Form 1041. Stephen Brooks

In carrying out this responsibility, the trustee has what is called a fiduciary duty to the trust beneficiary or beneficiaries. Generally, the trustee is charged with the responsibility of administering the trust property solely in the interest of the trust beneficiaries.²³ If there is more than one trust beneficiary, the trustee must deal with them all impartially.²⁴

The trustee is generally entitled to reasonable compensation for performing its duties as trustee.²⁵ Often the trustee's compensation is based on a percentage of the value of the trust assets. The trustee must also keep accurate records with respect to the administration of the trust²⁶ and provide complete and accurate information concerning the nature of the trust property upon reasonable request.²⁷

      Investments of the trust

      Sometimes the trust document will provide specifically how the trust principal is to be invested (for example, only in “triple A-rated bonds”). However, most of the time, the document will not specifically direct the trustee as to how to make investments; instead, the manner in which they are made is controlled by the trustee's fiduciary duty and the terms of the Uniform Prudent Investor Act (UPIA). Under the terms of the UPIA, the trustee is not restricted to one type of investment but may invest in a manner which is prudent and consistent with the trust purpose. Under the UPIA, the trustee's performance will be judged not on the basis of a single investment but rather on the basis of total return of the entire trust portfolio. The underlying premise of this approach is to allow trustees to use modern portfolio theory in analyzing risk versus return.

      Breach of duty

If, in managing the trust, the trustee breaches the trustee's fiduciary duty and causes damage to the trust, the trustee can be held liable for the loss (“surcharged”).²⁸

The tax definition

      The regulations

The regulations define a “trust” for tax purposes in a manner consistent with the legal definition discussed previously; that is a trust is “as an arrangement created either by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts.”²⁹

Generally, an arrangement will be treated as a trust under the IRC if it can be shown that the purpose of the arrangement is to vest in the trustees' responsibility for the protection and conservation of property for beneficiaries (that is, fiduciary duty) who cannot share in the discharge of this responsibility, and therefore, are not associates in a joint enterprise for the conduct of business for profit.³⁰

      Other entities

      In addition to what might be termed ordinary trusts, there are other entities which are referred to as a trust, which may or may not be treated as a “trust” under the IRC. These include the following.

      Business trusts

Entities known as business or commercial trusts are generally created by the beneficiaries simply as a device to carry on a profit-making business which normally would have been carried on through business organizations that are classified as corporations or partnerships. The fact that an organization is technically cast in the trust form, by conveying title to property to trustees for the benefit of persons designated as beneficiaries, does not change the real character of the organization if the organization is more properly classified as a business entity.³¹

      Investment trusts

A so-called “investment trust” will not be classified as a trust if there is a power under the trust agreement to vary the investment of the certificate holders. An investment trust with a single class of ownership interests, representing undivided beneficial interests in the assets of the trust, will be classified as a trust if there is no power under the trust agreement to vary the investment of the certificate holders.³²

      Liquidating trusts

A liquidating trust may be recognized as a trust for tax purposes if it is organized for the primary purpose of liquidating and distributing the assets transferred to it, and if its activities are all reasonably necessary to, and consistent with, the accomplishment of that purpose.³³

Environmental remediation trusts

An environmental remediation trust is considered a trust for tax purposes if the organization is organized under state law as a trust; the primary purpose of the trust is collecting and disbursing amounts for environmental remediation of an existing waste site to resolve, satisfy, mitigate, address, or prevent the liability or potential liability of persons imposed by federal, state, or local environmental laws; all contributors to the trust have (at the time of contribution and thereafter) actual or potential liability or a reasonable expectation of liability under federal, state, or local environmental laws for environmental remediation of the waste site; and the trust is not a qualified settlement fund, as defined by the regulations.³⁴

      Knowledge check

      1 What is generally not recognized as a trust for tax purposes?An investment trust.A business trust.An environmental remediation trust.A liquidating trust.

      2 What best describes the trustee's fundamental fiduciary duty to the trust beneficiaries?The fiduciary standard requires a duty of loyalty and a duty of prudence.The fiduciary standard requires the trustee to communicate with the trust beneficiaries.The fiduciary standard requires the trustee to keep good records.The fiduciary standard requires that the trustee perform its duties without compensation.

      The law governing the trust

      In general

The law that governs the administration of a particular trust is generally determined by the jurisdiction designated in the trust, or absence such a designation, by the law of the jurisdiction with the most significant relationship to the matter at issue.³⁵ This generally means the state law of the state in which the trust is subject to administration. Many states have adopted the Uniform Trust Code (2000) (UTC) as their governing law in one form or another. The UTC represents an effort to create a uniform model of the law of trusts. Another source of reference, particularly in areas not addressed by local law, is the Restatement (Third) of Trusts. The restatement is a treatise published by the American Law Institute, which summarizes the common law; that is, the law as developed by court decision rather that statutory law. The restatement attempts to resolve conflicts where they may exist among different jurisdictions, and also provides guidance if existing law does not address a particular issue.