Can A Grantor Be Trustee Of His Irrevocable Trust?

Many lawyers shudder at the idea of allowing the grantor of an irrevocable trust to be the trustee.  But the primary reason for this fear is long-rooted in traditional estate tax planning principles.  Particularly, § 674 of the Internal Revenue Code provides that any trust wherein the grantor retains the power to control the beneficial enjoyment of the income or principal of the trust will make all of the income on that trust taxable to the grantor, and Internal Revenue Code § 2036 provides that any trust where the grantor retains the right to possess or enjoy the property or designate who will possess and enjoy the trust property will make the principal of the trust includable in the grantor's estate at death for estate tax purposes.  Prior to 2001, irrevocable trusts were predominantly utilized for estate tax protection.  Triggering code Section 2036 would violate estate tax planning goals.

However, after the Tax Act of 2001, wherein the estate tax exemptions were increased to in excess of $5,000,000, the traditional tax planning rationale was no longer valid.  Currently, the estate tax rule is triggered only on individuals who have assets greater than $5,430,000, and on married couples who have twice that amount.  Recent statistics indicate that only two in 1,000 Americans have assets that exceed the federal estate tax exemption limits, which represents .2 percent, leaving 99.8 percent of Americans without an estate tax concern.  The key question is, why do lawyers continue to hold 99.8 percent of clients prisoner to the rules meant for the .2 percent?

The Restatement Second of Trusts § 99 – and the cases cited thereunder, particularly Markham v. Faye, 74 F.3d 1347 – clearly states that creditors can only access the assets of a trust to which the grantor has retained rights.  The question as to what rights the grantor has to access income or principal is a designing issue related to the beneficiary designations in the trust, not the trustees.  The Baldwin case goes on to clarify that a grantor, as trustee, has the same fiduciary duties to the beneficiaries as any other trustee.  Restatement Second of Trusts § 266 and the cases thereunder further clarify that it is well-established law that assets of a trust are not subject to personal claims against the trustee, even if the liability arises out of his trustee capacity.  Further, Restatement Second of Trusts § 170 provides that a trustee is prohibited from self-dealing or acting in his or her own best interests.  Nothing in the law is better settled than the provision that a trustee may not advantage himself or herself in dealings with the trust estate.  Gibson v. Sec. Trust Co., 107 F.Supp. 766.  A grantor's creditors are only entitled to income or assets available to the grantor, as is well-established under Uniform Trust Code § 505, and as further clarified under the Restatement Second of Trusts § 156.  So in order to properly provide asset protection, the trust by its terms must prohibit distribution of the principal and/or income to the grantor, and no discretion shall be permitted to the trustee or anyone else to distribute it to the grantor.  This will ensure asset protection. 

The key question then becomes what the grantor is seeking protection for.  If one wants to protect income and principal, then no benefits should be retained, but the right to be trustee is still permitted.  The only adverse consequence is that all of the income is taxed on the personal income tax returns of the grantor, and they are responsible for the income tax on the trust income.  Further, all of the trust principal is included in the estate of the grantor at death, but for the 99.8 percent of Americans who are not subject to estate tax, this is not an adverse result; in fact it's usually a preferred result.  If there is any question as to whether the grantor has the ability to pay the income taxes, then the trust can contain a provision that allows the trustee to pay any income tax due to the taxing jurisdiction exclusively (not the grantor) by reason of the inclusion of the income from the trust on the personal tax return of the grantor.  This restricts distributions to the grantor, and only allows the trustee to distribute to the taxing jurisdiction, and only as to the income tax caused by the inclusion of the trust income on the tax return of the grantor.

The key benefit of letting the grantor be trustee, and the one most important to clients, is maintaining control.  Most people who have worked their whole lives accumulating assets are not ready to just turn them over to the kids or other third parties.  Doing so not only puts the assets outside of the control of the grantor, but it also creates a risk of losing the assets to the creditors, predators, and lawsuits of the individual to whom they are transferred. Nothing could have a more adverse impact or be a greater risk to a client than that.  Whereas the ability to control the assets, and to continue to manage the investments of the assets and keep them in the form they are currently in or change them as they desire along the way, is one of the greatest benefits to grantors when serving as trustee of their irrevocable asset protection trust.  All of these provisions are permitted in the Lawyers with Purpose iPug® Trust system.  The iPug Trust system monitors all of the various legal provisions to ensure the trust being utilized is proper to benefit clients in the ways they desire.  So being a trustee and grantor of your trust does not subject it to risk.  There is no legal authority anywhere that indicates being a trustee of your own trust makes it subject to your creditors.  There is an entire line of cases where courts have invaded trusts where the grantor is the trustee, but in every case it is due to the grantor's “fraudulent conveyance and management” of the assets where the trust was invaded, not because the grantor was trustee.  So, be informed and be conscious of your clients' needs, and share with them the many advantages of having them stay in control of their assets.

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David J. Zumpano, Esq, CPA, Co-founder Lawyers With Purpose, Founder and Senior Partner of Estate Planning Law Center