Summary: Recent Arizona case exposes weakness in many inheritance protection trusts.
If your estate plan includes inheritance protection trusts for your children or other beneficiaries, you may want to consider an amendment in response to a 2016 Arizona legal case. The case involved an inheritance trust established for a child by his Mother’s will upon her death. The IRS filed a tax lien against the trust because the beneficiary owed substantial personal income taxes from prior years. The beneficiary argued that the inheritance was a “purely discretionary trust” and therefore not a personal asset subject to the lien. The judge ruled against the beneficiary based upon a careful review of the specific trust provision regarding distribution of income and principal.
The relevant provision stated, “The Trustee shall pay to [the beneficiary] so much or all of the net income and principal of the trust as in the sole discretion of the Trustee may be required for support in the beneficiary’s accustomed manner of living, for medical, dental, hospital, and nursing expenses, or for reasonable expenses of education, including study at college and graduate levels.”
The judge interpreted the phrase “shall pay” as a mandatory fiduciary duty owed to the beneficiary by the Trustee, although he also noted that specific calculations were left to the discretion of the Trustee. This approach is sometimes referred to as a “discretionary support” or “hybrid” trust. The combination of the Trustee’s duty to make distributions (“Trustee shall pay to the beneficiary…”) and the inclusion of guidelines regarding how to define support (“in the beneficiary’s accustomed manner of living…”) gives the beneficiary an underlying right to distributions from the trust – at least to the extent of the support guidelines. The judge applied this logic to permit the IRS to attach a lien to the beneficiary’s interest in the trust.
For maximum protection of inheritance you leave to others, it may be appropriate to amend your will or living trust to clarify your intent that a Trustee’s power to make distributions is purely discretionary and not mandatory. Otherwise, a creditor could use the above-described case to establish a legal argument that diminishes, or worse, eliminates the protections you intended to create.
If your trust was drafted by a Wealth Counsel attorney using its industry-leading WealthDocx software, it probably does not include the type of extraneous wording (“in the beneficiary’s accustomed standard of living”) that contributed to the adverse ruling in this case. However, WealthDocx, by default, uses the phrase “shall pay” and that may be enough to give creditors a slight opening to argue that you actually intended to create a discretionary support trust. Thus, in response to this recent Arizona case, I recommend an amendment that does the following:
 Duckett v. Enomoto, U.S. District Court, D. Arizona; April 18, 2016.
 A purely discretionary trust does not grant a property interest to the beneficiary because the Trustee is not legally obligated to make any distributions to the beneficiary. See A.R.S. §14-10504(E).
 Whether the IRS could immediately seize assets from the trust to pay the lien is a different matter and was not ruled upon in the case.
 Bouman Law Firm has used WealthDocx software exclusively since October 2006.
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Contrary to popular belief, it is rarely a good idea to name parent and child as joint owners of a bank or investment account. Here is why:
If there is a legitimate reason to have a child assist a parent with management of a bank or investment account, the better alternatives to joint ownership are (1) Title account in parent's individual name and add child as agent under financial power of attorney, and (2) Title account in trust name and add child as co-Trustee. The only time when I would recommend joint ownership between parent and child is when they are operating a business together.
Thomas J. Bouman