Why and When Is a Trust Accounting Report Required?

May 20, 2011

Clients often ask why we need to report or account to beneficiaries. This is a particularly perplexing concept when the beneficiaries are remote (i.e., they are not currently due to receive anything from the trust and may never receive, unless they outlive the current beneficiary(s)). A related question is to whom we must report and when?

When the grantor is still alive and is serving as his or her own trustee, there is no duty to report. This makes sense, as it would be a duty for the owner who retains total and complete control over the assets in the trust to report to him or herself. These very common estate planning trusts are known under the Internal Revenue Code as "Grantor-Revocable Trusts." The get this name from the section in the Internal Revenue Code which exempts them from filing or reporting separately on an income tax return. Instead, the grantor simply continues to report these items on their personal tax return. However, on the death of the grantor (and in some circumstances, when the grantor no longer is acting as trustee, if though they may be still living), the duty to report and file income tax returns arises.

Perhaps the most direct answer to why we must do this is that the law requires it. But what, exactly does that mean? Estates, whether Probate Estates or Trust Administration, are mainly governed by the law of the state where the grantor is/was a resident, or where they stipulated in the Trust Agreement which state law would govern. So we must look to the Statutes of the State. At the same time, in an effort to achieve some uniformity from state to state, there are "unofficial," but very influential and persuasive guidelines to Trust and Estate administration. State statutes often follow the guidance of these "national" guidelines.The Restatement of Trusts (now in its 3rd iteration) is one such uniform nationally recognized guideline. The Restatement (Third) of Trusts states that A trustee has a duty to maintain clear, complete, and accurate books and records regarding the trust property and the administration of the trust, and, at reasonable intervals on request, to provide beneficiaries with reports or accountings. Following on this, Michigan's new Michigan Trust Code contains provisions requiring a Trustee to report to beneficiaries.

The Trustee of a Trust is a fiduciary. That means that they have a special duty to all of the trust beneficiaries, of fair and honest dealing, and of sensible management and investment of the trust's assets. This fiduciary duty also includes the duty to keep beneficiaries apprised of the status of the trust's assets and investments.

Who are the beneficiaries entitled to an account or report? That is a bit less clear. It is clear that the current beneficiaries are entitled. But what about more remote (or contingent) beneficiaries? The commentary to the new Michigan Trust Code says the language of the code "clarifies" this formerly unclear area. I am not so sure. The Code uses the new term (new to us in Michigan, anyway), "qualified beneficiaries." It defines "qualified beneficiary" in what I think is a rather confusing way. What is clear is that current beneficiaries are entitled to an accounting and that more remote beneficiaries may be entitled. The code requires a reporting to the current beneficiaries (current generally meaning that they have some current rights to trust assets, either in the form of income distributions or the right to distributions of some or all of the principal in the trust). It then goes on to say that other "qualified" beneficiaries are entitled to an accounting on request.

The Michigan Trust Code authorizes the maker (grantor) of the Trust to limit the duty of the Trustee to report to certain beneficiaries. However, a Probate Court can override this and order reporting anyway.

In my view, what this tells us is that a Trustee should keep detailed records, and prepare a report at least annually, to keep in its records. While that does not necessarily mean provide each beneficiary with an account, it puts the Trustee (or successors) in a position to provide that information upon an order of the Court. It may serve a secondary purpose of highlighting for the grantor and/or Trustee any problems that might be lurking out there in terms of trust accounting and record – keeping.

Finally, on all but "grantor revocable trusts," the Trustee will be required to file an annual income tax return with the IRS and with any state or states in which it earns reportable income. So it doesn't seem like a huge inconvenience for the tax preparer and/or Trustee to simply put together some kind of accounting report each year as and when the tax return is prepared.

The Michigan Trust Code does not specify a format for the report. It does give guidelines, suggesting that the report should be thorough and detailed enough to fully apprise the recipient of the nature and status of trust assets. This means it should probably have a method for recording items of income as well as how they affect the capital or income side of the trust accounts, as well as items of loss and expenditure, for the same reasons.


Michigan Supreme Court Buys Us Another Generation on Real Property Taxes

Mar 11, 2011

Thursday, March 10, 2011, the Michigan Supreme Court, in Klooster v. City of Charlevoix, seems to have granted us another "generation" on Michigan Real Property Taxes. In 1994, so-called "Proposal A" placed a cap on the amount of increase in Michigan Real Property taxes a municipality could apply, regardless of how much the actual market value increased, as long as there was not a "transfer of ownership." The devil is always in the detail, and the Klooster case centered on the definition of "transfer of ownership," and the meaning of one of the exceptions laid out in the act.

The Act, which allows the municipality to remove the "cap" in the tax year following a change in ownership, has a rather involved definition of transfer of ownership. It also has a long list of exceptions to the rule allowing the cap to be removed. The Klooster decision focuses on the so-called "joint-tenancy" exception. That exception provides that the creation or termination of a joint tenancy by one who is an original owner does not result in an uncapping event, even though it is a change of ownership. The court defines "original owner" as one who has ownership immediately following the last "uncapping" transfer. The court further explains that death of a joint owner (joint with rights of survivorship) results in a "transfer" by operation of law. So an original owner who has created a joint tenancy with another and then dies, effects a transfer of ownership, but it is within the exception and therefore not an "uncapping" transfer.

There has been some question about this since the exception of the act. Some of us (particularly municipalities) felt that the intent of the act was to prevent an unfair increase in taxation while the same original owners and spouses were alive and owned the property, but the when the last original owner in a generation died or transferred out of ownership, an uncapping transfer occurred. The Klooster opinion makes clear that, as a matter of Michigan law (now anyway J ), we were incorrect. The court carefully dissects the language of the statute and concludes that the uncapping will occur on the next transfer. In other words, my dad and mom could add me as a joint with right of survivorship owner to real property and after both of their deaths (which would be a "transfer of ownership" by operation of law), an "uncapping event" would still not occur until the next transfer (either by deed or by my death) happens. This means the cap can stay on for my lifetime, if no transfer of ownership occurs.

Great care must be taken in planning. Once my parents die, for example, I may want to plan for my own succession. If I add a joint tenant who does not come within one of the "not a transfer" exceptions in the statute (e.g., adding children or siblings), an uncapping transfer occurs (adding a spouse or conveying to a grantor revocable trust would probably not be viewed as a subsequent uncapping event). Also, presumably, on my death, an uncapping transfer occurs. This opens much proverbial "food for thought" in real estate succession planning transactions.

It will also be interesting to see if the Legislature takes any action to change the statutory language the Court interpreted.


Trusts After 2010 Estate Tax Reform

Jan 9, 2011

Since the extension of the so-called "Bush Tax Cuts" by Congress on December 17, 2010, and the very favorable changes to the Federal Estate Tax, I have received numerous calls and e-mails, all asking essentially the same question: "Can I scrap my Trust?" My answer is, "of course not!" Indeed this question underscores the continued misunderstanding by clients and advisors alike about the part Trusts play in the Estate Planning Process. We too frequently view the process as only a tax-driven process. In one of my earliest Blogs here, I pointed out that Estate Planning is an overall process involving a number of tools, only one of which is a Trust, which covers only some portion of a well-thought out Estate Plan. So, with changes which eliminate estate taxes as a concern for the vast majority of our clients, I get very concerned that clients and their advisors will unwittingly abandon one of the more important and useful planning tools.

The function of a Revocable Trust Agreement in the estate plan is primarily as an administrative tool to manage and distribute assets, during lifetime, during incapacity, and after death. It most often acts as a Will substitute, and properly structured and maintained, can avoid the need of Probate Court proceedings. With proper drafting, a Trust can also restrict the scope of "outsiders" entitled to information on administration, and can manage assets for minors, and others who are not ready or capable of handling assets yet.

What the new Tax Law does do is, in my view, allow us to vastly simplify the Trust planning we have customarily done to avoid taxation, making it an even more palatable and powerful tool. As I read the new law provisions, even for the relatively rare clients who may have assets exceeding $5 million, we no longer need to set up separate Trusts for spouses and divide up assets before a death occurs. Thus, Trust planning has just become more flexible and inviting in my view.


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