M.    Beneficiary Controlled Trusts (BCTs)

A beneficiary-controlled trust (BCT) could provide your children with the power to manage its assets and choose a successor beneficiary at death. BCTs are  designed to give their beneficiary (your child) all of the rights  and control over it’s property as if he owned the BCT’s property outright. The BCTs assets are segregated from the child’s assets and are beyond the reach of creditors, divorcing spouses and estate tax. The child gets asset protection plus functional control over the property. By utilizing the GSTT exemption this trust becomes dynastic to make the benefits available to later generations.

Beneficiaries don’t have to be given total control immediately, but can be allowed to do so over time. For maximum flexibility in the event of changes in the law or family’s circumstances, your child can be given a limited power of appointment so he can pass the trust on to whomever he chooses (except himself, his estate, his creditors or the creditors of his estate, because that would cause estate inclusion).

If the beneficiary-controlled trust receives lifetime gifts, your child can start a business. The wealth created by the venture could stay in trust, shielded from predators and estate tax.

§4:150       The Trust Your Child Wants

A BCT can provide your children with almost total trust control. The children control the trust by being non-independent trustees. As such, the child would have control over the BCTs management, investment decisions, and, after that child’s death, who the next set of beneficiaries will be. However, BCT distributions can only be made by the Distribution trustee (an independent trustee). This type of trust has your child as the non-independent trustee and perhaps your or his best friend as the independent trustee.

This type of trust is irrevocable and doesn’t terminate during the child’s life. By utilizing the GST tax exemption, this BCT becomes dynastic, its benefits available to later generations. Trust assets are beyond the reach of creditors, divorcing spouses, and estate tax, perhaps forever.

BCTs are popular among the wealthy because they dislike institutional trustees and are concerned about asset protection. The heirs want protection and are pleased with the control they have over the BCT. Because of these benefits, the heirs should prefer to receive their inheritances in a BCT, not outright.

BCTs can be set up during your lifetime or at death.

Strategy:

You can create a BCT. The BCT could set up and 100% own an LLC. Your child can serve as the LLCs non-member manager. He would be fully protected both from creditors and the tax man. He, not the BCT, would run the LLC and sign on its account.

The client needs to determine when the child will assume control of the BCT and the extent of that control. Clients often set an age requirement for the child to become the non-independent trustee and begin to assume control. Some add incentive, such as a college degree.

For flexibility in the event of changes in law or the family’s circumstances, give your child a broad limited power of appointment (LPA). A LPA allows him to pass the trust to whomever he chooses except himself, his estate, his creditors, or the creditors of his estate, because these powers would cause the LPA to become a general power of appointment and would cause estate inclusion.

§4:151       Managing Trustee and Distribution Trustee

From an asset protection and estate planning viewpoint, assets inherited in trust are far more advantageous than assets received outright. However, many beneficiaries want to receive assets outright because they believe that an inheritance in trust, while advantageous, will not give them the control over the assets and that the trustee will not be responsive.

To give the beneficiary the control he wants, the trust can be drafted as a Beneficiary Controlled Trust (BCT).

A BCT is discretionary and it could contain many of the beneficial clauses used for other trusts, such as clauses that allow it to:

•        Be dynastic. [See §4:120.]

•        Take full advantage of the GSTT exemption. [See §4:121.]

•        Have powers of appointment. [See §§4:160 et seq.]

The prime beneficiary can be the trustee (the non- independent trustee) with all trustee powers except one: the power to distribute assets out of the trust. If the beneficiary had the power to distribute trust assets to himself, he would lose the trust’s asset protection and estate tax benefits.

Therefore, settlors who create trusts for beneficiaries who want to manage the trust and the trust assets must design the trust so that there are two types of trustees for two different trust functions:

•        The “Managing Trustee”: This trustee manages the assets, and is the prime beneficiary, but he cannot make distributions.

•        The “Distribution Trustee”: This trustee makes distributions from the trust, and is an “Independent” person.

FORM:

4-22 Beneficiary Controlled Trust: Authority of Distribution Trustee

4-23 Beneficiary Controlled Trust: Removal of Distribution Trustee

§4:152       Definitions

Distribution Trustee

A Distribution Trustee can be a person or a corporate fiduciary who is qualified to serve as an Independent Trustee. [See IRC §§672 and 674.]

A Distribution Trustee’s authority is limited to deciding on and making discretionary distributions, and has no other powers or responsibilities.

Independent Trustee

An “Independent Trustee” is a person who:

•        Is not related or subordinate to the Settlor or a beneficiary.

•        Cannot benefit from the exercise or nonexercise of any power given a trustee.

•        Is neither a beneficiary nor a settlor of the trust.

•        In a trust where a beneficiary’s general power of appointment may only be exercised with the consent of an Independent Trustee, does not have a substantial interest in the property subject to the power which is adverse to the exercise of the power in favor of the beneficiary, the beneficiary’s estate, the beneficiary’s creditors, or the creditors of the beneficiary’s estate.

In other words, an Independent Trustee is a trustee who is not an Interested Trustee.

Whenever a trust agreement specifically prohibits an Interested Trustee from exercising discretion or performing an act, then only an Independent Trustee may exercise that discretion or perform that act.

Interested Trustee

An Interested Trustee is a trustee who is any of the following:

•        A transferor of property to the trust (including a person whose qualified disclaimer resulted in property passing to the trust)

•        A beneficiary of the trust

•        A replacing trustee in a situation where a beneficiary can replace an existing trustee by a trustee that is related or subordinate to the beneficiary

A Beneficiary

A Beneficiary of the Trust is a person who is, or in the future may be, eligible to receive income or principal from the trust pursuant to the terms of the trust.

A person shall be considered a beneficiary of a trust even if he or she has only a remote contingent remainder interest in the trust. However, a person shall not be considered a beneficiary of a trust if the person’s only interest is as a potential appointee under a testamentary power of appointment.

§4:153       Authority of the Two Trustees

The Managing Trustee has full authority to invest, reinvest, encumber, transfer, buy, sell, lease, or otherwise deal with trust assets.

The Distribution Trustee does not have to participate in the decisions relating to the internal management of the trust or the management of its assets. He need only be concerned with respect to distributions. To safeguard the settlor’s interests, the Distribution Trustee does not have the right to distribute assets to anyone other than one of the beneficiaries the settlor has designated in the trust.

The Distribution Trustee could be a trusted non-beneficiary friend or an attorney.

The beneficiary can be given the power to replace the trustees, thereby maintaining the beneficiary controlled feature of the trust, as long as the replacement Distribution Trustee is not a “related or subordinate party.”

§4:154       Asset Protection and Tax Powers

The different roles of the two trustees provide asset protection and keep a separation of powers for tax purposes.

Asset Protection

A creditor of a trustee-beneficiary (the Managing Trustee) can reach as much of a trust’s assets as the trustee-beneficiary could distribute to himself under the terms of the trust instrument. However, the Managing Trustee can not make distributions. It is the Distribution Trustee who holds the dispositive powers over the trust.

Tax Sensitive Powers

The Independent (Distribution) Trustee has tax sensitive powers that include:

•        The power to make distributions to a beneficiary.

•        The power to terminate the trust.

•        The power to give or take away general powers of appointment.

•        The power to amend the trust in favor of the beneficiary.

[See IRC §674(c) (providing an exception for Independent Trustees to the general rule that a grantor shall be treated as the owner of a portion of a trust subject to a power of disposition exercisable by a nonadverse party); IRC §672(c) (defining “related or subordinate party”).]

§4:155       Control of Trust

Initially, the settlors may control the trust via a Protector and a Distribution Trustee, both of which the settlor appoints.

As time goes on, the trust may be set up with age sensitive transfer of controls. That is, the percentage of the trust over which the beneficiary has the right to control can shift at certain ages (e.g., 25/30/35).

If the client so wishes, control can pass to the beneficiaries at the death of the settlor (or at some earlier time).

[§§4:156-4:159 Reserved]

A Non-General (also sometimes called “special” or “limited”) is in essence a re-write power. The client has the power to re-write the trust. The Non-General power (as contrasted with the General power) is tax neutral. The holder of a Non-General power can amend the trust over which he holds this power without concern that he will be exposed to transfer taxation. If on the other hand, the power is a General power (a General power permits the holder to exercise it in favor of himself, his estate or the creditors of either, in trust or outright) he would be exposed to transfer taxation. The Non-General power is used to great effect both in the Beneficiary Controlled Trust (see §4:150, above) and the Pre-Inheritence Trust (see §4:270, below).

In practice the distinction between the two tends to blur. Whereas a holder who wants to amend a trust  “in favor of himself, his estate or the creditors of either, in trust or outright”, cannot without transfer tax ramifications hold a General power an independent trustee selected by the powerholder could. The IRS established in Revenue Ruling 95-58 that the grantor's retention of the power to replace an independent trustee of an irrevocable trust with another independent trustee will not result in the inclusion of the trust corpus in the grantor's estate. Estate of Wall v. Commissioner, 101 T.C. 300. (1993) established that the retained power to replace independent trustees was not the equivalent to the grantor retaining trustee powers. In addition an independent "trust protector" could likewise hold this power.

The Non-General power and the General power creatively used place the both the client and his successor  in full control of the trust. As has been said “the power to appoint is the power to disappoint.” Understanding that the powerholder could “disappoint” a beneficiary guarantees that beneficiary will not attempt an action adverse to the powerholder.