Representing Trustees and Beneficiaries of Income Trusts in Light of Recent Statutory Revisions

Oftentimes grantors, through their trust agreement, will create different classes of income and principal beneficiaries.  There are valid reasons for this type of planning (e.g. planning for children from a prior marriage, imposing some restrictions on outright access to trust corpus to spendthrift beneficiaries, etc.)  Conflict may arise between the different classes of beneficiaries, some with the goal of short term high interest return and some with the goal of long-term growth of principal.  As a trustee these issues can raise particular concerns with regard to a trustee’s fiduciary duties of impartiality and duty to diversify under the Uniform Prudent Investor Act.   See NRS 164.700 – 164.775.

During the last legislative session in 2007 the Nevada State Legislature passed SENATE BILL No. 148 approved by the Governor on May 28, 2007 effective October 2007 revising the Uniform Principal and Income Act.  Bill No. 148 capped the amount of administrative expenses that may be paid out of income of a trust during the applicable accounting period.

Bill No. 148 revised NRS 164.900 and allows for the payment of regular trust administration expenses (e.g. trustee’s fees, accountant, attorney, and professional advisors fees, expenses related to the upkeep of trust property, etc.).  The statute provides that fees during the accounting period can be paid one half from principle and one half from income, but the hitch is the one half paid from income cannot exceed 5 percent of the income for the applicable accounting period.

The Legislative Counsel Digest provides a brief example of the workings of the revised statute:

Under existing law, regular compensation for the services of a trustee and any person providing investment services to the trustee must be paid evenly out of the principal of the trust and income from the trust.  (NRS 164.900, 164.905)  Sections 2 and 3 of this bill provide that the amount paid for regular compensation out of income must not exceed 5 percent of income for that portion of the accounting period on which compensation is based.  

For example, under existing law, if regular compensation owed to a trustee is $20,000 for one year, $10,000 is paid out of income, regardless of income for that year.  Under the provisions of sections 2 and 3 of this bill, the amount of income for the year would first be determined. Assuming the amount of income for the year were $100,000 and the regular compensation owed to a trustee were $20,000, then $5,000 would be paid out of income and the reaming $15,000 would be paid out of principal.  However, if the amount of income for the year were $200,000 instead of $100,000, then regular compensation would be paid evenly out of income and principal, as under existing law, because the amount paid out of income, $10,000 would not exceed the cap of 5 percent income. 

Legislative Counsel Digest, Senate Bill No. 148

NRS 164.800, entitled “Applicable rules after death of a decedent or end of income interest in trust,” specifically gives a trustee the discretion to pay from income or principal, “fees of attorneys, accountants and fiduciaries, court costs and other expenses of administration, and interest on death taxes.”  However this discretion is tempered to the extent that payment of certain expenses will not cause a reduction or loss of applicable tax deductions.

While there is some ambiguity between NRS 164.900 and its specific reference to 164.800, it seems clear that although the trustee may have broad discretion to allocate administrative expenses between income and principal on the death of the grantor, his discretion is not unfettered when it comes to ongoing trust administration and the Uniform Principal and Income Act. 

It appears that the provisions of NRS 164.900 and 164.905 are mandatory and a trustee is bound by the five percent cap as it relates to payment of administrative fees from income of the trust.  However, there is nothing that prevents a grantor from drafting around the requirements of NRS 164.900 and 164.905 during the grantor’s life.  Sections of NRS chapter 163 specifically allow the grantor to relieve the trustee of certain duties or restrictions and ameliorate the trustee’s liability for certain actions.

Alternatively, the trustee could petition the court to reform the trust provisions regarding income to allow a percentage of the total trust return to go to the income beneficiary (unitrust).  Traditionally, income trusts left all income to beneficiary A for A’s life with the remaining trust corpus to beneficiary B upon A’s passing.  This traditional drafting may create a catch 22 in that the trustee may focus on income producing assets at the expense of long term growth, leaving the income beneficiary with the goldmine and the remainder beneficiary with the shaft.

Several states have allowed a conversion from a traditional income trust to a unitrust as part of their Uniform Principal and Income Act. If an income trust was converted to a unitrust it appears that the five percent expense cap on income would be nugatory.  All trust expenses would be paid from the total trust income and would in essence be prorated between the income and residual beneficiaries.   

After converting an income trust to a unitrust the trustee would make an annual unitrust distribution of the fair market value of the trust assets instead of the annual income payment.  The unitrust provisions bring both the income and remainder beneficiaries’ interests in line and allow the trustee to focus on total investment performance without fear of breaching his fiduciary duty to either beneficiary.   

In light of these recent statutory changes, it is, and will continue to be of utmost importance to the planner to discuss the grantor’s intent and long term goals regarding the administration of the trust so that proper care is taken to ensure that the trust agreement accomplishes the grantor’s goals and accurately reflects his overall testamentary intent.   

NRS 164.900:

A trustee shall make the following disbursements from income to the extent that they are not disbursements to which paragraph (b) or (c) of subsection 2 of NRS 164.800 applies:

1. One-half of the regular compensation of the trustee and of any person providing advisory or custodial services to the trustee concerning investment, except that the amount of the disbursements from income made pursuant to this subsection must not exceed 5 percent of income for the portion of the accounting period on which such regular compensation is based;

2. One-half of all expenses for accountings, judicial proceedings, or other matters that involve both the income and remainder interests;

3. All the other ordinary expenses incurred in connection with the administration, management or preservation of trust property and the distribution of income, including interest, ordinary repairs, regularly recurring taxes assessed against principal, and expenses of a proceeding or other matter that concerns primarily the income interest; and

4. Recurring premiums on insurance covering the loss of a principal asset or the loss of income from or use of the asset.

NRS 164.800:

After a decedent dies, in the case of an estate, or after an income interest in a trust ends, the following rules apply:

1. A fiduciary of an estate or of a terminating income interest shall determine the amount of net income and net principal receipts received from property specifically given to a beneficiary under the rules in NRS 164.810 to 164.925, inclusive, which apply to trustees and the rules in subsection 5. He shall distribute the net income and net principal receipts to the beneficiary who is to receive the specific property.

2. A fiduciary shall determine the remaining net income of a decedent's estate or a terminating income interest under the rules in NRS 164.810 to 164.925, inclusive, which apply to trustees and by:

(a) Including in net income all income from property used to discharge liabilities;

(b) Paying from income or principal, in his discretion, fees of attorneys, accountants and fiduciaries, court costs and other expenses of administration, and interest on death taxes, but he may pay those expenses from income of property passing to a trust for which he claims an estate tax marital or charitable deduction only to the extent that the payment of those expenses from income will not cause the reduction or loss of the deduction; and

(c) Paying from principal all other disbursements made or incurred in connection with the settlement of a decedent's estate or the winding up of a terminating income interest, including debts, funeral expenses, disposition of remains, family allowances, and death taxes and related penalties that are apportioned to the estate or terminating income interest by the will, the terms of the trust, or applicable law.

NRS 163.160:

The settlor of any trust affected by NRS 163.010 to 163.210, inclusive, may, by provision in the instrument creating the trust if the trust was created by a writing, or by oral statement to the trustee at the time of the creation of the trust if the trust was created orally, or by an amendment of the trust if the settlor reserved the power to amend the trust, relieve his trustee from any or all of the duties, restrictions, and liabilities which would otherwise be imposed upon him by NRS 163.010 to 163.210, inclusive; or alter or deny to his trustee any or all of the privileges and powers conferred upon the trustee by NRS 163.010 to 163.210, inclusive; or add duties, restrictions, liabilities, privileges, or powers, to those imposed or granted by NRS 163.010 to 163.210, inclusive; but no act of the settlor shall relieve a trustee from the duties, restrictions, and liabilities imposed upon him by NRS 163.030, 163.040 and 163.050.

See generally, “The Impact of Recent Cases on the Administration of Trusts,” Christopher Cline, Esq., Estate Planning, October 2007, Vol. 34, No. 10.