SENATE, No. 982

STATE OF NEW JERSEY

INTRODUCED MARCH 18, 1996

By Senator DiFRANCESCO

An Act concerning the limits on certain trustees' powers of distribution and supplementing Title 3B of the New Jersey Statutes.

    Be It Enacted by the Senate and General Assembly of the State of New Jersey:

    1. a. The following powers conferred by a governing instrument upon a trustee in his or her capacity as a trustee shall not be exercised by that trustee:

    (1) The power to make discretionary distributions of either principal or income to or for the benefit of the trustee, the trustee's estate, or the creditors of either, unless either:

    (a) limited by an ascertainable standard relating to the trustee's health, education, support or maintenance, within the meaning of 26 U.S.C. §§ 2041 and 2514; or

    (b) exercisable by the trustee only in conjunction with another person having a substantial interest in the property subject to the power which is adverse to the interest of the trustee within the meaning of 26 U.S.C. 2041(b) and (1) (C) (ii);

    If a trustee is prohibited by paragraph (1) of this subsection from exercising a power conferred upon the trustee, the trustee nevertheless may exercise that power but shall be limited to distributions for the trustee's health, education, support or maintenance to the extent otherwise permitted by the terms of the trust.

    (2) The power to make discretionary distributions of either principal or income to satisfy any of the trustee's personal legal obligations for support or other purposes;

    (3) The power to make discretionary allocations in the trustee's personal favor of receipts or expenses as between income and principal, unless such trustee has no power to enlarge or shift any beneficial interest except as an incidental consequence of the discharge of such trustee's fiduciary duties;

    (4) The power to exercise any of the powers proscribed in this subsection with regard to an individual other than the trustee to the extent that such individual could exercise a similar prohibited power in connection with a trust that benefits the trustee.

    b. Unless otherwise prohibited by the provisions of subsection a. of this section, a trustee may exercise a power described in that subsection in favor of someone other than the trustee, the trustee's estate, or the creditors of either.

    c. If a governing instrument contains a power proscribed under subsection a. of this section the following shall apply:

    (1) If the power is conferred on two or more trustees, it may be exercised by the trustee or trustees who are not so prohibited as if they were the only trustee or trustees; or

    (2) If there is no trustee in office who can exercise such power upon application of any interested party, a court of competent jurisdiction shall appoint a trustee to exercise such power or, except as provided in subsection d. of this section, a successor trustee who would not be disqualified shall be appointed to exercise the power that the other trustees cannot exercise in accordance with the provisions of the trust instrument as if the office of trustee were vacant.

    d. No beneficiary of a trust, in an individual, trustee or other capacity, may appoint, or remove and appoint, a trustee who is related or subordinate to the beneficiary within the meaning of 26 U.S.C. §672 (c) unless:

    (1) the trustee's discretionary power to make distributions to or for such beneficiary is limited by an ascertainable standard relating to the beneficiary's health, education, support or maintenance as set forth in subsection a. of this section;

    (2) the trustee's discretionary power may not be exercised to satisfy any of such beneficiary's legal obligations for support or other purposes; and

    (3) the trustee's discretionary power may not be exercised to grant to such beneficiary a general power to appoint property of the trust to the beneficiary, the beneficiary's estate or the creditors thereof within the meaning of 26 U.S.C. §2041.

    This subsection d. shall not apply if the appointment of the trustee by the beneficiary may be made only in conjunction with another person having a substantial interest in the property of the trust, subject to the power, which is adverse to the exercise of the power in favor of the beneficiary within the meaning of 26 U.S.C. §2041(b) (1) (C) (ii).

    e. The provisions of this section shall not apply during the time that a trust remains revocable or amendable by the grantor.

    f. This section applies to:

    (1) Any trust created under a governing instrument executed 90 days or more after the effective date of this act, unless the governing instrument expressly provides that this act does not apply; and

    (2) Any trust created under a governing instrument executed before 90 days after the effective date of this act, unless all interested parties affirmatively elect on or before three years after the effective date by a written declaration signed by or on behalf of each interested party and delivered to the trustee, not to be subject to the application of this act. In the case of a testamentary trust, such declarations shall be filed with the clerk of the court in which the will was admitted to probate.

    g. In this section the term "interested party" means:

    (1) Each trustee then serving; and

    (2) Each person having an interest in income or principal whom it would be necessary to join as a party in a proceeding for the judicial settlement of a trustee's account or, if such a person has not attained majority or is otherwise incapacitated, the person's legal representative under applicable law or the person's agent under a durable power of attorney that is sufficient to grant such authority.

    2. This act shall take effect immediately.

STATEMENT

    This bill supplements New Jersey's probate code by addressing situations in which trustees named to serve also may be beneficiaries of the trust. This situation is common with trusts where a family member may serve as trustee with discretion as to payments of income and principal among family members. However, this situation presents the problem of the inherent conflict of interest between a trustee who could favor himself and the balance of the beneficiaries. Moreover, due to the increased complexity of the Internal Revenue Code and the aggressive positions taken by the Internal Revenue Service, certain powers held by a trustee can have the unintended consequences of causing a trustee who also happens to be a beneficiary of the trust to have the entire trust fund included in the trustee/beneficiary's estate, to cause some or all of the trust income to be taxable to the trustee and be charged with a taxable gift in the exercise of his or her fiduciary powers.

    The tax issue is whether the fiduciary powers granted to a trustee under a will or trust agreement will be deemed to confer upon the trustee a general power of appointment under Section 2041 of the Internal Revenue Code thus causing the trust property to be included in the trustee's estate for Federal estate tax purposes.

    In this determination, the Internal Revenue Service focuses on two questions: (1) whether the trustee's distribution powers are subject to an enforceable, ascertainable standard and (2) whether the trustee can make distributions to discharge a legal obligation of the trustee.

    State law determines the limits on a trustee's power of distribution. Therefore, whether a trustee's distribution powers are limited by an ascertainable standard related to health, education, support or maintenance is a matter of state law. This bill addresses these limits.

    The bill deals with the problem by prohibiting a trustee/beneficiary from making discretionary payments of principal and income for his own benefit unless the power is limited by an ascertainable standard or the power is exercisable only with the consent of a person having a substantial interest in the trust. The bill would not affect such a power given to an independent trustee and the bill provides if there is no trustee who can exercise the power of invasion, a court can appoint a special trustee.

    In addition, the bill prevents unintended taxation by prohibiting a trustee/beneficiary (a) from making discretionary allocations in the trustee's favor of receipts or expenses as between income and principal, (b) from making distributions to discharge his legal obligations and (c) from exercising powers for a beneficiary other than the trustee to the extent that such beneficiary could exercise a similar power for the instant trustee.

    The sponsor hopes that this bill may leave family members free to select one of their own to act as the fiduciary and retain the discretion to make discretionary payments to all the beneficiaries including the trustee.

Limits certain trustees' powers of distribution.