Useful But Overlooked Trusts: A Planner’s Guide to When and How to Use Them

“Useful but Overlooked Trusts: A Planner’s Guide to When and How to Use Them,” that is the subject of today’s ACTEC Trust and Estate Talk.

This is ACTEC Fellow Travis Hayes of Naples, Florida.

Sometimes estate planners need to step outside the usual toolkit and consider more advanced under-the-radar trusts. A Health and Education Exclusion Trust, better known as a HEET, is one example that can cover a family’s medical and educational expenses across generations. But with specialized trust come trade-offs. How do you weigh the opportunities against the risks?

ACTEC Fellow Wendy Goffe of Seattle, Washington, joins us to explore these more nuanced trusts and share her practical insights. Welcome, Wendy.

Trust Fundamentals: Legal vs. Beneficial Ownership

Wendy Goffe: Thank you, Travis. Good morning. Before we dive into the exotic structures, let’s establish our foundation. Understanding what makes a trust a trust is crucial when we start exploring these unusual arrangements.

An express trust is created when a grantor intentionally transfers legal ownership of property to a trustee for the benefit and enjoyment of a beneficiary. Trusts involved two distinct elements of asset ownership, legal title and beneficial title. Because a trust is not a legal entity, title to assets should be held by the trustee, not the trust. However, it’s a modern tendency to treat the trust as a legal owner, and the restatement of trust hints that that is the direction that we’re going, that the trust can be treated as an independent legal entity.

Health and Education Exclusion Trusts (HEETs) Explained

So, with that background, let’s start with the Health Education Exclusion Trust, or HEET. These are particularly powerful for clients who’ve exhausted their GST Exemption but still want to benefit future generations. By having a charity as a beneficiary, this type of trust avoids GST tax for certain limited distributions. It provides for distributions for education and medical expenses that are not subject to GST.

With respect to education, qualified transfers include tuition payments made directly to an educational organization for the education or training of an individual on behalf of a skip person. Payments for other educational expenses, such as room and board and fees, don’t qualify as qualified transfers even when made directly to the educational institution and would therefore be subject to GST tax upon distribution. Similarly, qualified transfers for medical care are payments made on behalf of anyone for their medical expenses, so they’re paid directly to the person who provides the medical care.

HEET Pitfalls: Qualified Transfers and the Separate Share Rule

The catch is that the trust must also provide for charitable distributions in a meaningful way. Another consideration for this type of trust is that we have to be aware of the separate share rule. This rule requires that separate and independent shares for different beneficiaries be treated as separate shares or trusts for purposes of determining the DNI allocable to beneficiaries. If the separate share rule applies, the charity would be assigned its own share, and this means that other shares no longer have a non-skip person, the charity, as a beneficiary. So, any distributions from that share would constitute a taxable distribution for GST purposes.

To avoid the separate share rule characterization, the trustee should be granted broad discretion to determine and vary the annual charitable distributions from the trust rather than tying that distribution to amounts distributed to non-charitable beneficiaries. So, you shouldn’t have a fraction or a set amount that goes to charity, but every year the charity must receive distributions that are meaningful.

Given the complexities involved with HEETs, this technique should be considered only by clients who’ve exhausted their GST exemption, maintain charitable objectives, and seek to create an education and healthcare safety net for future generations.

Alimony and Maintenance Trusts After Section 682

Next, I want to talk about alimony and maintenance trusts. In Washington (state), we don’t have alimony, we have maintenance, so we also refer to it as a maintenance trust, but typically, you’ll hear these referred to as an alimony trust. Under former Section 682, we could shift income tax on alimony to a former spouse. So, alimony trusts were more popular, but they still have a place in our toolbox. They protect against the payor’s death or insolvency, they ensure remaining assets can be passed to designated residual beneficiaries when the alimony is paid in full, and they provide neutral third-party management and reduced interspousal conflict because you have a trustee between them.

Post-repeal of Section 682 (Guidance in Connection with the Repeal of Section 682), the grantor continues to be taxed on the income of the trust even after divorce. For practitioners advising clients on spousal trusts, whether during marriage or even in a pre-nup or a post-nup, careful consideration should be given to having this asset available for use as an alimony trust if that becomes necessary in the future. Some practitioners suggest including mandatory reimbursement provisions requiring a donee ex-spouse to reimburse the donor spouse for income taxes, either from the trust itself or from other assets.

Using Alimony Trusts for Business Owners

An alimony trust may still be particularly useful if a business owner cannot or doesn’t want to sell an interest in the family business to make payments to the former spouse, or if the business lacks the liquidity to redeem the stock of the former spouse. The business owner could fund an alimony trust with equity in the family business, shifting the income generated by the equity interest to the former spouse for a defined term. The business owner could even serve as a trustee, and the instrument could provide that the former spouse’s interest reverts back to the business upon termination.

Voting Trusts for Divorce, Succession, and Governance

Next, I’m going to move to a voting trust, which can be a useful tool in a divorce sometimes. Voting trusts allow shareholders to transfer voting rights to trustees while retaining economic interests. These are valuable for family business succession planning as well. A voting trust is distinguishable from a proxy in that it may serve broader purposes beyond mere voting rights and create a more durable arrangement, whereas a proxy is typically revocable and limited to voting matters. Most states have adopted some form of voting trust statute.

A Washington voting trust becomes effective upon registration of the first shares in the trustee’s name and, like most voting trust statutes, it’s valid for 10 years following its effective date. Delaware’s voting trust statute allows for tremendous flexibility, particularly because it’s not subject to a time limitation.

Voting trusts may also be used to implement multi-generational planning strategies, which are particularly valuable for family businesses where ownership may be distributed among multiple family members with varying levels of business involvement and expertise. They also serve as useful mechanisms to carry out environmental, social and governance objectives.

Blind Trusts and Emerging Trust Structures

Another trust I want to talk about is the blind trust. For business executives, blind trusts are often necessary to comply with securities laws regarding insider trading. The trust should have an independent trustee with discretion to buy and sell pursuant to guidelines established when the executive doesn’t possess material non-public information.

That wraps up my discussion of unusual trusts. As we look to the future, we’re seeing fascinating emerging structures: personal revival trusts for cryogenic preservation, trusts for cryptocurrency and NFTs and other blockchain assets. We’re even seeing trusts designed to hold social media accounts and digital assets.

Travis Hayes:  Thank you. Thank you, Wendy, for giving us an overview of useful trusts that are sometimes overlooked by estate planners and the circumstances under which these types of trusts should be considered.

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