So, you created one or more trusts in 2020 with interesting sounding acronyms: SLAT, DAPT, SPAT, etc. And now you are just happy to be done. Well, you are not done yet! You and your advisers should prepare a compilation of the planning documentation you have completed for your files, and for your other advisers. This is vital for a host of reasons:
It is essential that you obtain and organize the necessary documentation to administer any trust you created. This information is also necessary to corroborate the positions taken on income and gift tax filings, to properly plan for trust distributions, to be certain no steps or ancillary documentation is missing, etc. This information, all identified in the checklist below, will facilitate administration of your trusts.
Why Create a Trust Compilation?
There are lots of reasons to create a trust compilation for each trust or trust plan you created in 2020. Here are a few:
- Having all your trusts and documents organized will save time, money and aggravation in the future. The time to do this is relatively soon while the transactions are fresh in everyone’s mind.
- A compilation will organize the 2020 planning documentation in an easily accessible format for administration of the plan.
- Even a simple trust plan can have a surprising number of documents that need to be organized and disseminated. You might think “gee I have my trust document,” but there is so much more. See a sample listing below.
- If you created and funded an irrevocable trust in 2020, you will have to have your CPAs file a gift tax return to report the gifts to the IRS. It may also be essential to allocate generation skipping transfer (GST) tax exemption to the trust. That can facilitate the trust avoiding transfer taxes for generations to come, or even indefinitely. Organizing a comprehensive package of all documents pertaining to your trust, gifts in 2020 to the trust, and other trust transactions, can provide a cost-efficient roadmap for your CPA to prepare that return. In fact, the table of contents for all trust documents can Also use our contents/checklist from the document compilation as the basis for preparing the exhibit list for the Form 709 gift tax return.
- Most important and unique to 2020 planning (the same thing last occurred in 2012) was the mad rush to plan, especially close to the end of 2020. That frenzy assuredly resulted in less organized and complete planning then would have occurred in a more reasoned planning environment. The process of assembling a compilation will identify missing steps or overlooked or incomplete documents. In short, preparing a compilation is vital to identifying the inevitable oversights resulting for the rush and volume of 2020 year end planning. For example, if a document was missed, not signed, partially signed, dated incorrectly, correcting these matters as soon as possible, while not a guarantee that it will be respected, is far preferable to having such issues brought up by an IRS auditor years later on audit!
Careful organization of all of your documents may be the only way to understand the transaction by making gaps in the documentation or transaction apparent and clarifying the issues that need to be followed up on in future years.
What Type of Trust Did you Create?
The type or characteristics of the trusts you created will affect the documentation you need, how you organize it, and the steps you should take. Organizing your files is not going to be an intuitive or obvious process, even for many professionals. It can be complex and the consequences of an oversight significant. Here are a few examples:
- If your trust is a non-grantor or so-called “complex” trust, that means the trust pays its own income taxes. That might be integral to using the trust to save state income taxes. But if the trust is to be a non-grantor trust it has to be administered to qualify. That means, among other things, that the trust should not own life insurance on your life, and if the trust makes a distribution to your spouse an “adverse party” (e.g., a child who is also beneficiary) will have to approve those spousal distributions. Thus, the checklist you create should include a section to save documentation of adverse party approvals and it should not have a heading for life insurance.
- If your trust is a life insurance trust it should have captions to include information on insurance premiums, insurance policies, split dollar or premium financing arrangements, and other aspects of your insurance plan.
- If you and your spouse both created trusts for each other (so-called non-reciprocal spousal lifetime access trusts or SLATs) they need to be operated in a manner that supports their integrity. You should not receive direct distributions from your trust for which you are not a beneficiary.
If there is any doubt or concerns, clarify with attorney who drafted the document, the CPA who is advising you on the tax reporting for the trust, your wealth adviser, etc.
Tailor your permanent file to properly reflect the actual nature of your trust or trusts, the assets being transferred to each trust, etc.
Typical Trust Compilation Contents
A checklist or table of contents for the compilation of your trust plan has to be unique to reflect your particular trusts and plan. The listing and explanations below are generic but should give you a good starting point to identifying what should be included and collecting and organizing all the relevant documentation. Just keep in mind that many items in the list will not be relevant for your trust, and some key items to your plan may not be listed.
When evaluating the relevance of the illustrated captions below to your trust plan, do not merely dismiss items you do not have. They may serve as a useful reminder of steps you might have taken in creating your 2020 trust plan but did not do so either because of the compressed planning framework, or perhaps because it was overlooked. For example, you may not have created a personal balance sheet, budget or financial forecasts before making transfers to your trust in 2020. That might still be done. While it would have been preferable to have created the financial background before a transfer, to demonstrate that there was no need for you to retain an interest in the trust, or that the transfer was not a fraudulent conveyance (i.e., intended to hinder, delay or defraud a creditor because you had plenty of resources after the transfer) you might create this documentation and analysis in 2021 and incorporate it into your trust compilation. If your financial position shortly after the transfer was solid, that might be used to suggest that it was solid in late 2020 when the actual transfers were made.
Create a Trust Summary
The first step in your trust compilation should be to create a succinct summary of the trust. This is particularly important for families that have multiple trusts (some have a score or more of trusts) so that you and each of your advisers can quickly be reminded of the key facts and purposes of each trust. As trust plans grow more complex, this becomes ever more important. Here are common categories/captions for a brief trust synopsis.
1. Name of Trust.
2. Formed under name and date of agreement. For a testamentary trust it might be formed under a will or formerly revocable trust so you would want to list that document name and date. In many cases existing irrevocable trusts are divided on certain events (e.g., the death of the settlor of the trust or the sale of a family business) so that prior trust is actually the instrument under which the particular trust in question is created. Some trusts might be merged or decanted from older trusts into the current trust. So, this historical background should be succinctly captured in the summary.
3. Trust Tax Identification Number.
4. Current Trustees. There may be multiple trustees. A modern trust might have a general, administrative, distributions, investment, charitable and even other trustees. Be certain to list each category of trustee and the person or institution serving. It may also be useful to succinctly indicate what the functions or responsibilities are for each trustee.
5. Successor Trustees may be listed.
6. Powerholders. Modern trusts can have an array of special function appointments or persons designated to hold certain powers. This could include a trust protector with certain designated rights or powers, a person with a power to appoint trust assets to the settlor or others, someone authorized to make loans to the settlor, etc. A person may be designated to hold powers to determine or resolve matters of who is a descendant, whether a person should remain a beneficiary despite the instrument referring to their dead name, and other LGBTQ issues. A special powerholder may be appointed to assure compliance with religious precepts, such as a limited power of appointment to assure dispositions in accordance with Islamic law. All these should be listed with brief explanations of the powers and purpose of the appointment.
7. Trust assets. Identifying key trust assets is helpful to understanding the purpose of the trust and how it should be administered. For example, if the trust owns stock in a Subchapter S corporation care will have to be taken to assure that the trust retains the right to hold that stock without disqualifying the S status.
8. Letters Trusteeship. Indicate details (dates, court number, etc.) from any court provided documentation appointing one or more trustees.
9. Beneficiaries should be listed with key information and any special circumstances which may be relevant to the trust administration.
10. Summary of Selected Trust Provisions. This should focus only on very broad overview with references to the actual section or provisions numbers of the trust for further details. For example, if income must be distributed to a spousal beneficiary then the trustee will have to be on notice of that, it may affect investment allocations and income tax implications.
Table of Contents for Trust Compilation and Explanations
*Client-Name *Trust-Name – Trust Compilation
Table of Contents
Organize each document using the sequence and numbering below to create a physical and/or electronic compilation of all relevant trust documents. If you have multiple trusts that are relatively simple, then perhaps you can create a single compilation for all of them. If you have a very complex trust plan, e.g., a note sale of interests in several closely held businesses to a trust in 2020, you might create a separate compilation for each such complex trust.
Each supporting document should be saved in an electronic folder with the corresponding tab number below. For example, a copy of the fully executed trust agreement should be saved as “10. Smith Family 2020 Irrevocable Trust,” and so on. If a physical/paper binder is created, then the trust agreement would be placed behind tab 10 in a loose-leaf binder.
- Schematics. Many complex trust transactions can best be understood and administered using a diagram. Many of these transactions are so unique and complex, that the old adage “a picture is worth a thousand words,” is true. A diagram may be critical to communicate the interrelationships of various trusts, trustees, assets, and entities.
- Planning Memorandum. Collect substantive letters and memoranda on your planning for various advisers. These could be helpful years from now when endeavoring to understand the motives or reasoning for a particular step in the planning.
- Financial Data.
- Balance sheet of settlor. This may corroborate that you had adequate resources after the transfer to the trust to demonstrate that the transfer was not a fraudulent conveyance.
- Financial projections. These may corroborate that you have adequate resources after the transfer to demonstrate that the transfer was not a fraudulent conveyance, that you have adequate resources for living needs.
- Judgment and Lien Searches. You want corroboration that you did not have any outstanding claims that would have made the transfer to the trust inappropriate. The documentation should corroborate that you made a good faith effort to identify debts that could later be argued demonstrate a fraudulent conveyance or inability to support you after the transfer.
- Title run-down. If real estate will be transferred to the trust, a title search on the real estate may be obtained prior to transfer to identify liens or claims that could relate to the property, the entity or even you as the grantor.
- Affidavit of Judgment and Lien.
- Affidavit of Solvency.
- Waiver of Elective Share and Community Property Rights.
- Counsel Opinion. If the trust is created in a state other than your home state, a legal opinion of an attorney in that state as to the validity of the trust under that state’s laws.
Trust and Trustee Documentation
- Executed Trust.
- Trust Company Ancillary Documents. If you have named a corporate or institutional trustee, or use a professional investment adviser, attach copies of all account opening and other forms.
- Fiduciary Actions Relating to Formation.
- Declaration of Initial Gift to Dynasty Trust. Some lawyers suggest that if you make transfers to a trust as gifts that there should be a document confirming that the assets were given to the trust.
- Initial Funding. Attach copies of the documentation supporting the initial gifts to the trust. Often, if business, real estate, insurance or other assts are to be transferred to a trust, the initial funding will include cash and/or marketable securities to open trust accounts. If the trust will purchase assets the initial funding may be used to support that later purchase.
Secondary Gift Funding
In many trust plans an initial or seed gift is made to the trust (see above) and then, perhaps, additional gifts of other assets (e.g., stock in a closely held business) are made.
- Entity Formation Documents.
- Certificate of Formation, Articles of Organization, etc.
- Certificate of Good Standing. If ownership interests in an entity, e.g., a limited liability company or corporation, was transferred to the trust, obtain a certificate of good standing from the state where the entity was created and authorized to do business. If the entity does not validly exist, or is not in good standing under state law, that may affect asset protection goals and even the validity of the transfers.
- Initial Governing Agreement for *Entity-Name. If the entity involved is a corporation then a shareholder’s agreement for that corporation before the transfers to the trust should be included. This demonstrates the ownership before you made a transfer and would confirm your position to make the transfer below.
- Old membership interest certificates. If the interests transferred to the trust are shares of stock in a corporation (or if membership interests in a limited liability company are certificated) attach copies of the relevant certificates. List the certificate numbers, shares each represents, date of issue and other relevant data here.
- Appraisal. An appraisal that values the private equity, real estate or other non-marketable assets you transferred to the trust should be included. Indicate the date of the appraisal and the determinations of value here. 2020 was so hectic, and the planning window so compressed, that some transactions may have been completed without an appraisal. In some instances, the appraiser may have provided the valuation figures, but the report would be issued later in 2021. That report should be attached when received and you should confirm that the final appraisal report reflects the values used when the transfers were completed in 2020. If there is a different consult with your attorney and the appraiser to determine how to address that. 2020 was also unique in that some transfers had to be completed before an appraisal could be obtained. In such instances an appraisal might be obtained at a later date and a valuation adjustment mechanism might have been incorporated into the transfer documents to adjust the interests or note on a sale to reflect the appraised value when determined. Also, if a transfer was made without a qualified appraisal (a defined term for gift tax purposes) determine what additional disclosures and steps may be required when filing a gift tax return.
- Direction Letter. Many trusts that are designed to hold non-marketable assets, such as equity in a real estate LLC or a family business, are often structured as “directed trusts” in which a specified person (e.g., an “investment director” or “investment trustee”) is authorized to determine which assets the trust will hold and to direct that the institutional or other independent trustee hold those assets. One advantage of this type of structure is that the institutional trustee is relieved of liability for investment performance and decisions (assuming applicable state law and the trust instrument permit this) so that fees are less. In such instances when transfers of non-marketable assets are made to the trust, the investment adviser should direct, in writing, the institutional trustee to hold such assets to confirm that the institution does not have responsibility for the decision. If there were multiple transfers be certain to include each direction letter for the appropriate phase of the trust plan in this compilation.
- Entity Resolution or Consent. The appropriate persons on behalf of the entity can approve the assignments, the new governing document, waive rights of first refusal, and other prerequisites to the assignment of entity interests by you to your trust.
- Assignment of Equity Interests. If you gave a gift of membership interests in a limited liability company to your trust in 2020 you should have signed an assignment of LLC interests to the trust to effectuate that transfer. Attach that assignment as exhibit 20 to this compilation and list here key information from the assignment (date, interests transferred, special terms of the assignment, etc.). If there was an amended governing document created after the assignment that the trust signed, or a joinder agreement in which the trust agreed to be bound by the governing document, attach that as well. If these were not done, contact corporate counsel and address what legal documentation beyond merely the assignment might be advisable to create.
- Amended and Restated Operating Agreement for *Entity-Name. Governing document could be amended and restated and executed by the trust to reflect the trust as an equity owner. In some instances, these documents did not exist because, prior to the transfer of interest to the trust, there was only one shareholder and no agreement was deemed necessary. If documents were created indicate the date, name of the document and other key items here and append the executed governing document as exhibit 22.
- New membership interest certificates. If new membership certificates were issued to the trust indicate its ownership indicate key information here and attach copies of the new certificate here as exhibit 23. Note that if the transfer were subject to a valuation adjustment mechanism there could be an indication of that as a legend on the certificate along with the more typical legends indicating transfer restrictions.
Sale to Trust – *Entity-Name
For larger estates, more complex trust plans may include the sale of significant assets to the trust in order to shift future growth, lock in discounts, etc. While in many instances sales and other leveraging techniques are used when the value of the estate is substantially above the exemption amount, because the 2020 exemptions were so large at $11.58 million per person, some taxpayers used note sales even to freeze values in their estate but to provide the access to the interest and principal payments on the note to assure sufficient resources. The template, below, should be adapted for whatever type of entity or other asset is sold, and replicated when many different entities are involved (e.g., non-controlling interests in 10 single purpose LLCs each owning an apartment building).
- Formation Documentation; Good Standing Certificate.
- Governing Agreement for *Entity-Name prior to sale.
- Old membership interest certificates prior to sale to trust.
- Equity Interest Sale Agreement. If the dollar size of the transaction exceeds the client’s remaining gift tax exemption, incremental transfers to the trust will have to be by way of sale to avoid a gift tax. These sale transactions can take many forms, and often are a combination of different approaches. The sale could be for an interest-only note with a balloon, a note with some principal amortization, a self-canceling installment note (“SCIN”), a private annuity, or some combination of these. Guarantees may be used in some transactions (e.g., if the assets in the trust are viewed as too modest in value relative to the value of the assets being sold) , but not others. In some transactions, and depending on who provides the guarantee, some advisers may recommend that a fee should be charged by the guarantor, but not in others. In some instances, the fee may be determined by independent appraisal. Whatever approach is used the appropriate captions should be provided for and copies of documents attached as exhibits in that sequence. The decisions as to what steps will be taken to support the validity of the transaction are typically determined at the structural design phase of the plan. However, because of the compressed planning time for 2020 planning, especially late in the year, some of these decisions may be addressed for the first time in 2020 (which is why creating a compilation and checklist like this is so important) or reconsidered (in which case contract and other documents might be renegotiated or amended). You might find it helpful to list items that might have been considered but which were rejected and indicate “Not Used” when applicable. This can avoid a confusing search in later years to determine what was done (or not).
- Escrow. Some sale, or other, transactions might use an independent escrow agent (or general counsel) to hold documents of title, especially if there is a valuation adjustment mechanism that could result in a change in the anticipated or estimated equity interests as a result of a future appraisal or audit. Depending on what arrangements were used, list key documents and relevant information below and attach copies of all relevant documentation numbered accordingly
- Escrow Agreement.
- Certificates held in escrow.
- Blank assignments for certificates.
- Note cancellation agreement.
- Loan Documentation. Many sale transactions are structured with the buying trust giving the seller, e.g., you, a secured promissory note for part or even all of the purchase price. Indicate the correct titles for each relevant document and attach these documents, appropriately numbered, as exhibits.
- Amortization Schedule.
- Pledge Agreement.
- Split-Dollar Loan Documentation.
- Financial Data on Guarantor.
- Guarantee Agreement.
- Guarantee Fee Agreement.
- Appraisal determining guarantee fee.
- Direction Letters.
- Assignment of Equity Interests.
- Unanimous Consent and/or Resolutions.
- Amended and Restated Operating Agreement for *Entity Name.
- New Equity Interest Certificates.
Many trust plans and transactions incorporate life insurance. If your plan did not, it may be worth revisiting that decision now that the rush of 2020 compressed planning has concluded. Life insurance can have important and special implications to common 2020 planning. One of the most common planning structures used in 2020 was non-reciprocal spousal lifetime access trusts (“SLATs”). These are where each spouse creates a trust for the other spouse and descendants or other beneficiaries. For such a plan to succeed the trusts cannot be too similar or the IRS or a creditor might uncross them. Life insurance can be used to differentiate the economics of the trusts, and that may be able to be grafted on to the 2020 plan. For example, if one SLAT includes significant life insurance, and the other none, or one includes permanent coverage and the other term, that may help differentiate the trusts. Also, an important consideration in many SLAT plans is mortality risk. If you created a SLAT for your spouse and descendants and your spouse dies prematurely, that might cut off your indirect access to the assets of your trust though your spouse as beneficiary. However, if your spouse’s SLAT purchases life insurance on your spouse’s life, you can hedge against the financial risks of premature death. If your irrevocable trust is to own life insurance on your life you cannot have any incidence of ownership over the life insurance or it will be included in your estate. If you were named as investment trustee or investment director so that you could make investment decisions concerning a family business held in the trust, the trust plan might benefit from designating an independent trustee to handle insurance matters and specifically proscribe you from having any involvement or control over insurance assets or decisions.
- Insurance Summary.
- Life Insurance Projections.
- Life Insurance Policy.
- Premium Financing or Split-Dollar Documentation.
Post Signing Tax Filings
While the 2020 trust plan is “fresh in mind” and you are working with your advisory team to organize all the relevant documentation use the opportunity to begin compiling a list of post-signing administrative matters that should be addressed to help you and your advisers properly administer the trust plan. Remember, the best drafted trust using the best trust plan (if “best” existed) will be unlikely to accomplish your goals if it is not administered properly.
- Gift Tax Return. A gift tax return may have to be filed to report gifts, allocate GST exemption and perhaps even report certain non-gift transactions (e.g., a sale to a trust). These returns are not simple and should be prepared by someone with considerable experience preparing these returns. For some plans, e.g., where a trust engages in transfers, beneficiaries of the trust might choose to report certain transactions by the trust of which they are a beneficiary on their gift tax returns. So, consider from a broad perspective who should file gift tax returns.
- Trust Income Tax Returns. Even grantor trusts that have no income tax implications might best file an annual informational return with the IRS. If you have split-dollar life insurance planning the trust may have to file a required disclosure statement.
- Individual Income Tax Return. You might have certain aspects of your trust plan that should be reflected on your income tax return. If you engaged in a split dollar life insurance plan a mandated statement may need to be appended to your return. If you sold or gave assets to one or more trusts subject to a valuation adjustment mechanism your personal income tax return might indicate that the income from those assets may be adjusted back to you.
- Entity Income Tax Returns. Certain aspects of your trust plan might warrant disclosure on entity income tax returns. If you sold or gave assets to one or more trusts subject to a valuation adjustment mechanism the entity income tax return, especially Forms K-1 for flow through entities, might indicate that the ownership percentages for certain members or partners, or S corporation shareholders are estimated and may be adjusted in the future based on the valuation adjustment mechanism.
Post Signing Annual Reviews
Given the complexity of most trusts and trust transactions, annual reviews with all advisers addressing each of the payments, points and documents that should be undertaken. Practitioners vary widely as to which, if any, of the following documents and steps should be addressed and how.
- Annual Review Steps.
- Certificate of grantor that he or she has not exercised power to substitute.
- Certificate of person holding power to loan grantor funds without adequate security that he or she has not exercised power to make such a loan.
- Certificate of person holding power to add a charitable beneficiary that he or she has not exercised power to add a beneficiary.
- Documentation of any actions by Trust Protector.
- Investment Trustee or Adviser direction letter to Institutional Administrative Trustee to continue to hold specific assets.
- Annual Minutes or Consents of underlying entities in which the trust holds an interest.
- Modification of Note.
Annual or other Periodic Payments
- Note Payments. If you sold assets to a trust for a note it is imperative that interest be paid in accordance with the terms of the note. List each year below and update it reflecting the wire or check information for effectuating each payment.
- GRAT Annuity Payments. If you gave assets to a Grantor Retained Annuity Trust (“GRAT”) it is imperative that the periodic annuity be paid in accordance with the terms of the trust. List each year below and update it reflecting the wire or check information for effectuating each annuity payment.
- Guarantee Fee Payments. If a guarantee was used in the transaction and a fee was required to be paid if that fee is to be paid annually