In common law legal systems, a trust is a relationship in which a person or entity (the trustee) holds legal title to certain property (the trust property or trust corpus), but is bound by a fiduciary duty to exercise that legal control for the benefit of one or more individuals or organizations (the beneficiary), who hold "beneficial" or "equitable" title. The trust is governed by the terms of the (usually) written trust agreement and local law. The entity (one or more individuals, a partnership, or a corporation) that creates the trust is called the settlor, or in the United States, the trustor, grantor, donor, or creator.
The trust has been called the most innovative contribution of English legal thinking to the law. Developed from the 11th century onwards, It plays an important role in all common law legal systems. Trusts developed out of the English law of equity which has no direct equivalent in civil law jurisdictions. Some scholars derive the origin of the trust in the western communities to the concept of Waqf in Islamic law. However, since the use of the trust is so widespread, some civil law jurisdictions have incorporated trusts into their civil codes. Civil law systems also have analogous concepts like patrimony of affectation and the foundation that have similar independent patrimonies from their donors that trusts can have from their grantor.
A simple example of a trust which is common in real life is the situation where Joe Bloggs makes a will, including the clauses:
Here, if Joe Bloggs dies while Doris Bloggs is still under 18, a trust comes into existence at that time, of which John Smith is the trustee and Doris Bloggs is the beneficiary. The Ownership of the trust's assets has become split:
This dual title (legal versus equitable) is frequently called "split title." The "title split" of trust law may be generalized colloquially as follows: legal title involves control, management, and possession, while equitable (beneficial) title involves "benefit," "enjoyment," and "use."
In general, a trust is not established until it is "constituted", meaning both that (1) the trust instrument -where one is required- is signed AND (2) money or something of value (e.g. farm land or a home) is transferred to the trustee. In legal parlance, there must be a res (Latin for "thing"; that is, there must be some property) that is the subject of the trust.
The trust instrument
Although there are other ways in which a trust may come into existence, typically a trust is created by one of the following:
The trustee can be either a person or a legal entity. There can be multiple trustees, in which case the trust should provide a mechanism for the trustees to make decisions. A trust generally will not fail solely for want of a trustee; if there is no trustee, whoever has title to the trust property will be considered the trustee. If the interests of the trust require it, a court of competent jurisdiction may appoint a trustee to ensure the continuing viability of the trust.
The trust property can be any form of property, be it real or personal, tangible or intangible. The beneficiary can be a single person, multiple persons, or a defined class or group of persons, including people not yet born at the time of the trust's creation. The trustee can be one of the beneficiaries, so long as the trustee is not the only beneficiary. A trust can also be created with some charitable purpose, as opposed to having a particular person or persons as its beneficiary.
Any competent individual may create a trust for any legal purpose. See the jurisdictions sections, below, for purposes which are specific to a certain jurisdiction. The most common usages worldwide are:
Society of Trust and Estate Practitioners
The international professional association for the trust industry is STEP, the Society of Trust and Estate Practitioners. Its members place the letters TEP after their names.
The United States
The Trust Industry
Most trust law in the United States is now statutory at the state level. Fiduciary tax law is both federal (see the Internal Revenue Code) and state.
Trustees may be (1) competent individuals or (2) state or federally chartered corporations with trust powers (usually banks). Typically bank trustees will have integrated their fiduciary organization into their investment management or private banking groups.
It is not unusual for an individual to serve as trustee alongside a bank trustee: they are typically called "co-trustees." Both individual and corporate trustees may charge fees for their services, although individual trustees typically serve gratis when part of the settlor's family or the settlor him/herself. The term "co-trustee" may and typically will fool either the bank trust officer or the individual co-trustee into thinking their roles are identical. Both should read the document carefully. If the roles are not further defined in the document, then their roles are legally the same. As a practical matter however the corporate trustee will nearly always do the custody work and keep the books. But many documents will give the individual co-trustee powers that differ from the corporate trustees. For example, the individual co-trustee's rights and duties may be limited to dealing with discretionary distributions of principal and income, sale of a personal residence held in the trust, or sales of a heartstring asset.
Note: in the context of bank trust organizations, references to the "co-trustee" are nearly always to the individual trustee.
Ever fewer American banks serve as trustee, as litigation costs rise. For most banks trust services are not profitable. For large and effective trust organizations a trust organization properly integrated into private banking and investment division can be quite profitable.
The fifty states harbor rich differences in fiduciary law despite on-going efforts to reduce disparities through the Uniform Principal and Income Act and other uniform act efforts. Nevertheless, unless the terms of the trust document are incompatible with public policy (creating a trust to advance a criminal enterprise, for example), the governing local law generally allows most trust agreements to be enforced according to their terms.
For example, some states require all trustee fees to be charged equally to principal cash and income cash. If the trust document directs otherwise, however, the law allows document language to prevail. Where a document contains obnoxious, unworkable, impractical, or outdated language, the beneficiaries and trustees have recourse to local probate courts -- most commonly for judicial construction or to deal with circumstances not imaginable by the settlor at the time the trust was created.
When the trustee or beneficiary needs interpretation of the trust document (often but no necessarily incident to a disupte) the local probate court judge is the place to get an answer. In the trust business one speaks of "docketing" a trust, i.e. taking it to the judge. When the judge is finished, the trust is then "undocketed."
The rule that a trust is not established until it has res, discussed above, creates a problem where there is a "self-declared" trust, i.e. one in which the settlor acts as his own trustee, nothing is accomplished by signing trust documents without assets being retitled in the name of the self-declared trust. Failure to follow through on retitling is one of the great bugaboos of self-declared trusts.
This rule sometimes gives rise to "one-dollar trusts" - trusts holding just one dollar yet still posted to the books of bank trust organizations, awaiting more significant funding from life insurance proceeds or the settlor's decision to fund inter vivos. The bank normally will charge nothing to hold the document and the one dollar until the trust is funded with more than the one dollar. Note: banks typically will not collect the one dollar: Usually one dollar is posted on and off the books to establish the trust's existence.
Many trusts specifically allow for additional deposits (cash, securities, real estate, etc.) at the direction of the settlor or others, provided the trustee is willing to accept those assets. This can be problematical in the case of real estate, where entry into the chain of title will make the trustee liable for the acts of all others in the change of title. Corporate trustees will often not accept certain real assets, especially where real property is compromised by unremediated environmental issues or where the trustee is unable to make a thorough inspection. A corporate trustee without real property expertise will sometimes avoid accepting any real estate.
While practitioners (bank trustees and fellow traveler trust and estate attorneys) persist in titling trusts as "Tr. u/a" (trusts under agreement a/k/a inter vivos trusts) or "Tr. u/w" (trusts under will), there is little practical difference between the two; it matters little whether a trust was created while the settlor is alive or following his death per terms of his will.
Industry convention is for the settlor's name to appear in the title. In the USA, the name follows a shorthand for the type of instrument. Consider "Tr. u/a John Smith" ("Tr. u/a" stands for "trustee under agreement"). This title indicates that during his lifetime John Smith created a trust. This title conveys no information about revocability and might better be titled "Tr. u/a John Smith Revocable" or "Tr. u/a John Smith Irrevocable". Conventional titles may further indicate the names of one or more beneficiaries in cases where the beneficiary is not the same as the settlor. Hence: "Tr. u/a John Smith FBO Alma Smith" or, if appropriate, "Tr. u/a John Smith FBO Alma Smith irrevocable". Titles also frequently include more information such as the existence of more than one trustee ("Co-tr. u/a John Smith": "co-tr" means co-trustee) or that one or more of the trustees are not the original trustee (Successor Co-Tr. u/a John Smith).
As a practical matter the typical corporate trustee's computer system will have room for a short title (with a limited number of characters: 32 in this writer's experience) and a long title with an unlimited character field. Typically, compromises are made in the short title and serve primarily as a reminder to the trust advisor which account he/she is viewing on the computer screen. Thus a complicated situation might be resolved as follows:
In this example the bank trustee is the successor trustee, i.e. not the original trustee. John Q. Smith is the settlor (the creator of the trust). Alma Smith and others are the beneficiaries. The original document was executed on May 1, 1982. That document was completely rewritten, i.e. a new document was substituted for the original, on April 11, 2003.
Because each trust document is potentially different from each other document, a seasoned and capable practitioner will carefully consult actual document language before making any important decisions.
Some settlors insist on trust names that defy industry convention. Thus, aggrieved parents who create a scholarship trust for a deceased daughter may put the following language in their document: "This trust shall be called the Sally Sue Smith Education Trust." Some bank trustees might ignore the legal name of the trust, and refer to the trust, in bank records, as the "John & Jill Smith Education Trust" where John and Jill Smith are the grantors.
Inadvertent termination of trust
The trustee is said to hold legal title to the corpus, while the beneficiary holds equitable or beneficial title. Generally, a trust cannot exist unless there is at least some "title split" - that is, the same person cannot generally hold all legal and all equitable title at the same time. If the legal and equitable title merge in the same person, the trust is considered nonexistent. This can happen when a sole trustee becomes the sole beneficiary.
It is common practice for an individual to name himself trustee as well as being settlor and sole beneficiary. In such case the trust exists provided there is also at least one other trustee, but the settlor signs the trust document first as SETTLOR and second as TRUSTEE. In such cases the settlor/trustee/beneficiary files income tax returns to report income from trust property under his own taxpayer ID number - usually his Social Security number. In such cases the settlor/trustee/beneficiary must be careful during trust administration to sign documents with the correct hat on. For example: The settlor/trustee/beneficiary hires an investment firm (often the purely investment part of a bank). Communication with the bank must be from "John Smith, Trustee" rather than "John Smith, settlor" or "John Smith, beneficiary." In the not unusual event that the self-declared trustee decides to resign in favor of a corporate trustee, he does so as "John Smith, trustee" with the concurrence of "John Smith, beneficiary/settlor." It happens....
Personal versus institutional
Practitioners typically distinguish personal trusts from institutional trusts: the former being established as a part of one or more individuals' estate and personal financial planning and/or investment needs, and the latter typically by or on behalf of foundations, endowments, and defined benefit and other qualifed pension plans. Most fiduciaries manage these two types of business separately, although it is not uncommon for small institutional accounts to be handled by the personal trust group.
The various names listed above for the creator of a trust are interchangeable -- with "settlor" preferred by the legal community and "grantor" by trust officers and related practitioners. Typically, a trust created by a single individual, in which the settlor retains the ability to remove funds at any time, is called a grantor trust. Such trusts are often created as an investment management vehicle -- at least during the life of the settlor.
The term "grantor trust" also has a special meaning in tax law: a trust in which the Federal income tax consequences of the trust's investment activities are entirely the responsibility of the settlor or another individual who has unfettered power to take out all the assets. Therefore, where "grantor trust" is used, one must inquire which meaning is called for.
Federal income tax implications
For Federal income tax purposes in the United States, there are several kinds of trusts: grantor trusts whose tax consequences flow directly to the settlor's Form 1040 (U.S. Individual Income Tax Return) and state return, simple trusts in which all the income created must be distributed to one of more beneficiaries and is therefore taxed to the non-settlor beneficiary (e.g. the widow of a trust created by the late husband), whether or not the income is actually distributed (it happens), and complex trusts, which are, in general, all trusts that aren't grantor trusts or simple trusts. Some trusts may alternate between simple and complex under certain conditions. Many but not all trust organizations do their own tax work. This can be highly specialized work.
All simple and complex trusts are irrevocable and in both cases any capital gains realized in the portfolios are taxed to the trust corpus or principal.
Civil Law Jurisdictions
Most jurisdictions that have the trust concept do so because their legal systems are based on the English legal system, (a common law system), where the trust was developed. As such, trusts tend to be most prevalent in Commonwealth jurisdictions.
However, at least two jurisdictions, Switzerland and Liechtenstein, are civil law jurisdictions which have "imported" the trust concept into their laws by means of statute. The basic principles of trust law in those jurisdictions are very much as set out in this article, with some variations, but the legal and intellectual underpinning of that law is entirely different.
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