A Living Trust is Not a Person

A corporation is, in legal terms, a person. This is probably most famously, or infamously depending upon your political persuasion, stated in  the United States Supreme court case Citizens United v. Federal Election Commission, 558 U.S. 310, which held that corporations have 1st amendment political speech rights. 

This notion of corporate personhood means that a corporation is a separate legal entity. Therefore a corporation can do a host of activities that a natural person can do, e.g. enter into contracts, own real property, be sued by a third-party, sue a third-party, engage in political speech, etc.

For example, if Abel and Baker band together to form a corporation to own real estate, Whispering Meadows, Inc. for instance, said corporation is one person and Abel and Baker are two separate people. Thus, the "persons" involved in the transaction are (1) Abel, (2) Baker and (3) Whispering Meadows, Inc.  

This is in stark contrast to a living trust. As stated in numerous California opinions over the years, a living trust is not a separate legal entity. "Unlike a corporation, a trust is not a legal entity." Galdjie v. Darwish 7 Cal.Rptr.3d 178, 187 (2003). Thus a living trust and the person that created the trust, the settlor, or the legal owner of trust property, the trustee, are not a separate person or persons apart from the trust. They are essentially the same person.

A common myth is that a living trust is considered a separate legal entity. Clearly, as stated above, such is not true. 

Death and taxes

"In this world nothing can be said to be certain, except death and taxes." Benjamin Franklin, as quoted in a letter to Jean-Baptiste Leroy in 1789.

Given this certainty, taxpayers respond by engaging in various tactics to reduce, minimize, avoid or evade their inevitable taxation. For example, nefarious individuals peddle phoney trusts as methods to ostensibly shield income from taxation.  Unfortunately, the zealotry to which a person pursues avoiding taxation can lead them to believe these crooked arrangements. A wealthy San Diego nursery owner, via her son, fell victim to this scam. The tale of her account unfolded in court as explained below.

Estate of Young (2008) 160 CA4th 62

The late Irma Young was a wealthy nursery owner who had amassed a number of real estate holdings. Through here attorney, Dennis Burns, she devised an estate plan in 1991 which called for the distribution of her estate to her 4 children equally. One peculiar part of her estate plan was that her son, Charles Parker, was only allowed to take his inheritance if he did not have any tax liabilities at the relevant time. This naturally prompts the response that Charles probably had difficulties with paying his taxes.

Charles began to attend asset protection seminars in 1992-1993 and became convinced that creating a land trust was an instrument that could be used to avoid paying taxes. Attorney Burns told her Irma that he believed that such trusts were not legitimate tax avoidance devices. Nevertheless, Charles convinced Irma to retain the individuals selling these trusts. In turn she, according to the court opinion, "paid approximately $30,000 to several persons to prepare such documents, some of whom took the money and did no work."

A total of 8 "tax avoidance" or "land trusts" were created for the 8 parcels of real property owned by Irma. Furthermore, 5 business trusts were created to hold her business interests. Of note, the drafting attorney for the business trusts was the trustee for 4 of them (Author's comment: this is generally a huge no-no in California).   

Later on in 1995, Irma became aware that these trusts were a facade and approached her old attorney to try to rectify the situation. Attorney Burns "asked her if she had gotten involved in one of Charles's schemes, and she said yes. He then told her that he had advised her against that, but she had not listened to him, and he could no longer help her and she should get another attorney." 

In 2000, Irma became acutely ill and she asked her son Stephen Parker to inquire as to status of her estate. Stephen naturally approached Charles who failed to provide him with the necessary information. Stephen then asked R. Richard Evans, the trustee of Irma's "trusts" for a copy of such and he provided Stephen with a copy of one of the land trusts. 

"Stephen told Irma about this and she said Charles and Evans were crooks. In May 2000, she called her four children to the hospital and told them that her plan was that each should share equally in her estate, and asked Charles to verify that that was her intent, which he did."    

"On July 30, 2000, Young died. Stephen was appointed the administrator of her estate. In that capacity, he formally requested that Charles and Evans supply him with business records relating to trusts, disposition of funds or property, and the original irrevocable land trust dated September 27, 1993. They replied that they did not have any such documents except for the 1991 will and inter vivos trust. The trusts had no cash left." (Author's comment: not good).

Ultimately, Stephen successfully sued for undue influence and fraud in the establishment of the trusts. 

One sad reality of this case is that neither Charles nor Evans knew Irma's tax bracket. Charles nonetheless coerced his mother to engage in very questionable and expensive behavior without knowing what benefits would accrue. One would think that knowing the current situation would be very helpful for future planning. For example, if Irma was a high-income individual who paid a lower tax rate than others, a la Warren Buffet or Mitt Romney, then pursuing such an exotic tax arrangement is baffling. The point of tax avoidance is to have a net gain. Yet with Irma, her son caused her to have a net loss, and a massive one at that.   

Suing a Trust

One of the more common fallacies in regards to trusts is the notion that a trust itself is the appropriate party to sue. Instead, the trustee of the trust is the appropriate party to sue. This distinction was raised in a recent California court case with unfortunate results for one party.

Portico Management Group, LLC v. Harrison (2011) 202 CA4th 464

Portico Management Group, LLC contracted with the Harrison Children's Trust and the Harrison Family Enterprise II, a limited partnership, to purchase an apartment building it owned jointly. Naturally, the sale was never completed and Portico sued the Trust and limited partnership, and ultimately was awarded $1.6M through arbitration. In 2007, Portico had the arbitration award entered by the trial court but judgment was entered against the Trust rather than the Trust's trustees. Portico then sought to enforce the judgment against the Trust but the Trust's trustees objected because Portico had obtained a judgment against the wrong party, the Trust as opposed to the Trust's trustees. The trial court ruled in trustees' favor and Portico appealed. 

The appellate court affirmed the trial court's decision because the trustee is the real party in interest, not the trust itself, and thus judgment had been entered against the wrong party. Still, even though the arbitrator incorrectly listed the wrong party as the judgment debtor, Portico had an opportunity to correct this mistake by either utilizing the arbitrator or the trial court within certain time periods. Yet, Portico failed to act in a timely manner and deprived itself of the opportunity to correct this mistake. Thus, the appellate court ruled that Portico could not levy upon trust assets for recovery.

The obvious takeaway from this case, is that if a litigant ever sues a trust, they must name the trustee in the complaint or else you might end up with a judgment against an entity, namely a trust, that does not fall within the statutory definition of a judgment debtor and recovery will be thwarted.   

Living Trusts

Here are some frequently asked questions associated with revocable trusts, or stated colloquially, living trusts 

1. What is a trust? 

A property interest held by one person, the trustee, at the request of another, the settlor, for the benefit of a third party, the beneficiary. Black's Law Dictionary (8th ed. 2004).

The easiest way to conceptualize a trust, is to picture a triangle, the settlor is on top with the trustee on the left corner and the beneficiary on the right corner. The settlor creates, the trustee manages and the beneficiary enjoys.

For illustration, Samuel and Selma, the settlors, transfer title to their Santa Cruz beach house to Thomas, the trustee, to hold in trust for the benefit of their son, Bobby, the beneficiary. Thomas now holds legal title to the beach house, so if you looked up county property records for the beach house, Thomas would be the record owner. Conversely, Bobby now holds equitable title to the beach house, meaning he can enforce his rights to enjoy the beach house in court if necessary. 

2. What are some kinds of trusts? 

There are an assortment of trusts that a person can write: irrevocable life insurance trusts (ILIT), qualified domestic trusts (QDOT), qualified terminable interest property (QTIP), A/B trusts, credit-shelter trusts, bypass trusts, disclaimer trusts, Crummey Trusts, grantor retained annuity trusts (GRAT), charitable remainder trusts (CRT), qualified personal residence trusts (QPRT), special needs trusts (SNT), living trusts, etc. 

3. What is the most common type of trust in California? 

A living trust is by far the most common type of trust written in California. 

4. What is a living trust? 

A living trust is a type of trust that is created during the lifetime of the settlor, the person who writes the trust. Conversely, a trust created at someone’s passing is called a testamentary trust. Consequently, a testamentary trust is created through a will.

The legal term for a living trust is an inter vivos revocable trust. Since the aforementioned phrase does not easily roll off the tongue, the phrase “living trust” has supplanted it in common dialogue. 

5. Who can write a living trust? 

There is no specific statute that determines the requisite capacity to draft a trust. Some argue that the requisite capacity is that of the capacity to contract while others believe that the capacity to transfer property is required. Hess, Bogert, & Bogert, The Law of Trusts and Trustees (3d ed 2000); 13 Witkin, Summary of California Law, Trusts §25 (10th ed 2005).

In regards to contractual capacity, a person entirely without understanding has no power to make a contract of any kind. CC §38. Furthermore, all persons are capable of contracting except minors, persons of unsound mind, and persons deprived of civil rights. CC § 1556.

Conversely, a person lacks the capacity to transfer property if either that person does not have sufficient mental capacity to either (1) be able to understand the nature of the testamentary act, understand and recollect the nature and situation of the individual’s property, or remember and understand the individual’s relations to living descendants, spouse, and parents, and those whose interests are affected by the will or (2) the individual suffers from a mental disorder with symptoms including delusions or hallucinations, which delusions or hallucinations result in the individual’s devising property in a way which, except for the existence of the delusions or hallucinations, the individual would not have done. 

6. What are the required components of a trust? 

As mentioned in a prior post, the five elements required to create a trust valid under California law is (1) A settlor, the owner of the property that will be subject to the trust. Prob C§15200; (2) The settlor's intent to create a trust. Prob C§15201; (3) Trust property. Prob C§15202; (4) A trust beneficiary. Probate Code §15205; and (5) A valid trust purpose. Probate Code §§15203-15204. 

7. How long do living trusts last? 

California law provides that a trust may last at least 90 years before the rule against perpetuities is applied. Prob C §21205. For example, media magnate William Randolph Hearst created a trust through his will in 1951 that is expected to last until at least 2040. See Hearst v Ganzi (2006) 145 CA4th 1195. As for the rule against perpetuities, this is an incredibly antiquated law that is not worth mentioning, trust me. 

8. What items can be placed into a living trust? 

Various property interests may be placed in trust: real and personal property, securities, bank accounts, mutual funds, individual retirement accounts, businesses and pets.

For example, you could place your family home, Bank of America checking and savings account and Exxon Mobil stock into a trust. 

9. What items are not placed into a trust? 

Though there is no prohibition against it, complex laws dictate that a retirement account should not be placed into a trust. Some attorneys do fund trusts with clients retirement accounts although the process can be complicated.

Living Trust Myths

The following are some myths I have seen that are related to living trusts.

Fiction: Writing a living trust will, by itself, avoids estate taxes for the decedent’s estate
Fact: Writing a living trust only allows a person to reduce or eliminate estate taxes. In order to reduce or eliminate estate taxes, a person needs to take affirmative steps. For example, assume that husband and wife establish an A/B trust in 2007. At the time of the husband’s passing in 2011, the estate is worth $8M. For reference, the estate tax in 2011 is $5M. Even though husband and wife wrote an A/B trust, wife will need to take affirmative steps to eliminate the estate tax by funding her husband’s B trust with the estate tax exemption amount, $5M, and then allocating the remainder to her trust, the A trust. In sum, simply because husband and wife wrote an A/B trust does not mean that an estate tax issue is resolved.

Fiction: Assets held in a revocable trust do not count towards the resource threshold for Medi-Cal eligibility.
Fact: If a trust is revocable, the assets of the trust are considered an available resource for the Medi-Cal applicant. 42 USC §1396p(d)(3)(A); 22 Cal Code Regs §50489.5(e); Medi-Cal Eligibility Procedures Manual (MEPM) Letter No. 192 (Dec. 18, 1997), 9J-73. However, assets held in a testamentary trust for the Medi-Cal beneficiary do not count towards eligibility requirements. 42 USC §1396p(d)(2)(A); 22 Cal Code Regs §50489.5(a)(1). For reference, a testamentary trust is a trust created at someone’s death for the benefit of another person. Conversely, a revocable trust is one created during someone’s lifetime that benefits them.

Fiction: A non-attorney, as trustee of a trust, can sue on behalf of the trust.
Fact: A non-attorney trustee cannot litigate on behalf of the trust in propria persona against a third party. Ziegler v Nickel (1998) 64 CA4th 545. For example, if a trust owned a vacant lot and a person routinely trespassed on the vacant lot, a non-attorney trustee would be required to hire an attorney to prosecute the trespass action. This is similar to legal action taken by a corporation, in that a corporation must be represented by an attorney in court as well.

Fiction: An irrevocable trust can never be modified.
Fact: Even though it sounds logically inconsistent, California law permits an irrevocable trust to be modified in the following circumstances: all beneficiaries consent (Prob C §15403); all beneficiaries and the settlor consent (Prob C §15404(a); at least one beneficiary and the settlor consent (Prob C §15404(b); principal is uneconomically low (Prob C §15408); there are changed circumstances (Prob C §15409); and to conform the trust to tax laws.

Fiction: A trust can last forever.
Fact: Only certain trusts can last forever. For example, a charitable trust may last forever provided there are ample funds. Prob C §21225(e). Conversely, a non-charitable trust will most likely last at most 90 years because of the Uniform Statutory Rule Against Perpetuities. Prob C §21225(b).

Fiction: The signatures that execute a trust require notarization.
Fact: There is no California law that says that a trust has to have notarized signatures. However, no competent attorney will allow a client to sign a trust without a notary present because it is best practice.

Fiction: Attending a living trust seminar is always a good place to find answers about trusts.
Fact: Living trust seminars are often facades to sell annuities to unsuspecting victims. The organizers of these seminars, known pejoratively as "living trust mills", are usually insurance agents, not attorneys, who use the allure of a trust as a Trojan horse to peddle annuities. This lawsuit filed by the California Advocates for Nursing Home Reform succinctly summarizes the scam that is perpetrated by these living trust mills.

Estate Planning Checklist

People often ask me what is estate planning and what does the process entail? Since the former question is a little bit too broad to explain in a blog post, I will attempt to answer the latter question. The following is the process I have used for the past couple of years. 

1. Meet with Clients 

At the initial meeting, I meet with clients to go over the truths, half-truths and outright myths that are associated with estate planning. For example, I am repeatedly told by potential clients that they do not want the government to inherit their estate, which rarely happens, or that a client has heard that a self-settled living trust will shield assets from lawsuits, a complete myth.

We usually go over what is included in the typical estate plan: a trust, a will, a power of attorney and an advance health care directive. Typically a client will insist that they need to write a trust because they saw a flyer for an estate planning seminar that exaggerated the benefits of a living trust. Yet a will, rather than a trust, is perfectly suitable for somebody with a modest estate with no children or a home because of non-probate transfers.

We also go over how long the process will take. I tell clients that I can go as fast as they want me to go. If they provide me with the necessary information I can draft the documents in a morning or an afternoon. For example, one client insisted that I complete everything in 1 week because he was leaving the country for an indefinite period of time. 1 week after coming into my office for that initial consultation, he signed the necessary documents in the morning and boarded a plane in the afternoon, never to be heard from again. No, not really. He was vacationing in the Middle East. 

2. Review Documents 

Once I receive all the necessary information, I am then able to draft all the documents. Of note, most people take on average a month or two to complete my estate planning questionnaire.

I then go over these documents with the clients. I am happy to review each document page-by-page but most clients find reading a will or trust to be quite tedious. For example, upon initial examination, most clients discover that a will or trust is a lengthy and complex document. To date, there has only been one client who has insisted that we go over everything in detail. His occupation was an engineer for reference. I should mention that lacking the desire to read a lengthy document written in legalese is an activity frowned upon by even prominent members of the legal community. Richard Posner, Chief Judge of the 7th Circuit Court of Appeals, a pre-eminent authority on contract law, said that when he received his 100-page home equity loan contract he surprisingly signed it without reading it because he had a life.

Also during this second meeting, I often highlight the distribution clauses in the trusts and wills because that is what concerns people the most typically, namely who will inherit their estate and who is in charge of the distribution. 

3. Sign Documents 

The final stage in the 3-step process is to formally execute the documents. This is by far the shortest meeting of the 3. The entire process takes about 15 minutes. If needed, I arrange for my notary to come to my office or the client’s home so that we have the appropriate parties present. There is no California law which mandates that a trust or certificate of trust be notarized rather it is notarized out of custom. However, a deed transferring the client’s home requires notarization.

Once the signing is complete, I provide the clients with all the executed documents for safekeeping. It is not my policy to safe keep the estate planning documents, instead I tell the clients to keep the items in a secure place such as a safe deposit box. The only document I do retain is the deed to the home. If the home is located in Santa Clara County, I personally record the document because it is a short drive from my office to the County office building. If the home is located outside Santa Clara County, I mail the document to that recorder. Approximately 4-6 weeks later, the recorded deed will be delivered to the client’s home.

Living Trust Myths

These are some more fallacies I have been asked, read and heard about in regards to living trusts:

Fiction: If I set up a trust I must file a separate tax return for the trust.

Fact: Most trusts do not require the filing of a separate tax return provided the person who drafted the trust has substantial control over it. IRC §§671-679. For example, if John Smith established a trust for his own benefit, the John Smith 2009 Living Trust, he would not need to file a separate tax return for the John Smith 2009 Living Trust. Such a trust in IRS speak is known as a “grantor trust.”

Fiction: If I transfer my house into a living trust, the house will be re-assessed for property tax purposes.

Fact: California law clearly says that if a couple or single person transfers their residence into a revocable trust that they created the property is not reassessed for property tax purposes. Rev & T C §§62(d). For example, if John and Mary Smith established a trust and transferred their 650 Rosewood Court residence into the trust, the assessed value of 650 Rosewood Court would remain the same after the transfer. This is particularly important for people who purchased their homes years ago and are acutely aware of the low assessed value for property tax purposes.

Fiction: Everything I own should always be transferred into a trust.

Fact: Due to tax and administrative reasons a retirement account and life insurance policy should not be transferred into a trust typically.

Fiction: If I do not write a will or a trust, the government will inherit my property.

Fact: To quote the character Randolph Duke from the movie Trading Places, “hogwash.” The government, namely the state of California, will only inherit your property (called escheat) if you have no relative or you do have a relative but they cannot be located. For example, there would be no escheat if your had either a spouse, child, parent, grandchild, grandparent, brother, sister, uncle, aunt, nephew, niece or distant cousins (Please click on the diagram below). Consequently, the odds of a person not having any relative alive when they die is ostensibly zilch. The cases in which escheat occurs, and it is very rare, comes about because a person moved far far away from their family. Ultimately, escheat is a very narrow exception to the rule that somebody other than the government will inherit your property.

Living Trust Myths

These are the most common misperceptions I have been asked, read and heard about in regards to living trusts:

Fiction: If I hold assets in a living trust, creditors will not be able to attach their claims to it, thereby making me judgment-proof.

Fact: Creditors can attach their claims to assets you hold in a revocable trust for your benefit. Prob C §15304(a). For example, suppose that a substantial judgment was rendered against you in a California court because you negligently ran over your neighbor’s beloved dog Muffy. The fact that you transferred all of your assets into a trust for your benefit would not prevent your neighbor from attaching the judgment to the assets held in trust per Prob C §15304(a).

Fiction: A living trust is the perfect estate planning document.

Fact: A living trust is usually the best estate planning document given your range of choices, but is most certainly not a perfect estate planning document. For a single person, there are essentially three ways to transfer property at death: probate, non-probate transfers (joint tenancy real property, payable on death accounts, life insurance designations, etc.) or a trust. For a married person, the surviving spouse is entitled to use a spousal probate petition as well as the three aforementioned procedures. While each of the methods has its strengths and weaknesses, a trust provides the best combination of flexibility, cost and timing in comparison to the others. Again, writing a living trust is not a panacea, rather it is best option in most cases.

Fiction: I need to have a living trust done because I heard it is the smart thing to do.

Fact: If you do not own a home, have children or have more than roughly $100,000 in assets it is not recommended to draft a living trust because there are quicker and cheaper methods to administer your estate upon death than through a trust.

Fiction: A living trust requires little or no post-death administration.

Fact: This is the most commonly propagated myth about living trusts. Many individuals have turned to living trusts to avoid the necessity and cost of probate, under the impression that administration will be easy, inexpensive and expedient. However, the administration of a trust typically requires the assistance of professionals: lawyer, accountant, appraiser, etc., who require appropriate compensation. Granted the administration of a trust is commonly more expedient and economical than probate, it still nonetheless is similar to probate: assets need to be collected, debts need to be paid and the remaining assets need to be distributed.

Fiction: Once I draft and execute a trust, the process is complete.

Fact: A valid California trust requires trust property. Prob C §15202. Thus, the person who created the trust needs to transfer some asset into the trust in order for it to be valid. For example, suppose John Smith created a trust and owned a home. A grant deed that transfers title from John Smith to John Smith, Trustee of Smith 2009 Revocable Trust dated 6/12/09, would provide the trust with the required element of property.