An Overview of Trusts
By Attorney Truman Scarborough
There are three separate discussions on this web site. If you are reading them in succession, you have already covered estate planning and probate. The discussion on probate ended by noting many people use a trust to avoid probate. To appreciate why there is a desire to avoid probate, there needs to be an understanding of the reasons for probate. If you have not yet read the discussion on probate you might find it helpful to read it before continuing with this discussion on trusts.
One way to avoid probate is by creating a legal entity called a trust. In Florida when someone turns eighteen (18) years of age they have the right to hold title to property, enter into contracts, and bring law suits. Entities like trusts and corporations have these same legal rights.
While trusts go back to the Middle Ages, their widespread use to avoid probate for the average person is a fairly recent development. Fifty (50) years ago, Norman F. Dacey (a non-lawyer) in his book, How to Avoid Probate, proposed that probate could be avoided with a revocable trust. Florida Statutes now fully recognize the validity of the Living Trust and have extensive provisions for the administration of this type of trust.
There are various kinds of trusts that are used for different purposes. The one suggested by Mr. Dacey is called an Inter Vivos Revocable Trust. “Inter Vivos” means the trust is created and assets are transferred into the trust while the creator of the trust is living, thus the term “living trust”. There are also “testamentary trusts” which come into being through the probate process after the creator has died. The word “revocable” means the creator can revoke and change the trust if and when he/she pleases.
To avoid probate, assets must be transferred into the trust while you are living. If I built a shed to keep my tools dry but forgot to put in the clippers, the shed won’t protect them from the weather. In a like manner, if I failed to re-title an asset in the trust, it is not protected from probate.
With corporations and trusts there is a division of rights and responsibilities. Both have creators: with the corporation it is the incorporators, with the trust it is the Settlors. Each has individuals authorized to manage the assets; with a corporation it is the officers and directors, with a trust it is the trustees. There are also those who have the beneficial rights; with a corporation it is the shareholders, with a trust it is the beneficiaries.
The person who incorporates a business could also be the sole stockholder and only corporate officer. Likewise, with the Living Trust one person could be the Settlor, Trustee, and Beneficiary. When a trust is created by a husband and wife together, they are generally the initial Co-Settlors, Co-Trustees and Co-Beneficiaries. They are responsible only to themselves with the exclusive right to amend the trust, manage the assets, and are free to use the trust assets as they please.
If one spouse dies or becomes incapacitated, the other spouse continues as sole trustee. Without a Trust, the incapacity of one spouse can freeze real estate, since both spouses’ signatures would be required on the deed conveying title to land. In case both Settlors or the surviving Settlor became incapacitated, the trust would provide for a special trustee to take control, avoiding the need for guardianship. Guardianship is not a pleasant process requiring a determination of incapacity and annual accountings to the court.
At the Settlor’s demise, the person named in the trust as successor trustee has immediate control of the trust assets. It is like a corporation. If the president dies, his/her successor immediately takes control. Without seeking court approval, the successor trustee has the authority to pay bills and make distribution to the beneficiaries.
The successor trustee has special responsibilities to the beneficiaries. When someone must rely on the honesty and diligence of someone else to protect his/her property it creates a fiduciary relationship. Fiduciaries are held to the very highest legal standards.
By not fully understanding fiduciary requirements, a trustee can innocently breach his/her duty. The trustee's specific duties are set forth in the Florida Trust Code. The successor trustee is required to follow the terms of the trust and protect trust assets. The Trust Code also states that “a trustee shall administer the trust solely in the interests of the beneficiaries”. This means the trustee must avoid any conflict of interest. He/she must hold all trust assets separately in the name of the trust and cannot commingle trust funds with his/her own funds. A trustee should not acquire assets from the trust (even at full value) without court approval or consent of all the beneficiaries. The Trustee cannot favor one beneficiary over other beneficiaries. This can be a particular problem when the Trustee is also one of the beneficiaries. If the Trustee places his interests as a beneficiary above the other beneficiaries, he breaches this fiduciary responsibility.
Beneficiaries need information to be sure the trustee is properly administering the trust. Therefore, the Trust Code requires that the Trustee keep accurate records and provide the beneficiaries with information including annual and final accountings. Merely failing to give complete and accurate information is a violation of the Trust Code.
The Trust has a responsibility to pay the decedent’s creditors. Nevertheless, a creditor cannot seek payment directly from the trust, but must go through the probate process. This creates a problem for the creditor if no probate estate has been opened (which normally is the case since a trust avoids probate) and would require the creditor to open probate. Because this puts a significant burden on creditors, I believe this portion of Florida law may be subject to change.
Like a Personal Representative in probate, the successor trustee has responsibilities to the IRS. He/she must obtain a tax identification number (EIN) from the IRS for the trust. With a revocable trust, income is reported under the social security number while the creator is living. But when the creator of the trust dies, the trust becomes irrevocable and income must be reported using the EIN. The EIN is like a social security number for artificial legal entities, i.e. corporations, probate estates and trusts. Financial institutions need this number for they cannot use a deceased person’s social security number. Income received under the EIN is reported to the IRS on a 1041, Fiduciary Income Tax Return.
By avoiding the probate court process, trusts generally shorten the time of settling the decedent’s estate. However, if the trustee lacks business savvy, has a cavalier attitude, or does not have the time to properly administer the estate, settling of an estate may flounder without court supervision.
The Florida Probate Code sets forth a number of timelines for administering an estate. With the court enforcing these time requirements, no action is generally required by a beneficiary. The probate court also oversees mandatory distribution of information to the heirs. On the other hand, if the beneficiaries of a trust need the court’s assistance, they will be required to file an independent civil action in the Circuit Court.
When a capable and trust worthy individual cannot be found to serve as trustee, a financial institution could be named as trustee to settle the estate. However, if the estate is small, a financial institution may not be willing to serve. One option is to have the assets pass through probate so the court can see that it is properly administered.
Like many issues in estate planning, this discussion ends without a definitive answer, requiring us to weigh the options. Concluding Comments are next.