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When using ascertainable standards, precise language is a must

How a trust works is fairly straightforward:

You place assets in a trust for the benefit of your heirs. The key to keeping the trust assets from being taxed as part of your estate is not retaining too much control over them. What isn’t so simple – in fact, it’s quite complex – is the trust’s language. And if your trust includes the use of ascertainable standards (which limit distributions to amounts needed for a beneficiary's health, education, support and maintenance), how the standards are drafted is critical to its success.

When to use ascertainable standards

Suppose you place stock and other assets into an irrevocable trust for the benefit of your children. To ensure that the assets are managed properly, you appoint yourself trustee. The danger here is that, if you have too much control over the trust assets, they may be pulled back into your estate and be subject to estate taxes.

Internal Revenue Code (IRC) Section 2036, for example, provides that assets are included in your estate if you retain “the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.”

One way to avoid this problem is to have the trust provide for mandatory distributions of specific amounts at specific times. But that means beneficiaries will receive distributions even if they don’t need them, depleting the trust and making it harder to preserve its assets for future generations.

A better solution may be to authorize distributions based on ascertainable standards. The idea is that ascertainable standards are objective, so they limit the trustee’s discretion and allow a court to determine whether distributions are appropriate or should be compelled. Because you, as trustee, have little control over the amount and timing of distributions, it's difficult for the IRS to argue that the assets should be included in your estate.

Another alternative is to appoint an independent trustee who can have even greater flexibility to make distributions based on changing circumstances and your beneficiaries’ specific needs. Still, it may be a good idea to use ascertainable standards or other guidelines to ensure that the trustee acts in accordance with your wishes.

IRC-recognized ascertainable standards

The IRC recognizes several ascertainable standards, including support, support in reasonable comfort, maintenance in health and reasonable comfort, support in one’s accustomed manner of living, education (including college and professional education), and health.

Whichever language you choose, careful drafting is important. Seemingly subtle differences can have significant implications. For example, “maintenance in health and reasonable comfort” would be a legitimate ascertainable standard, while “comfort, welfare or happiness” would not.

For extra protection, most trusts also contain a “savings” clause. This clause “saves” the trust in the event that the IRS or a court determines that the trust’s distribution provisions aren’t based on an ascertainable standard. A typical savings clause expressly prohibits the trustee from making discretionary distributions other than for a beneficiary’s health, education, support or maintenance and from making distributions that would benefit the trustee.

Even IRS-endorsed ascertainable standards can lead to disputes among beneficiaries and make the trustee’s job difficult. For example, if your trust allows distributions for education, does it make a difference if the beneficiary goes to a state university or an Ivy League school? If the trust provides for “support in one’s accustomed manner of living,” is that fair to beneficiaries who are students or work in low-paying jobs? To avoid disputes and ambiguity, consider including more specific language in the trust.

Ascertainable standards are objective, so they limit the trustee’s discretion and allow a court to determine whether distributions are appropriate or should be compelled.

Pass the pen to your advisor

Including ascertainable standards in a trust provides flexibility in how assets are distributed to your beneficiaries while preserving estate tax savings, but great care must be given regarding the trust’s language. Your estate planning advisor can help you determine the ascertainable standards that are right for your estate plan.

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