnesota’s capital city. With its beautiful natural setting along the Mississippi River, Saint Paul is a
charming, historic river city with interesting architecture, world-class theaters, museums, river cruises and
award-winning dining.
Saint Paul is truly a big city with small town
charm. The quaint neighborhoods and family values
are its cornerstone. Art, museums and many historical landmarks make Saint Paul a cultural hot spot. It
was home to F. Scott Fitzgerald, Charles M. Schulz
and John Dillinger. John Dillinger? That’s right,
John Dillinger made Saint Paul his home when
things were too hot in Chicago. This is just one of
Thursday, June 26 through
Sunday, June 29
Radisson Riverfront Hotel St. Paul and
The Saint Paul Hotel
St. Paul, Minnesota
June 25
June 26
the fascinating facts you will learn about Minnesota’s capital city.
Minneapolis/Saint Paul International Airport is
just 81 ⁄2 miles from downtown Saint Paul, a 15-minute
taxi or shuttle ride. The airport is served by nine commercial airlines which offer service from any part of
the 48 contiguous states in less than four hours and less
than 11 ⁄2 hours from anywhere in the Midwest. Major
highways (Interstates 94 and 35E) run through downtown Saint Paul, also making it easily accessible by car
from all parts of the country.
Further information regarding hotel reservations
and our unique tours in the Twin Cities area will be
sent to you in December.
Historic St. Paul Homes—
Tour the James J. Hill House and the
Alexander Ramsey House.
Historic Houses of Worship—Visit St.
Paul Cathedral and other religious
institutions of architectural acclaim
along Summit Avenue.
Minnesota Zephyr Dinner Train—
Journey back in time to the era of the
late 1940s
President’s Welcome Reception
For all Fellows and spouses/guests—
as scheduled in the evening
Historic Landmark Center
Committee meetings—
as scheduled in the afternoon
Stillwater: Birthplace of Minnesota—
Find the warmth of the past in this
enchanting river town on the St. Croix.
Committee meetings—
as scheduled throughout the day
June 28
Gangster Tour—See where Dillinger,
Baby Face Nelson and other Prohibition
gangsters cooled off.
Twin Cities Highlights Tour—
Experience Twin Cities diversity; with
contemporary skylines, pastoral settings, sparkling lakes and waterways.
Taylor’s Fall Canoeing—A relaxing
afternoon on the St. Croix River
Mississippi River Dinner Cruise—
Relive the Great Steamboat Era while
enjoying sites along the river.
June 27
Private Summit Avenue House Tour—
Discover Saint Paul’s historic
European charm.
Professional Program—
to be announced
Committee meetings—
as scheduled throughout the day
Cocktail Reception and Dinner
For all Fellows and spouses/guests—
Committee meetings—
as scheduled in the morning
June 29
Cooking Demonstration/Garden Tour—
A demonstration at Cooks on Crocus
Hill followed by a wonderful private
garden tour.
ACTEC Journal C3
ACTEC National Meeting Schedule
February 27–March 4
La Quinta Resort & Club
La Quinta, California
(February 25*)
June 27–30
The Waldorf-Astoria
New York, New York
October 9–14
Westin La Paloma
Tucson, Arizona
March 5–10
El Conquistador Resort
and Country Club
Las Croabas, Puerto Rico
(March 3*)
June 26–29
Radisson Riverfront Hotel/
The Saint Paul Hotel
St. Paul, Minnesota
October 29–November 3
Charleston Place/
The Mills House
Charleston, South Carolina
March 10–15
Westin La Cantera
San Antonio, Texas
(March 8*)
July 8–11
Fairmont Empress/
Hotel Grand Pacific
Victoria, B.C., Canada
October 20–25
Omni William Penn
Pittsburgh, Pennsylvania
February 23–28
Hyatt Regency
Grand Cypress Hotel
Orlando, Florida
(February 21*)
June 23–26
The Westin Hotel
Michigan Avenue
Chicago, Illinois
October 19–24
Amelia Island Plantation
Amelia Island, Florida
March 8–13
Grand Wailea Resort
Maui, Hawaii
(March 6*)
July 6–9
Millennium Biltmore Hotel
Los Angeles, California
October 11-16
Providence, Rhode Island
March 7–12
The Westin Kierland
Resort & Spa
Scottsdale, Arizona
To be determined
To be determined
March 5–10
Boca Raton Resort and Club
Boca Raton, Florida
(March 3*)
To be determined
To be determined
March 4–9
The Westin Mission Hills
Rancho Mirage, California
(March 2*)
To be determined
To be determined
* Committee members early arrival
ACTEC Journal C4
(Continued from page 118)
committed by the predecessor, and the successor is
liable to the extent to which a loss results from his failure to take such steps. Id., Comment d.
4. “A successor trustee is liable for breach of
trust if he neglects to take proper steps to compel the
sureties on his predecessor’s bond to indemnify the
trust estate for liabilities incurred through a breach of
trust committed by his predecessor.” Scott § 223.3 at
B. Breach of trust by co-trustee.
1. The general rule is that a trustee is not
liable to the beneficiary for a breach of trust committed
by a co-trustee. Restatement § 224.
2. However, there are several exceptions. A
trustee will be liable for acts of his co- trustee, if he:
3. Where several trustees are liable for a joint
breach of trust or for a breach of trust by a co-trustee
under the rules described above, their liability to the
beneficiary is joint and several. Id., Comment a.
C. Acts of agents. See generally Bennett, Charles
M., “When the Fiduciary’s Agent Errs–Who Pays the
Bill–Fiduciary, Agent, or Beneficiary?” 28 Real Prop
Prob and Trust LJ 429 (1993).
1. With certain exceptions, the trustee is not
liable to the beneficiary for acts of the trustee’s agents
employed in the administration of the trust. Restatement § 225(1).
2. Those exceptions involve an agent’s act,
which if done by the trustee would constitute a breach
of trust, if the trustee:
ment § 225(2)(a)-(f).
3. Accordingly, under appropriate circumstances, a trustee may not be liable for acts of his agent.
See Russell v. Rici, 213 N E 2d 566 (Ill 1966) (trustee
blameless for loss on conversion of sales proceeds
where he properly delegated authority to attorney to
exchange deed upon payment of purchase price).
4. However, an error of the agent may constitute a breach of trust by the trustee. See Estate of
Lohm, 269 A 2d 451 (Pa 1970) (co-executors guilty of
negligence where untimely filed estate tax return resulted in loss to estate; reliance on properly retained counsel does not excuse failure to ascertain crucial filing
dates, as trustees should have known that tax returns
were due). Presumably there would have been no
trustee liability if the return had been filed on a timely
basis but asserted positions that resulted in penalties to
the estate, as the co-executors would not have been
expected to know that the positions were wrong.
5. Restatement § 225(2) limits liability to acts
of agents “which if done by the trustee would constitute
a breach of trust.” Given this language, is a trustee
liable if he improperly delegates to an agent who acts
reasonably but nevertheless causes a loss? It seems
strange the Restatement would approve improper delegation so long as the agent acts reasonably. Comment a
further confuses the issue and implies that a trustee is
always liable for improper delegation: “[A trustee] is
not liable to the beneficiary for losses resulting from the
improper conduct of the agent, unless the trustee is
himself guilty of a breach of trust. The trustee is himself guilty of a breach of trust under the circumstances
stated in Subsection (2) and is liable therefor.” Thus,
any of the actions or inactions listed above is itself a
breach of trust for which the trustee is liable.
6. A corporate trustee is liable to the beneficiary for acts or omissions of its own officers and
employees committed in the course of their employment. However, they are not considered agents in the
administration of the trust for purposes of this rule.
Restatement § 225, Comment b.
D. Payments or conveyances made to persons
other than the beneficiary.
2. This rule applies to trust income as well as
to trust principal. It also applies whether the payment
ACTEC Journal 119
or conveyance is made at or before termination of the
trust. Id, Comment a.
3. Reasonable mistake of fact or law does not
absolve the trustee. Restatement § 226, Comment b.
4. If a creditor of a beneficiary has acquired a
ACTEC Journal 120
legitimate lien on the beneficiary’s interest and the
trustee has notice of the lien, the trustee is liable to the
creditor if he pays or conveys income or property to the
beneficiary. Restatement § 226, Comment e. However, this is an area governed by statute in many states.
Total Return Unitrusts: Is This a Solution in
Search of a Problem?
by Alvin J. Golden*
Austin, Texas
I. INTRODUCTION . . . . . . . . . . . . . . . . . . . .122
II. PURPOSE AND SCOPE . . . . . . . . . . . . . . .123
A. Qualities to Be Possessed by the
Draftsman . . . . . . . . . . . . . . . . . . . . . . . .123
B. Determine the Needs of the Client . . . . .124
C. Determine How Those Needs Can
Best Be Accomplished . . . . . . . . . . . . . . .124
D. Assist the Client in Choosing a Trustee 124
A. Definition of Private Unitrust . . . . . . . .124
B. A Brief History . . . . . . . . . . . . . . . . . . . .124
1. Prudent Man Theory . . . . . . . . . . . . .124
2. Prudent Investor Rule . . . . . . . . . . . . .125
C. Modern Portfolio Theory . . . . . . . . . . . .125
1. The General Rule . . . . . . . . . . . . . . . .125
2. Diversification and Risks . . . . . . . . . .125
3. The Efficient Capital Market
Hypothesis (ECMH) . . . . . . . . . . . . .126
THE USE OF UNITRUSTS . . . . . . . . . . . .127
A. Some of the Principal Players . . . . . . . .127
B. The Arguments for the Unitrust . . . . . .127
1. The Unfairness of the “All Income”
Requirement . . . . . . . . . . . . . . . . . . . .127
2. Simplifies Investment Decision
Making and Distributions . . . . . . . . . .127
3. Elimination of Friction . . . . . . . . . . . .128
C. The Arguments Against the Routine
Use of Unitrusts . . . . . . . . . . . . . . . . . . . .128
1. Inflexibility . . . . . . . . . . . . . . . . . . . . .128
2. Discretion Is Usually Given
Even in a Unitrust . . . . . . . . . . . . . . .128
3. Protection of the Trustee . . . . . . . . . .128
4. Assumes a Financial Portfolio . . . . . .129
5. Difficulty of Administration . . . . . . . .129
*Copyright 2002. Alvin J. Golden. All rights reserved. Appendices
to this article are posted on the ACTEC Web site at
A. The Theory is Untested . . . . . . . . . . . . .129
B. Trusts That Are Invested the Same
Way Produce the Same Result . . . . . . . .129
C. Ignores Human Nature . . . . . . . . . . . . . .130
D. Bull Markets Make the Unitrust Hum. . .130
A. Types of Trusts . . . . . . . . . . . . . . . . . . . .130
1. Unitrusts . . . . . . . . . . . . . . . . . . . . . . .130
2. Fixed Payout Trusts Not Tied to
Value or Market Averages . . . . . . . . .130
3. Trusts with a Discretionary
Distribution Standard . . . . . . . . . . . . .130
4. Fixed Payout Based on Market
Averages . . . . . . . . . . . . . . . . . . . . . . .130
5. The “Give-Me-Five” Trust . . . . . . . . .131
B. Economic Considerations . . . . . . . . . . .131
1. History as a Predictor . . . . . . . . . . . . .131
2. Use of Averages in Projections . . . . .131
3. Volatility . . . . . . . . . . . . . . . . . . . . . . .132
4. Inability to Protect the Real Value . . .133
5. “Excess” Distributions of Bond
Interest . . . . . . . . . . . . . . . . . . . . . . . .133
6. A Summary of the Effects of the
Various Policies . . . . . . . . . . . . . . . . .133
THOUGHT ABOUT . . . . . . . . . . . . . . . .134
A. Focus Should Be on the “Real”
Beneficiary . . . . . . . . . . . . . . . . . . . . . . .134
1. Understanding the Difference Between
Distributions, Spending and Return . . .134
2. Understanding Whether the Client’s
Desires Can Be Met . . . . . . . . . . . . . .134
3. Real Returns . . . . . . . . . . . . . . . . . . . .135
4. Costs . . . . . . . . . . . . . . . . . . . . . . . . . .135
B. The One Thing the Beneficiary of a
4% Unitrust Never Gets Is 4% . . . . . . .135
1. Effect of Smoothing . . . . . . . . . . . . . .135
2. Effect of Tax Allocation. . . . . . . . . . .135
GENERAL . . . . . . . . . . . . . . . . . . . . . . . . .135
ACTEC Journal 121
X. UPAIA . . . . . . . . . . . . . . . . . . . . . . . . . . . . .136
A. The Power to Reallocate . . . . . . . . . . . . .136
1. Trustee’s Power to Reallocate —
UPAIA §104 . . . . . . . . . . . . . . . . . . .136
2. Exception to Trustee’s Power
to Reallocate . . . . . . . . . . . . . . . . . . . .136
3. Application to Existing Trusts . . . . . .136
4. Judicial Control of Discretionary
Powers — New UPAIA §105 . . . . . . .137
5. Will Trustees Exercise This
Discretion? . . . . . . . . . . . . . . . . . . . . .137
6. How Will the Trustee Exercise
This Discretion? . . . . . . . . . . . . . . . . .137
XI. STATE OPT-IN STATUTES . . . . . . . . . . . .138
A. New York’s Initial Attempt . . . . . . . . . .138
B. The Variations Among States . . . . . . . . .138
C. Considerations Prior to Converting . . .138
1. Desire of the Beneficiaries . . . . . . . . .138
2. Availability of UPAIA §104 . . . . . . . .138
3. Composition of the Trust . . . . . . . . . .138
4. Projections . . . . . . . . . . . . . . . . . . . . .138
INCOME” TRUST . . . . . . . . . . . . . . . . . .138
A. Amendment to Definition of Income . . .139
B. Capital Gains Allocated to DNI and
Capital Losses . . . . . . . . . . . . . . . . . . . . .139
C. Distributions in Kind . . . . . . . . . . . . . . .139
D. Charitable Remainder Unitrust . . . . . .139
E. Marital Deduction Provisions . . . . . . . .140
F. GST Regulations . . . . . . . . . . . . . . . . . . .140
G. Qualified Domestic Trust . . . . . . . . . . . .140
FORMULATIONS . . . . . . . . . . . . . . . . . .140
A. Solutions to the Statutorily Mandated
All Income Trusts . . . . . . . . . . . . . . . . . .141
1. Discretionary Principal Distribution .141
2. Formula Distributions . . . . . . . . . . . .141
3. Redefine Income . . . . . . . . . . . . . . . .141
4. Powers of Appointment . . . . . . . . . . .142
B. Conventional Solutions Where All
Income Is Not Mandated . . . . . . . . . . . .142
1. Total Discretion Trusts . . . . . . . . . . . .142
2. Distributions According to Standard . . .142
3. Formula Distributions . . . . . . . . . . . .142
4. Powers of Appointment . . . . . . . . . . .142
C. The Give-Me-Five Approach . . . . . . . . .142
1. Underlying Theories . . . . . . . . . . . . .143
2. Use with All Income Trusts, et. al. . . .143
3. Use as Marital Trust. . . . . . . . . . . . . .143
4. Flexibility and Easing of Tensions . . .143
ACTEC Journal 122
A Sample Clause . . . . . . . . . . . . . . . .143
Creditor Protection . . . . . . . . . . . . . . .143
Transfer Tax Avoidance . . . . . . . . . . .144
Income Tax and Grantor Trust Issues . .144
Assumes Financial Corpus . . . . . . . . .144
A. Hoisington Provisions
(as Modified by Golden) . . . . . . . . . . . . .144
1. Discretionary Distributions Not to
Exceed Certain Percentage of Value . .144
2. Discretionary Distributions Not to
Exceed Fixed (Inflation Adjusted)
Amount . . . . . . . . . . . . . . . . . . . . . . .145
3. The Fixed Percent of Market Value . .146
4. Indexed Annuity . . . . . . . . . . . . . . . . .147
5. Market Performance Unitrust . . . . . . .147
B. The Northern Trust Forms . . . . . . . . . .148
XV. CONCLUSION . . . . . . . . . . . . . . . . . . . . .148
A. The Economic Conclusions . . . . . . . . . .148
B. Fixing Existing Trusts . . . . . . . . . . . . . .148
C. The Drafting Conclusions . . . . . . . . . . .148
D. The Bottom Line . . . . . . . . . . . . . . . . . . .149
In conceptualizing the structure of a trust, draftsmen have pictured an income interest followed by a
remainder interest, even though the income recipient
and the remainderman may be one and the same. Thus,
traditional trust drafting has long concentrated on the
distinction between income and principal, and has often
set different standards for the disbursement of each.
This traditional approach has been adopted in the tax
laws also.1 Subchapter J relies in many instances on the
concept of trust accounting income. The QTIP rules
mandate that the spouse has a right to receive all the
income and the QSST rules likewise require the distribution of all income. State statutes also rely on the distinction between income and principal; e.g., the rules in
the Texas Trust Code for trust accounting and the “prudent man” standard. Equally as important, trustees traditionally have made investment decisions to produce a
certain level of income. However, in this brave new
world of modern portfolio theory, the investment gurus
preach overall return without regard to such time-honored distinctions. This approach is indeed adopted in
Restatement of the Law of Trusts, Third, and the Uniform Prudent Investor Act (“UPIA”).
However, the tax laws are adapting to the need for investing for
overall return as reflected in the proposed regulations under §643(b).
Most of the literature dealing with private unitrusts
is written by persons with a definite point of view, and,
while sometimes attempting to be somewhat evenhanded, they still advocate the particular author’s
viewpoint. While this paper (which is now in its sixth
iteration and still developing) started out to present a
bipartisan approach, I would be less than honest if I did
not admit up front that I have, as my thinking evolved,
developed a definite viewpoint. Thus, this paper takes
the position that the fixed return unitrust should not be
the default drafting method for dealing with the sufficiency of distributions to the income beneficiary.
More importantly, however, is the feeling (expressed
throughout the paper) that the real solution is for the
draftsman to spend more time talking to the client in
depth about what the client is trying to accomplish
with the trust, and then draft to accomplish that goal.
Hopefully, then, this discussion will also cause practitioners to rethink the manner in which trusts are drafted and to encourage draftsmen to cause the client to
focus more sharply on the client’s desires rather than
lapsing into the automatic formulations—all income
and HEMS principal, total trustee discretion as to
either income, principal or both, unitrusts or annuity
trusts.2 Particularly in these times following the passage of EGTRRA in which the possibility of repeal of
the estate tax looms, it becomes even more important
that documents reflect the desires of the testator or
grantor as well as tax considerations. This outline will
examine some of the various options available for the
design of private (as opposed to charitable) unitrusts,
as well as the considerations of reconciling traditional
trust concepts with modern portfolio theory. It will
delve briefly into modern portfolio theory, prudent
investor standards, and some comments on the 1997
Uniform Principal and Income Act (“UPAIA”). It will
also discuss the new proposed regulations under Internal Revenue Code §643(b) as they impact the availability of unitrusts and the application of UPAIA §104.
The broader question which this paper will attempt to
Professor Dobris at the University of California Davis Law
School has noted the same necessity:
In the past, the garden variety trustee of an “income to A
remainder to B” trust would create a conservative portfolio,
enabling him to pay the traditional income to A and when A died,
pay the remainder to B. The more conscientious trustee might try
to come to an understanding of what the settlor intended and what
the income beneficiary wanted, and structure the investments
accordingly. Modern Portfolio Theory notwithstanding, trustees
will likely continue to operate in the way described. There will be,
however, more pressure on lawyers to discuss with the clients the
clients’ ideas about what kind of income stream the trust is expect2
answer is, “Is the unitrust an answer to the problem in
the current investment environment, or is it merely a
solution in search of a problem to solve?”
In the immediately following portions of the paper,
modern portfolio theory and its underlying economic
theory will be discussed. The rationale behind the
growth of unitrusts will also be explored and critically
analyzed. What, you may legitimately ask, is the relevance to me as an estate planner to develop an understanding of the basics of underlying financial theory
and the arguments for and against unitrusts? “Why
should I care about efficient markets when I do not
advise clients about their investments?” The answer
could be that we should all thirst for knowledge, but it
really is not. The answer is that, as competition
increases from financial planners, CPAs and other professionals (and some not so professional), the focus of
the attorney must change and increased skills must be
brought to bear. And, if you are to use unitrusts in
drafting, you should understand some of the effects
that are not readily apparent when reading articles by
the advocates of that technique.
A. Qualities to be Possessed by the Draftsman
In his Heckerling Institute article,3 William
Hoisington, a California lawyer who was one of the
first and is still a leading advocate for fixed return unitrusts, lists five skills the estate planner must have to
develop a successful distribution formula:
(1) a reasonably clear understanding of the
settlor’s human and financial objectives for the trust,
(2) a reasonably clear understanding of the
personal circumstances and financial needs of the trust
beneficiaries (present and future),
(3) some understanding of modern financial
principals and the supporting empirical data,
(4) a reasonably clear understanding of the
investment strategies that are likely to be employed by
the trustee and of the probable financial consequences
of each of those strategies, and
ed to provide for the life tenant and what kind of value is to go to
the remainder beneficiary. To the extent that lawyers currently
steer clear of discussions of investment return and the financial
role of the trust in the beneficiaries’ lives, that is likely to change
over the next decades. (Emphasis added)
Dobris, Changes of the Role and the Form of the Trust in the
New Millennium, Or, We Don’t Have to Think of England Anymore,
62 Albany L.R. 543 (1998), at 570, fn. 125.
Hoisington. “Modern Trust Design: New Paradigms for the
21st Century,” 31st University of Miami Heckerling Institute on
Estate Planning ¶603 (1997)
ACTEC Journal 123
(5) expert level knowledge of the alternative
distribution designs and constituent distribution formulas that may be used to implement the settlor’s
human and financial objectives for the trust.
B. Determine the Needs of the Client
For too many years, the focus of estate planning attorneys has been more on complying with tax
statutes and less on really analyzing what the client is
trying to accomplish with the trust. In some cases,
such as a QTIP trust with the surviving spouse as
trustee, the desire of the client is easily manifest. It is
not so easy in a second marriage situation with a nonspousal trustee, especially if the trustee is a child by
the first marriage. It is also not so easy to determine
the desires of the client when the beneficiary is a child
or other descendant. Many clients today worry that
their children will have no incentive to be productive
citizens if they can rely on the trust, and those clients
desire that the trust be designed to avoid that result to
the extent possible, while still providing some benefits.
C. Determine How Those Needs Can Best Be
If the estate planner is truly to meet the needs
of the client as far as payouts (distributions) from the
trust, the attorney must understand the economics
which will be necessary to produce those returns, and
the economic effects of the approach employed,
whether it be discretionary, ascertainable standard,
unitrust, annuity trust, etc. Does this mean that the
attorney should also take on the role of the investment
advisor? ABSOLUTELY NOT! It has long been
accepted that the attorney must understand the various
insurance products and the different purposes each
serves without any thought that he was replacing the
life underwriter. The same is true of the relationship
with the financial planner or investment advisor.
D. Assist the Client in Choosing a Trustee
A critical choice in this process is the choice of
the Trustee. There are many factors involved in deciding whether to choose a family member, a close friend
(almost never a good idea) or an institution, or some
sort of co-trustee arrangements. The choice of trustee
will affect, or in many cases dictate, the distribution
formula and the availability of UPAIA §104. Removal
and replacement powers are also of utmost importance.
When used generically, “unitrust” also includes an annuity
It could be argued that a mandatory income trust which
allows distributions of principal based upon a health, education,
maintenance and support standard is a unitrust in that the beneficiary is provided for irrespective of the income of the trust. However, the fact that the beneficiary has a right to all the income (and,
conversely, that all the income MUST be distributed), argues
ACTEC Journal 124
No third party trustee should ever be appointed that
someone does not have the right to remove.
A. Definition of Private Unitrust
The inclination is to think of private unitrusts
in the same terms as charitable unitrusts; i.e., a trust
with a fixed return to the current beneficiary.4 However, for purposes of this paper, a private unitrust is any
trust other than a trust which draws a distinction
between income and principal in establishing a distribution standard. The most common trust which is not a
unitrust is a mandatory income distribution trust with or
without any power to invade principal.5 As discussed
below, unitrusts can be used as a primary distribution
formula, or to supplement all income trusts. Unitrusts
can be as simple as a pure discretionary trust, or as
complex as a trust in which the distributions are dependent upon market performance by tying distributions to
earnings, such as a percentage of the average dividends
paid by companies listed on the Standard & Poor’s 500
Index. In actuality, the use of §104 of UPAIA converts
a standard all income trust to a unitrust, but not necessarily one in which the return is determined by a fixed
percentage which cannot vary from year to year.
B. A Brief History
1. Prudent Man6 Theory
The development of the all-income standard
probably descends from an agrarian society in which
wealth was the land and, after putting back funds needed for next year’s crop (plus perhaps a reserve against
weather and other natural disasters), the remaining
money could be spent without diminution of capital.
In line with that, one of the leading aphorisms in
regard to investing, “spend income but protect principal,” was embodied in the prudent man rule adopted by
Restatement of the Law of Trusts, Second, in §227,
which mandated a trustee:
to make such investments and only
such investments as a prudent man
would make of his own property having in view the preservation of the
estate and the amount and the regularity of the income derived therefrom.
[Emphasis added.]7
against this kind of trust being treated as a unitrust.
With apologies for not being politically correct (i.e., referring to the rule as the “Prudent Person Rule),” I simply use the term
utilized in the statutes and Restatement.
It might be possible to argue that preservation of capital
includes protecting it from inflation, but it is doubtful that was the
meaning contemplated by the Restatement.
The Texas Prudent Man Rule, adopted in 1983
with the codification of the Texas Trust Code,
§113.056(a), is a hybrid of the prudent man rule, since
it commands a trustee to invest:
Under the prudent investor standard, the
trustee is still bound by the duties of loyalty and impar-
tiality. See Restatement of the Law of Trusts, Third
§227, and the comments thereunder. Restating the
obvious, the prudent investor standard still holds the
trustee to a duty of prudence, while redefining what
constitutes prudence.
C. Modern Portfolio Theory9
The driving force behind the rise of the prudent investor rule is the advent of modern portfolio
theory. This aggregate of economic theories is based
upon the idea that the financial markets are efficient (a
term of art) and that the investor will choose investments based upon diversification and degree of acceptable risk. While these are concepts in which the estate
planning attorney has not usually dealt, they are concepts which drive the debate over the use of unitrusts
in estate planning.
1. The General Rule
Traditional investment philosophy was
that a sophisticated investor, by studying past performance and analyzing relevant data, particularly price
data, could find undervalued stocks or stocks that were
about to increase in value because of growth of the
company, and stay ahead of the market averages.
While some portfolios may have been diversified,
diversification was not a central concern. But diversification is one of the centerpieces of modern portfolio
theory. In addition to an emphasis on diversification,
modern portfolio theory posits that the market is “efficient,” and to an extent a “random walk” (both theories
discussed below), and thus the successful investor does
not get that way by picking and choosing individual
issues, but rather by diversification, reduction of risk,
and reduction of volatility.
2. Diversification and Risks
One of the guiding principles under modern portfolio theory is that investors, particularly institutional investors, are risk averse. This does not mean
This rule is set forth in the completely revised §227 of
Restatement, Third as follows:
The trustee is under a duty to the beneficiaries to invest and mange the funds of the
trust as a prudent investor would, in light of the
purposes, terms, distribution requirements, and
other circumstances of the trust.
(a) This standard requires the exercise of
reasonable care, skill, and caution, and is to be
applied to investments not in isolation but in
the context of the trust portfolio and as a part
of an overall investment strategy, which should
incorporate risk and return objectives reasonably suitable to the trust.
(b) In making and implementing investment decisions, the trustee has a duty to diversify the investments of the trust unless, under
the circumstances, it is prudent not to do so.
(c) In addition, the trustee must:
(1) act with prudence in
deciding whether and how to delegate authority and in the selection and supervision of
agents (§171); and
(2) incur only costs that
are reasonable in amount and appropriate to
the investment responsibilities of the trusteeship (§188).
(d) The trustee’s duties under this Section
are subject to the rule of §228, dealing primarily with contrary investment provisions of a
trust or statute.
Much of the material in this section is based upon Macey,
An Introduction to Modern Financial Theory, 2d Edition, published
by the American College of Trust and Estate Counsel Foundation.
A copy may be obtained from the Foundation at 3415 S. Sepulveda
Blvd., Suite 330, Los Angeles, CA 90034.
...not in regard to speculation, but in
regard to the permanent distribution of
their funds, considering the probable
income from, as well as the probable
increase in value and the safety of
their capital. [Emphasis added.]
2. Prudent Investor Rule
In an increasingly service oriented and information driven society, and in an environment in which
the returns (dividends) on stocks are low, along with
relatively low interest rates on fixed income securities,
a different philosophy has taken hold. This theory,
which derives from modern portfolio theory, is known
as the prudent investor rule8 and is set forth in §2(a) of
the Uniform Prudent Investor Act (“UPIA”). The rule
has three basic tenets as its underpinnings:
1. Trustees should invest for total
2. The investments must be suitable
to the purposes of the trust (emphasis
added); and
3. In determining whether the trustee
has acted with prudence, the entire
portfolio must be examined, rather
than an asset by asset valuation.
ACTEC Journal 125
that investors do not take risks; rather that the intelligent investor determines the amount of risk the investor
is willing to take, and then structures the investments in
the portfolio to that level of risk. The balancing of risk
and return is what determines the price an investor is
willing to pay. There are basically two kinds of risks,
firm specific risk and systematic risk.
a. Firm Specific Risk
Firm specific risk can be almost
entirely eliminated with diversification, which is nothing more than following the old adage about not
putting all of your eggs in one basket. Enron is a perfect example of firm specific risk; i.e., that any particular company’s value can be influenced by factors peculiar to that company. Firm specific risk theory can also
be applied to industry groups. For example, if your
investments are all in oil stocks, and the price of oil
drops, then the value of the portfolio will drop also.
But if your portfolio also contains utility stocks, which
are likely to improve if the cost of fuel drops, then you
have substantially reduced firm specific risk because
the loss in value of part of the portfolio is offset by the
rise in value of another part. Studies have shown that it
does not require a great deal of diversification to
almost eliminate firm specific risk. As few as ten
stocks, properly diversified, will eliminate 88.5% of
the firm specific risk, while twenty stocks will eliminate 94% of such risk.
b. Systematic Risk
Systematic risk cannot be diversified
away nearly so easily. This is the type of risk which
occurs because the system itself reacts to an external
force; for example, an increase in interest rates by the
Federal Reserve or a general economic downturn.
Diversification into non-U.S. markets can, to some
extent, reduce systematic risk.
c. Balancing Risk and Return—The
Capital Asset Pricing Model
Again stating the obvious, an investor
will insist upon a greater return (or the chance of a
greater return) in direct proportion to the risk assumed.
Macey, supra, refers to this as “incremental happiness.” For instance, a gift of $100 to you now, while
appreciated, is less appreciated than a gift of $100 to
you while you were student. Suppose you had
$1,000,000 and someone offered to bet you $500,000
on a flip of a coin or a cut of the cards. Most people
would probably not take that wager, since the loss of
half your wealth is more terrifying than a 50% increase
in your wealth is rewarding. However, if the wager
were to double or triple your wealth on the upside, and
still only lose half on the downside, the proposition
becomes more attractive. That, basically, is how
stocks are priced—the investor determines that the
reward to be received is sufficient to risk his capital.
ACTEC Journal 126
d. Volatility
Diversification can also be used to
reduce volatility of the overall portfolio. As counterintuitive as it may seem, adding a dash of highly speculative stocks or foreign stocks to a portfolio may reduce
overall volatility because those stocks may well run
opposite to the domestic market as a whole. Reducing
volatility is simply another way of reducing risk.
3. The Efficient Capital Market Hypothesis
Modern portfolio theory depends upon the
efficiency of the market. ECMH holds that a market is
efficient if the prices of the goods sold in that market
fully reflect all available information about those
goods; i.e., when new information becomes available,
such new information is immediately reflected in the
price of goods. In these days of the Internet and rapid
communication, if ECMH is correct, the markets will
become even more efficient.
a. Weak Form Efficiency
Weak form efficiency holds that past
price performance is not a predictor of future price performance. This is the “random walk” theory, which
does not mean that stock prices are random, but rather
means that an investor cannot make a profit by using
past pricing to determine future value. As Professor
Macey describes it,
If you leave a drunken person in a field
and you want to find him later, how
should you go about looking for him?
If the assumption is that the drunk will
wander in a random pattern, then the
best place to begin a search is where
the drunk was last seen. That position
will produce an unbiased estimate of
the drunk’s future position.
Macey, supra, at 40.
In other words, ascertaining where the stock price
has been is not helpful since it does not predict where
it is likely to go.
b. Semi-Strong Form Efficiency
While weak form efficiency relies only
on one form of available data (price), semi-strong form
efficiency posits that the price immediately reflects all
publicly available data. Thus, an analyst, using such
data, cannot find “undervalued” stocks, because such
data is already reflected in the price of such stock.
There is strong empirical evidence that the weak form
and semi-strong form efficiency are valid hypotheses.
The emphasis on better accounting standards and
reporting will strengthen semi-strong efficiency.
c. Strong Form Efficiency.
Strong form efficiency takes the
ECMH to its logical conclusion. It holds that all information, both public and private, is immediately reflected in the price of the stock. If this form of efficiency
were true, then even insiders could not out perform
other investors. There is little empirical evidence that
this form of efficiency exists, but with the increase in
both amount and speed of available information, it will
become increasingly difficult for someone to possess
private information, and thus the markets will become
more efficient. A recent SEC rule requiring public disclosure of certain data to the public at the same time it
is disclosed to analysts and mutual fund managers is a
move in this direction.
AUTHOR’S NOTE: Does all this
market efficiency mean that the professional money manager is obsolete?
No. While there is little reality in the
hope that a money manager will find
undervalued stocks on a consistent
basis, there is still a certain amount of
skill and experience required to
assemble the properly diversified
portfolio for each individual investor.
A. Some of the Principal Players
Two of the principal attorneys involved in this
discussion are William Hoisington, a California attorney, and Robert Wolf of Pittsburgh, Pennsylvania, both
of whom are ACTEC Fellows and leading advocates
for the use of private unitrusts. Jerry Horn, of Peoria
Illinois, a past president of ACTEC, has also written on
this matter, but, as will be discussed below, his viewpoint differs markedly from that of Messrs. Hoisington
and Wolf. There are several economists and academicians involved in this debate also. Most prominent are
David Levine, former chief financial analyst for Sanford Bernstein & Co., and James P. Garland, an economist with the Jeffrey Company in Ohio. It is interesting to note that Messrs. Hoisington and Wolf favor the
fixed return unitrusts while the economists who have
weighed in on this matter believe that such trusts present serious problems.
B. The Arguments for the Unitrust
Two factors combined to create the impetus to
seek a nontraditional form of drafting for trust distributions—the rise of modern portfolio theory and the
Note that a decline in value has not produced an increase in
income in relation to values in the new millennium. If the present
market conditions continue for any substantial period of time, will
the unitrust appear nearly as attractive?
diminution of income in relation to increases in value
caused by the incredible bull market of the second half
of the 1990’s.10 This discussion continues on three levels—(i) the drafting of private unitrusts, (ii) legislation,
in those states which have adopted UPAIA, to allow
the conversion of existing trusts which use income as a
distribution standard to unitrusts (but not annuity
trusts) and/or allowing the trustee greater flexibility in
allocating between receipts between income and principal, and (iii) the almost lemming-like rush to adopt
legislation which will permit an existing “income rule”
trust to be converted to a unitrust. There are, as nearly
as I can discern, three principal arguments for the use
of unitrusts.
1. The Unfairness of the “All Income”
The tax statutes have for some time
required, and still require, that all of the income be
available (marital deduction trusts), or be actually
distributed (QSSTs) to the beneficiary of certain
kinds of trusts. This directs the Trustee, in effect, to
invest the trust in such manner as to produce a reasonable return for the income beneficiary. The
restriction on investments created by this approach is
in direct conflict with modern portfolio theory which
mandates investment for overall return. Further, in
the current environment, with low dividend yields
and falling interest rates, it is very difficult for the
Trustee to invest in such a way as to produce a reasonable return and still maintain the real11 value of
the trust. The private unitrust is thus seen as a
method to assure that the current beneficiary receives
a reasonable distribution. There are other, and I
believe better techniques which should be considered
in trying to obtain a fair distribution for the current
2. Simplifies Investment Decision Making
and Distributions
Since the trustee does not have to be concerned as to the character of the return produced, the
trustee may simply look for the best investment return,
and thus its decision making process is simplified
because the goal is straightforward. In fact, the underlying argument here is that the trustee can take a
greater position in equities because, as everyone
knows, in the long run equities produce a better return
than any other investment. As an additional benefit,
distributions are fixed by the instrument and therefore
(at least theoretically) easily determined.
“Real” as used herein means adjusted for inflation, while
“nominal” means that no time value is taken into account and dollars are expressed in constant terms.
ACTEC Journal 127
3. Elimination of Friction
The unitrust approach is advocated as a
“win-win” (or perhaps even “win-win-win”) approach
in that it eliminates friction between the current beneficiary and the remainder beneficiary, while a trust with
any real trustee discretion has the possibility (and perhaps even the probability) of creating friction every
time the trustee makes a distribution or investment
decision. In a unitrust environment, so the argument
goes, a trustee may invest for overall return without
regard to archaic distinctions between income and
principal. Thus, if the trustee is successful in increasing the value of the trust, the current beneficiary gets
larger distributions, the value of the remainder interest
increases, and everyone lives happily ever after. And,
if the value goes down, both classes of beneficiaries
suffer equally, thus providing company for everyone’s
misery (and a common enemy in the trustee who ought
to “do better” no matter what the market). Also, the
argument goes, the duty of impartiality is automatically satisfied.
The annuity trust is also designed to provide a fair return to the current distributee and usually
is designed to maintain the purchasing power of the
distribution through indexing. While the annuity trust
eliminates friction also, it does not have the same
effect of a rising tide lifting all ships. Whether the
value of the trust goes up or down, the annuity amount
remains constant, except as it may be adjusted for
changes in economic indices. Thus, if the value of the
trust increases at a pace greater than the index used, the
annuity distribution is a smaller portion of the trust.
On the other hand, if the value of the trust decreases,
the annuity distribution becomes a larger portion of the
trust. In a steep, prolonged decline, this formula could
seriously affect the viability of the trust. In almost any
environment, an annuity trust is counter-cyclical.
C. The Arguments Against the Routine Use of
The caption for this portion was carefully chosen. As noted earlier, unitrusts and annuity trusts are
not malum in se. Rather, they are an arrow in the estate
planner’s quiver to be used in those situations in which
they meet the testator or grantor’s carefully considered
goals, but only in those situations. However, they
should not be used routinely as the preferred default
technique for the following reasons.
1. Inflexibility
It is axiomatic that the best planning is the
most flexible planning, allowing the trustee to adjust
its actions (both as to investments and distributions) to
fit the situations that changing times present so that the
purposes of the trust may be carried out. The primary
problem with the unitrust and annuity trust approach is
the total lack of flexibility offered by such trusts. At
least in the income-principal formulation, the trustee
can affect the returns to the current beneficiary through
investment choices. In the unitrust scenario, the
trustee is mandated to pay a fixed percentage of the
value of the trust to the current beneficiary; and the
annuity trust mandates a fixed dollar amount without
regard to the value of the trust. Ten years ago, it would
have been impossible to have anticipated the state of
the investment markets in the last half of the 1990s,
although the decline in this millennium may have been
more predictable (except as to timing). How can we
advise our clients to establish long term trusts which
are inflexible?
In fact, it is this inflexibility that could
well negate the proposed benefit of easing friction
among classes of beneficiaries:
Although commentary implies that a total
return trust design coupled with a unitrust or indexed
annuity distribution formula mitigates the potential for
conflict between current and remainder beneficiaries,
such a result may not actually occur. Grantor selection
and trustee implementation of irrevocable distribution
formulae may create a level of antagonism between
beneficiary classes equal to that found in the more traditional net income trusts. The antagonism arises not
so much from the operation of the formula, but from its
initial selection and the ensuing consequences.12
2. Discretion Is Usually Given Even in a
To counter the inflexibility argument, leading proponents of the use of unitrusts also advocate that
the unitrust be given some flexibility by giving the
trustee discretion to make distributions in addition to
the unitrust amount. The mere presence of this discretion, in many cases, will create the same friction as an
“all income” trust with principal invasion powers.
3. Protection of the Trustee
This is a corollary to the lack of flexibility.
One “virtue” of the unitrust, as noted above, is it puts
all beneficiaries and the trustee on the same team,
thereby taking the trustee out of the middle. I submit
that the trustee is not paid to be taken out of the middle. The trustee is paid to exercise discretion in both
Collins, Savage, and Stampfli, “Financial Consequences of
Distribution Elections from Total Return Trusts,” 35 Real Property., Probate & Trust Journal 243, 249 (Summer 2000). This is an
excellent and well thought out article in which another group of
economists conclude that fixed return unitrusts do not make
economic sense. (Hereafter cited as “Collins.”) See also Collins
and Stampfli, “Promises and Pitfalls of Total Return Trusts,”
27 ACTEC Journal 205 (2001).
ACTEC Journal 128
the investment and distribution arena unless a conscious decision is made to limit discretion in one of
those areas. If the unitrust becomes the default drafting technique, the decision to remove discretion with
respect to distributions will cease to be a deliberate
(i.e., conscious) one. Note also that if there are allowable discretionary distributions in addition to the unitrust amount, the trustee is back in the middle.
4. Assumes a Financial Portfolio
All of the market formulas in the unitrust
assume that the trust estate is primarily financial assets
—traded securities, bonds and cash. Many trusts have
difficult to value assets which will not adapt to a fixed
percentage of market value, and perhaps these assets
will not even lend themselves to an annuity approach
or a formula based on the S&P average return and
bond returns (as discussed below). The valuation of
non-financial assets must be dealt with in the trust and
that may add a significant expense to the trust administration. Such expense will dramatically reduce return
because of the compounding effect. One obvious consideration is that a fixed return unitrust (regardless of
the formula) does not work well with non-financial
assets. This same problem is present with the GiveMe-Five Trust, discussed below.
a. Real Estate
If the trust contains income producing
real property, then so long as the income remains relatively stable, the trust can meet its obligations (assuming that the return to the beneficiary was not set too
high). In addition to the expense of reappraisals, a
slump in the real estate market or the ranching or farming business, depending upon the nature of the asset,
could make it impossible for the trustee to meet its
obligations. And, as a practical matter, the trustee, in
order to make required distributions, would then be
forced to sell off all of the real estate (or at least all of
one of the pieces of real estate) since there is no real
market for undivided interests. Or, to make distributions, the trustee might try to borrow, when obtaining
credit is very difficult, and borrowing to make distributions is of questionable prudence.13 The problem is
even greater if the trust has a large percentage of nonincome producing realty.
b. Oil and Gas
Oil and gas interests are probably the
least desirable type of asset to be used in a unitrust.
Because prices for these commodities are very volatile,
any sort of fixed payout will be very difficult to meet.
Valuation of these kinds of assets is also very difficult.
And a forced sale by the trustee in a down market
A. The Theory Is Untested
All of the sturm und drang surrounding the use
of the unitrust has arisen over the last few years. Thus,
the unitrusts created are largely non-operational, and, if
operational, have been in existence for only a short
period of time. Thus, it is far too early to say with any
certainty how these trusts will operate over a long period of time. I realize that this argument is advanced
against any new or different technique, and that, if new
techniques were not tried, there could be no progress.
However, I believe that the analysis has been basically
in the economic area, with little or no regard to the very
likely human component of trust distributions.
B. Trusts That Are Invested the Same Way
Produce the Same Result
Almost all the illustrations which are used to
A distribution of an undivided interest, while theoretically
possible, is not realistic. There are valuation issues, but, more
importantly, the trustee is no longer in total control of the Property.
Collins, at 269.
could prove disastrous.
c. Closely Held Business Interests
If a closely held business interest is
part of the trust estate, many of the same problems
exist as with real estate, especially if the trustee cannot
control the business’s dividend or distribution policy.
And there may well, and probably would be restrictions on disposition of such interest by the trustee,
even if there were a market.
d. Limited Partnership Interests
While a form of a closely held business interest, this type of asset has even more valuation
problems and if all the trustee holds is an assignee
interest, the problems are even greater. Again, since
the trustee may be unable to sell the asset, and cannot
even influence distributions, how can it meet a mandatory distribution standard?
5. Difficulty of Administration
While the advocates of unitrusts argue that
simplicity in administration is an attribute, these trusts
are, in reality, somewhat difficult to administer even
without hard to value assets, in that the trustee must be
very careful in the valuation of the assets in a unitrust or
the calculation of the annuity interest. Further, because
of the inflexibility of distributions, the trustee must
carefully monitor the trust and adjust investments so
that the cash flow to pay the fixed distributions in a unitrust can be maintained without jeopardizing the future
value of the trust. Since the distribution policy must
drive the asset allocation, the trustee must consistently
monitor the investments to assure the ability to meet the
fixed requirements of a unitrust or annuity trust.14
ACTEC Journal 129
demonstrate the superiority of investment performance
of the total return unitrust assume that the unitrust
(because there is no need to invest to produce income)
will be a largely equity based portfolio, while the “all
income” trust (because of the “need” to produce
income) will be invested at least one half in fixed
income which will not increase in value, and thus the
unitrust will outperform the all income trust. This is
only true if the trust provides for no principal distributions (and some relief such as UPAIA §104) is not
available. If the trustee has discretion to distribute principal to the income beneficiary, then the trustee is free
to invest for overall return. No matter what the distribution standard, two trusts invested in the same
manner will produce the same investment results.
The two trusts will not perform identically over the
long term because the distributions will be different, but
there is no way to compare such performance.
C. Ignores Human Nature
One of the arguments for the unitrust, as noted
above, is that all classes of beneficiaries prosper or suffer together and thereby peace and harmony will reign,
the income beneficiary sheep will lie down with the
remainderman lamb, and all beneficiaries will beat their
swords into plowshares and their spears into pruning
hooks. Of course, this ignores a basic tenet of human
behavior—greed is a stronger force than gravity.
D. Bull Markets Make the Unitrust Hum.
Advocates of the unitrust say that while there
may be some difficulties in a down market, there is no
doubt that a bull market will produce only happy beneficiaries as the distributions and the value of the trust
both rise. I submit that the following scenario is not
only reasonably possible, but reasonably probable:
Assume bull markets such as the last 5 years of the 20th
Century, and that in that time span the value of a
$3,000,000 portfolio increased in year one to
$3,750,000, while the 4% beneficiary’s distribution
increased from $120,000 to $150,000. And in year two,
the portfolio increased from $3,750,000 to $4,5000,00,
again producing a $30,000 increase in annual distributions. Now, the beneficiary looks around and says to
the trustee, “In the last two years the portfolio has
increased by $1.5 million, and I got a lousy $60,000
increase in distributions. I’m not going to live forever
you know, so I want more of the gravy now.” The flip
side, of course, is that in a bear market the current beneficiary is likely to ask, “Just because the value of the
trust went down, why should I suffer?” Somehow, I
doubt that the trustee’s explanation that it is following
There are several potential designs for total return
trusts, as set forth below in the drafting examples.
Each of these designs, of course, has its own economic
effects, but there are some general propositions which
can be applied to all. This section seeks to examine the
general types of total return trusts, along with certain
economic effects.
A. Types of Trusts
The total return trusts fall generally into five
1. Unitrusts
The distribution, or payout, is tied to the
market value of this type of trust, usually at annual
intervals. In order to avoid extreme short term swings,
it is generally suggested by the proponents of this trust
that some average over a period of time be used to create a “smoothing” effect. Generally, such terms are
three to five years.
2. Fixed Payout Trusts Not Tied to Value or
Market Averages
The annuity trust has the advantage of predictability and does not tie distributions to the current
value of the trust. As noted earlier, distributions from
this type of trust are almost always counter-cyclical,
and, in a prolonged downturn, could impair the viability of the trust.
3. Trusts with a Discretionary Distribution
These types of trust divide into basically
three types: (i) purely discretionary, (ii) mandatory
income with pure discretion as to principal, and (iii)
mandatory income with discretion as to principal limited to a standard such as HEMS. In each of these cases,
the trustee can invest for overall return because it has
the flexibility to make discretionary distributions. A
discretionary payout with a cap based on value might
have some of the best (or perhaps the worst) attributes
of the variations on fixed payout trusts.
4. Fixed Payout Based on Market Averages15
James P. Garland, while purporting to
argue against unitrusts, is really only opposed to the
fixed percentage of market value unitrusts. He actually favors the unitrust approach, but with a formula tied
to market performance. He argues that spending tied
This idea is vigorously supported by James P. Garland, who
has set out his position clearly and eloquently in Garland, “The
Problems with Unitrusts,” The Journal of Private Portfolio Man-
agement, Vol. I, No. 4, Spring, 1999. A helpful source of references is included at the end of the article for those interested in
delving more deeply into this morass.
ACTEC Journal 130
the trust design will suffice, any more than the explanation that the trustee cannot distribute more than the
HEMS standard in a discretionary trust employing that
standard satisfies the income beneficiary.
to value places the ability to provide for the income
beneficiary beyond control of the trustee, since it cannot control market fluctuations. In fact, two bad
results will accrue if the fixed percent of value unitrust
is used because of the desire of a trustee to avoid substantial swings in trust distributions: (i) practical considerations will force a trustee away from more equities, and (ii) the trustees will engage in market timing,
a proven failure under modern investing standards.
Finally, although troughs have been of relatively short
durations in recent years, the market has historically
experienced troughs as long as 10 years, and even
longer if adjusted for inflation. Therefore, Garland
champions a payout based upon some percentage of
earnings on the S&P 500 plus the real bond yield (perhaps averaged over some short period) of mid-term
treasury bonds. “Real bond yield” is the stated interest
rate on the bond less inflation; e.g., If the stated interest is 5%, and inflation is 3%, then the real bond yield
is 2%. By tying the return to earnings in the market
place, fluctuations are smoothed. And that is the basic
argument for this approach—that the amount of real
dollars received by the income beneficiary is predictable, even though the percent of value approach
could have produced much more in bull markets such
as we enjoyed until recently.
5. The “Give-Me-Five” Trust.
Jerry Horn is a staunch advocate of the
“Give-Me-Five” approach to distributions in which
the current beneficiary is given the right to draw
down up to 5% of the value of the trust, the 5% number being based on Code §2041(b) which allows the
lapse of a general power over 5% of a trust without
any adverse transfer tax results. Mr. Horn bases this
approach on the surmise that most clients would leave
property outright if given a choice, but there are real
asset protection, tax and other benefits to the use of
trusts. Therefore, the trust should come as close to
outright ownership as possible. He argues, as do I,
that the unitrust or annuity trust approach is too
inflexible, and this approach is his answer as to how
to let the trustee invest for total return and still maintain the desired flexibility. The pros and cons will be
discussed below in the drafting section. From an economic standpoint, this approach at least lets the beneficiary determine how much the payout from the trust
should be.
B. Economic Considerations
In contemplating the efficacy of a fixed percent of market value unitrust, there are certain economic realties and problems to be considered, some of
which may not be too obvious. These arguments are
succinctly summarized by David Levine and may be
found in Appendix C (see Table of Contents).
1. History as a Predictor
A centerpiece of the arguments as to the
type of unitrust, the spending policies and the efficacy
of such policies is the debate as to the reliability of history as a predictor. If, for instance, dividend policies
of the past could be arithmetically applied to the
future, dividend yields would eventually go to zero,
and price/earnings ratios would go to 300%. In that
environment, a fixed percent of value unitrust would
continue to work well. But remember that a fall in
prices has historically produced a higher dividend
yield as a percent of value. But prices have been
falling for over a year now, and not only have dividend
yields as a percent of value not risen, actual dividends
have been reduced or eliminated.
While I believe that historical trends can
be useful in certain areas, I also believe that they are
valid only in the short run.
Electing a distribution formula based
primarily on successful historical
results is not a good decision....When
suggested distribution formulae are
back tested against historical results,
the methodological flaw is known as
“data mining.”16
The one certainty is that things will
change. This belief that history is not an accurate predictor is the very heart and soul of the Random Walk
2. Use of Averages in Projections
In the vast majority of projections I have
seen of the long-term effects of the unitrust, an
assumed growth rate has been used to illustrate the
results of the unitrust over a long period of time.
Because of this, the illustration is at best misleading,
since the growth will not be steady, but, rather, it will
be cyclical. Thus, to fully understand the effects of the
unitrust, projections should contain some periods of
higher return and some of lower than the average anticipated long term growth. While the projections will
undoubtedly not be accurate as to the timing of the
cycles, it will demonstrate the distribution swings that
the beneficiary can expect and the effect of such
swings on the long term prospects of the trust. Projections without the cyclical calculations demonstrate a
fallacy referred to as the “expected value” fallacy.
That fallacy postulates that, based on historical data,
bad years will be offset by good years and, therefore,
Collins, at 245.
ACTEC Journal 131
wealth accumulations and portfolio distribution will
remain on track.
These principles are illustrated by the
graphs attached as Appendix B-1 through Appendix
B-12.18 These graphs use a three year smoothing formula and assume that capital gains are paid from the
trust and are not distributed as DNI. They are based
upon two investment paradigms—an all equity fund
represented by the S & P 500, and a “balanced” 60%
equity (represented by the S&P 500)-40% bond (represented by the Lehman Bros. intermediate bond index)
mix. There are three time periods shown, and it is particularly interesting to note the impact of the bull market of the last five years of the twentieth century and
the difference that the time period chosen makes.
Utilizing the almost 30-year time period
from 1973 through 2001, Appendix B-1 illustrates the
distributions to the beneficiary based upon actual S&P
performance versus average performance. For most of
the period, the actual performance distributions trailed
the compounded average of 12.01%, but in 1997, after
the lower years disappeared from the smoothing base,
the actual returns from the bull market of that period
surpassed the average. The same is true of the account
balance illustrated in Appendix B-2. The actual
account balance starts to exceed the average account
balance in 1995 (unrestrained by smoothing). But,
note that the drop in 2000 and 2001 was steep enough
to bring the actual year end value below the average
again. This is an accurate predictor of what will happen to distributions when the bull market years drop
out of the smoothing formula. And, even though the
actual total distributions to the beneficiary over that
period total more than the illustrated returns using the
compound average, the beneficiary’s actual distributions trail the average distributions by a substantial
amount. The balanced portfolio follows much the
same parameters, although the returns are less volatile,
but ending balances are substantially less. (See Appendices B-3 and B-4).
The 20-year period beginning in 1982
shows, not surprisingly, the same results as the longer
period, although the compounding rate of 15.24%
skews the results a little bit more. (See Appendices B4 to B-8.)
If, however, we choose the 20 year period
from 1973-1992 in which the average S&P compound
rate is 11.33%, then actual distributions always trail
the averages. This is also true in the balanced portfolio
model. (See Appendices B-9 to B-12.)
So what do all these numbers mean other
than that many of us who write in this area love to put
charts together. (Truth be told, I am not really that
fond of economic modeling.) The bottom line is that
the period chosen and the indices chosen dramatically
impact the results, and that averages have no relation to
actual. As noted by Collins, the beneficiary cannot
rely on averages. He or she must live year to year with
the actual results.
3. Volatility
Using a 60-40 asset allocation, there is wide
fluctuation of the return to the beneficiary in real dollars.
Mr. Garland, in the article cited earlier, measured the
spending from a 5% market value unitrust from 1951
through 1998. In 1951 dollars, such spending ranged
from $1 in 1951 to $1.84 in 1986, to $0.756 in 1981, and
back to $1.938 in the bull market of 1998 (before the dip
experienced in 1999). Using a market return of 125% of
the earnings of the S&P 500 companies only, the volatility was from a high of $1.385 in 1966 to a low of $0.931
in 1986 and $1.136 in 1998. So, if the desire is for stability, the earnings model is much more predictable than
the percent of market value.19
Mr. Garland’s analysis demonstrates even
more volatility as the portfolio tends toward a greater percent of equities. The return is always higher in the 80%
to 100% equity mode, but a good deal more volatile.
Volatility can be better tolerated so long as everything
goes up, especially in nominal terms which would produce even more dramatic results. However, in a sustained
drop involving a fixed return unitrust based upon a percentage of value, problems will invariably develop.
Id., at 282-3.
The illustrations use nominal rather than real returns. The
author is indebted to the Kentor Company, Austin, Texas for its
assistance in preparing these graphs.
This illustration was developed in connection with expendi-
tures by non-profits from endowments and thus ignores the effect
of income taxes. There is a greater virtue in predictability in the
non-profit arena, but it is achieved by failing to take advantage of
upswings in the market to increase distributions. In the private sector, the beneficiary likes the increase in an up market.
Consider, for example, an intoxicated
person wandering down the middle of
the road. As he progresses, he wanders outside of the double yellow lines
(the zone of safety). Sometimes he
stumbles to the left (into oncoming
traffic) and sometimes to the right
(also into traffic). The average position of the intoxicated person is in the
safety zone. However, the average
physical state of the intoxicated injury or death.17
ACTEC Journal 132
Indeed...the formula fails to fulfill the
grantor’s objectives with respect to the
remainderman in approximately 18%
of the trials. On average, the formula
works. However, the remainder beneficiary cannot rely on the average result
and must accept the actual result.20
4. Inability to Protect the Real Value
In addition to volatility in distributions,
using the 60%-40% model and taking into account
administrative costs, taxes and inflation, a requirement
to distribute all the income will cause a real long term
loss in value in the income stream and in the value of
the trust estate. In real terms, two economists calculated that the value of $1,000,000 invested in 1960 would
be worth only $677,000 in 1995, and the real income
in 1960 dollars from that amount would have dropped
from $25,000 to $22,000.21 Using the greater of all
income or a 4% mandatory payout22 may cause the
trust to lose enough value that it will expire during its
term and prior to the termination date stated in the
instrument, depending upon its net after tax return.
Thus, the all income or mandatory fixed percent unitrust may not protect either the remainderman or the
income beneficiary, and putting the two standards
together only exacerbates the problem.
AUTHOR’S NOTE: Messrs. Hertog’s
and Levine’s study concluded in 1995
and thus does not include the phenomenal upward spiral of the market in the
succeeding five years. However, as we
have learned since the spring of 2000,
and, as the Random Walk theory would
confirm, past price trends are not necessarily a predictor of future price trends.
Thus, while the Hertog-Levine study
results would clearly have been different in the 1995-2000 period, that period
may not be reflective of the future.
5. “Excess” Distributions of Bond Interest
Some economists argue that bond interest
reflects not only real return but in part a payback on
inflation. Bonds are valuable in a portfolio in that they
decrease volatility and provide a more stable return
Collins, at 251.
Hertog and Levine, “Income versus Wealth: Making the
Trade Off,” 5-1 The Journal of Investing 1, (Spring 1996)
This formula was often advocated to meet QTIP requirements. The Proposed Regulations under §643(b) will allow a fixed
return unitrust to meet the “all income” requirement in states which
adopt a unitrust statute. See discussion of the Proposed Regula20
than do stocks. So long as the stated rate of bond interest is higher than the unitrust amount, the excess of the
stated rate over the unitrust amount is “automatically”
plowed back into principal or capital. However, this
proposition only holds true if the value of the bond is at
par or below. If, because of lower interest rates on
newer bonds the value is in excess of par, then more
than the stated interest rate would be paid out as the
unitrust amount. Assume a 4% unitrust rate and a
$10,000 municipal bond with a rate of 5%. The unitrust amount would be $100 less than the trust
received, therefore allowing that $100 to be reinvested.
However, if the bond were valued at a 25% premium
($12,500) or higher, the payout would be equal to or
greater than the amount received. This might force the
trustee to sell the bond to realize the premium and reinvest at a lower rate, which might again force the unitrust payout to be greater than the stated rate.
6. A Summary of the Effects of the Various
Mr. Levine has prepared a summary showing the effects of the various types of distribution formulae. While Mr. Wolf disagrees with the formulation, it is an interesting exercise. The analysis is part
of Appendix C-1, including the Unstressed and
Stressed scenarios.23 Both illustrations are expressed
in real (i.e., inflation adjusted) dollars. “Modified Garland” is the Garland approach wherein interest returns
are adjusted for inflation. The calculation as to when
the trust goes broke, assumes that the trustee has the
power to invade in excess of the fixed distribution, and
exercises that discretion to maintain the spending
power of the dollar. None of these will reduce to zero
without that consideration.
In analyzing the Unstressed scenario, a 6040 mix of equities and fixed income closely approximates the Modified Garland +1% results. Obviously in
the 100% equities scenario, the all income beneficiary
fares substantially worse, and the Modified Garland
+2% approximates the 2.5% unitrust.
The Stressed scenario postulates a first
year bear market with a 70% loss in value,24 a first year
rise in interest rates of 4% and a rise in inflation of 3%
from 2.4% to 5.4%. (We can all agree that this is a
great deal of “stress”). The important part of this
analysis is that the value of the trust decreases dramatically using the 4% unitrust.
tions below.
The boxes on the Unstressed illustration indicate corrections made from previously distributed projections.
Not so long ago, this magnitude of drop in value would
have seemed not only improbable, but even impossible. Once
again, history has not proved to be a reliable predictor.
ACTEC Journal 133
As stated earlier, and the proposition cannot be
restated too often, the primary consideration in drafting a trust is to meet the client’s objectives. The
corollary to that, of course, is that the client must
understand the effect of the trust design chosen. The
advocates of private unitrusts point out that all
income formulations are almost certain not to meet
client objectives and to create tension between the
income beneficiary and the remainder beneficiary.
Further, they argue, all income formulations (i) practically assure that the trustee’s investment philosophy will focus more on increasing current return than
on overall return and (ii) put the trustee at a disadvantage in maximizing return. The discretionary
trust, while allowing investment for overall return,
still creates tension between the temporal and permanent interests.
A. Focus Should Be on the “Real” Beneficiary
Remember that the underlying philosophy of
the unitrust is to assure certain benefits to the current
beneficiary and have some left over for the remainderman. So, the first step in designing the trust is to determine whether that assumption accurately reflect’s the
testator’s wishes. In many cases, the testator may
desire to benefit the current beneficiary without regard
to the interests of later beneficiaries; e.g., the first
spouse to die may wish to provide lavishly for the survivor, and whatever is left for the children, they are
welcome to. In other instances, it may be the desire of
the testator to assure that the next generation is amply
provided for, without any concern for generations
beyond that; e.g., one spouse may wish to provide
assistance for a surviving second spouse, but assure
that the children of the first spouse have a substantial
portion of the assets left to enjoy. It is almost impossible to extend the distribution standard beyond the beneficiary or beneficiaries for whom the trust was created
because of the impossibility to predict with any degree
of certainty future economic conditions, both macro
and in the case of an individual beneficiary. While it
may be possible to determine spending objectives
through the child’s generation, it certainly is not realistic to try to formulate spending to the generation
beyond that.
So, even in drafting a unitrust formula for a
dynasty type trust, the draftsman may still be faced
with the task of determining distribution standards for
future generations. There is, it appears to me, a certain
logical inconsistency in advocating unitrusts because
they hone in on the settlor’s concrete desire to provide
a specific type of benefit for the current beneficiary
ACTEC Journal 134
and then extend that specific desire to future generations whose needs may be entirely different. Thus, in a
dynasty trust, at least two different spending formulas
may need to be considered.
1. Understanding the Difference Between
Distributions, Spending and Return
“Return” is the amount earned by the trust,
and total return includes both income and realized and
unrealized capital gains. “Distributions” are the
amount distributed to the beneficiary. “Spending” is
the actual amount available to be spent after taxes and
costs, and may be applied at both the trust and beneficiary level, depending upon allocation of expenses and
taxes. For example, if the grantor or the trustee allocates capital gains to the trust, and if a portion of the
4% distribution is capital gains, the spending by the
beneficiary is increased because a portion is free from
tax. Likewise, the spending by the trust has increased
beyond 4%. The converse is true if the capital gains are
included in distributable net income. Although the
beneficiary receives the same amount of dollars, he or
she has less available to spend because of the allocation of taxes. This is an extremely important concept
in drafting fixed percent interest unitrust provisions.
2. Understanding Whether the Client’s
Desires Can Be Met
Once the spending desires are determined,
the next point in the analysis is whether the client’s
expectations can be met. This involves projecting
whether the trust can reasonably sustain the spending
desired by the settlor. It is possible, if these projections are not carefully done, that the trust will not be
able to sustain the spending even during the life
expectancy of the current beneficiary. If under the plan
ultimately adopted, the trustee is expected to exercise
its discretion in such a manner as to substantially
diminish the trust during the life of the current beneficiary, that should be specifically noted in the trust
instrument so that the trustee can feel comfortable in
so doing. A general provision to prefer the current
beneficiary may not be sufficient. A suggested provision might be as follows:
I have given consideration as to the
benefits to be conferred under this
trust, and my desire is to benefit my
children in the manner stated without
regard to the interest of more remote
beneficiaries. In fact, I recognize that
the distribution directions may well
deplete the trust in its entirety, and I
direct the trustee to invest with a view
to being able to maintain such distributions during the life of my child
without regard to the preservation of
assets beyond the life of my child.
The trustee shall have no liability to
more remote beneficiaries for following such direction.
3. Real Returns
The formula must take into account that
the client probably desires to maintain the spending in
terms of real dollars—dollars that take inflation (or
deflation) into account. The total return trust clauses
below do make such adjustments for inflation in an
annuity context, but rely on valuation to automatically
adjust returns in percentage of value unitrust formulas.
4. Costs
It is very easy to ignore the effect of costs
on the anticipated return. Taking into account the
effect of compounding, such very real and expensive
factors cannot be ignored. In fact, their effect on the
overall return can be staggering.
During the period 1926-1997,
the compound mean annual return of
large capitalization U.S. stocks as represented by the S&P 500 stocks, after
inflation (which ran at a compound
annual rate of 3.1%), was 7.9% and for
smaller companies 9.6%. A 1% annual
management fee that was not offset by
at least some increase in investment
return would have reduced this average
large capitalization equity return (after
inflation) by about 12% and the average smaller capitalization equity return
by something on the order of 10%.
made in kind. This phenomenon is relatively easily
understood upon a small amount of reflection.
1. Effect of Smoothing
If the unitrust percentage is applied to an
average (three or five years being the most commonly
used), then by definition the beneficiary will not receive
4% of the present value of the trust. When the value of
the trust is increasing, the growth in the beneficiary’s
distribution lags behind the growth in the value of the
trust. Conversely, as the value of the trust trends downward, the beneficiary’s distribution will not decrease as
rapidly as the value of the trust is declining. Depending
upon the length and steepness of the decline, the trust
may be dissipated at a very rapid rate, thereby causing a
diminution in value which will impair future distributions and the remaining value of the trust. These results
are dramatically illustrated above in ¶VII.B.2 “Use of
Averages in Projections.”
2. Effect of Tax Allocation.
If capital gains taxes are allocated to DNI,
then the value of the trust is increased, increasing the
annual distributions. However, the real effect may be
to reduce the spending by the beneficiary, because
while the beneficiary is receiving more funds, he or
she will have to pay more taxes. If the taxes are paid
by the trust, then over a long period of time, even
assuming a very low turnover, the payment of taxes
can substantially affect the ending value of the trust.
(See Appendices D-1 and D-2.)
Obviously, whether taxes (a very real cost)
are allocated to the current beneficiary or to the trust
can also dramatically affect returns.
B. The One Thing the Beneficiary of a 4%
Unitrust Never Gets Is 4%.
One of the principal things the client must
understand is that the distribution from the unitrust
after the initial period will never be the stated percent
if smoothing is used, if capital gains taxes are allocated
to the beneficiary or, in some cases, if distributions are
As of the date of this writing 37 states have adopted UPIA, so that it is clear that the Prudent Investor
Rule in Restatement of the Law of Trusts, Third, is the
law in most jurisdictions. However, the adoption of
UPIA will not solve the problems with existing trusts
in light of modern portfolio theory. It also will not deal
with the multitude of trusts which will be drafted after
its passage either because the tax laws will still require
all income formulations, or just because of inertia in
changing forms. Remember that the proposed regulations under §643(b) only expand the definition of
income. They do not change the statutory all income
requirement, and they are not effective until final.
In order to deal with existing trusts and provide flexibility for trusts in the future, there are two basic and
non-exclusive legislative approaches being taken, an optin unitrust26 and UPAIA’s §10427 creating a trustee’s right
William L. Hoisington, Modern Trust Designs, ©1999
which was an update and expansion of his article for the Heckerling Institute, cited supra.
As of the date of this writing, 12 states have passed statutes dealing with opt-in unitrusts, with legislation pending in two other states.
As of the date of this writing, UPAIA has been adopted in
24 states, and is being considered for adoption in 6 other jurisdictions. In some of those jurisdictions, it has been adopted without
§104, and in others, such as Alabama, §104 has been made applicable only to trusts created after the effective date.
Over the last 25 years, a 10%12% lower compound annual return
reduced ending real wealth by about
ACTEC Journal 135
to reallocate between income and principal. These
approaches are not mutually exclusive. The application
of UPAIA §104 allowing the trustee to reallocate what
would be characterized as principal receipts to income,
and vice versa, concerns only trusts which mandate
distributions in terms of income, and have a trustee
other than the beneficiary making such reallocations.
If a trustee wants to opt into the statutory unitrust, a
trustee must, as a practical matter, seek approval from
the beneficiaries or the Court. (The statutes usually
gives the trustee the ability to opt in or out in its discretion, but I believe that would take a very brave trustee.)
UPAIA deals with the mandatory income trust
with no invasion power (or a limited invasion power)
by allowing the trustee to reallocate receipts between
income and principal. While it is easy in this environment to assume that receipts normally a part of principal will be reallocated to income, in other times
receipts that are normally income could be reallocated
to principal.
A. The Power to Reallocate
Section 104 is the answer of the National Conference of Commissioners on Uniform State Laws to
the problem of how the trustee can be impartial and
invest for overall return while being mandated to pay
all the income of the trust to the income beneficiary.
Remember that this power to reallocate is not a
panacea for all existing trusts since it is not available
if the trustee is the beneficiary.
1. Trustee’s Power to Reallocate—UPAIA
The proposed statute would give a trustee
the power to “adjust between principal and income to
the extent the trustee considers advisable to enable the
trustee to make appropriate present and future distributions....” (The italicized language is the standard
under the Uniform Prudent Investor Act.) To invoke
this power, (i) the prudent investor rule must apply to
the trust, (ii) the trust must describe distributions in
terms of income, (iii) the trustee must determine that
such adjustment would be fair and reasonable, and (iv)
such reallocation must give the income beneficiary use
consistent with preservation of the property. The Act
also lists factors that the Trustee is to consider in making such reallocation:
a. the nature, purpose and duration of the
b. the intent of the creator of the trust;
c. the identity and circumstances of the
d. the need for liquidity, regularity of
payment, and preservation and appreciation of capital;
e. the assets held in the trust and their
ACTEC Journal 136
uses by the beneficiary;
f. the net amount allocated to income
under the other sections of UPAIA and the increase or
decrease in the value of the principal assets;
g. whether and to what extent the terms
of the trust give the trustee the power to invade principal or accumulate income or prohibit the trustee from
invading principal or accumulating income, and the
extent to which the trustee has exercised a power from
time to time to invade principal or accumulate income;
h. the actual and anticipated effect of
economic conditions on principal and income and
effects of inflation and deflation; and
i. the anticipated tax consequences of an
2. Exception to Trustee’s Power to Reallocate
The trustee may not make an adjustment:
a. that diminishes the income interest for
which the marital deduction would be allowed if the
trustee did not have the power to make such adjustment;
b. that reduces the actuarial value of the
income interest in a trust to which a person transfers
property with the intent to qualify for a gift tax exclusion;
c. that changes the amount payable to a
beneficiary as a fixed annuity or a fixed fraction of the
value of the assets;
d. from any amount that is permanently
set aside for charitable purposes, unless income and
principal are so set aside;
e. if the holding or exercise of the power
would cause the trust to be a grantor trust;
f. if possessing the power would cause
estate tax inclusion in the estate of a person possessing
the power to remove and replace the trustee;
g. if the trustee is a beneficiary (emphasis added); or
h. if the beneficiary is not the trustee, but
the trustee would benefit directly or indirectly.
A trustee may release the power to
reallocate if continuing to hold the power would produce a detrimental tax effect.
Note that the emphasized phrase is
very important in limiting the applicability of this section since spouses are often the trustee of QTIP trusts.
3. Application to Existing Trusts
Since UPAIA applies to existing trusts
from the date of its enactment, if the trust is governed
by that Act and provides for distributions based upon
income, the reallocation provisions will not be negated
by a prohibition against invasion of principal or a bar
against equitable adjustments. UPAIA is applicable to
all trusts whether created on or after the effective date,
unless specifically made inapplicable by the terms of
the instrument or court decree.
4. Judicial Control of Discretionary Powers—New UPAIA §105
A new §105 of UPAIA was adopted by the
National Conference of Commissioners on Uniform
State Laws at their August, 2000, meeting in order to
make it clear, as the commentary to that section states,
that the discretionary powers in UPAIA (and specifically the power under §104) “are subject to the normal
rules that govern a fiduciary’s exercise of discretion.”
The rule referred to is that the trustee’s decisions
should be reviewed on the basis of an abuse of discretion. The comments also make clear that the trustee
must demonstrate that it exercised discretion after consideration of relevant factors. Mere inaction is failure
to exercise discretion, not abuse of discretion, and
therefore is not subject to the rule, citing Comment b,
§50 of the Restatement of the Law of Trusts, Third.
The remedies prescribed are first to make
adjustments within the trust among the beneficiaries,
and if it is not possible to do this, the trustee may be
required to pay the beneficiaries and/or the trust to
make everyone whole. The trustee has the authority to
apply to the court to determine whether his action
would be an abuse of discretion. If the petition makes
sufficient disclosure, the burden of proving an abuse of
discretion is on the beneficiary asserting the abuse, an
almost impossible burden.
5. Will Trustees Exercise This Discretion?
Proponents of the power of reallocation
argue that this power is no different than the other discretionary powers trustees exercise in invading principal or in determining income distributions in a discretionary environment. Here, again, the draftsman can
assist greatly by setting out the purpose of the trust, but
that may not occur. The trustee’s willingness to exercise is obviously influenced by the terms of the trust.
a. Trust Is Silent
Perhaps, the most obvious situation is
that in which the trust is simply silent as to invasion of
principal. There, it would seem the trustee has a real
basis for exercising this discretion. Absent language in
the trust to the contrary, it is reasonable to believe that
the creator of the trust would have wanted a sufficient
amount of income to pass to the beneficiary and at the
same time preserve the principal. The ability to invest
for total return and still provide for the income beneficiary would seem almost to demand the exercise of this
discretion. After all, the alternative is to invest to produce a sufficient amount of income at the expense of
overall return.
b. Trust Prohibits Invasion of Principal
While on the surface it may seem that
the trustee should not exercise discretion in this type of
trust, the same reasons appertain as in the trust that is
silent; i.e., absent a contrary indication in the instrument, the trustee must, in the exercise of its duty of
impartiality, invest to produce a sufficient return for
the income beneficiary, thereby potentially sacrificing
a better overall return. An exercise of the ability to
reallocate solves this problem and should not be seen
as a prohibited invasion of principal.
c. Trust Provides for HEMS Standard
If the trust provides for principal invasion subject to a standard, and if the income beneficiary does not need such principal distributions, then
should the trustee reallocate? Again, absent some
guidance in the instrument, the trustee may choose to
exercise the §104 power to satisfy its duty of impartiality. Once again, the issue is whether it is better to
invest for overall return, and that has been decided by
the adoption of UPIA, a prerequisite to the application
of §104.
Analyzed in this manner, the choice is
not how much the income beneficiary gets, but
whether the trust should be invested for overall return
in accordance with the law of the state. The inclusion
of §104 has met with resistance in some states considering the adoption of UPAIA, and §105 is obviously
designed to alleviate some of the concerns trustees
may have with §104.
6. How Will the Trustee Exercise This Discretion?
If the trustee is willing to exercise the discretion under UPAIA §104, how will the trustee exercise the discretion? One option is for the trustee to
wait until the end of the year, see what the actual
income is and then adjust to what it deems to be a fair
return for the beneficiary in whose favor the adjustment is made. However, that is a little cumbersome,
but quarterly adjustments might not work a lot better.
Another approach is to project the income and overall
return for the year, and make adjustments off the projections. That might be a little risky in a volatile or
downward trending market.
The approach most likely to be adopted by
the trustee is a unitrust approach, with the percentage
determined at or near the beginning of the year based
on closing values for the preceding year as determined
by the trustee. This is certainly easier than the mandated unitrust because the flexibility is so much greater
since the trustee is not bound by a mandated formula.
However, will the trustee, having once determined a
unitrust percentage for one year, carefully review that
percentage every year? Or will the trustee in effect use
the reallocation power simply to convert the trust to a
unitrust? This approach (as with the more formal unitrust) will not work very well with trusts containing
non-financial assets.
ACTEC Journal 137
As noted above, 12 states have adopted statutes
which allow the conversion of an all income trust to a
unitrust either upon action by the trustee or requests by
the beneficiary. This approach is thought to be solve
the problem when UPAIA §104 is not available, and,
also, arguably, provides all of the benefits as if the
grantor had been far sighted enough to draft a unitrust
in the first place.. The proposed §643(b) Regulations,
and their expected promulgation as final regulations,
has added impetus to this rush by several states to
enact unitrust conversion statutes.28
A. New York’s Initial Attempt
New York, while not the first state to adopt a
unitrust conversion statute, was the first state to seriously consider so doing, and clearly provided the basis for
the present wave of statutes. In connection with New
York’s desire to adopt the prudent investor rule, a statute
was proposed that would establish a 4% fixed income
unitrust as a default rule; i.e., if the trust provided that
the trustee was to distribute all the income to the beneficiary, that would be interpreted to mean that the trustee
was required to distribute 4% of the value of the trust.
This could only be overridden by specific direction in
the instrument. After that initial recommendation met
with some serious opposition, the statute was changed
in several key aspects, the most important of which is
that the unitrust would become an opt-in rather than a
default; i.e., the unitrust approach would operate only if
chosen by the trustee or directed by the court. The New
York experience would lead me to believe that it would
be very difficult in any jurisdiction to get the unitrust
legislated in as a default provision.
B. The Variations Among States
A detailed analysis of the statutes of the various jurisdictions is beyond the scope of this paper, but
there are clearly differences in approach and quality.
For example, the New York statute is extremely
detailed in both the terms of the trust and the procedures to be followed in converting. The Missouri
statute is almost skeletal in comparison, and the Pennsylvania statute is somewhere in between. New Jersey
has a “safe harbor” approach and Delaware allows a
fluctuating amount. What all of these statutes (other
than New York and possibly Pennsylvania) have in
common is that they were cobbled together very quickly, there is not even an attempt at any kind of uniformity, and there certainly was not time between concept
and enactment for a great deal of reflection. It will be
interesting to see how, or if, these statutes are utilized
and what the long term effect will be.29
C. Considerations Prior to Converting
The considerations as to whether to convert to
a unitrust under the statute are much the same as those
to be considered in deciding whether to use a unitrust
1. Desire of the Beneficiaries
It would take a very bold trustee to decide
to opt into a unitrust if at least the vast majority of most
classes of beneficiaries do not agree. As discussed
below, accurate projections of the effect of the conversion is of ultimate importance. And if the performance
of the trust varies widely from the projections, the
trustee can be almost certain that some beneficiaries
are going to feel (allege?) that they were not given
complete and accurate information.
2. Availability of UPAIA §104
If UPAIA §104 is available under state
law, I believe that it is almost always better to use that
approach rather than the conversion to a unitrust. As
indicated above, the trustee will probably do the §104
reallocation so that the payout is essentially a unitrust
payout, with the major difference being that the trustee
has the flexibility to change the percentage and even
the approach to the reallocation or to stop the reallocation entirely if situations change.
3. Composition of the Trust
Oddly enough, the trust in which it may be
most difficult to produce income is a trust which contains
non-financial assets, and it is exactly those assets which
are the most difficult to deal with in a unitrust context.
4. Projections
The trustee should run projections under
several different scenarios. (We are now much wiser
than to believe that the only scenario is always and consistently up.) It is very important that such projections
be based on different returns for different periods rather
than an average consistent growth rate. Even though the
timing will not be accurate, the benefit is to show the
beneficiary and the trustee the possible effects of different markets and that averages do not apply in the real
world when distributions are made on an annual basis.
Texas will probably take a different approach and enact a
statute that will allow a unitrust, drafted as such, to qualify for the
marital deduction upon the issuance of final regulations, but would
not allow for conversion to a unitrust without following the trust
modification procedures under existing law.
As of the date of this writing, the following states have
adopted unitrust conversion statutes: Delaware, Florida, Illinois,
Iowa, Maine, Maryland, Missouri, New Hampshire, New York,
Pennsylvania, South Dakota and Washington. New Jersey and
Louisiana have adopted unitrust safe harbor statutes. Legislation is
pending in two other states.
ACTEC Journal 138
One of the major issues in the drafting of total
return trusts is whether such trusts would meet the all
income requirement for marital deduction trusts. This
same issue surrounds the application of UPAIA §104.
On February 15, 2001, the Service published Proposed
Rules on Trust Income Definition.30 These proposed
regulations, according to the Summary, revise “the definition of income under section 643(b) take into
account changes in the definition of trust accounting
income under state laws.” The proposed regulations
also deal with capital gains as a part of distributable net
income (“DNI”), charitable issues, marital deduction
issues, and generation skipping issues. The proposed
regulations become effective on publication of final
regulations in the Federal Register.
A. Amendment to Definition of Income.
The proposed regulations revising §1.643(b)-1
maintain the old position that trust provisions defining
income which depart from accepted accounting procedures will not be recognized. The proposed regulations go on to provide:
However, amounts allocated between
income and principal pursuant to
applicable local law will be respected
if local law provides for a reasonable
apportionment between the income
and the remainder beneficiaries of the
total return trust for the year, including ordinary income, capital gains,
and appreciation.
The proposed regulations then give the specific example of a 3%-5% unitrust31 or “equitable adjustments” under state law. There are other requirements
for the application of equitable adjustments:
(1) the trust is managed under the prudent
investor rule;
(2) the trust describes distributions in terms of
the income of the trust; and,
(3) the trustee, after applying the statutory
rules regarding allocation of principal and income is
unable to administer the trust impartially.
An allocation of capital gains to income is
recognized if made pursuant to the terms of the governing instrument or local law, or “pursuant to a reasonable and consistent exercise of a discretionary
power granted to the fiduciary.” There is an interesting question as to how the exercise can be “consistent” at least the first time it is exercised. Perhaps
some statement of the intent to do so in the trust’s
records would be sufficient.
REG-106513-00, amending primarily Treas. Regs.
§1.643(b)-1, but also making conforming amendments to other
Although the proposed regulation refers specifically to a
B. Capital Gains Allocated to DNI and Capital
In addition to those situations in which capital
gains are included in DNI under the existing regulations, the proposed regulation §1.643(a)-(3) permits
capital gains to be included in DNI if so allocated by
the fiduciary pursuant to a reasonable and consistent
exercise of discretion in the following situations:
(1) allocated to income;
(2) allocated to corpus but treated as part of a
distribution to a beneficiary; or
(3) allocated to corpus but used in determining
the amount distributed or required to be distributed to a
Note that, in a unitrust, either the governing
instrument must deal with the allocation of capital gains
or the state statute must if there is a statutory opt in.
Capital losses are netted against capital gains
at the trust level except for those used under (3) in
determining the amount to be distributed to a particular
C. Distributions in Kind
Treas. Regs. §1.651(a)-2 is amended by
adding a new subsection (d) which treats distributions
in kind from an all income trust as a sale by the trust on
the date of distribution, but permits a §651 deduction if
no more than the amount of DNI is distributed. Treas.
Regs. §1.661(a)-2(f) is substantially revised to provide
that gain or loss is recognized by the trust or estate if
property is distributed in kind in satisfaction of a
requirement to distribute income currently.
D. Charitable Remainder Unitrust
There is a unique problem with Charitable
Remainder Unitrusts (“CRUT”) which use income as
the measure of the unitrust amount. Federal law
requires that the CRUT unitrust amount be not less
than 5%. If a unitrust provides for payment of the
lesser of the income of the CRUT or a defined unitrust
amount, and if there is a state statute defining income
as a unitrust amount of 4%, then the CRUT will fail to
meet the 5% test since net income (as defined by
statute) will always be less than the designated unitrust amount. The proposed regulations deal with this
by requiring that the instrument contain its own definition of income which is consistent with the CRUT
rules. Additionally, capital gains attributable to appreciation after its contribution to the trust may be allocated to income pursuant to the terms of the governing
instrument and state law, but not in the discretion of
the trustee.
3%-5% unitrust, this would also presumably apply to an annuity
approach with an inflation adjustment provision. It should, logically, also apply to the Give-Me Five approach.
ACTEC Journal 139
E. Marital Deduction Provisions
Language is added in the proposed amendments to Treas. Regs. §20.2056(b)-5(f)(1) so that the
all income requirement is met: “In addition...if the
spouse is entitled to income as defined by a state
statute that provides for a reasonable apportionment
between the income and remainder beneficiaries of the
total return of the trust and that meets the requirements
of section 1.643(b)-1 of this chapter.”
Although comments on the Proposed Regulations have noted that a unitrust formula or an equitable
allocation clause should be available to meet the all
income test even if the state has not adopted a unitrust
statute or UPAIA §104, the Service has indicated that is
not the result under the proposed regulations, and probably will not be under the final regulations. Because of the
specificity of the Proposed Regulations, will they override
the more general test concerning the all income requirement contained above in the Regulations? Remember, the
Proposed Regulations say “in addition to.”32
The prohibition against appointing QTIP property to a third party is not violated by a power conferred
by state law to allocate between income and principal
to meet the duty of impartiality by adding a sentence to
the end of Treas. Regs. §20.2056(b)-7(d)(1).
Similar amendments are made with respect to
gift tax marital deduction regulations.
F. GST Regulations
The GST regulations are amended to provide
that the use of a unitrust or power to reallocate will not
be considered to be a shift of a beneficial interest.
G. Qualified Domestic Trust
Under existing law, it is possible that the regulations would permit a unitrust (and perhaps even a
trust permitting reallocation of principal under UPAIA
§104) to qualify for QTIP treatment), but the QDT had
additional problems because the §2056A regulations
further provide as follows:
In an earlier version of this paper, I analyzed the existing
regulations as follows:
If the definition is other than the long standing common law
approach, will that satisfy the federal requirements? The only way
to answer that question is to analyze the exact language of the Treasury Regulations. In determining whether a beneficiary has the
“right to income” Treas. Regs. §20.2056(b)-5(f)(1) provides that
such test is met:
...[I]f the effect of the trust is to give her
[sic] substantially that degree of beneficial
enjoyment of the trust property during her life
which the principles of the law of trusts afford
to a person who is unqualifiedly designated as
the life beneficiary of a trust. Such degree of
enjoyment is given only if it was the decedent’s intention, as manifested by the terms of
the trust instrument and surrounding circumstances, that the trust should produce for the
ACTEC Journal 140
In addition, income does not include
any other item that would be allocated
to corpus under applicable local law
governing the administrations of trusts
irrespective of any specific trust provision to the contrary. In cases where
there is no specific statutory or case
law regarding the allocation of such
items under the law governing the
administration of the QDOT, the allocation under this paragraph (c)(2) will
be governed by general principles of
law (including but not limited to any
uniform state acts, such as the Uniform Principal and Income Act, or any
Restatements of applicable law).
Under this language, coupled with the specific
reference to capital gains, it is doubtful that distributions from a unitrust in excess of the accounting
income of the trust would be treated as income, at least
absent a state law to the contrary. However, the proposed regulations make it clear that the rules regarding
§104 allocations or a unitrust permitted by state law
apply to QDTs as well as QTIPs.
In the real world, many trusts measure distributions
in term of income, whether such trusts were drafted
because of a statutory requirement, because that was
the wish of the testator or grantor, or because that was
the way the draftsman always drafted them. While it
will require legislation to deal with existing all income
trusts, there are ways to allow the trustee to invest for
total return either through the use of unitrusts, annuity
trusts, “Give-Me-Five” trusts, or more conventional
surviving spouse during her life such an
income, or that the spouse should have such
use of the trust property as is consistent with
the trust corpus and with its preservation.
Treas. Regs. §20.2056-5(b)(f)(2) makes it clear that the
right to enjoyment may be given under the instrument as well as
under state law. Almost seeming to anticipate section 104 of the
UPAIA, Treas. Regs. §20.2056(b)-5(f)(4) state that the trustee’s
power to allocate between income and principal will not run afoul
of the right to income requirement if the powers are such that local
courts would require the reasonable exercise thereof.
From a review of the language of the existing regulations, it
would be relatively easy to conclude that all of the formulae set
forth below for unitrusts would meet the all income test. However,
prudence dictates that one would not use them without either a private letter ruling or some published authority. And in this respect,
the proposed regulations may actually narrow the ability to apply
the all income trusts to unitrusts.
techniques. Remember that the soapbox I am on is that
the draftsman needs to spend more time helping the
client focus on what he really wants, and then developing a distribution plan which allows the client to meet
those desires. And as always, flexibility is the key.
Thus, the issue at the private level is not whether
an attorney ought to be drafting private unitrusts as a
principal drafting approach. It is the overriding thesis
of this paper that the most productive result of the unitrust debate will be to refocus attorneys on the need to
better emphasize client desires in developing distribution provisions, and not the ascendancy of the unitrust
as the first drafting preference.
A. Solutions to the Statutorily Mandated All
Income Trusts
In those situations in which the settlor or testator
is restricted by statute from designing the trust so that it
precisely carries out his wishes, the amount of income
can be controlled somewhat by the investment blend, and
if there is a supplementary standard, the beneficiary can
still enjoy distributions sufficient to provide for his or her
needs. I do believe that an attempt to obliterate the distinction between income and principal will fail, as that
concept is too deeply imbedded throughout the statutory
and common law of trusts. In fact, UPAIA maintains this
dichotomy, as will be discussed in greater detail below.
1. Discretionary Principal Distribution
The trustee can be authorized to exercise
discretion over principal for the benefit of the income
beneficiary, and thereby protect the beneficiary while
allowing the trustee to invest for total return.
a. Total Discretion
The discretion granted can be total discretion allowing the trustee to distribute “such amounts
of principal as my trustee determines in its sole discretion.” The total discretion standard can also be used in a
spray or sprinkle trust. Consideration should be given to
a provision which would unequivocally state that the creator of the trust intends for the discretion to be absolute,
and that no beneficiary may require a distribution.
Should the trust contain factors for the trustee to consider in exercising its discretion? Some believe that this
only creates problems, and that totally discretionary
trusts should be totally discretionary. However, if the
trust is drafted so that it is clear that the factors are only
an expression of the settlor’s intent, and cannot be used
as a basis for compelling distributions, then such expression may help the trustee in exercising its discretion.
Obviously, the trustee cannot be a beneficiary of the trust
under this standard. Equally obvious is that the trustee
must exercise the discretion given, including a decision
to make no distributions. Regardless of how broad the
language of the trust is, the trustee must still exercise its
discretion in a reasonable manner. Thorman v. Carr, 408
S.W.2d 259 (Tex. Civ App. [San Antonio] 1966).
b. Best Interest Standard
The discretion given the trustee may
be a “best interest” standard; i.e., “the trustee may distribute such amounts of principal as it determines to be
in the best interest of the beneficiary.” Again, this standard will work with a spray or sprinkle trust, but the
trustee cannot be a beneficiary. If the best interest
standard is to be used, the draftsman should specify
whether a beneficiary can compel a distribution. If any
guidance is given as to what the settlor envisioned
would be in the best interest of the beneficiary, again
the trust should be clear as to whether such guidelines
can be used as a basis to compel a distribution. Since a
fiduciary is always required to act in the best interest of
the beneficiary, it is hard to see how this standard
improves upon total discretion. I have determined that
I will never use this standard in drafting.
c. Subjective Standard
As a middle ground, the trustee could
be given discretion, with general guidelines that the
trustee must consider. The beneficiary could use such
standards in trying to convince a court that the trustee
had abused its discretion and to compel a distribution.
Again, the key is clarity in drafting.
d. Objective Standard
The discretion given the trustee may
be an objective standard, such as “health, education,
maintenance and support.” This standard is normally
used when a beneficiary is a trustee. If there are multiple permissible distributees, then clear directions
must be given as to preferences. In practice, these
standards are seldom as objective as they seem, and
almost always raise interpretation issues.
2. Formula Distributions
Principal distributions can be made
according to a preset formula, which could take into
account the size of the income distribution by providing a fixed amount, so that the standard really becomes
a “greater of” formula. The formula could also permit
distributions in excess of the formula subject to a standard, or the formula could operate as a cap on distributions. A discussion of the various formulas is set out
below in the unitrust drafting section.
3. Redefine Income
State law may, of course, define income in
any way the legislative body of the state chooses. For
example, Texas Trust Code §113.101(a)(1) mandates
the trustee to administer the trust with respect to the
allocation of income and principal “in accordance with
the terms of the instrument,” and in states which have
adopted UPAIA there is even greater flexibility. Texas
Trust Code §113.101(a)(2) provides that the Trust
Code controls “in the absence of any contrary terms of
the trust instrument.” Therefore, the creator of the trust
is able to define what is income and what is principal.
ACTEC Journal 141
Of course, even under the proposed §643(b) regulations, if the instrument deviates from state law, it may
run afoul of the federal tax rules.
4. Powers of Appointment
The beneficiary can be given a power of
appointment over principal.
a. Special Power of Appointment
The beneficiary could be given a special power of appointment which could be limited as to
(i) time of exercise (i.e., either during life or at death, or
both), (ii) amount, either by amount or percentage of
the trust, and/or (iii) permissible appointees. In the latter case, the power could be as broad as possible (i.e.,to
anyone other than the beneficiary, the beneficiary’s
creditors, the beneficiary’s estate or the creditors of the
beneficiary’s estate) or as narrow as desired (i.e., limited to one or more persons or classes such as descendants, charities, etc.). In any event, such a power would
prevent inclusion in the estate for tax purposes. While
such a power, whether exercised or not, would avoid
inclusion of the trust in the beneficiary’s estate,33 an
inter-vivos exercise of the power would create a gift of
the income interest at the date of and to the extent of the
exercise.34 Thus, an inter-vivos exercise of the power so
as to appoint 10% of the principal will carry with it a
gift of 10% of the income, which may or may not be
subject to the annual exclusion depending upon the
manner of exercise. A special testamentary power will
still allow the trust to qualify for QTIP treatment if it
meets the other tests under Code §2056(b)(7).
b. General Power of Appointment
The beneficiary may be given a general power of appointment which may also be limited as
to time of exercise and the amount of the trust over
which it may be exercised. This power will cause
inclusion in the decedent’s estate of the property over
which it may be exercised and will always constitute a
gift of the entire interest transferred upon its intervivos exercise in favor of anyone other than the holder
of the power or upon the lapse or release of the power
in excess of 5% of the value of the trust. This type of
power cannot be used in connection with a QTIP trust
since the general power would cause the trust to be
treated under Code §2056(b)(5). The general power
may of course be limited to 5% of the value of the trust
without its lapse or release causing a gift,35 but there
will still be inclusion in the estate to the extent the
power was exercisable at death. The 5% power will be
discussed more fully below in dealing with the so
called Give-Me-Five trust.
B. Conventional Solutions Where All Income
Is Not Mandated
Even in cases in which all income is not mandated, there may be better solutions than the unitrust to
allow the trustee to invest for total return. Again, the
choice of this approach is based on the twin ideals of
flexibility and drafting clarity.
1. Total Discretion Trusts
The Trustee can be given total discretion
as to income and principal. The considerations in
drafting are the same as noted above.
2. Distributions According to Standard
Distributions of principal and income
could both be according to some standard. Once
again, the considerations as to the use of standards for
both income and principal are as set out above.
3. Formula Distributions
It would seem obvious to me that where
the law permits greater flexibility by not dictating the
distribution of income, the draftsman should not create
inflexibility by going to a unitrust approach. Therefore, any formula approach should be thought of as a
minimum amount and be accompanied with some discretion in the trustee. In most cases, my approach
would be to use no formula at all.
4. Powers of Appointment
a. Special Powers of Appointment
Special powers of appointment may
be used as with all income trusts, but with no adverse
gift tax implications. Since the beneficiary is not entitled to the income, an exercise of the special power
will not result in a gift.
b. General Power of Appointment
The use of a general power of appointment is subject to the same considerations as with an
all income trust.
C. The Give-Me-Five Approach36
While under Mr. Horn’s own classification,
the Give-Me-Five approach is a unitrust approach, and
while it fits the definition of a unitrust posited in this
article, I have chosen to present it separately from the
other unitrust provisions since the Give-Me-Five
Code §2041(b)(1) limits a general power of appointment to
one which can be exercised in favor of the decedent, his estate, his
creditors or the creditors of his estate.
See Treas. Regs. §25.2511-1(e).
Code §2514(e). Note that this section specifically provides
that a “lapse” of a power “shall be considered a release of such
The comments and forms are taken from a presentation
made by Jerold I. Horn at the Southwestern Legal Foundation 40th
Annual Institute on Wills and Probate in May 2001. Mr. Horn’s
paper was entitled “Total Return Trusts: Trusts That Do Not Distinguish Between Income and Principal.” See also, Horn, “Prudent
Investor Rule, Modern Portfolio Theory,” and “Private Trusts:
Drafting and Administration Under the ‘Give-Me-Five’ Unitrust,”
33 Real Property Probate & Trust Journal 26 (1998).
ACTEC Journal 142
approach is anything but a fixed distribution approach
to drafting. What this approach does is give the beneficiary an annually lapsing general power of appointment to withdraw up to 5% of the value of the trust.37 It
is presumed, although not required, that this power
will be exercised by the donee in favor of the donee.
To the extent the power is not exercised, the theory
goes, the property stays within the trust, safe from
transfer taxes and creditors. The efficacy of those theories is examined below.
1. Underlying Theories
Mr. Horn has developed the Give-Me-Five
approach based upon his belief that clients would
always (or at least almost always) favor outright gifts,
and it is the lawyer who injects the use of trusts for tax
reasons, to provide asset and divorce protection, or
control the ultimate devolution of the property. The
latter reason is somewhat in conflict with the Give-MeFive approach. Since the client, under this theory,
would have preferred just an outright gift, this technique is designed to approximate that as closely as
possible in the trust context.
2. Use with All Income Trusts, et al.
While this technique may be used as a
stand alone standard for a non-marital trust, it may also
be used as to principal in connection with an all
income trust or a trust which distributes income
according to a standard. Any exercise of the power in
favor of a third party will result in a taxable gift.
3. Use as Marital Trust.
Although the marital deduction all income
requirement is usually couched in terms of distribution
to the spouse, it is sufficient that the spouse have the
right, exercisable at least annually, “to require distribution to herself of the trust income, and otherwise the
trust income is to be accumulated and added to corpus.”38 Since the proposed regulations under §643(b)
permit a 3%-5% unitrust to satisfy the all income
requirement, it would seem that a 5% withdrawal right
by the surviving spouse would meet the proposed regulatory test for both the testamentary general power of
appointment trust under Code §2056(b)(5) and the
QTIP provisions of Code §2056(b)(7) in those states
which have a statute allowing the creation of unitrusts.
4. Flexibility and Easing of Tensions
Give-Me-Five also provides tremendous
flexibility (at least up to 5% of the value of the trust).
Unlike mandated distribution trusts, there is no
requirement that any of the property subject to the 5%
power be distributed. And, unlike discretionary trusts,
the determination as to whether to withdraw anything
lies with the beneficiary and not the trustee. Thus, the
trustee is not in conflict with the remainder interest
since only the beneficiary holding the power can
decide what to draw down. The conflict still exists
where the trustee also can make discretionary distributions. See clause below.
5. A Sample Clause
Following is a clause taken from the
Southwestern Legal Foundation paper cited above. I
have not changed the language utilized by the original
draftsman as I did with Mr. Hoisington’s clauses
below. This is the “omnibus” version the of the GiveMe-Five drafting approach in that it permits distribution in excess of 5% subject to a standard by a beneficiary/trustee and totally discretionary distributions by
an independent trustee, even to the extent of terminating the trust. Obviously, the clause can be pared back
by eliminating any of those additional powers. The
clause is a fractional share clause, but a pecuniary
clause could be used. Following the sample clause is a
listing of the issues raised by this approach.
a. Give-Me-Five. If, after attaining thirty years of age, the descendant is living immediately
before the end of a calendar year, the Trustee shall pay
to the descendant so much, if any, of the trust estate,
not to exceed in value five percent of the value of the
trust estate as of the end of the year, as the descendant
last directs in writing before the end of the year.
b. Additional Distributions. The Trustee
shall pay to the descendant so much or all, if any, of the
trust estate as the Trustee determines to be advisable
from time to time, considering resources otherwise
available, to provide for the descendant’s health, education and support in the manner of living to which
accustomed. Additionally, The Trustee shall pay to the
descendant so much or all, if any, of the balance of the
trust estate as the Independent Trustee in its sole and
absolute discretion determines to be advisable from
time to time, considering or not considering resources
otherwise available, for any purpose or reason whatsoever, including termination of the trust.39
6. Creditor Protection
One of the stated purposes of the GiveMe-Five trust is creditor protection. Yet the law in
many states, is unclear as to the effect this provision
has with respect to creditors. For instance, prior to the
lapse of the power, could a judge order a beneficiary to
This is really nothing more than the Crummey power in a
different context.
Treas. Regs. §20.2056(b)-5(f)(8).
If the Trustee making the HEMS decisions is other than
beneficiary, then how will the trustee know what to distribute if he
has no idea what the beneficiary is going to withdraw until the end
of the year? Even with respect to distributions under the total discretion standard, how much the beneficiary is going to withdraw
still might affect the trustee’s decision.
ACTEC Journal 143
exercise this power for the benefit of creditors? As a
corollary issue, in most states, spendthrift trust protection is not available for self-settled trusts. Does the
lapse of the power cause the beneficiary to become the
grantor of the trust to the extent of the lapse?40
7. Transfer Tax Avoidance
The property subject to a general power of
appointment will be included in the donee’s estate.
Thus, one problem may be the inclusion of 5% of the
trust in the gross estate of the donee. Mr. Horn would
argue that the fact that the descendant must be alive at
the end of the year would avoid inclusion in the estate.
This, of course, presents some problems in the Trustee
exercising its discretion since it has no way of knowing, in advance, how much the beneficiary will draw
down, and obviously cannot make distribution of that
amount prior immediately before the end of the year.
8. Income Tax and Grantor Trust Issues
Code §678(a) treats the holder of the
lapsed power as the grantor to the extent of the lapse.
Further, it is the IRS position that the grantor status is
cumulative, so that the donee of the power becomes the
grantor of a greater portion of the trust each year.41 A
detailed discussion of the income tax issues is beyond
the scope of this paper, but suffice it to say that while
Mr. Horn believes the problems are “solvable,” I
remain less sure. That issue has never been raised by
the IRS, but until it is resolved, there is a certain
amount of risk in the Give-Me-Five formulation.
Another issue that must be dealt with is
who may choose the assets to be distributed if the
Give-Me-Five power is exercised, the trustee or the
beneficiary? And what is the effect on grantor trust
status if the trustee is the beneficiary?
9. Assumes Financial Corpus
As with the fixed return unitrust, the valuation issues are difficult to deal with if the assets of the
trust are not primarily financial assets.
also that some of these clauses are designed to be used
to create supplemental benefits in addition to the primary benefits. These well thought out clauses are
taken in large part from Mr. Hoisington’s article for the
Heckerling Institute, cited above, with some modifications by the author.43 Most of these provisions employ
averages rather than the current value in an attempt to
reduce volatility in the amount distributed. Keep in
mind that a discretionary trust, as noted earlier, is a
form of unitrust. See the discussion above as to the
various types of discretionary formulae.
1. Discretionary Distributions Not to Exceed
Certain Percentage of Value
Mr. Hoisington suggests that the following
provision can be used as a supplement to a foregoing
distribution formula such as all income or a fixed percentage. With slight modifications, such as raising the
2% cap to a larger number, it could also be used as a
primary formula. Note that the beneficiary cannot be
the trustee of this trust (at least as to distributions to
himself or herself) and the spray or sprinkle provision
must be removed if this provision is to be used in a
QTIP trust.
Additional distributions may be
made to or for the benefit of the
beneficiary and/or the descendants
of the beneficiary in the discretion
of the special trustee, but not in
excess of 2% of the preceding 5 year
end average fair market value of the
trust property. In addition to the
required distributions set out above,
after the end of the first full calendar
year during which the trust is funded
(in whole or in part), the Trustee may,
in its discretion, distribute to, or for
the benefit of the Beneficiary and/or
any of the then living descendants of
the Beneficiary as much (if any) of the
property in the Trust and in such manner, as the Trustee,44 may at any time
determine and direct. The exercise of
the trustee’s discretion, however, is
limited as follows:
A. Hoisington Provisions (as Modified by
Following are some suggested clauses for implementing the unitrust design. Note that none of the provisions are the “greater of x% or all the income.” Note
Some states have dealt with that issue by statute. See Texas
Trust Code §112.035, which defines spendthrift trusts, and provides that the holder of a lapsed general power does not become a
grantor as a result of the lapse.
See Priv. Ltr. Ruls. 200022035, 9034004, and 8701007.
Much of the material concerning the use of the private unitrust and its variations are based upon William L. Hoisington, Modern Trust Designs, ©1999 which was an update and expansion of
his article for the Heckerling Institute, cited supra.
ACTEC Journal 144
The essence of our specialty is selective plagiarism with, of
course, some modification to make such purloined material our
own. While the type of formula is from Mr. Hoisington’s work, the
author has taken the liberty, in some cases, of making substantial
stylistic changes, which may even affect the substance.
Mr. Hoisington suggests that a special trustee may be used
to make such distributions so that the trustee with investment and
other distribution powers could be a beneficiary.
(1) The Trustee shall not make any
discretionary distribution of trust
property directly or indirectly to, or
for the benefit of, the Trustee or in any
circumstance in which such discretionary distribution would constitute a
taxable gift by such Trustee; and,
(2) The aggregate amount of any distributions made pursuant to this subparagraph during any one calendar
year shall not exceed two percent of
the average net fair market value of the
trust property at the close of the last
business day of each of the immediately preceding five calendar years or
lesser number of years of the trust’s
existence (excluding, in each case, any
amounts that were required to be distributed during any preceding calendar
year of the trust, but were not actually
distributed prior to the end of the calendar year, and any residential real or
tangible personal property held in the
trust that was occupied by, or was
within the possession or control of, the
Beneficiary or any descendant of the
Beneficiary at any time during the
immediately preceding calendar year).
Except to the extent that the Trustee
may direct otherwise, distributions
from the Trust to, or for the direct benefit of, any descendant of the Beneficiary shall be charged against the trust
estate of the Trust as a whole and not
against the ultimate distributive share
(if any) of such descendant.
Note that this provision does not provide the kind of certainty of distribution that the supporters of unitrusts advocate in that there is still a
potential for disputes between the current beneficiaries
and remaindermen, but it has the attribute of giving
flexibility while still ostensibly preserving principal.
Note, also, that this provision may require an allocation of GST exemption to the trust. The exclusions,
which have been italicized, are extremely important.
Note that there may be undistributed income in the
trust on the valuation date which should not be included in determining value for the purpose of applying the
unitrust percent.
2. Discretionary Distributions Not to Exceed
Fixed (Inflation Adjusted) Amount
This provision is also designed to be used
as a supplement to a primary distribution formula.
Used as a primary formula, it would be the annuity
unitrust described below except for the discretionary
feature. Because of the ascertainable standard, a beneficiary could also be the trustee.
Additional amounts are required to
be distributed for the beneficiary’s
support if all financial resources
available for the beneficiary’s support are insufficient, but not in
excess of $50,000/year adjusted for
inflation. If, at any time after the end
of the first full calendar year during
which the trust is in existence, the
Trustee, in his good faith judgment,
determines that the sum of (i) the
amounts required to be distributed pursuant to subparagraphs [x.x.1] and
[x.x.2] during the current calendar
year and (ii) all other financial
resources then available for the support of the Beneficiary that are reasonably quantifiable by the Trustee (such
sum being referred to as the “Available
Resources”) are insufficient in the
aggregate to provide adequately for
the Beneficiary’s reasonable support,
the Trustee shall distribute to, or
directly for the support of, the Beneficiary as much of the property then held
in the Trust as, when added to the
Available Resources of the Beneficiary, will, in the good faith judgment of
the Trustee, provide adequately for the
reasonable support of the Beneficiary;
provided however that the aggregate
amount of all distributions made pursuant to this subparagraph during any
one calendar year of the trust (or portion thereof) shall not exceed the following described total amount (the
Dollar Limit): The Dollar Limit for the
first calendar year shall be Fifty Thousand Dollars ($50,000) increased or
decreased by a percentage of such dollar amount as is equal to any percentage increase or decrease in consumer
prices between January 1, 2000, and
January 1 of the first calendar year
during which the trust is funded (in
whole or part); and the Dollar Limit
for the next and each succeeding calendar year during which the trust is in
existence shall be the Dollar Limit for
ACTEC Journal 145
the immediately preceding calendar
year increased or decreased by a percentage of such dollar amount that is
equal to the annual rate of change in
consumer prices during the preceding
calendar year determined as of the end
of such preceding calendar year (yearover-year). For purposes of the foregoing changes in consumer prices
shall be determined by reference to the
Consumer Price Index for All Urban
Consumers (CPI-U), not seasonally
adjusted, or any other independently
maintained cost of living index that the
Trustee determines in good faith more
accurately reflects the costs of living
of the Beneficiary during such preceding calendar year.
This provision could also be accompanied with
a cap on total distributions from principal based upon
the amount of income received by the beneficiary. Provisions of this nature dealing with “Available
Resources” are difficult to draft. While I believe this
one is relatively clear in that includes capital as well as
income, does this mean that the beneficiary must sell his
or her home or ranch before getting anything from the
trust? I think not, but a court may see things differently.
3. The Fixed Percent of Market Value
This formula is designed to be used as a
primary formula, and the beneficiary can serve as
trustee. This is nothing more than the charitable unitrust formula without a congressionally mandated
amount. Some of the practical problems in the use of
this formula can be seen in the clause below and in the
New York statute.
in the Beneficiary’s Family Trust on
the last business day of each of the
immediately preceding five calendar
years or lesser number of years of the
trust’s existence; provided however
that, in the case of a short year, the
Trustee shall prorate the aggregate
annual amount on a daily basis. Within a reasonable time after the end of
each calendar year, the Trustee shall
pay to the Beneficiary (in the case of
an underpayment) or receive from the
Beneficiary (in the case of an overpayment), without interest (in either case),
the difference between any amounts
actually paid during the preceding calendar year and the aggregate amount
required to be paid during that year.
Solely for purposes of determining the
annual amount that is required to be
distributed to the Beneficiary pursuant
to this subparagraph [x.x.1], “net fair
market value of all property held in the
Beneficiary’s Family Trust” shall
exclude any amounts that were
required to be distributed during any
preceding calendar year of the trust,
but were not actually distributed prior
to the end of the calendar year, and
shall not include the fair market value
of any residential real or tangible personal property held in the trust that
was occupied or possessed by, or the
occupancy or possession of which was
within the control of, the Beneficiary
(other than merely in their capacity as
the Trustee of the trust) at any time
during the calendar year of the trust.
4% of the value of trust is distributed to or for the support of the beneficiary annually. The Trustee shall
distribute to, or as directed by, or
directly for the support of, the Beneficiary, at convenient intervals, but at
least annually, amounts in the aggregate equal to four percent of the net
fair market value of all property held
in the Trust at the close of the last business day of the year45 during which the
Trust was first established and, thereafter, four percent of the average net
fair market value of all property held
Studies by David Levine and Roger Hertog indicate that the real value of the trust can probably
be sustained, but barely, with a 3% distribution
requirement, and that a 5% distribution requirement
would result in a substantial reduction in real value of
the portfolio and resultant reduction in real value of the
income distributions.
Even today, there is no agreement as to
whether 4% (the New York amount) is too high. So
long as the growth rate exceeds the inflation rate,
everyone ought to be relatively happy campers. However, if the inflation rate suddenly outpaces growth and
Note that Mr. Hoisington uses a five-year rolling average as
opposed to the three-year rolling average utilized by Mr. Wolf.
Studies would indicate that the five-year period adds little additional smoothing, and the three-year period would seem preferable.
ACTEC Journal 146
the unitrust rate, then the real value of the income beneficiary’s distributions will drop. A large drop well
into the term of the trust, after the beneficiary has
established a lifestyle based on the distributions could
prove disastrous. It is of course possible that the distributions would drop in nominal terms also.
4. Indexed Annuity
This is the charitable annuity trust formula,
but indexed for inflation. It is designed to assure that
the beneficiary always has a fixed amount in terms of
inflation adjusted dollars. One of the more interesting
features is that the trust is designed to substantially
increase its distributions after reaching a certain age.
This may answer the concern often expressed by clients
today that they do not want their children to receive so
much from the trust that the incentive to be productive
is diminished. Note the inflexibility of this, and the
fixed percent of value formulae, if there are no discretionary distributions in addition to these amounts. Also
note that this is a cap based on the value of the trust, in
case the distributions deplete the value of the trust. The
beneficiary can be the trustee under this formula.
$48,000 is distributed to or for the
support of the beneficiary annually as
long as the beneficiary is living and
under the age of 60 and $96,000 after
60. The Trustee shall distribute to, or as
directed by, or directly for the support
of, the Beneficiary, at convenient intervals, but at least annually, amounts in
the aggregate equal to the Annuity
Amount as hereinafter determined. The
Annuity Amount for the first calendar
year during which the Trustee is satisfied that the trust is substantially fully
funded shall be $48,000 if and while the
Beneficiary is living and under the age
of 60 years and $96,000 if and while the
Beneficiary is living and over the age of
60 years, in either case, increased by a
percentage of such dollar amount that is
equal to any percentage increase in consumer prices between January 1, 2000,
and January 1 of the first calendar year
during which the trust is funded (in
whole or part). The Annuity Amount
for the next and each succeeding calendar year during which the trust is in
existence shall be the Annuity Amount
for the immediately preceding calendar
year increased or decreased by a percentage of such dollar amount that is
equal to the average annual rate of
change in consumer prices during the
preceding five calendar years determined as of the end of each such preceding calendar year. For purposes of
the foregoing, changes in consumer
prices shall be determined by reference
to the Consumer Price Index for All
Urban Consumers (CPI-U), not seasonally adjusted, or any other independently maintained cost of living index that
the Trustee determines in good faith
more accurately reflects the costs of living of the Beneficiary during such preceding calendar year.
Notwithstanding anything in the foregoing to the contrary, in no event shall
the Annuity Amount exceed five percent of the net fair market value of all
property held in this trust at the close
of the last business day of each of the
immediately preceding five calendar
years or lesser number of years of the
trust’s existence, excluding, in each
case, any amounts that were required
to be distributed during any preceding
calendar year of the trust, but were not
actually distributed prior to the end of
the calendar year, and further excluding the fair market value of any residential real or tangible personal property held in the trust that was occupied
or possessed by, or the occupancy or
possession of which was within the
control of, the Beneficiary (other than
merely in their capacity as the Trustee
of the trust) at any time during the calendar year of the trust.
5. Market Performance Unitrust
This type of unitrust formula was developed
by James P. Garland. The theory behind this is that tying
distributions to value is a very artificial measurement,
and that distributions should be tied to market returns.
The beneficiary can be the trustee under this provision.
Distributions are sum of 125% of
dividends plus bond yields and 4%
of other assets held for investment.
While Beneficiary is living, the Trustee
shall, each calendar year, distribute to
Beneficiary an amount or amounts in
the aggregate equal to the following:
(a) The product of [i] 125% of the
average dividend yield on the S&P
ACTEC Journal 147
500 Stock Index for the immediately
preceding 5 calendar years and [ii] the
average fair market value on the last
business day of each of the immediately preceding 5 calendar years (or
lesser number of years of the trust’s
existence) of that portion of the trust
investments that consists of publicly
traded equity securities, plus
(b) the actual yield on the portion of
the trust property that is invested in
bonds or other debt instruments, less
any percentage increase (or plus any
percentage decrease) in consumer
prices during the immediately preceding calendar year (year-over-year), as
reflected in any change in the Consumer Price Index for All Urban Consumers (CPI-U), not seasonally
adjusted, plus
(c) 4% of the market value at the end
of the preceding calendar year of all
other trust property that is held primarily for investment, which shall not
include the fair market value of any
residential real or tangible personal
property held in the trust that was
occupied or possessed by, or the occupancy or possession of which was
within the control of, the Beneficiary
(other than merely in their capacity as
the Trustee of the trust) at any time
during the calendar year of the trust.
Mr. Hoisington suggests, although Mr.
Garland would probably not agree, that the formula
was developed at a time when dividends were a good
deal higher in relation to value, and that clause (a)
should be permanently modified to something such as
150% of the average earnings on S&P 500 stocks. Of
course, this assumes that dividend policies will remain
constant. This assumption may or may not be valid. In
fact, as Mr. Garland points out, if stock values decline,
then, in all probability, the amount of dividends will
increase in relation to the value of the stock and therefore in relation to earnings also.
Clause (c) causes some problems also
in that if the assets held for investment but are neither
publicly traded securities nor bonds, then valuation
becomes a problem. If you use this type of formula,
there must be some provision made, either here or in
the administrative provisions as to how the valuation
of these difficult to value assets is to be done. This is,
ACTEC Journal 148
of course, a problem in any percentage of value distribution formula.
B. The Northern Trust Forms
Northern Trust Co. has prepared forms creating
a fixed payout unitrust and an annuity type trust. I
believe that these forms are exceptionally well thought
out, and deal with the issues of hard to value assets
much better than the New York statute. Northern Trust
notes in its comments that a unitrust (whether fixed percent or annuity type) should not be used where the trust
has large non-financial and difficult to value assets.
Copies of the proposed Northern Trust forms are posted
on the private side of the ACTEC Web site as Appendices A-1 and A-2.
Drawing a conclusion about the various approaches and the multi-faceted and complex arguments is
very difficult and goes to the heart of what an estate
planner does.
A. The Economic Conclusions
The economic arguments center largely
around belief in future performance and whether the
past is indeed prologue to the future. The arguments
certainly prove that statistics can be used to prove
almost any proposition. Almost all agree that higher
returns in the present inevitably produce lower returns
in the future, and vice versa. David Levine argues that,
“[Fixed percentage of value] Unitrusts represent the
classic error of ‘fighting the last war.’” I am not persuaded by the advocates of the fixed percent of value
unitrust, primarily because of the lack of flexibility.
Additionally, this type of trust spends a great deal of
appreciation in the early years and discriminates heavily in favor of the income beneficiary.
B. Fixing Existing Trusts
Each of the statutory solutions to adapting
existing trusts to the prudent investor standard is
flawed. The unitrust model is simply too inflexible.
Even if all beneficiaries agree, a beneficiary could
potentially claim that all of the facts were not
explained. UPAIA §104 cannot be used with a beneficiary/trustee. In some situations, perhaps, a modification could be sought to allow the appointment of an
independent trustee to make the §104 allocations.
C. The Drafting Conclusions
One of the more interesting aspects of this discussion is that the two lawyers involved believe passionately in unitrusts, one economist (Garland) also
believes in unitrusts, but only those related to returns,
not value. And Messrs. Levine, Collins, et al., the
economists, believe that the all income trust works just
So what is the estate planner to do with all
these decisions?
• First, remember that this is not
• Second, the main goal is still to
accomplish the client’s objectives, particularly with respect to current beneficiaries. While the generation skipping
transfer tax causes many people to set
up dynasty trusts, there are also strong
non-tax reasons that apply only to
spouse and children. Most of my
clients are not really concerned beyond
that. (And special powers of appointment allow children to deal with their
• Third, depending upon the trustee,
a totally discretionary trust or a trust
with standards that apply to both
income and principal allow the trustee
to invest for overall return. Even an
all income trust that allows principal
invasion should not limit the trustee’s
investment power. And if there is any
doubt, the draftsman can clearly state
that the trustee can invest for overall
return in accordance with modern
portfolio theory, and then gild the lily
by incorporating the prudent investor
rule as the investment standard. If an
ascertainable standard is used, the
draftsman must make it clear as to
how the income beneficiary is to be
treated and whether the trustee is to be
relieved of the duty of impartiality.
• Fourth, the choice of trustee is
critical. In a long term “happy” marriage, the choice of the surviving
spouse probably will get the testator
where he or she wants to be—leave all
the money at the disposal of the
spouse. This may also be true with a
trust for a responsible child where the
child is the trustee. In situations of a
second marriage, perhaps the only
way to get the proper spending result
is an independent trustee or a fixed
return unitrust.
• Fifth, if the testator desires to prefer one beneficiary, then that should
be spelled out also.
• Sixth, if the testator desires to
assure a real fixed level of spending,
then an annuity approach may work,
but a choice of the level must be carefully considered since a sharp and prolonged downturn could substantially
deplete the trust.
D. The Bottom Line
When I first started reading in this area, I
was convinced that the fixed percentage of value unitrust was the wave of the future and the way future
trusts should be drafted. However, after much consideration, I am convinced that more attention to the
client’s spending desires and more careful statements
in the trust as to intent produce a better result. The
question I could not escape is, “If the ‘experts’ cannot agree on the proper formula, how can I lead a
client into this morass?” In other words, the unitrust
concept is a solution in search of a problem, but the
discussion surrounding it has exposed some things
on which we, as estate planners, should focus more
ACTEC Journal 149
Washington Report
by John M. Bixler and Ronald D. Aucutt
Washington, D.C.
The anticipated Senate vote on permanent repeal
of the estate tax occurred on June 12. It required 60
votes to pass, and the vote was 54-44. Therefore, to
the surprise of no one, the measure failed.
Before voting on permanent repeal, the Senate
took up alternatives offered by Democratic senators,
including accelerated increases in the unified credit
(which failed by a vote of 38-60) and expansion of
qualified family-owned business interest (QFOBI)
relief (which failed by a vote of 44-54).
The Republican leadership vowed to continue the
repeal effort at another time.
Election Prospects
It is widely believed that the 2002 congressional
elections will produce little change. In the House of
Representatives, almost all incumbents’ seats are safe,
some made more so by recent friendly redistricting.
Whichever party holds control of the House in the
108th Congress (2003-04), control will probably continue to be by a razor-thin margin. And no one needs
to be reminded of how fragile control of the Senate is.
Given that a majority of the members of both the
House and the Senate, as well as the President, have
expressed support this year for making the repeal of
the estate tax permanent (albeit in the year 2010), one
might wonder how long, in a democracy, that
expressed will of the majority can be suppressed. It is
easy to imagine that if the Democrats regain control of
the House and retain control of the Senate, they will
consider trying to roll back some of the 2001 tax cuts,
including the repeal of the estate tax. But they would
probably have trouble undoing the majorities that
favor estate tax repeal, especially the somewhat bipartisan majority in the House, and in any event any
attempt to roll back repeal would meet with a veto
from President Bush.
The more interesting scenario to envision is what
to expect if the Republicans regain control of the Senate and keep control of the House. The way votes on
the estate tax are currently balanced, especially in the
Senate, the biggest effect of control will not be the
votes it brings, it will be the ability to control the agenda. In the Senate, there is always the possibility of a
filibuster, which requires 60 votes to break, but that
possibility is often diluted by strategic mixing of popular and controversial items in the same bill. In general, though, only the party that controls the Senate has
the ability to do that.
ACTEC Journal 150
Legislative Agenda
The election year of 2002 has not been very productive of tax legislation. Congress left medical and
long-term care relief, military tax relief, pension legislation, energy tax legislation, the charity/“faith based
initiative” proposals (about which we were optimistic
in the summer issue), the trade bill, tax shelter legislation, corporate “inversion” legislation, investor tax
relief, and any measures dealing with the foreign sales
corporations (FSCs) to be carried over to the 108th
Congress in 2003, or a late-2002 lame duck session of
the 107th Congress.
A lame duck session is expected in mid-November,
to deal with “continuing resolutions” to keep the government funded and homeland security legislation,
which the White House regards as a high priority. Such
a session could be interesting. Control of the Senate is
so fragile that if former Republican Congressman Jim
Talent defeats Sen. Jean Carnahan in their close Senate
race in Missouri, Republicans will immediately regain
control of the Senate for any lame duck session in
2002. That is because Sen. Carnahan is an appointed
Senator (to take the seat of her deceased husband,
whose name was on the 2000 ballot), the 2002 election
is therefore a special election to fill a vacancy, and the
results will be given effect immediately. Meanwhile, a
Senator to take the seat of Democratic Sen. Paul Wellstone for the rest of 2002 may be appointed by the
quixotic governor of Minnesota, Jesse Ventura.
Legislative prospects—short-term and long-term—
are just impossible to predict. Two generalizations seem
reasonably safe (which means they might be the first
things we have to take back in 2003). The first is that
even a “permanent” repeal of the estate tax, if it occurs,
is unlikely to be effective before 2010, providing ample
opportunity for future Congresses and Administrations
to reconsider it. The second is that fundamental tax
reform, which many view as an alternative to total repeal
sometime this decade, is very unlikely in 2003, while an
uncertain economy and a military and homeland security buildup combine to deny Congress the budget surpluses that once were promised. That aspiration still
seems to be on a trajectory to begin to make progress no
earlier than 2005, at the beginning of either President
Bush’s second term or a new Administration.
Administrative Developments in the Works
Meanwhile, the “business plan”—the 2002-2003
Priority Guidance Plan released by Treasury and the
Internal Revenue Service in early July—sets forth 250
projects to be completed during the twelve-month period from July 2002 through June 2003.
Twelve of these projects are listed under the heading of “Gifts, Estates and Trusts”:
1. Final regulations under section 643 regarding
state law definition of income for trust purposes. (Proposed regulations (REG-106513-00) were issued in
February 2001. As we elaborated in the summer issue,
we are interested in the degree to which these regulations will address all tax issues—income tax, gift tax,
and GST tax—and the degree to which they will recognize the autonomy of state legislatures and courts
without prescribing federal standards.)
2. Final regulations under section 645 regarding
an election by certain revocable trusts to be treated as
part of the associated estate. (Proposed regulations
(REG-106542-98) were issued in December 2000.
The final regulations should be close to issuance.)
3. Update revenue procedures under section 664
containing sample charitable remainder annuity trust
4. Update revenue procedures under section 664
containing sample charitable remainder unitrust provisions.
5. Guidance under section 664 regarding capital
gains for charitable remainder trusts.
6. Final regulations under section 671 regarding reporting requirements for widely held fixed
investment trusts. (The IRS issued proposed regulations on June 19 (REG-106871-00), replacing proposed regulations that had been issued in 1998.
Widely held fixed investment trusts are most likely to
arise in investment and commercial, not estate planning, contexts.)
7. Guidance under sections 671 and 2036 regarding tax reimbursement provisions in grantor trusts.
(This recalls the intensely controversial observation of
the Service in Letter Ruling 9444033 (Aug. 5, 1994),
dealing with two GRATs, that “[i]f there were no reimbursement provision, an additional gift to a remainderperson would occur when the grantor paid tax on any
income that would otherwise be payable from the corpus of the trust.” After a firestorm of protest, the ruling
was reissued a year later with that provision deleted.
Letter Ruling 9543049 (Aug. 3, 1995).)
8. Guidance under sections 2033 and 2039
regarding New York City and New York State Accidental Death Benefits.
9. Final regulations under sections 2055 and
2522 based on the Boeshore decision. (Estate of
Boeshore v. Commissioner, 78 T.C. 523 (1982), acq. in
result, 1987-1 C.B. 1, invalidated the rule in the regulations that prohibited a deduction for a charitable lead
interest if there was a preceding or concurrent non-
charitable lead interest. Proposed amendments to the
regulations issued on July 22 (REG-115781-01) provide an exception to that prohibition where the noncharitable lead interest, like the charitable lead interest,
is in the form of an annuity or unitrust interest.
10. Regulations under section 2519 regarding net
gifts. (Proposed amendments issued on July 19 (REG123345-01) fill in heretofore “reserved” portions of the
regulations, to provide that the donee’s obligation
under section 2207A(b) to pay the gift tax on a
spouse’s section 2519 disposition of a QTIP interest is
subtracted, in “net gift” fashion, in computing the
amount of the gift, and also that the spouse’s failure to
exercise that right of recovery constitutes an additional
taxable gift. In due course, the IRS cancelled the public hearing on these regulations, because no one had
asked to testify, implying that these regulations might
be finalized without significant changes.
11. Guidance under section 2642 regarding issues
relating to the generation-skipping transfer tax exemption. (This guidance will address the new rules related
to allocation of GST exemption, enacted in the Economic Growth and Tax Relief Reconciliation Act of
12. Guidance under section 2702 providing model
qualified personal residence trust provisions.
Exempt Organizations
The following projects appear on the business plan
under the heading of “Exempt Organizations”:
1. Guidance on joint ventures between exempt
organizations and for-profit companies. (This guidance will presumably build on the “good” and “bad”
examples in Rev. Rul. 98-15, 1998-1 C.B. 718, possibly including joint ventures in contexts other than
health care, joint ventures based merely on simple contracts rather than separate entities, and joint ventures
involving a commitment of less than all of the exempt
organization’s assets.)
2. Guidance on section 501(c)(4) organizations.
3. Guidance under section 501(c)(12).
4. Guidance on private foundation terminations.
(Rev. Rul. 2002-28, 2002-20 I.R.B. 941, addressed the
common scenarios of a split-up of a private foundation
into two or more private foundations, the incorporation
of a private foundation that had been a charitable trust,
and the merger of two private foundations. The clarifications in Rev. Rul. 2002-28 will eliminate the need to
file individual ruling requests in many cases. It is not
clear what issues any further guidance might address.)
5. Guidance on the application of existing UBIT
rules to the Internet activities of exempt organizations.
6. Regulations under section 529 regarding qualified tuition programs.
7. Guidance on split interest trusts.
ACTEC Journal 151
S Corporations
The following projects appear on the business plan
under the heading of “Subchapter S”:
1. Final regulations under section 1361 regarding
the time for beneficiary to make a QSST election.
2. Guidance under section 1362 regarding ESOP
rollover to IRA.
3. Guidance under section 1362 regarding late S
corporation election.
4. Guidance under section 1367 regarding the
basis of S corporation stock held by ESOP.
Split-Dollar Life Insurance Arrangements
“Guidance regarding split-dollar life insurance”
appears on the business plan under the heading of
“Insurance Companies and Products.” This closely
watched project revolves around proposed regulations
that were issued on July 9, 2002 (REG-164754-01, 67
Fed. Reg. 45414), following Notice 2002-8, 2002-4
I.R.B. 398. As of press time, the most recent public
development was the issuance of Notice 2002-59,
expressing IRS and Treasury disapproval of the use of
“high” P.S. 58 or Table 2001 premium rates to justify
inflated payments by senior-generation insured persons in “reverse split-dollar” contexts to transfer
wealth (non-insurance economic benefits) to younger
Notice 2002-59 (in section 3.01) pronounces what
amounts to a death sentence: “The use of such techniques by any party to understate the value of these
other policy benefits distorts the income, employment, or gift tax consequences of the arrangement and
does not conform to, and is not permitted by, any published guidance.” Even apart from Notice 2002-59,
the effectiveness of such techniques was poignantly
questioned by ACTEC Fellow Howard Zaritsky, who
was quoted in Steve Leimberg’s Estate Planning
Newsletter as skeptically musing: “I voluntarily overpay for something, give up the asset to a family member, and then assert that it is not a gift?” We think
Howard has a point.
Personnel Changes
Pamela F. Olson was sworn in on September 26 as
the new Assistant Secretary of the Treasury for Tax Policy, a position she has filled on an “acting” basis since
Mark Weinberger left Treasury in April 2002 to rejoin
Ernst & Young LLP. In her statement to the Finance
Committee, Assistant Secretary Olson appeared to
affirm the commitment frequently identified with IRS
Chief Counsel B. John Williams to concentrate
enforcement resources on “tax shelters”—that is, “bad
actors”—not necessarily routine controversies. Her
exact words were: “Working together with former
Assistant Secretary Mark Weinberger, Commissioner
ACTEC Journal 152
Rossotti, and Chief Counsel B. John Williams, we have
endeavored to resolve and remove from contention
other issues—issues more appropriately resolved with
published guidance—that absorb too many Internal
Revenue Service enforcement resources and distract
from far more significant compliance issues.”
It is tempting to suppose that many routine estate
and gift tax controversies—notably valuation disputes—might disappear from the IRS radar screen
under this approach, and there is some anecdotal indication from IRS examiners and counsel in the field that
they might be observing, or at least perceiving, such a
shift. There is cause to wonder, however, how valuation disputes could effectively be addressed by “published guidance.” A “tax shelter” approach, if it is not
handled with sensitivity to the uniqueness of the estate
planning context, could produce mischief by categorizing assets and transactions with reference to broadbrush “objective” criteria that produce inappropriate
results. Such a remedy might well prove to be worse
than the malady. (Nothing about valuation appears on
the 2002-2003 business plan.)
Significantly, Assistant Secretary Olson was asked
in the Finance Committee hearing if, in light of the
recent Senate vote, Treasury would consider supporting estate tax relief short of complete repeal, particularly for farmers and family-owned businesses. Her
response affirmed the Bush Administration’s commitment to total repeal.
Catherine Veihmeyer Hughes, an ACTEC Fellow
and our former partner, has recently joined Treasury to
work on estate and gift tax issues. Noting Cathy’s
ACTEC and bar association experience, Treasury’s
August 12 press release quoted Acting Assistant Secretary Pam Olson as saying that “Treasury is extremely
fortunate to have someone of her caliber join the
Office of Tax Policy.” We agree.
Heather C. Maloy has moved from the IRS Chief
Counsel’s Income Tax & Accounting Division to
become Associate Chief Counsel (Passthroughs &
Special Industries), with overall responsibility for the
division that issues rulings and writes regulations and
other guidance relating to the estate, gift, and GST
taxes, the income taxation of estates and trusts and
their beneficiaries, and the tax treatment of partnerships and S corporations. She succeeds Paul Kugler,
who retired from the Service after a distinguished
career, in which he earned great respect both in and out
of the Service for his even-handed decision-making
and his knowledge of the subject matter under his
oversight, especially partnerships. Ms. Maloy’s name
will be less familiar to most estate planners at first, but
there are ample reports, from both inside and outside
the Service, of good experiences with matters in which
she has been involved.
Foundation News
by John A. Wallace
Atlanta, Georgia
The Board of Directors of the ACTEC Foundation
met on June 27, 2002 in New York City in conjunction
with the summer meeting of the College. This was my
first meeting as President, and our first order of business was to express our appreciation to Norm Benford
for his leadership as President of the Board of Directors of the Foundation for the past three years. Norm
did a splendid job on our behalf during this time period. The next order of business was to welcome Professor Mark L. Ascher, an Academic Fellow at the University of Texas School of Law, to the Board; he was
immediately appointed to the Grant Committee, which
continues to be chaired by Professor Jeffrey N. Pennell, a faculty member of the School of Law at Emory
University. Mark will add considerably to our grantmaking deliberations.
There has been a substantial degree of grant-making activity of the part of the Foundation over the past
year, with approximately $160,000 of grants payable
currently outstanding. The Foundation remains solvent with between $400,000 and $500,000 of assets on
hand, but we are spending down the principal of the
Foundation rapidly because annual contributions in
recent years have only averaged between $40,000 and
$50,000 annually.
Most importantly, we are busy implementing a
$100,000 grant to finance yet another law program
through a one-hour television special to be broadcast
over the PBS network as a part of the Inside the Law
series. This latest program will be entitled “Financial
Planning for Incapacity.” This follows on the heels of
the one-hour special entitled “Are you Prepared for
Death,” which like the inaugural program was by all
accounts a great success in terms of distribution
through local PBS stations around the country.
The “Are You Prepared for Death” program was a
product of a steering committee composed of Jack
Lombard, Sara Stadler, Frank Collin, Gerry Cowan
and Donna Barwick. The new program covering incapacity issues will be formulated through a steering
committee composed of Frank Reiche, Jim Wade,
Susan House, Judy McCue and Bob Chapin. We owe
this hardworking committee our thanks for their work
on this program, which should be available early next
year. We will be asking the Fellows to assist us in
encouraging their local PBS stations to air this program in their cities and states. We will be preparing a
talking piece for you and you will be hearing from us
in that regard. Your efforts in the past for both the “Are
You Prepared for Death?” and “Death and Taxes” in
encouraging your local PBS stations to air our programs has been quite effective, and we expect to call
on you again this time around.
“Financial Planning for Incapacity” will address
various property law and social considerations in planning for disability and will include discussions of revocable trusts, guardianships and durable powers of
attorney. We hope that the educational outcome from
this program will assist all of us encountering the frustration of dealing with institutions that still attempt to
thwart appropriate uses of, say, durable powers of
attorney when a client becomes incapacitated. We
expect that educating the public and those connected
with financial institutions around the country will be
very useful in helping to recognize the use of durable
powers of attorney for our clients going forward. Further to this point, the Foundation has made funds available to underwrite the costs of a study on the use and
misuse of powers of attorney, again with a view toward
assisting the appropriate use of durable powers. The
Elder Law Committee of the College has been helping
coordinate this study, and we look forward to the
results with great anticipation.
Moreover, the Board approved a $10,000 grant to
The University of Miami School of Law to support
scholarships for its Graduate Tax Program in Estate
Planning attendees. This one-year program is unique,
and the Board felt that it should be supported by the
Foundation with the hope that the success of this program might cause comparable programs to be established in other law schools around the country. This
type of activity attempts to fulfill one of the primary
goals of the Foundation, which is to help convince
lawyers and law school programs to support the fields
of law in which we have an interest.
Finally, the Directors spent a considerable amount
of time discussing the fund raising experience of the
Foundation since its inception. Several special events
have been quite successful in raising funds for the
activities of the Foundation in the past, but in those
years when we limited our appeal for support to asking the Fellows that they include the Foundation in
their charitable giving plans, we have met with less
than optimal results. As noted earlier, we usually
receive between $40,000 and $50,000 a year from this
appeal, and we have a number of Fellows who have
supported the Foundation in this manner faithfully and
substantially. The unfortunate news is that we typical-
ACTEC Journal 153
ly number only around 10% of our membership in the
donor category each year. Frankly, this is disappointing to the Directors, and we feel that a yield of this
sort must result from a failure on our part (or perhaps
our broader leadership group) to educate the Fellows
about the activities of the Foundation and the contributions that it makes toward educating the public in
the areas of our fields of practice and also with respect
to important decisions that many people either ignore
ACTEC Journal 154
or refuse to address. Our case to you must clearly be
made with greater impact, something that we will
attempt to achieve well before charitable giving time
this year. Meanwhile, we encourage you to be on the
lookout for our efforts in this regard, and to be generous in your support of our programming and the activities of the Foundation when you have the opportunity
to consider your personal charitable giving decisions
this year.
Spotlight On Attorneys’ Fees
compiled by Martin A. Heckscher
Philadelphia, Pennsylvania
This report, which is a regular feature of ACTEC
Journal, focuses on significant recent court decisions
and rules, legislative enactments and IRS developments
bearing on attorney compensation in the trust and
estate practice. The report is heavily dependent on the
willingness of all the Fellows to furnish material that
they think would be suitable for inclusion. Please send
Spotlight’s compiling editor a brief write-up (as little as
one paragraph will do) about a recent case, rule,
statute or ruling which you believe is either important
in the jurisdiction in question or of widespread interest.
In addition, the Surrogate found that the attorneys’
second trip to the court to “examine original file” for
which they billed $1,625 was an unnecessary and
unreasonable expense to the trust. The court found the
reasonable attorneys’ fee to be $12,187.50 including
disbursements and directed the attorneys to refund
$7,812.50 to the trust. Wright v. Bankers Trust Hudson Valley, N.A, (N.Y.L.J. June 8, 2002, at 26,
Dutchess Co. Surrogate Pagones).
Jeffry L. Weiler, Cleveland
Sanford J. Schlesinger, New York City
Attorneys’ Fee for Trust Accounting Preparation
Services Disallowed; Fee Based on Retainer
Agreement Substantially Reduced
The corporate trustee of an inter vivos trust filed a
judicial accounting covering twenty years of trust
administration and sought approval of $40,000 in
attorneys’ fees, half of which had already been paid.
After the parties waived a hearing the Surrogate’s
Court decided the issues on the papers. The trust provided that the trustee may employ counsel and agents
and pay them reasonable compensation. At the outset
the court found that the hourly rates for two partners
($295 to $325) and for associates and paralegals at the
trustee’s law firm were not excessive, although it
pointed out that the rates were substantially higher
than the average in the geographical area. The court
noted, however, that more than half the recorded time
was attributed to “review of transaction statements”
and “account preparation.” The trustee had agreed to a
flat fee of $40,000 based on the “size and complexity
of the trust.” The court stated that it “bears the ultimate responsibility to decide what constitutes reasonable legal compensation,” even when there is a specific retainer agreement between the parties, and that “it
is appropriate for the Surrogate to cut a requested fee
when it appears that executory services were performed by an attorney.” The court observed that it was
apparent that a substantial portion of the non-legal
accounting services, which are the trustee’s responsibility, were performed instead by the attorneys as part
of their “flat-fee” arrangement. The Surrogate held
that “under the circumstances, I do not find that it is
appropriate for those services to be billed to the trust.”
Fee for Attorney Serving as Attorney and
Executor Cannot Be Based Solely on Schedule in
Local Court Rule
Attorney Kammer served as the executor and
attorney for decedent’s estate. Kammer applied to the
probate court for his executor’s and attorney’s fees.
The beneficiaries of the estate consented to the fees
requested. The probate court allowed the statutory
executor fee but reduced the attorney’s fee by 50 percent based on the formula established by local court
rule, which provides that an attorney serving as both
executor and attorney for an estate is entitled to onehalf of his attorney’s fee if he receives a full executor’s
fee. The Court of Appeals held that the probate court
improperly applied the formula provided in the rule
without an evidentiary hearing to determine the reasonableness of the attorney’s fee based on the value of
the services rendered. The court cited three Ohio
cases holding that the probate court may not arbitrarily award an attorney’s fee based on a fee schedule but
must exercise its discretion to determine the fee when
the attorney serves in dual capacities. Accordingly,
the court remanded the matter for a hearing to determine the fee. In re Estate of Rothert, 2002 WL
834509 (Ohio Ct. App., May 3, 2002).
Gerry W. Beyer, San Antonio
Compiling Editor’s Note: Although the following
case dealt with several questions about attorneys’ fees
in litigation involving an estate and a testamentary trust,
the writeup does not focus on the attorneys’ fees.
Instead our focus is on the court’s principal holding
ACTEC Journal 155
which substantially reduced an executor’s commission,
an issue not usually covered in Spotlight. Your editor
believes that the court’s reasoning in this case for
increasing the surcharge for an excessive executor’s
commission is important because it may apply by analogy in substantial estates where a surcharge for an excessive fee payable to an executor’s attorney is at issue.
Surcharge for Excessive Executor’s Commission
May Not Be Reduced by Estate Tax Savings That
Would Have Resulted If Full Commission Were
Allowed and Deducted; Trustee of Testamentary
Trust Removed for Breach of Fiduciary Duty
Required to Reimburse Trust for Beneficiary’s
Attorneys’ Litigation Fees Plus Interest
In Lee v. Lee, 47 S.W. 3rd 767 (Tex. App. Houston
[14th Dist.] 2001, pet. denied), decedent left the bulk
of her estate to testamentary trusts for her son, daughter and grandchildren and named her son executor of
the estate and trustee of the trusts. Because of valuation, tax, liquidity, and related issues, it took about
eight years before the son began to fund the trusts and
make distributions. During that time the son paid himself over $2.8 million for his executor’s commission.
The daughter objected, claiming that the commission
was excessive. After a jury determined that the commission was unreasonable by approximately $2.2 million, the trial court reduced the surcharge by $660,000
by giving credit for the tax saving realized by deducting the disallowed portion of the commission on the
federal estate tax return. On appeal the daughter
asserted that it would be unjust to permit her brother to
retain $1.5 million of his excessive commission
because the increased deduction would reduce the federal estate tax. The Court of Appeals first addressed
the possible application of § 241 of the Texas Probate
Code which permits the court to deny the commission
allowed by statute if the executor does not manage the
estate prudently. Because settlor’s will directed that
the son shall receive just and reasonable compensation,
the court concluded that § 241 could not apply.
Next, the court examined whether the trial court
properly applied the “benefits rule” to reduce the
damages awarded against the executor for the excessive commission. The benefits rule was established
ACTEC Journal 156
in Nelson v. Krusen, 678 S.W. 2d 918 (Tex. 1984),
when the Texas Supreme Court refused to recognize a
cause of action for wrongful life and held that the
court must offset any special benefits the plaintiff
receives resulting from the negligence. In Nelson, the
court held that the collateral source rule prevents a
tortfeasor from receiving any benefit from payments
conferred upon an injured party from sources other
than the tortfeasor. In Lee, because the estate tax
deduction emanated from a different source than the
wrongdoer, the court held that the executor was not
entitled to have the surcharge for his excessive commission reduced by the increased estate tax deduction. After an extensive analysis of the benefits rule
in which it reviewed decisions of the United States
Supreme Court, the Texas appellate courts and courts
in other jurisdictions, the court held that the trial
court erred in applying the increased tax deduction as
an offset to the commission. Although the estate will
be enriched by $1.5 million, the court observed that
“it is more appropriate for the estate to obtain the
benefit of a windfall than to let [the executor] keep
$1.5 million in fees the jury found was unreasonable.”
Lee, at 780. The court further found that sufficient
evidence supported the jury’s finding that $2.2 million was an excessive executor’s commission.
The court also passed on various claims for
allowance of attorneys’ fees in the litigation in light of
its holding that the son should be removed as trustee of
the testamentary trust (but not as executor of the estate)
because he had committed various breaches of fiduciary duty. The parties stipulated that the fees of the
daughter’s and son’s attorneys’ in the trial court were
$1.5 million each. The trial court also awarded both
parties $300,000 in attorneys’ fees for the appeal to the
Court of Appeals and $100,000 if either should seek
review by the Texas Supreme Court. On appeal the
court held that the trial court erred in refusing to
require the son to reimburse the estate for the daughter’s attorneys’ trial court fees and that he also reimburse the trust for the daughter’s attorneys’ appellate
court fees paid by the trust. Finally the court held that
the son must pay the trust post-judgment interest at
10% per annum compounded annually on the reimbursements for attorneys’ fees.
New Developments in Construction
and Instruction Case Law
compiled by John F. Meck
Pittsburgh, Pennsylvania
The following case summaries are a project of the
Construction and Instruction Subcommittee of the
Fiduciary Litigation Committee. The project is intended to update Fellows regarding cases in the instruction
and construction area. The committee invites all Fellows to furnish material that would be suitable for
inclusion in the column. The material may be sent to
any member of the subcommittee.*
C. Fred Daniels, Birmingham
Traceable proceeds from sale of timber by life
tenant with absolute power of disposition belong
to remainder beneficiary at life tenant’s death
Husband died in 1994. His will left all his property to his wife for her life, “with the absolute power of
disposition of all or any part thereof, and upon her
death any part of my said estate then remaining” to go
to the husband’s descendants. The wife sold timber
from the real estate and used the proceeds to purchase
certificates of deposit in the names of her daughter and
herself as joint tenants with right of survivorship.
When the wife died in 1998, her son, who was the
executor of her estate, filed a petition to determine the
ownership of the certificates of deposit.
At common law, a purported life estate coupled
with an absolute power of disposition was deemed to
be an estate in fee simple absolute, with the result that
the remaindermen did not take anything.
The common law rule was modified by statute in
Alabama to provide that an absolute power of disposition with respect to an estate for life or years that is not
in trust remains subject to the future estates limited
thereon if the power is not executed or the property is
not sold for the satisfaction of debts during the continuance of the particular estate. Ala. Code § 35-4-292(a)
(1991 Repl.). Accordingly, a life tenant with absolute
power of disposition is free to dispose of the property
during his or her lifetime, but any portion of the property remaining at his or her death passes to the remain-
* Construction and Instruction Subcommittee: John F. Meck,
Chair, Arthur H. Bayern, Clark R. Byam, Gerald L. Cowan,
dermen to the extent that it is not disposed of.
The Alabama Supreme Court recently interpreted
the statute as not being limited to the portion of the
estate that remained unchanged in kind or form.
Williams v. Burgett, 2002 WL 442718 (Ala.), March
22, 2002. Instead, the proceeds in this case that
remained under the power and control of the wife as
life tenant remained a part of the life estate and passed
to the remaindermen at her death. The daughter as
joint tenant with right of survivorship of the certificates of deposit took nothing.
One justice who concurred specially noted, however, that the record failed to reflect whether the decedent practiced tree farming and, if so, whether the sale
by the wife during her life estate was similar to the
timber operations practiced by the husband. He noted
that if it was, the life tenant had a right to the proceeds
from the timber sale without regard to the power of
disposition. The implication is that had the daughter
argued that some or all of the proceeds from the cutting of timber were income, that portion might have
been freed from the life estate.
Clark R. Byam, Pasadena
Fiduciary Did Not “Transcribe” the Trust
A recent California Supreme Court decision
affirmed both the trial and Appellate Court’s rulings
that California Probate Code section 21350(a) does not
include within the class of “persons disqualified”
(from inheritance) because they cause an instrument to
be transcribed, a fiduciary who provides information
needed in the instruments, preparation, and encourages
the donor to execute it, but does not direct or otherwise
participate in the instrument’s transcription to the final
written form.
The petitioner, Rice (who was not an heir of decedent), sought to invalidate gifts given by the decedent by
a 1995 trust and by other instruments that left the dece-
John G. Grimsley, Karen M. Moore.
ACTEC Journal 157
dent’s entire estate to the respondent, Richard Clark,
and his wife, on the basis that the transfers to Clark were
invalid under section 21350(a)(4), which treats as
invalid, an instrument providing donative transfers to
“any person who has a fiduciary relationship with the
transferor, who transcribes the instrument or causes it to
be transcribed.” Clark was in a fiduciary relationship
with decedent, having been the trustee of the decedent’s
trust prior to her death, and was the recipient of the
entire trust estate upon decedent’s death.
The trial court concluded that in order to be
deemed to have caused an instrument to be transcribed,
within the meaning of section 21350(a)(4), the recipient had to be “substantially, and uninterruptedly,
[involved in] the writing down, or causing to be printed,
the words of another.” The trial court noted that while
Clark had arranged for the preparation of the challenged documents, he neither drafted the instruments,
transcribed them, or caused them to be transcribed
because “he did none of the thinking or writing himself
nor did he order or request any other person to do so.”
This decision will make it much more difficult to
challenge donative transfers to fiduciaries under Probate Code section 21350(a)(4), unless the fiduciary
was actively involved in the actual transcribing of the
document. Otherwise, contestants will be left to the
common law cause of action based on undue influence.
children and Wife’s to her children, with the joint property to be divided between the two sets of children at
the survivor’s death. Prior to execution of the wills,
the attorney suggested Husband and Wife execute a
post- nuptial agreement or a joint will to acknowledge
the oral agreement, but Husband and Wife declined
because “each had great confidence in the other.”
Subsequent to Wife’s death, Husband executed a
new will leaving everything, including the previously
joint property, to his children.
After Husband’s death, Wife’s children sued to
enforce the oral agreement reflected in the original
wills. The trial court granted summary judgment to the
children. On appeal, the court noted that the mere execution of a joint will or of mutual and reciprocal wills
raises no presumption of a contract not to change the
wills. The mutual and reciprocal wills remain totally
ambulatory. In this instance, however, the original
wills clearly stated there was an oral agreement and the
wills reflected the terms of the agreement. Accordingly, there was a contract not to revoke as required by
Section 474.155, RSMo 1994:
Calvin J. Karlin, Lawrence
Moran v. Kessler, 41 S.W.3d 530 (Mo.App. W.D.
Will Construed to Qualify for Marital Deduction
Declaratory judgment statute was used to construe
decedent’s will to preserve marital deduction where
365 day survival period was required for spouse.
Kansas statute allowing construction of wills to bring
them into conformity with federal estate tax statute on
marital deduction permitted construction of will to
include 60 day survival period (although decedent had
crossed out the 60 day provisions and replaced them
with 365 day provisions). In re Estate of Keller, 46
P.3d 1135 (Kan. May 31, 2002).
Clifford S. Brown, Springfield
Mutual and Reciprocal Wills Remain Revocable
Absent a Contract Not to Change
Husband and Wife executed mutual and reciprocal
wills in which each acknowledged an oral agreement
as to the ultimate disposition of their estate to their
respective children from prior marriages. The agreement was that Husband’s property would go to his
ACTEC Journal 158
“A contract…not to revoke a will…
can be established…by
(1) Provisions of a will stating material provisions of the contract;”
Layne T. Rushforth, Las Vegas
Unilateral Gift of Homesteaded Residence Void
The case of Besnilian v. Wilkinson, 117 Nev. Adv.
Op. No. 45, 25 P.3d 187, 2001 Nev. LEXIS 45 (June
21, 2001) involved residential real property that was
purchased in joint tenancy by a husband and wife in
1975. In 1990, the couple signed a joint declaration of
homestead. The husband subsequently signed a deed
in an attempt to convey his one-half undivided interest
as a gift. The ruling turned on language in Article 4,
Section 30 of the Nevada Constitution, which states
that a homestead “shall not be alienated without the
joint consent of husband and wife when that relation
exists.” One justice dissented stating that the ruling
stands for the proposition that homesteading joint tenancy property converts it into community property.
[Editorial comment: In reference to the conversion of
joint tenancy property into community property, the
dissenting judge stated, “I do not find any indication
of this intent in Nevada law.” None of the justices
took notice that NRS 115.061—a law that was in
effect in 1990 when the homestead declaration was
signed—provides that a married couple’s homestead
declaration converts the ownership into “community
property with a right of survivorship”. Obviously,
none of the attorneys involved in the case had read
that statute, either.]
Prof. Gerry W. Beyer, San Antonio
WILLS – Restraint on Alienation
Rather than create a trust, Testator devised real
property to his children. The devise provided that if
any child wanted to sell his or her share to someone
other than Testator’s siblings, the written consent of all
of the surviving siblings was required. After all sib-
lings die, however, children may sell to anyone, but the
descendants of siblings will have a right of first
refusal. Two of the children conveyed their interests to
third parties without obtaining the prior consent. The
remaining children sued to set aside the sales for violating the terms of the devise. The trial court granted
summary judgment in favor of the selling children.
The appellate court affirmed. The provision requiring Testator’s siblings to approve a sale is a restraint on
alienation which is against public policy and thus not
enforceable. The court rejected the claim that the Will
merely created rights of first refusal. Only after all of
Testator’s siblings are deceased does the Will impose a
right of first refusal on siblings’ descendants. Williams
v. Williams, 73 S.W.3d 376 (Tex. App.—Houston [1st
Dist.] 2002, no pet. h.).
A person wishing to impose restrictions on alienation should consider a trust or other techniques.
ACTEC Journal 159
ACTech Talk:
Tips for Technophobes
by Robert B. Fleming
Tucson, Arizona
You may be one of the growing minority (but still
minority) of lawyers who loves to experiment with and
implement technological approaches to problem-solving in your law office. You may even be inclined to try
out a high-tech “solution” for problems that haven’t
yet proven to need solutions at all. If, however, you are
like most lawyers, your attitude may be that you would
rather practice law than play with “toys.” You may
believe that you haven’t the time or inclination to pursue questionable and ultimately unreliable approaches
to the practice.
Do not misunderstand our emphasis—we are committed technology partisans, and we are proud of our
high-tech toys (though we object to anyone else characterizing them as such, since we really do see them as
tools to help us in the practice of law). We acknowledge,
however, that there is still a significant segment of the
practicing bar that proudly proclaims a complete inability to manage or deal with computers. We have seen and
heard more than one Fellow, chest puffed, announce that
he (usually) knows where the on/off switch is located but
absolutely nothing else about the paperweight placed on
the Fellow’s desk by the firm’s managing partner.
We firmly believe that such technophobia is professionally limiting. But we also recognize that the
technology can be daunting, and that its first creative
use can be the most difficult. Accordingly, we offer a
handful of specific tips for Fellows suffering from
technophobia. We do not mean to suggest that each of
these can be implemented by the technologically backward; some or all will require the participation of support staff and even the MIS (Management Information
Systems—the modern euphemism for professional
nerds) Department.
In publishing this list we hope to accomplish two
entirely separate goals. First, we hope that some of the
more open-minded Luddites among our membership
will see an opportunity to utilize technology in discrete, relatively painless ways—possibly leading (who
knows?) to more extensive use of technology in the
future. Second, we hope to entertain those who are
more technologically advanced, reassuring them that
they know more than they think and (who knows?)
maybe even suggest a few new ideas to that group.
Herewith a handful of tips for technophobes—or for
those merely aspiring to technophobia:
ACTEC Journal 160
Digital Photographs of Clients
You should be able to see most or all of the work
product associated with a given client or file in one
place on your computer. You may even be able to find
the list of files using a document (or information) management program like Worldox, or iManage. Even if
you are limited to the simple approach of using Windows Explorer, you probably already know how to get
to the files for a particular client or case. But can you
see a picture of your client(s) in that directory?
Wouldn’t it be nice if, while working on Mr. and
Mrs. Jones’ estate plan, you could remind yourself what
they look like—and perhaps even recall the substance
of their office consultation two weeks ago? When Mr.
Jones calls to suggest some minor changes, or to
inquire how long before drafts will arrive, wouldn’t it
be nice to be able to call up his picture and put face to
name while you talk to him on the phone? If you occasionally go to court, wouldn’t it be an advantage to be
able to remind yourself what your clients look like
before searching for them in a crowded courtroom?
This technological advance is easy for the technophobe, and relatively inexpensive. It requires no action
on his or her part except to direct implementation. Buy
the office a small handheld digital camera (one of us
uses a Canon PowerShot A20, which currently lists for
about $340—but completely acceptable models can be
found for $200 or so) and hand it to the receptionist.
Ask him or her to take a picture of every new client,
and any long-time client whose picture is not already
in the (electronic) file. The receptionist may initially
balk, but will probably find the exercise entertaining
and a pleasant way to establish rapport with clients.
In case you are worried about file size (feel free to
skip this paragraph if you are not), a reasonably clear
picture should be in the 200-300 kilobyte range. With
hard drive sizes and prices where they are today, that
additional storage requirement will be inconsequential.
The draft of your revocable trust will be nearly as
large, and the scanned copy of the signed trust two or
three times larger. In other words, the size and number
of files on your computer network is simply not an
issue at present.
In addition to helping remind you what your
clients look like, a number of ancillary benefits flow
from regularly photographing them as you do their
work. In our experience clients will be pleased that you
are helping to prevent any future instances of fraud.
Many will have heard of digital cameras, but not seen
them in use; most will not have seen pictures of themselves captured digitally (we always print a copy to
hand to the client, since we received so many requests
when first implementing this project). You will also
have created a record of the client’s appearance at
about the time of signing important documents in most
cases, which may help reduce the prospect of later
challenges (though with inadequate or poorly arranged
lighting, clients may actually look more haggard and
less competent than they appear in real life). Finally,
you will have reassured clients that no one else can
appear, claiming to be them, and confuse or frustrate
their estate plans.
Working from Home
Almost everyone professes to be interested in
working at least part time from home, or from a summer cabin, Tahiti or the Rive Gauche. Turns out it’s
easy to accomplish. If your remote location includes
access to a web browser, you can launch your office
desktop computer with a modest investment and even
more modest technological skills.
The easy way to get access to your office computer from elsewhere is to use GoToMyPC ( Installation is simple; first browse out to
the website from your office computer and install the
software. Cost is a mere $19.95 per month, with unlimited access. Costs are even lower if you pay for a year
at a time (that reduces the cost to $14.95 per month) or
enroll two or more computers. There is even a thirtyday free “test drive” option. While installing you will
be prompted for an e-mail address, a password for the
program and another, separate password for each computer to be shared.
Once GoToMyPC is installed on your office computer, you will see a small icon in that computer’s system tray (don’t worry if you don’t know what that
means—you don’t have to see it or do anything with it
to make the program work). Now you simply log into from any other computer, enter
your e-mail address and the two passwords you provided, and voila (assuming you are actually on the
Rive Gauche), you are looking at your office computer
This method of accessing your office is simple and
inexpensive, though there are two caveats: (1) your
MIS department (if you have one) may want to have a
say in letting you do this, and (2) the link is immensely more useful if you have high-speed internet access
(DSL, cable or other non-dialup type access) at both
ends of the connection. With the increasingly widespread availability of high-speed access, however, this
remote computing approach can give you incredible
PDAs (Personal Digital Assistants)
All right—this is a song we have sung before.
Palm or PocketPC handheld computing devices are
capable of changing your professional life. Carry your
calendar everywhere without having to rely on staff to
update a paper version every day. Enter new contact
information while at a seminar, a cocktail party or a
court hearing. Schedule a new court hearing and have
it automatically show up on your office calendar when
you return. Maintain, update and complete your list of
ToDo items during your commute (assuming you do
not drive), on an airplane or while waiting for your car
to get washed.
We often see three roadblocks to the widespread
use of PDAs by Fellows. Some like the idea, but can
not decide which PDA they should buy. Some can get
past that problem, but are worried that installation and
management will be too difficult to figure out. And
some—perhaps most—are simply uncertain whether
the handheld device will prove to be valuable.
As to the last of those problems, you may just have
to take our word for it. The good news: if you buy the
least expensive PDA on the market, you can try a $100
(or less) experiment. If you are sold, but decide you
need a more capable unit, your teenage child will love
the hand-me-down PDA while you go out to upgrade.
Working backwards through the problem list,
installation may indeed require the intervention of a
technical expert. We suggest relying on your secretary,
or that same teenager, to get the unit installed and connected to your office’s calendar and case management
system. Know in advance that it is astonishingly easy
to use Microsoft Outlook, Time Matters, Amicus
Attorney or any of the widely-used case management/calendaring systems with PDAs, though there is
some difference in how well each program relates to
the two main types of handheld.
Now for the hardest question: which unit should
you try? If you are a Microsoft Outlook user, and especially if you are also a Microsoft Office user, purchase
a PocketPC unit. Otherwise, look at one of the many
Palm-powered units. The choices are myriad, but the
good news is that at these prices, it is hard to make a
bad choice.
Deciding which Palm-type unit you want/need is
dependent on the answer to two questions: (1) do you
need a color screen? And (2) do you want to combine
your Palm with your cell phone? If the answer to both
those questions is negative, start with a Palm m105, a
Handspring Visor Platinum, or a Sony Clie PEG-SL10.
These basic machines will give you an introduction to
the genre, and cost less than $150 each.
ACTEC Journal 161
Why would you need color? There is one major
advantage—the color screens provide better contrast
and are easier for middle-aged eyes to read. The tradeoffs, of course, are cost and battery life, but neither suffers so much that it makes the investment in color foolish. Palm, Handspring and Clio (the main competitors
in this market) each make a collection of color
options—choose one and give it a try, knowing that you
can always trade out for another model and your spouse
or child(ren) will be delighted with their new PDA(s).
The latest development in the PDA market,
though, is the notion of convergent technology—combining a Palm with a cell phone. There are three major
competitors for this market, and each has its partisans.
You will have a hard time making a mistake here, and
so you should probably start by contacting your cell
phone carrier to see which unit it offers, and at what
(discounted) price. In a general way, the Samsung
SPH-I300 is best described as a PDA with cell-phone
capabilities, the Kyocera 7135 as a cell phone with a
built-in PDA, and the Handspring Treo 300 as a compromise between the two (though the Treo uses a
thumb-operated keyboard exclusively, which may
make it harder to utilize than the handwriting-based
input on other PDAs). For our money the Kyocera
7135 looks like the early winner, but all three are
excellent choices.
Multiple Monitors
Okay—this one takes a little more technical expertise to set up, but the payoff is definitely worth it. You
probably have a growing collection of used monitors
ACTEC Journal 162
sitting around the office—castoffs as staffers upgrade
to LCD panels, or at least to larger monitors. Grab one
of those, clear some desk space and set it next to your
existing monitor. Now get someone to connect it to
your computer (it will probably require a second video
display card, but that need not cost more than about
$30-50). The benefits are amazing.
With two monitors, you can have your case management program open on one screen at all times. Your
calendar, or your list of clients and contacts, can be
immediately available even while your word processor
is open on an active document. Or you can have two
separate word processing documents open, and cut and
paste between them without having to switch screens
(or shrink either document to an unreadable size). Or
your e-mail can be always-on, letting you know at a
glance when you are outbid on eBay.
If your desk (the real one, not the virtual one) is
small and/or cluttered already, it may be difficult to
find space for a second monitor. In that case, or if you
have lots of extra monitors looking for homes, try
installing the second monitor at your assistant’s workstation. We predict that he or she will love the new
flexibility it affords.
These relatively simple ideas are useful no matter
how technologically adept you may be. You may have
others, and if so we would love to hear from you. Email your ideas to [email protected] or
[email protected] If we use your tips in a future
column, we just might send you one of our leftover
monitors, or PDAs. On the other hand, we both have
children and spouses.
New Developments in Malpractice
compiled by Keith Bradoc Gallant, New Haven, Connecticut and
Sharon B. Gardner, Houston, Texas
The Malpractice Subcommittee of the Fiduciary
Litigation Committee has initiated a new project to help
keep Fellows current on issues that are relevant to their
practice area. The following cases summarize opinions
from several states published in 2002 in the ethics and
malpractice areas. Some opinions have not yet been
finalized or published. All Fellows are requested to
provide any cases from their respective jurisdictions
that may be suitable for this column. Any Fellow of the
subcommittee will be glad to receive a submission.1
United States further reasoned because Murphy had no
standing individually, the damages recovered inured
solely to the benefit of the estate.
The court of appeals, in considering the summary
judgment filed by the United States, reasoned that Maryland follows a strict privity rule in causes of action for
malpractice against an attorney. Maryland has a narrow
third party beneficiary theory, but the exception requires
allegation and proof that the intent of the client to benefit the nonclient was a direct purpose of the transaction.
The central question before the court of appeals was
whether, as an individual, Murphy had standing to sue
Hackney either because of an employment relationship
with Hackney or because, as primary beneficiary under
Mrs. Murphy’s will, he was the intended third party beneficiary of Hackney’s legal services to the Estate. At the
hearing, Murphy did not offer evidence to support that
Mrs. Murphy’s primary purpose in engaging Hackney
for legal services was to benefit Murphy as the primary
beneficiary of her estate. The court noted there was no
retainer agreement and held that Murphy had failed to
produce sufficient evidence that Murphy had standing to
sue Hackney as primary beneficiary of the Estate.
Accordingly, the settlement proceeds constituted Estate
property to which the United States has a superior claim
because of its tax lien. The summary judgment for the
United States was granted.
Murphy v. Comptroller of the Treasury, 207 F.
Supp. 2d 400 (D. Md.)
Murphy brought an interpleader action to determine his entitlement to $130,460.20. The amount represented settlement proceeds recovered by Murphy for
alleged malpractice committed by Hackney for negligently valuing the Estate’s assets and computing the
Estate’s tax liability. Murphy alleged Hackney’s malpractice conduct resulted in a substantial assessment of
taxes, penalties and interest against the Estate. Murphy
and the United States each argued that they have a
superior claim to some or all of the settlement proceeds. The opinion notes that on September 9, 1993,
the IRS assessed taxes totaling $292,199.00 against the
Estate. As of January 14, 2002, the Estate owed the
IRS $1,271,800.98 in estate taxes, penalties and interest. The Estate also owed the State of Maryland
$33,377.41. The United States and the State of Maryland had placed a tax lien on the estate property.
Murphy argued that he had a superior claim to a
portion of the settlement proceeds because of the dual
capacity in which he brought the malpractice suit. The
suit was brought by Murphy individually and as a copersonal representative of the estate. The United States
argued that it had a superior claim to all of the settlement proceeds because of the federal tax lien against
the estate. The United States further alleged that under
Maryland law Murphy did not have standing to sue
Hackney in an individual capacity for damages. The
Leak-Gilbert v. Fahle, 2002 WL1753198 (Ok. 2002)
(not yet released for publication)
In 1997, Mr. Leak hired Fahle to update his will.
Mr. Leak provided a copy of his current will to Fahle
and asked that his grandson be disinherited. Fahle indicated that Mr. Leak identified his only heirs as the children of a deceased son, Alvin Troy Leak, Alvin James
Leak, and the Plaintiffs in this matter.
After Mr. Leak’s death in 1999, the will was submitted for probate. The proceedings revealed that Mr.
Leak had four additional grandchildren by another
deceased son. Those grandchildren were not mentioned in the will. Consequently, the probate court
treated the grandchildren as unintentionally omitted
Members of the subcommittee include Woody Davis, Ed
Downey, Brad Gallant, Sharon Gardner, Charles Gibbs, Rodney
Houghton, Ron Link, Peter Matwiczyk, John Price, and Judith
ACTEC Journal 163
heirs, and it divided the estate among the grandchildren as if the decedent had died interstate.
The beneficiaries of the will brought a legal malpractice action against Fahle, asserting that she was
negligent, and that she had breached the contract with
the decedent because she failed to properly prepare his
will according to his intentions.
Apparently, Fahle’s sister was a lawyer and had
probated the will of another deceased family member,
where the grandchildren may or may not have been
named. Fahle admitted her sister may have handled the
probate of the decedent’s wife, but Fahle and her sister
never practiced law together and those files were maintained in storage. Fahle claimed she had no affirmative
duty to locate additional heirs beyond what Mr. Leak
told her at their consultation
The Oklahoma Supreme Court was asked to
answer questions of law from the Western District of
Oklahoma: 1) whether, in the absence of a specific
request by the client, an attorney owes a duty to the
client or to the beneficiaries named in the client’s will
to conduct an investigation into the client’s heirs
independent of, or in addition to, the information provided by the client; and 2) whether the residual beneficiaries under a decedent’s will have a cause of
action for legal malpractice against the attorney who
drafted the will under a theory of negligence or
breach of contract when the will fails to identify all
the decedent’s heirs?
The Oklahoma Supreme Court held that when an
attorney is retained to prepare a will, the attorney’s
duty to prepare the will according to the testator’s
wishes does not ordinarily include an investigation of a
client’s heirs independent of, or in addition to, the
information provided by the client, unless the client
requests such an investigation; and 2) an intended will
beneficiary may maintain a legal malpractice action
under either negligence or contract theories against the
drafter when the will fails to identify all the decedent’s
heirs as a result of the attorney’s substandard professional performance. This decision is a case of first
impression in Oklahoma.
Volume 28, No. 2, Fall 2002
Published quarterly for the Fellows of The American College of Trust and Estate Counsel as
a professional service.
Members of the College receive a subscription to ACTEC Journal without charge. Nonmembers may subscribe to ACTEC Journal for $60 per year. Price for single issue, if available, is
$15 per issue.
This publication contains articles that express various opinions. The opinions expressed in
such articles are those of the authors and do not necessarily reflect the opinion of the College.
Correspondence with respect to College business may be addressed to Executive Director,
The American College of Trust and Estate Counsel, 3415 S. Sepulveda Boulevard, Suite 330,
Los Angeles, California 90034. Telephone: (310) 398-1888. Fax: (310) 572-7280. Web site:
ACTEC Journal 164