Written by Sagar Jariwala, JD, LLM
A trust instrument may give a trustee different levels of powers over distributions. A trustee can have full discretion over distributions, meaning that the trustee can decide if distributions should be made, when distributions should be made, and what amount of distributions should be made to a beneficiary. Alternatively, a trust instrument can require a trustee to make distributions. For example, the trust may require distributions of all income at least annually or of required minimum distributions received from a retirement account, or the trust may grant a beneficiary a withdrawal right that the beneficiary exercises. Sometimes, a trustee can have a distribution power that falls somewhere between a discretionary power and a mandatory requirement to distribute. In this case, we are talking about ascertainable standards (i.e., health, education, maintenance, and support, often referred to as HEMS). If an ascertainable standard applies, the trustee can make distributions only if the particular standard is met and cannot make distributions if the particular standard is not met. If a particular standard is met and the trust requires the trustee to make distributions if that standard is met, a beneficiary can compel the trustee to make a distribution. Alternatively, a trust may further require that a beneficiary exhaust their other income and resources before they compel a trustee to make distributions under an ascertainable standard.
Usefulness of Ascertainable Standards in Estate Planning
Estate planners use ascertainable standards for two primary reasons: asset protection and transfer tax avoidance. They may also be used to shift income tax liability.
Asset protection. If a trustee’s discretion to make distributions for the trustee’s own benefit is limited by ascertainable standards related to the health, education, maintenance, or support of the beneficiary-trustee, it can restrict a creditor’s ability to reach assets or compel distributions. Without this safeguard, beneficiaries concerned about asset protection would be prevented from serving as trustees of trusts created for their benefit.
Transfer tax avoidance. Possessing, exercising, or releasing a general power of appointment can subject the powerholder to estate tax or gift tax. General power of appointment means any power of appointment exercisable in favor of the powerholder, powerholder’s estate, powerholder’s creditors, or creditors of the powerholder’s estate. A power to consume, invade, or appropriate property for the benefit of the powerholder that is limited by an ascertainable standard relating to the health, education, support, or maintenance of the powerholder shall not be deemed a general power of appointment. A beneficiary serving as trustee can thus avoid estate tax inclusion and gift tax imposition if the trustee’s discretion to make distributions to the beneficiary is limited by ascertainable standards.
Trustmakers often want a beneficiary-controlled trust—a trust for which the beneficiary serves as trustee—to simplify trust administration, minimize costs associated with trust administration, and give the beneficiary control over the trust assets. However, ascertainable standards benefit more than just beneficiaries serving as trustees. A settlor serving as trustee of an irrevocable trust for the benefit of a nonsettlor can avoid estate tax inclusion under Internal Revenue Code (I.R.C.) § 2038 if the settlor-trustee’s power to make distributions is limited by ascertainable standards.
Income tax purposes. In addition to asset protection and transfer tax avoidance, the use of ascertainable standards can help a trustmaker avoid being deemed the owner of trust property for income tax purposes. A trustmaker of an irrevocable trust can possess a power to distribute corpus and not be deemed the owner for income tax purposes if the power is limited by a reasonably definite standard. A reasonably definite standard can be viewed as equivalent to an ascertainable standard.
What Are Ascertainable Standards?
According to the Uniform Trust Code, ascertainable standard means a standard relating to an individual’s health, education, support, or maintenance within the meaning of I.R.C. §§ 2041(b)(1)(A) or 2514(c)(1). The regulations expand on the definition of ascertainable standards and provide that “support,” “support in reasonable comfort,” “maintenance in health and reasonable comfort,” “support in his accustomed manner of living,” “education, including college and professional education,” “health,” and “medical, dental, hospital and nursing expenses and expenses of invalidism” are additional standards that qualify as ascertainable standards. The Internal Revenue Service (IRS) considers care to be an additional ascertainable standard. While ascertainable standards are a federal tax law concept, additional standards such as enjoyment can be construed as ascertainable under state law. The standards of comfort, welfare, or happiness typically do not qualify as ascertainable standards unless provided otherwise by state law or accompanied by modifying language (e.g., “support in reasonable comfort” or “maintenance in health and reasonable comfort"). It is recommended that trustmakers use the standards specifically approved under the I.R.C. and Treasury Regulations because, by modifying the wording or using different standards, the trustmaker risks granting a general power of appointment, which in turn could mean the loss of asset protection and adverse tax consequences.
Ascertain means to fix, to render certain or definite, to estimate and determine, or to clear of doubt or obscurity. A standard is something set up and established by authority as a rule for the measure of quantity, weight, extent, value, or quality. In theory, a trustee should be able to determine with certainty if a particular expenditure is needed under an ascertainable standard. In practice, making the determination may at times be difficult because it may be debatable whether an expenditure falls within the standard. To add to the complexity, the meaning of each term (health, education, maintenance, and support) depends on the statutes and case laws of the governing state.
Maintenance and support. Generally, support and maintenance are synonymous and their meaning is not limited to the bare necessities of life. Furthermore, courts have interpreted support and maintenance to include not only the beneficiary’s support but also the support of the beneficiary’s family. Thus, a trustmaker who does not want to provide for a beneficiary’s family should express that intent in their will or trust. The standard typically allows for. . .
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