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The Power of Appointment
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What is It?
The power of appointment is one of the most powerful instruments
in estate planning. Simply put, a power of appointment is the
right to tell the trustee to pay money from the trust to someone.
Who can that "someone" be? That
is the major tax question. How is the power to be exercised? That
is a secondary question.
Example: assume a trust to
pay income to C for life, and at C's death the principal would go
to C's children. But C might be given the power to appoint
(perhaps a portion of ) the trust among her descendants by will.
Thus, C can vary their shares. This is a minimal
power which I strongly
recommend, even if parents don't want to
give the beneficiary full control because it gives C a chance
to see what the respective needs of her children are. It gives
her a chance to adapt the trust for the needs
of her family.
This is a testamentary power of
appointment -- exercisable only at death. C might be given a
power to appoint during life as well as at death, making gifts to
the children.
This is a special power of
appointment -- it may only be appointed among C's descendants. It
could be made broader. Perhaps C's descendants and their spouses.
Perhaps your descendants. Perhaps include charities. Perhaps as
far as the power to appoint to herself (a power to withdraw). How
far can we go? How far do you want to go?
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The Only Tax Limitation
The most important thing to know
about a power of appointment is its Federal Estate Tax
consequences.
A trust created by A will be
included in C's federal taxable estate if C is given a general
power of appointment. That is defined as a power to appoint to
yourself, your estate, your creditors, or the creditors of your
estate. Furthermore, even if you can appoint to yourself, it is
not a general power of appointment for tax purposes if your right
to do so is limited by an ascertainable standard relating to your
health, education, maintenance and support. [There's a potential
trap here -- a power to distribute to yourself based on your
needs is OK -- but not a power to distribute based on the needs
of your dependents -- which is why we may need another trustee --
see trustee discussion]. But words like "comfort", "welfare",
"best interests" are not ascertainable standards and cause a
problem *if the beneficiary is trustee* -- it's the combination
of beneficiary and unrestricted power that causes a problem
Aside from a
QTIP deducted by one spouse and
included in the survivor's estate, a trust created by A will only
be included in C's federal estate if C is given a general power
of appointment. No other restrictions on C's power are required
for tax purposes. A may want to put on other restrictions for
non-tax purposes (see
Introduction to Trusts, but they are not required to avoid
taxation.
That is such an important
statement, let me repeat it:
Aside from a QTIP
deducted by one spouse and included in the survivor's estate, a
trust created by A will only be included in C's federal estate if
C is given a general power of appointment.
No other restrictions on C's power are
required for tax purposes.
A may want to put on other restrictions for non-tax purposes, but
they are not required to avoid taxation.
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Can a Beneficiary be Trustee?
Being trustee does not by itself
create a taxable situation. The problem comes when the trustee
has powers which may lead to taxation. A beneficiary may be
trustee. The trustee-beneficiary may distribute to themselves
based on an ascertainable standard. But what about their
dependents? I have taken the approach of restricting the trustee
from voting on distributions to persons dependent on them but
creating a position of "designator" who can change trustees.
Thus, if the beneficiary wants money for that purpose, they can
appoint a co-trustee with authority to distribute and ask the
trustee to do so. If the trustee does not comply, they change the
trustee. At one point, the I. R. S. argued that this made the
beneficiary taxable as though they had the trustee's powers
directly, but they gave up after losing the issue in court.
For full discussion of the
potential flexibility this provides, see
Give the Advantages of Trusts.
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