Professional Fiduciary - Trustee

A professional fiduciary is commonly used to serve as the trustee of a special needs trust. The rationale is that the professional fiduciary is equipped to navigate the myriad of rules and regulations regarding a special needs trust. This would include applicable federal law, state law (namely the probate code) and the California Rules of Court. In short, an expert is needed and a professional fiduciary fits that mold. However, not all professional fiduciaries follow the appropriate rules. In such a case, the consequences can be acute and expensive.

In a recently decided published appellate opinion, the California Court of Appeal upheld a $93,036.75 surcharge issued against a professional fiduciary.

Scott v. McDonald (2018) _______ CA4th _______

The opinion was not especially kind to the professional fiduciary in regards to her request for trustee compensation:

"The trust instrument provides, "The Trustee shall receive just and reasonable compensation, to be paid from the Trust, for [her] services in an amount to be determined by the Court on the occasion of the Trustee's court accountings or such other times as that issue may be brought before the Court with jurisdiction over the Trust. The Trustee may receive interim compensation on account, in accordance with the order of the Court with jurisdiction over the Trust."

Trustee did not file the required accountings with the court because she was unaware the trust was court supervised. Trustee did not look at the trust instrument to understand her authority under the trust. Trustee continued to serve as trustee of the trust when her professional fiduciary license was suspended from 2008 to 2010. Trustee did not keep accurate time records for her fees. Trustee breached her fiduciary duty by making disbursements for rent, clothing, vehicle expenses, and vacations. Trustee also breached her fiduciary duty by making a final distribution to Mother in the amount of $15,574.85, which was then commingled with Mother's personal funds and primarily spent on living expenses and household items.

Given Trustee's mismanagement of the trust estate, failure to make the required court filings, and continued service when she lacked a license, the probate court could reasonably conclude that Trustee was not entitled to compensation because any compensation for the service rendered would be inequitable due to Trustee's multiple failures in administering the trust (Cal. Rules of Court, rule 7.776(2))."

Trustee Compensation

6th Circuit Court of Appeal, San Jose, CA

A trustee is entitled to reasonable compensation under the circumstances unless the trust provides otherwise. Prob C § 15681. A recent 6th Circuit California Court of Appeal case emphasized the extent of specifying trustee compensation.

Thorpe v. Reed, No. H037330 (Cal. Ct. App. Dec. 13, 2012).

 
Danny Reed was the beneficiary of a special needs trust. Mr. Reed had unfortunately been injured in multiple accidents which resulted in the creation of a first-party special needs trusts to hold his recovery proceeds.  His mother, Jolaine Allen, was the original trustee. Then Thomas Thorpe of Dragomir Fiduciary Services Inc. became the successor trustee for approximately 4 1/2 months. Then Jenivee Reed, Mr. Reed's sister, became successor trustee. 

The issue in the case was whether or not Mr. Thorpe and his associated parties, lawyers Diane Brown and Michael Desmarais, were entitled to compensation for their services during Mr. Thorpe's time as trustee. The reason that this was an issue in the case was because the trust specified that a successor trustee was not entitled to compensation.      

In Mr. Thorpe's petition, he asked for $65,844.08, $31,047.85 for Ms. Brown and $11,879.14 for Mr. Desmarais as trustee and trustee attorney fees. The trial court judge reduced the fee for all 3 parties whereby Mr. Thorpe received $27,006, Ms. Brown $19,540.61 and Mr. Desmarais $4,739.02.

Ms. Reed appealed this decision and the appellate court reversed, holding that the trial court improperly re-wrote the trust to provide for Mr. Thorpe and his attorneys' compensation. The appellate court reasoned that since Mr. Thorpe accepted trusteeship without it being predicated upon modification to provide for compensation, he was entitled to no compensation as provided for in the trust. The opinion's final footnote summarizes it nicely "Before the appointment order, plaintiff (Mr. Thorpe) wrote the Supervising Court Investigator that he was willing to accept the trusteeship and conservatorship "subject to my attached fee schedule." But the probate court's order was unconditional, plaintiff began performing duties, and the trust was never amended to eliminate the no-compensation provision." The ultimate result was that Mr. Thorpe and his attorneys were entitled to $0.00 as compensation for their services.

Going forward, this case presents an interesting precedent. Presumably, a successor trustee of a special needs trust is entitled to $0.00 compensation if (1) the trust provides for such and (2) the successor trustee does not condition acceptance upon modification of the compensation clause.

California Estate Tax and other Topics

The following are the most common search terms for 2012 that have yielded results for my blog. I thought I would write about this because readers might be curious as to what other people commonly research. The following terms are in order of most frequency.

1. California Estate Tax

This search term strikes me as odd because there is no California estate tax. Furthermore, California has not had an estate tax since 2004. In other words, people are looking for something that does not exist, e.g. Bigfoot, a unicorn, etc.

Unfortunately the amount of legal misinformation on the Internet is expansive. It should not come as a surprise then that people cannot be sure about what they read. Hence, they do some Internet research to see what is true and what is not.

2. Heggstad Petition

This might be the most common probate petition. 

Essentially, a Heggstad petition is where a successor trustee of a trust seeks a court order to transfer property, commonly a home, into the trust because the settlor, the person who originally wrote the trust, never formally did so when they were alive.

3. Small Estate Affidavit California

If a person's estate is small enough, less than $150,000 gross in 2012, a person may collect such assets through the use of an affidavit rather than formal probate.

The valuation amount was increased to $150,000 from $100,000 starting January 1, 2012.

A common erroneous perception of many clients I have spoken to is that real property may be transferred this way. Real property transfers require an abridged probate procedure.

4. California Estate Tax 2012

See # 1

5. California Inheritance Tax 2012

The term used for the at-death tax imposed by the government is called the "estate tax." The "inheritance tax" is presumably a more informal method of saying it. Of note, opponents of the estate tax like to use the term "death tax" when describing it. All three terms: (1) estate tax, (2) inheritance tax and (3) death tax have the same meaning.

6. California Small Estate Affidavit

This proves that not every mind thinks alike. Some Internet users like to lead with California while others like to trail with California.

7. California Inheritance Tax

See # 5

8. CUTMA

This is the acronym for "California Uniform Transfers to Minors Act." 

A CUTMA is a hybrid between a trust and a guardianship where a custodian has control over a minor's assets to utilize for the minor's benefit until they reach a certain, at most 25 in California.

9. Special Needs Trust California

A SNT is an irrevocable trust designed to maintain government resource eligibility for a disabled individual while simultaneously allowing the trustee access to trust funds to benefit the beneficiary, i.e. the disabled individual, for specific purposes.

This is a technical type of trust that requires much more planning and administration than a regular living trust.   

10. Inheritance Tax California

Apparently most people use the term "inheritance tax" when they think of the estate tax.

Types of Irrevocable Trusts

The majority of trusts that are drafted are known as revocable or living trusts. However, some people write irrevocable trusts as well if the situation dictates the necessity for such. The following are some of the more common irrevocable trusts:

Life Insurance Trust (commonly known as a ILIT)

In this type of trust, parents gift money to their children to pay the life insurance policy premiums, which are taken out for the parent's lives, and the parents then designate the children as the policy's beneficiary. An ILIT provides the benefit of reducing the parent's taxable estate for Estate Tax purposes and provides the children with liquidity to satisfy Estate Tax obligations. For example, the parents might gift $26,000 to their children annually to purchase the largest life insurance policy they can obtain. When the parents pass away, the proceeds from the policy will not be included in his or her gross estate for Estate Tax purposes. In turn, the children will reap sufficient liquidity to pay any Estate Tax liability. Generally speaking, the IRS requires prompt payment of the Estate Tax, hence access to large quantities of cash is needed to pay it. Unfortunately, you cannot barter services with the IRS as a form of payment so money is needed to pay them off not your impressive karaoke skills.  

Crummey Trust 

This type of trust allows a parent to gift the maximum annual exclusion amount, $13,000 in 2012, to their child's trust. The name is derived from the court case which recognized its validity, Crummey v Commissioner (9th Cir 1968) 397 F2d 82. Basically, a parent tells their child that they are gifting their Crummey Trust $13,000 and the child has the right to withdraw said funds within a specified time period if they so desire. Invariably the child will not withdraw the funds whereby the funds become part of the child's trust. If this seems like a big charade to you, then you can think prudently. 

Charitable Trust

Since the Estate Tax allows a charitable deduction, a wealthy individual might write a trust which benefits a recognized charity to offset the Estate Tax. There are two types of these, a charitable remainder trust ("CRT") and a charitable lead annuity trust ("CLAT"). In a CRT, individuals are designated as beneficiaries for a specified period of time, with the remainder interest passing to charity. In a CLAT, the formula is reversed, the charity is the initial beneficiary for a specified period of time, with the remainder interest passing to named individuals. 

Special Needs Trust (commonly known as SNTs)

A SNT is a trust designed for individuals who are disabled with the goal of retaining the individual's public benefits such as Medi-Cal and Supplemental Security Income while simultaneously allowing them to receive property. There are two types of SNTs, a First-Party Specials Needs Trust and a Third-Party Special Needs Trust. In a First-Party SNT, the disabled individual themselves creates the trust. For example, the individual is awarded a substantial judgment for a personal injury claim and creates the First-Party SNT to maintain eligibility for public benefits. Conversely, with a Third-Party SNT, some person other than the disabled individual, almost always the parents, creates the trust for the individual. 

Qualified Domestic Trust (commonly known as a QDOT)

In the case of a couple, the Estate Tax is not an immediate concern should one spouse away. The reason for this is because one spouse is allowed to transfer to the surviving spouse an unlimited amount of property upon their passing. IRC §2523. For example, if Jack and Jill were collectively worth $250M and Jack suddenly passed away in a tragic hot air balloon accident, Jill would have no immediate concern of paying the Estate Tax since Jack could leave his entire to her absent Estate Tax liability. Although Jill's estate would have to pay the Estate Tax once she passes away. Regardless, the major qualification for the unlimited marital deduction is that the surviving spouse be a U.S. citizen. IRC §2056(d).

If the surviving spouse is not a U.S. citizen, the couple can write a QDOT to take advantage of, albeit partially, the marital deduction for Estate Tax purposes. The nuances of a QDOT are beyond the scope of this brief post because the requirements are rather technical and more importantly for you the reader, quite boring. However, a prior post is dedicated to this topic.   

There are many other types of irrevocable trusts. I focused on the above trusts because I see them in use most frequently.

Special Needs Trust

Since writing a post about special needs trusts a few months ago, I noticed that it has been a common reading item. In response, here are some additional issues that arise in the special needs trust context. 

1. How does a disabled-beneficiary qualify for public assistance?

A disabled-beneficiary may qualify for public assistance through two methods: needs-based or entitlement. For needs-based, a disabled-beneficiary will qualify out of necessity so to speak. For example, food stamps are an example of a needs-based public benefit because only those with very modest incomes are eligible to receive food-stamps. Conversely, an entitlement public benefit is where the recipient qualifies just for the sheer fact that they are a member of a certain class of individuals. For instance, Medicare is an example of an entitlement benefit because anybody 65 or older will qualify.

Needs-based public benefits include Supplemental Security Income (SSI) and Medi-Cal, while entitlement benefits include Social Security Disability Insurance (SSDI) and Medicare. Since SSI and Medi-Cal are needs-based public benefits, a recipient of those public benefits will require a special needs trust in order to maintain eligibility should they be the beneficiary of some other person’s estate plan. 

2. What are some important on-going requirements for a special needs trust?

Two important on-going requirements of a special needs trust are tax returns and accounting.

Generally speaking, a special needs trust must file a California tax return if the net taxable income is over $100 or the gross income exceeds $10,000, regardless of the net taxable income. Rev & T C §18505(e)-(f). A federal tax return must be filed if the trust has any taxable income or has gross income of $600 or more, regardless of the amount of taxable income. IRC §6012(a)(4). Since this involves a microscopic threshold, it is almost certain that any trust with require the filing of a federal and state tax return.

As for the accounting, a special needs trust needs to periodically provide an accounting to each disabled-beneficiary. The frequency of the accounting is dependent upon whether or not the trust is court-supervised. If the trust is not court-supervised, then the trustee must annually account to the disabled-beneficiary unless the trust instrument provides otherwise or the disabled-beneficiary waives such right in writing. Prob C §16062; Prob C §16064(a); Prob C §16064(c). If the trust is court-supervised, then the trustee must account no less frequently than biennially, unless otherwise ordered by the court. Prob C §2620(a). In most cases, an annual accounting will be required.

3. What happens to the trust assets after the passing of the disabled-beneficiary?

The main consequence is that the State may entitled to reimbursement for the Medi-Cal coverage it provided the disabled-beneficiary. The answer depends upon whether the trust is first-party or third-party.

A first-party trust is one personally created by the disabled-beneficiary. An example of this would be where a disabled-beneficiary was the recipient of a large court settlement which would otherwise jeopardize their eligibility for public benefits if not for the creation of the special needs trust. A third-party trust is one created by a person other than the disabled-beneficiary. An example of this would be where parents create a trust for their disabled child.

If the trust is a first-party special needs trust, federal law requires that "the State will receive all amounts remaining in the trust upon the death of such individual up to an amount equal to the total medical assistance paid." 42 USC §1396p(d)(4)(A). This is known as Medi-Cal reimbursement. Basically, the State will recoup all the money it has provided the disabled-beneficiary over the years through Medi-Cal.

However, if the trust is a third-party special needs trust, then there is no Medi-Cal reimbursement.

4. Can a special needs trust be terminated?

Yes, a special needs trust could be terminated for a number of reasons. For instance, the disabled-beneficiary could pass away, the trust assets could run out or the disabled-beneficiary could lose their eligibility for public benefits despite the creation of the special needs trust.

5. Can a special needs trust purchase a home with maintaining the disabled-beneficiary’s eligibility for public benefits?

Yes, a special needs trust can purchase a home while maintaining the disabled-beneficiary’s eligibility for public benefits. Federal and California law says that a personal residence is an exempt asset and will not be counted against the disabled-beneficiary for eligibility purposes. 20 CFR §416.1212 (SSI); 22 Cal Code Regs §50425 (Medi-Cal). However, there are a multitude of issues that would confront a trustee during the process. First, the trust would require liquidity in order to purchase a home. Second, the trustee would most likely need to procure financing for the home purchase. Third, the trustee would need to allocate the responsibilities for improvements and repairs to the home amongst the affected parties.

6. How long does a special needs trust last?

Generally speaking, a special needs trust will last for the lifetime of the disabled-beneficiary.

7. How does a trustee make a distribution to a disabled-beneficiary?

There are a couple of ways in which a trustee could make a distribution to a disabled-beneficiary. For illustrative purposes, assume that the trustee would like to buy the disabled-beneficiary a couch. The trustee could purchase the couch personally and have it delivered to the disabled-beneficiary, or the trustee could purchase a furniture store gift card which they would later provide to the disabled-beneficiary.

8. Can the attorney who writes the special needs trust be the trustee?

Yes, theoretically the drafting attorney could serve as the trustee but given the legal hurdles that must be cleared, it is doubtful that a prudent attorney would serve as trustee. One reason why this situation is problematic is because the attorney is considered a “disqualified donee”, whereby the approval of another attorney is needed to cure the perceived conflict of interest. Another reason why an attorney-trustee is undesirable is because the attorney would typically not be entitled to compensation as both trustee and attorney, double-dipping. Prob C §15687. Hence, even though the attorney would serve two roles, they would only be compensated for one role.

9. Is court supervision of a special needs trust mandatory?

No, there is no requirement that a special needs trust be subject to the continuing supervision of a local superior court. Consequently, this means that parents could establish a special needs trust for their child and the trust’s administration would never require the approval of court order. 

Special Needs Trust

Over the years, a few clients have asked about a special needs trust (SNT) because they have a child with a disability. Here are some common questions/answers:

1. What is a special needs trust?

A special needs trust is an irrevocable trust in which the disabled beneficiary's assets are sheltered from general use in order to allow the disabled beneficiary to remain eligible for government benefits such as Supplemental Security Income (SSI) and Medi-Cal. For example, if Hal and Wendy had a daughter, Diana, who was blind, it would be prudent for Hal and Wendy to create a special needs trust for Diana. Otherwise, Diana would later become ineligible for government benefits should she inherit her parents' estate. The reason for this is because the eligibility requirements for SSI and Med-Cal are needs-based, whereby a person will become ineligible for benefits if they have too many assets.

2. Are their different types of special needs trust?

Yes, there are two kinds of SNTs, first-party SNT and third-party SNT.

In a first-party SNT, the trust is self-funded by the person with a disability. For example, if a disabled person won a large court judgment against someone, they would establish a first-party SNT with the proceeds from that judgment. Conversely, in a third-party SNT, the trust is established with the assets of someone other than the person with a disability. For instance, from the example above, Hal and Wendy would create a third-party SNT for their daughter Diana by leaving their estate to her in trust.

3. What can a special needs trust be used for?

SNT assets can only be used for special items such as a vehicle, a computer, furniture, laundry, audio equipment, electronic devices, medical care not covered by Medi-Cal, etc. The reason for this is because general items such as food, shelter and basic medical care are meant to be paid for by SSI funds and Medi-Cal. 

4. Who can be the trustee of a special needs trust?

Generally speaking, there is no prerequisite for being the trustee of a special needs trust. In most cases, a family member is selected to be the trustee. 

However, the responsibility of a trustee of a special needs trust is significantly greater than that of a trustee of a regular revocable trust. This stems from the fact that the trustee of a special needs trust not only has to follow the duties of being a trustee, (See Prob C §§ 16000-16015), they must also keep attuned to the ever-charging laws of public benefits, namely the Social Security Act law and regulations and the Program Operation Manuel System (POMS). In short, being the trustee of a special needs trust is not something to take on casually. Furthermore, it is common to select a professional trustee to handle such a role.

5. What happens if a special needs trust is not created for my disabled child?

Since SSI and Medi-Cal are needs-based government benefits, the disabled child will most likely lose those benefits because their inheritance will make ineligible for them due to the fact that they will exceed the eligibility threshold. In particular, to maintain eligibility for SSI, the countable resource limit is $2000 for an eligible individual and $3000 for an eligible couple. 20 CFR §416.1205(c).  As for Medi-Cal eligibility, an individual cannot have more than $2000 in countable resources and a couple cannot have more than $3000. 22 Cal Code Regs §§50419-50420. Of note, a bank account constitutes a countable resource for both SSI and Med-Cal. For illustrative purposes, from the above example, if Diana inherited a $10,000 bank account from her parents' estate, this inheritance would make her ineligible for SSI and Medi-Cal.