Report No. 11 (Wed. 1/16)
As we have done in January for the last eleven years, and again with the
permission of the University of Miami School of Law Center for Continuing
Legal Education, we will be posting daily Reports to this list containing
highlights of the proceedings of the 42nd Annual Philip E. Heckerling
Institute on Estate Planning that is being held January 14-18, 2008 at the
Orlando World Center Marriott Resort and Convention Center in Orlando,
Florida, a new venue for the Institute starting in 2007. A complete listing
of the proceedings will be published here and is also available on the
Institute's Web site at http://www.law.miami.edu/heckerling.
We also will be posting the full text of each of these Reports on the ABA
RPPT Section's Web site, as we have since the 2000 Institute. Those Reports
can be found at URL http://www.abanet.org/rppt/meetings_cle/heckerling. In
addition, each Report can also be accessed at any time from the ABA-PTL
Discussion List's Web-based Archive at URL
http://mail.abanet.org/archives/aba-ptl.html.
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This Report covers the Prudent Investor Rule from the Wednesday sessions
and Trust Decanting, Perpetuities and Dear Trustee, Send Money from the
Thursday sessions. We anticipate that the next Report will cover more of
the Thursday sessions, including the ever popular Q&A session.
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CROSS-SELLING, INDEXING AND THE PRUDENT INVESTOR ACT: PITFALLS AND
ALTERNATIVES
Wednesday, January 16, 2008
Presenters: Christopher Cline, Daniel Miller, and William Norris
Reporter: Carol Cobczak
This special session was divided into three parts:
(i) Modern Portfolio Theory, the Restatement, the Uniform Prudent Investor
Act and Passive Investing;
(ii) The Pitfalls of Passive Investing - Uncovering the Vulnerabilities of
Index-Based Passive Investing; and
(iii) Cross-Selling under the Prudent Investor Rule
Part One - Modern Portfolio Theory, etc. (Mr. Cline)
Two concepts emerge from modern portfolio theory (MPT): risk
(both market risk and non-market risk) and market efficiency (which assumes
that information about assets is disseminated efficiently).
The Restatement (Third) of Trusts (Restatement) was a reaction
against the old theory of trust investing which provided a list of
authorized investments and which reviewed a trustee's investments
individually. The Restatement, on the other hand, provides that a trustee
may invest in any type of investment and the portfolio will be reviewed as
a whole.
According to the Restatement, a trustee has the duty to review
the contents of a trust portfolio and implement investment decisions
"within a reasonable time after the creation of the trust." While the
trustee has a general duty to diversify, he may hold special assets (such
as closely-held business interests) if the asset had a special relationship
to some objective of the settlor. The concepts of risk and efficient
market theory are incorporated into the Restatement. A very important part
of the Restatement states that a mere authorization for the trustee to
invest in specific assets is not sufficient to exculpate the trustee from
the duty to diversify. The speaker noted that most trusts he has seen,
including his own, include such a mere authorization, which is ineffective.
The Prudent Investor Act (PIA) relies on the principles in the
Restatement. The PIA is a default rule and may be overridden in a
trust. The trustee's standard of care is the prudent investor standard,
and the trustee must consider the purposes, terms, and distribution
requirements of the trust. The portfolio is judged as a whole, and the
trustee must develop an overall investment strategy. The trustee must
diversify unless, because of special circumstances, the purposes of the
trust are better served without diversifying. The trustee has a duty of
loyalty and may only incur reasonable costs. Finally, compliance with the
PIA will be determined at the time the investment decisions are made, not
by hindsight.
Most of the PIA litigation resulting in trustee liability
includes a high level of non-communication between the trustee and the
beneficiaries, so make sure your trustee client develops an investment
strategy and communicates it to the beneficiaries.
Because market efficiency is part of the PIA, trustees have been
drawn to passive investing, but there can be dangers.
Part Two: The Pitfalls of Passive Investing etc. (Mr. Norris)
This part of the session discussed the advantages and
disadvantages of passive investments, such as indexed mutual funds and the
newer exchange traded funds (ETFs).
An advantage is that ETFs are designed to invest efficiently,
and so tie in with the requirements of the PIA. Most have low internal
expenses. While mutual funds are only traded at the end of the day, an
investor can sell shares of an ETF at any time. ETFs are tax efficient as
they tend to distribute limited, if any, short-term capital gains.
Disadvantages include the exclusion of active management, high tracking
error, and concentration risk. Also, modern portfolio theory (which drives
passive investments) assumes investors are risk averse, so such investments
may not include risky, but high-return, investments.
A trustee may rely on active or passive investing under the PIA, but must
follow the PIA and have a well-developed investment strategy and
communicate it with the beneficiaries.
Part Three: Cross-Selling (Mr. Miller)
Corporate and bank trustees run the risk of violating the duty of loyalty
in the PIA if he uses affiliated products and services provided by his
organization. The Office of the Comptroller of the Currency has stated
that conflicts of interest may occur with cross-selling, and that trustees
and their organizations must distinguish between cross-selling that is
advantageous to the customer and that which is disloyal and imprudent.
Trustees, therefore, must properly manage and disclose potential conflicts
that could result in litigation. The duty of loyalty may be modified by
the terms of the trust, by statute, by court order, or by the consent of
the beneficiaries, so the trustee must determine if a modification exists
and must document it. In any case, trustees should disclose all
cross-selling and fees involved to the beneficiaries.
Before investing in the affiliated product or service, the trustee should
objectively evaluate its merit and document his review and
conclusions. There should be no sales goals or incentive compensation
programs tied to product revenue unless they are disclosed. Finally, the
bank or corporation should supervise its sales program to be certain
investment are appropriate to their clients.
* * * * *
What I took from this session is that we need to be certain our trustee
clients follow not only the terms of the trust, but also that they are
making appropriate investments for the trust beneficiaries.
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You May Not Need to Whine About Problems with Your Irrevocable Trust: State
Law and Tax Considerations in Trust Decanting
Thursday, January 17, 2008
Presenter: Alan Halperin
Reporter: Joanne E. Hindel
Alan H. started the presentation by indicating that he would cover
circumstances when one might seek to modify irrevocable trusts and provide
an overview of statutory authority to decant. He would then describe a
model statute for the authority to decant.
He would then discuss tax consequences of modifying irrevocable trusts and
finally, make some comparisons of trust decanting statutes with the Uniform
Trust Code provisions that allow for modification of trusts.
Advisors often wrestle with irrevocable trusts that no longer reflect the
clients' objectives. Because the trust terms are irrevocable, it may appear
that little can be done.
However, it may be possible to modify an irrevocable trust
One might seek to modify irrevocable trusts in order to deal with changed
circumstances such as extending the termination date of a trust because of
a beneficiary's lack of maturity, significant trust appreciation or to
address unanticipated circumstances such as a beneficiary's drug, alcohol
or gambling problem. One might also want to modify because a beneficiary
has become disabled after the creation of the trust. To protect the trust
assets and to ensure that the beneficiary is eligible for public
assistance, the trustee may consider distributing the trust assets to a
supplemental needs trust.
One might also want to change trust terms in order to consolidate trust
assets or in order to reduce administration expenses. One might want to
modify administrative provisions such as altering trusteeship provisions,
changing the succession of trustees or changing trustee compensation. One
might also want to name a protector or change the trust's situs or
governing law.
There are basic common law principles that support the ability of the
trustee to decant.
Many trusts permit distributions not only to a beneficiary, but also for
the benefit of such beneficiary. Arguably, such authority permits a
distribution to another trust for the benefit of the beneficiary.
A trustee with absolute power to invade principal generally is equivalent
to a donee of a special power of appointment. See Restatement (Second) of
Prop.: Donative Transfers §11.1 cmt. d (1986), which states that a
trustee's power to make discretionary distributions is a power of
appointment. Restatement (Third) of Prop.: Donative Transfers, which
remains unpublished (but has been approved by the American Law Institute),
specifically states that a trustee's power to distribute is not akin to a
power of appointment. The rationale is that the distribution power, unlike
a power of appointment, is exercisable in a fiduciary capacity. This
analysis does not necessarily undermine the argument that a distribution
power, which can be exercised via an outright distribution, also can be
exercised with a distribution in further trust.
There are six states that have enacted statutes authorizing trustees to
appoint trust property in favor of another trust. They are: New York;
Alaska; Delaware; Tennessee; Florida; and South Dakota. Alan H. then
discussed the statutory prerequisites for each of the six states and
concluded this segment of his presentation with a review of a model statute
and the provisions that should be included in that model statute.
They are: the authority to invade principal or distribute income; a
prohibition against reducing a fixed income, annuity or unitrust right;
identify clearly the persons who may be beneficiaries of the pour over
trust; and the statute should confirm that the exercise of the power may
not extend the permissible perpetuities period.
Alan H. then discussed the tax consequences of modifying an irrevocable
trust. With respect to the GST tax, he pointed out that the GST regulations
confirm that a beneficiary's extension of an exempt trust by an exercise of
a non-general power of appointment in favor of another trust does not
expose the trust to GST tax.
However, one must take care not to make an actual or constructive addition
to the trust.
Whether extending a GST exempt trust taints GST exempt status turns on the
GST regulations and state law. Even if applicable state law did not empower
the trustee to
appoint in further trust when the GST exempt trust became irrevocable, but
such authority under state law now exists, the distribution to a new trust
will not cause the loss of GST grandfather protection if certain conditions
are met.
With respect to the gift tax, Alan H. pointed out that assuming the
beneficiary is not a trustee (and therefore is not exercising the power to
decant), and assuming the consent of the beneficiary is not required, a
trustee's exercise of the decanting power should not be a taxable gift. It
is conceivable that the IRS might argue that, unless the beneficiary
objects to the modification, distribution or extension, the beneficiary has
made a gift.
Presumably the IRS would advance this argument, if at all, only in cases
where there is the potential for the shifting of beneficial interests or a
delay in vesting. Under this theory, the beneficiary's acquiescence would
be the equivalent of a gratuitous transfer.
To minimize the risk that the IRS might assert that a gift has occurred,
the beneficiary could be given a limited testamentary power of appointment
over the new, modified or extended trust.
Alan H. then discussed the income tax consequences of decanting and pointed
out that this area is often overlooked by practitioners.
The general rule is that exercising the power to appoint in further trust
is a non-recognition event for income tax purposes. In early rulings
following Cottage Savings, the IRS suggested that a distribution in further
trust might constitute a taxable exchange of an interest by each
beneficiary of the original trust for an interest in a new trust if the
beneficiary's new interest was "materially different" from its old interest.
However, in more recent rulings, the IRS appears to recognize that a
distribution in further trust does not constitute a recognition event for a
beneficiary if the distribution is authorized either by (i) the trust
document or (ii) local law.
While a distribution in further trust pursuant to a state statute (or the
governing instrument) generally should not give rise to a recognition
event, special rules might apply if the trustee transfers encumbered
property or a partnership or LLC interest with a negative capital account.
Example 5 of Treas. Reg. § 1.1001-2(c) deals with the
income tax consequences arising when a grantor trust holding a partnership
interest with a negative capital account ceases to be a grantor trust. If
the transferring trust and the receiving trust are both grantor trusts for
income tax purposes, this issue does not arise.
Alan H. then turned to a comparison of decanting statutes to the Uniform
Trust Code provisions that allow modification of trusts and reformations to
correct mistakes and combinations and divisions of trusts. He compared such
issues as who initiates the modification, whether or not consent is
required and if so, by whom, whether or not court involvement is required
and the prerequisites under trust decanting versus UTC statutes.
He concluded the presentation by stating that he practices in a
jurisdiction (New York) that has had a decanting statute for over 15 years
and he believes that it is a very useful and necessary component in the
representation of clients in estate planning matters.
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Perpetuities, Taxes, and Asset Protection: An Empirical Assessment of the
Jurisdictional Competition for Trust Funds
Thursday, January 17, 2008
Presenter: Professor Robert Sitkoff and Max Schanzenbach
Reporter: Kimon Karas
Although the presenter was Professor Sitkoff the outline draws on both
authors previously published works.
The presenter started the discussion by referring to FDIC annual reports
from 2004 reporting that there were $1 trillion of assets in trust, with
1.0 million accounts with the average account size being $1.0 million(M).
Referring to IRS statistics from 1041 filings for 2004, 2.0M returns were
filed, reporting $94 Billion in total income, reflecting $2.3 Billion in
deductions for fiduciary fees and $1.4 Billion in deductions for attorneys
fees.
The presenter also showed data comparing 1041 information between years
1997 and 2004. Results reflected a significant increase over the period in
income reported by complex trusts from $44.5 Billion to $60.8 Billion.
The presenter also reported on another trend coinciding with the enacted of
the Prudent Investor Acts. Trusts reflected a swing/increase in equities
holdings from 50% in 1986 to 70% in 2006 and similarly a drop in bond
portfolios from 25% to 15% for the same period.
Conclusions from the study indicates:
Interstate competition for trust funds is real and intense; and on average
through 2003 a state's abolition of the Rule Against Perpetuities (RAP)
increased its reported trust assets by about $6 Billion and its average
trust account size by $200,000.
The implications from the analysis reflects:
* Strong evidence that transferors have been escaping the RAP's
application at an increasingly rapid rate since mid-1990s; and
* Also relevant to the ongoing policy debate regarding the future of
wealth transfer taxation.
The study examined the impact of abolishing the RAP on a state's trust
business. In the analysis the authors reviewed:
* RAP
* Self settled asset protection trusts (APT); and
* State income taxation of trust funds attracted from out of state.
The presenter discussed the genesis of the RAP and its initial purposes of
* Keep property marketable; and
* Limit "dead-hand" control,
Through the various periods of reform to the race to abolish the
rule. Starting in the mid 1990s a movement arose to repeal the RAP as
applied to trusts starting with Delaware which abolished the RAP in
1995. The presenter identified what the authors meant by defining
abolition of the RAP. The authors acknowledged that:
* Some states abolished the rule entirely. Some as it applied to
interests in trusts if the trustee had a power to sell and reinvest the
proceeds;
* Some states abolished the rule as applied to interests in personal
property;
* Some states established lengthy perpetuities periods (i.e. 360 to
1,000 years);
* Some states created a default rule that applies unless the settler
provides otherwise.
For purposes of the study, all that mattered was whether the state's
perpetuities law in effect permitted a perpetual trust.
The dominant view of scholars and policymakers was the enactment of the GST
tax in 1986 triggered the movement to abolish the RAP. Prior to 1986
estate tax could be avoided by successive life interests in trusts. In
enacting the GST Congress put no limit on the duration of a transfer-tax
-exempt trust. From a tax perspective it could be stated that the move to
abolish the RAP as a race between states to allow donors to exploit a
federal transfer tax loophole.
Next the authors examined self-settled APTs. Although those concepts
existed off shore the concepts started domestically in 1997 with Alaska and
closely followed by Delaware. The difference between the abolition of the
RAP is desire of donors to provide for future generations and with APTs is
settlor's personal liability that drives that concept.
Next the author's examined a state's income taxation of trusts.
The author's considered and will more fully explore in the future the
impact of directed trustee statutes and the new prudent investor rule.
The presenter then reviewed graphs reflecting trends. There were multiple
graphs all contained within the outline which supported the proposition
that a state that abolished the RAP reflected an increase in trust assets
on a per person basis as well as on an average account size.
Although not in the outline the presenter discussed a regression analysis
that reflected that states that abolished the RAP increased its trust
business by $6.63 Billion and states that abolished the RAP and did not tax
trusts increased business to $14.0 Billion. This was based on data through
2003. The analysis was the same when average account size was examined.
The authors concluded that it was the GST tax that provided the impetus to
abolish the RAP. Prior to the GST abolishing the RAP had no significant
impact on a state's trust business. States that had abolished the RAP had
the same or lower trusts assets than similar neighboring states that
retained the RAP.
The summary since the GST tax:
* A state that abolished the RAP reported trust assets increased by
roughly $6.0 billion relative to states that retained the rule.
* Regarding fiduciary income taxes, that by itself, whether a state
levied an income tax on trust funds from out of state had no observable
effect on a state's reported trust assets.
* States that abolished the RAP and also did not tax trusts experienced
an inflow of trust assets after abolishing the RAP.
The authors stated certain caveats for perpetuities and taxes.
1. Could not estimate the tax revenue lost owing to the use of
perpetual transfer-tax-exempt trusts.
2. Could not discern extent to which any given state's increase in
reported trust assets stemmed from an inflow of newly created trusts versus
movement to the state of existing trusts.
3. Since sample is limited to federally reporting trustees the
estimates likely understate the amount of trust assets that moved because
of abolishing the RAP.
4. APTs appear not to have much of an impact, for reasons that not
many states have statutes and the "newness" of the concept.
Conclusions:
* Juridictional competition. On average from the enactment of the GST
through 2003, a state's abolition of the RAP increased its trust business
by $6.0 billion. Estimates imply that roughly $100 billion in trust funds
have moved to take advantage of abolition of the RAP, whereas prior to GST
a state's abolition of RAP did not increase state's trust business.
* Situs/Choice of Law. Both matter and trust funds flow to states with
more favorable laws and lower taxes.
* RAP is "dead." Evidence reflects that demand for perpetual trusts
was sparked chiefly by tax considerations and not dynastic impulses.
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TRUST DISTRIBUTIVE PROVISIONS
Thursday, January 17, 2008
Presenter: Jon J. Gallo
Reporter: Ronda Martinez
Mr. Gallo strongly recommends that drafting attorneys focus more on the
client's personal issues rather than focusing more on estate planning and
tax techniques. His discussion covered drafting issues surrounding
discretionary disbursement and investment policy, related tax matters,
people issues, and value based trusts.
Discretionary provisions range from zero discretion to absolute
discretion. Zero discretion is when all the income must be paid out and
any one can serve as trustee. Problems arise with the inability to shift
the income in response to changed circumstances. There may be gift tax
consequences if a beneficiary exercises a limited power of appointment; the
gift tax may be imposed to the extent that the exercise reduces or impairs
the beneficiary's interest in the trust. There will be no ability to use
decanting statutes also with a zero discretion trust.
Some trust provisions provide discretion for an ascertainable standard,
typically for health, maintenance, support and education. Here the settlor
or beneficiary can serve as trustee with no estate tax consequences. But a
disadvantage might arise from the right to accumulate income because the
accumulated income will be taxed at the compressed rates of the trust. One
way to avoid that tax consequence is to permit discretion to make
disbursements under an ascertainable standard to another class of
beneficiary, with a lower tax bracket, circumstances change. Such
disbursements though, may create other disputes within the family. What
may be reasonable for one could be unreasonable for another.
Unlike the zero discretion trust, the ascertainable standard trust should
not result in a gift tax liability to a beneficiary exercising a limited
power of appointment.
While the term, ascertainable standards, is a tax concept, this language is
often a source of litigation. It is important to discuss with the client
how the standards should apply to whom, when and under what
circumstances. Does the term "accustomed standard of living" mean the bare
necessities, and when is the standard determined? Does "support and
maintenance" mean comfortable or generous? Is invasion of principal
authorized for dependents, or grown kids who return home? Does the
discretion include making gifts - to whom, and in what manner? Is
precedence given to one class of beneficiary over another? If the trustee
must consider "other source of income", what sources are looked at - home
equity? Note that if the language is silent about other resources, the
Restatement of the Law of Trusts, Second, assumes that no regard to other
sources. Should the trust size matter - might a percentage limit be
imposed? Is the language really discretionary or mandatory? Finally, what
recourse does a beneficiary have if a request for discretionary funds is
denied? What if the beneficiary wants funds to attend one school but the
trustee decides to pay for a less expensive school?
Then there is the absolute discretion trust. Is it really fully
discretionary? State law may provide modifications. Neither the settler
nor beneficiary may act as trustee due to estate and gift tax consequences.
Many investment limitations may be placed on the trustee's investment
discretion if the trust is planned to be irrevocable at the settlor's
death. These include naming an outside investment advisor, limiting
percentages for various asset classes, or creating an investment committee
to continue the settlor's investment philosophy. There is an increasing
trend to using non-traditional discretion holders in the administration of
discretionary trusts.
A trust protector may be named with the authority to direct the trustee,
add, remove or replace the trustee, etc. The statutory powers range and
appear to be very broad in guiding the trustee.
In drafting for ascertainable standards, it is important to delve into the
client's meaning.
Another trend is more interest in values estate planning. These may be
incentive trusts designed to incent certain behavior by the beneficiary, or
discourage other behavior. Some children may or may not comply with the
incentives, so that any family disputes may actually be perpetuated over
the generations.
The emerging adulthood theory was mentioned as being relevant to a
settler's expectations for his or her progeny. Two authors were
recommended to read in this area, Barry Baines and Jay Hughes.
Creating a mission statement was suggested as an alternative to incentive
trusts. The approach asks the client to consider what would be in the best
interest of their kids, rather than focusing on behavior. The mission
statement then sets forth the client's values and serves as a guide for the
discretion to be exercised by the trustee. Such mission statements may
emphasize education, philanthropy, vacations or whatever the client deems
to be in the best interest.
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THE REPORTERS
Our on-site local reporters who are present in Orlando this year are Gene
Zuspann Esq. of Zuspann & Zuspann in Denver, Colorado; Joanne Hindel Esq.
of Fifth Third Bank in Cleveland, Ohio; Jason Havens Esq. of Howard, Mobley
& Havens PLLC in Florida and Tennessee; Kimon Karas Esq. of McCarthy,
Lebit, Crystal and Liffman Co., LPA in Cleveland, Ohio; Bruce Stone Esq. of
Goldman, Felcoski & Stone, PA in Coral Gables, Florida; Craig Dreyer Esq.
of McDonald Hopkins LLC in Cleveland, Ohio; Carol Sobczak Esq. of The Law
Offices of Carol A. Sobczak in St. Helena, California; Ronda Martinez Esq.
of Fifth Third Bank in Southfield, Michigan; and Mike Stiff Esq. of
Hutchins & Stiff LLC in Denver, Colorado. The editor again this year will
be Joseph G. Hodges Jr. Esq, a solo practitioner in Denver, Colorado, who
also is the Chief Moderator of the ABA-PTL List.
_________________________________________
GENERAL INFORMATION ABOUT INSTITUTE:
Inquiries/Registration:
Philip E. Heckerling Institute on Estate Planning
University of Miami School of Law
Center for Continuing Legal Education
P.O. Box 248087
Coral Gables, FL 33124-8087
Telephone: 305-284-4762 / FAX: 305-284-6752
Web site: www.law.miami.edu/heckerling
E-mail: heckerling@law.miami.edu
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Headquarters Hotel - Orlando World Center Marriott
8701 World Center Drive
Orlando, FL 32821
Telephone (407) 239-4200, FAX (407) 238-8777
==================================================
NOTICE: Although audio tapes of all of the substantive session at the Miami
Institute currently are only made available to Institute registrants for
purchase, the entire proceeding of the Institute are published annually by
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proceedings is also available on CD ROM from Authority On-Demand by
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