Can a California living trust give the trustee authority to distribute assets to beneficiaries on an as-needed basis?

Question

I am the trustee of two California trusts: the first has 5 beneficiaries and the second has 8 beneficiaries.

Both trusts grant me the power to withhold distributions to beneficiaries prior to their reaching specific age milestones.

The estate attorney I've retained strongly suggested that I divide the trust assets of both trusts into separate sub-trusts for each beneficiary and that each sub-trust have its own federal tax ID number.

I objected to this idea primarily for the following three reasons:

1. That would be 13 tax IDs and 26 tax returns per year (13 federal and 13 state) and I don't want to use trust funds to pay for all the additional CPA fees this would incur.

2. To continue investing trust funds in the manner they had been invested prior to the death of the trustors, I would be purchasing certain financial instruments that have a minimum buy in that would be too large for any single beneficiary to own (i.e. it would limit the diversification of investments for each beneficiary and force me to provide different beneficiaries with different investments -- a real problem if one investment does well while another does not).

3. The trusts own interests in small, private partnerships that would not be willing, nor obligated under the terms of the partnership agreements, to further sub-divide these trust interests into smaller interests for each beneficiary.

The attorney asked how I would track all of this if I didn't split everything up into separate sub-trusts for each beneficiary. I responded that I would keep a running percent-ownership of each asset based on the distributions made to each beneficiary. The attorney suggested that that would be very challenging, but gave no legal reason why I couldn't do that.

So my question is, can a trust be written that grants powers to a trustee that are sufficiently broad to allow the trustee to make distributions of principal and interest to beneficiaries on an as-needed basis? Of course, that would require that exquisitely detailed records be kept to track the percent ownership of various assets, but is there anything in estate law (or IRS rules) that precludes this?

It seems this would be a good way to preserve the corpus of the estate rather than making a distribution to beneficiary X just because I made an equal distribution to beneficiary Y (and where X doesn't even need the distribution).

Answer 1

Your objections are entirely reasonable and the attorney is going overboard with caution and penning you in when you aren't legally bound, perhaps in the hope of avoiding hurt feelings among potential clients, or to avoid creating a conflict of interest for the attorney.

can a trust be written that grants powers to a trustee that are sufficiently broad to allow the trustee to make distributions of principal and interest to beneficiaries on an as-needed basis?

This is allowed and indeed is common and routine. A requirement to make distributions equally would be the exception rather than the rule.

Of course, that would require that exquisitely detailed records be kept to track the percent ownership of various assets, but is there anything in estate law (or IRS rules) that precludes this?

Regardless of what the trust allows, you must keep detailed records of what is distributed to whom, when. But, you have no obligation to keep track of percentage ownership of various assets so long as you have this discretion which it appears you do. You don't need to keep track of that because you have no duty to treat everyone equally.

For income tax purposes, you are managing what is called a "complex trust". In a complex trust, you first calculate total trust income. Distributions are treated as if they come first from income and then from principal. They are taxable to the person receiving them to the extent that they are from income. Undistributed income in a given tax year is taxable to the trust on form 1041, not to any beneficiary and once taxed becomes principal for income tax purposes.

There are moderately complicated rules to decide which kind of income is taxed to whom if the trust has more than one kind of income in a given year (e.g. partially taxable interest, partially tax free municipal bond interest, and partially long term capital gains), that an accountant can help you figure out.