The dual life of the (un-) ascertainable standard
Health, Education, Maintenance and Support: the four “chosen words” that make up the “ascertainable standard.” Sometimes abbreviated as HEMS, the ascertainable standard is undeniably a creature of tax law,1 though it must also operate in the realm of trust. This dichotomy is central to the internal conflict that permeates HEMS and, in fact, defines it. At its core, the ascertainable standard is a line drawn by Congress that differentiates between a beneficiary/trustee2 with a general power of appointment over a trust and a beneficiary/trustee without that authority. The effect of the standard is considerable: beneficiaries/trustees that possess a power to appoint trust property that isn't limited by the ascertainable standard must include trust property in their federal gross estate while those whose power is so limited need not.3 The significance of the standard doesn't end there, however. After being deemed “ascertainable” for tax purposes, it must serve as the standard by which trustees must make distributions from the trust. It's at this nexus of tax law and trust law that the testator's intent, the touchstone of all donative law, can be frustrated.
There are two key issues at play here: first, whether the distribution standard is “ascertainable” for purposes of federal tax law and second, what distributions are permitted by that standard under applicable state law. The answers are far from clear and the issue is further obfuscated by the tension inherent in crafting a standard that both effectuates the testator's intent and remains within the boundaries of the Internal Revenue Code. The first hurdle is, of course, the IRC.
Inclusion in Gross Estate
The IRC is ostensibly straightforward on the issue of inclusion of trust property in a beneficiary's federal gross estate. If a beneficiary/trustee's power to invade a trust's principal is limited by an ascertainable standard, the power isn't a general power of appointment and thus, the trust isn't included in her federal gross estate.4 HEMS is constructed as an exception to the general rule that a power to invade trust principal is a general power of appointment. The standard is defined, somewhat circuitously, as a power that's limited by a “duty to exercise and not to exercise the power [that] is reasonably measurable in terms of [the beneficiary's] needs for health, education, or support (or any combination of them).”5 Curiously, the Treasury regulations effectively restrict the statutorily provided standard by noting that “maintenance” and “support” are synonymous.6
What's outside the ascertainable standard?
The task of defining the ascertainable standard for tax purposes is perhaps best approached as an exercise in defining what it's not. First, according to the Treasury regulations a “power to use property for the comfort, welfare, or happiness of the holder of the power is not limited by the requisite standard.”7 The courts are generally in accord.8 A notable exception to this general rule comes out of the U.S. Court of Appeals for the 10th Circuit applying Florida law.9 In Vissering v. Commissioner, an estate challenged the Tax Court's finding that a general power of appointment existed because the trust permitted the trustee to invade the principal “as may … be required for the continued comfort, support, maintenance, or education of said beneficiary.”10 Because “comfort” was modified by “required” and “continued,” the court found that the language didn't permit an unlimited power of invasion and found the language to be within the ascertainable standard.11 Despite the contentious litigation surrounding “comfort,” the term apparently “adds nothing to the usual meaning of accustomed support” so long as the beneficiary already leads a lifestyle that's “at least reasonably comfortable.”12 This position would seem to put the Restatement (Third) Trusts in conflict with the overwhelming majority of courts that hold that “comfort” is outside the ascertainable standard.
Even language not specifically proscribed by the IRC meets with considerable resistance in the courts. Questioning whether “enjoyment” was a limitation at all, at least one court found it to be outside the ascertainable standard.13 Another court found “benefit” to be “much broader” than “support” and rejected it as an ascertainable standard.14 It's somewhat curious that “benefit” is outside the ascertainable standard, given that a trust is typically characterized by a person holding title to property for the benefit of another.15 The Restatement (Third) Trusts notes that “support” and “maintenance” wouldn't permit distributions that “merely contribute … to a beneficiary's contentment or happiness,”16 thus suggesting that both of those would be outside the ascertainable standard. Characterized as lacking objectivity, terms such as “best interests” and “welfare” would also be beyond the ascertainable standard.17
What's within the ascertainable standard?
Having reviewed a litany of standards that aren't “ascertainable” for tax purposes, it's now instructive to examine what, precisely, is the ascertainable standard. Courts are extremely reluctant to interpret anything beyond the precise language given in the IRC as being within the ascertainable standard. That leaves drafters with little more than HEMS if the intention is to avoid inclusion of the trust res in the beneficiary's federal gross estate. This already strict limitation is effectively further constricted by the fact that two of the four terms (support and maintenance) are expressly redundant18 and a third term (health) is likely wholly encompassed by support.19
Given the courts' narrow interpretation of the IRC, it's now instructive to examine the practical meaning of the four “chosen words” for distribution purposes. While the cases previously examined involved federal courts interpreting varying standards under state law to determine the characterization of the power of appointment under federal law, distribution issues presented by the ascertainable standard are questions of pure state law. This means that the conclusions and observations drawn in this article are generalizations. When using HEMS, it's of paramount importance that the drafter examine the interpretation of those words under applicable state law.
“Education” may be the most easily definable of the four words, but its meaning as a practical matter can be elusive. Fees and costs of attending an institution of higher education, including living expenses, seem to be included under the standard.20 The case law, though, illustrates the shades of gray. For instance, one court found that education didn't include post-graduate studies but was any education up to, and including, a bachelors degree.21 In another decision that opinion cited to, a court found that “college education” didn't include medical school, notwithstanding testimony from the drafter that indicated that the deceased had wanted the beneficiary to become a doctor.22 Another court found that it was within a trustee's discretion to decline to further fund the education of a beneficiary who was 42 years old, well-educated and had a “large income.”23 The trust document should give special consideration to fleshing out the definition of this term for settlors wishing to provide for a private education at the grade school and secondary school levels, given the substantial costs often associated with those institutions.24 The trust document should also explicitly address the cost of studying abroad for a semester in light of the growing popularity of the practice.
“Health” is similarly straightforward in principle but nuanced in practice. The Restatement (Third) Trusts unhelpfully notes that “health” would “provide merely for health and medical benefits like those normally implied by a support standard.”25 Treasury regulations make clear that a standard that provides for “medical, dental, hospital and nursing expenses and expenses of invalidism” is ascertainable for tax purposes26 and thus, presumably a court would find those expenses to be included in the definition. It's important to note, especially in the sensitive area of health, that the distribution standards aren't mandatory and thus, while a distribution might be permissible under health, it could be within the discretion of the trustee to deny it.27 Inevitably, the bulk of disputes will likely arise around the boundaries of health in areas such as plastic surgery, laser eye surgery, elective medical procedures and concierge medicine.
“Support” has been interpreted considerably more broadly. The Restatement (Third) Trusts provides a non-exclusive list of examples of permissible expenditures: “regular mortgage payments, property taxes, suitable health insurance or care, existing programs of life and property insurance, and continuation of accustomed patterns of vacation and of charitable and family giving.”28 Support includes not just payments for the named beneficiary, but also for the support of the beneficiary's immediate family. One court noted that “[t]he needs of a married man include not only needs personal to him, but also the needs of his family living with him and entitled to his support.”29 The Restatement (Third) Trusts clarifies that all “members of the beneficiary's household” would be included under the standard, as would the cost of education for the beneficiary's children.30 Commentators have noted the lack of consensus on the issue of precisely who should be entitled to support under this principle.31
In one case, In re Family Trust of Windus, an Iowa court found that invasion of principal to pay off credit card debt in excess of $60,000 was permissible under the support standard.32 There, the court noted that the credit card debt was incurred prior to the death of the settlor (and thus, presumably, with his approval) and that the money was borrowed to salvage two businesses.33 In the end, though, the court rested on the fact that if the beneficiary hadn't invaded trust principal, “she would not have adequate funds to cover her basic living expenses.”34 Contrast that with In re Estate of Morgridge, a California case in which a court found that invasion of principal to pay $71,000 in credit card debt wasn't within the support standard.35 The court reasoned that it wasn't necessary to invade the principal given the beneficiary's other assets and noted that “the needs of the beneficiary are [not] to be measured by his extravagance or his ability to spend.”36 These cases illustrate not just the dynamic nature of the ascertainable standard, but also a significant issue pertaining to HEMS.
Whether to consider a beneficiary's separate assets and income is a critical question raised in some of the above cases and an issue in which jurisdictions aren't in accord. It's significant for distributions not just under support, but under any of the standards encompassed by HEMS. In both Windus and Morgridge, the courts considered the beneficiary's separate assets and income.37 In contrast, the Arkansas Supreme Court has held that absent specific contrary language in the trust, “the presumption is that the trust assets are available for use immediately.”38 That presumption is effectively the opposite of that adopted in California where a beneficiary's separate assets and income are considered so long as “[n]othing in [the trust] prevents the consideration of outside resources in determining whether is it necessary to invade the principal … ”39 Confusion on this issue also exists in academia as is evidenced by the apparent shift in the Restatement (Third) Trusts to a presumption of consideration of other resources.40 Regardless of the jurisdiction, though, it's clear that if trust language is explicit in the consideration of outside assets and income, that determination is controlling. According to the IRC, such a provision would have no effect on a determination of whether the power is limited by an ascertainable standard.41 Thus, drafters would be wise to consult with settlors on that issue and include such a clause in all trust documents.
Practical Definition Elusive
In the end, a practical definition of the ascertainable standard is elusive. Context, as with most areas of the law, is absolutely critical. Perhaps more important, though, is the language of the trust document. Though some drafters might shy away from the practice due to concerns about going beyond the ascertainable standard, it may be advisable to explicitly elucidate the settlor's intent with regard to each element of HEMS. There's no indication from the courts that to do so would go beyond the ascertainable standard, but a cautious drafter should include a clause providing that the clarifications are limited by an overriding purpose of establishing an ascertainable standard.42 Also important is that the document specifically address whether a beneficiary's outside resources are to be considered in the decision to invade principal. Even with these considerations taken into account, there are significant hazards in employing HEMS that are simply unavoidable. Thus, as has been suggested by other authors,43 it's probably best practice to forgo HEMS in favor of a more specific standard unless the settlor can take advantage of the tax benefits of HEMS. Even in such cases, a practitioner ought to ensure that settlors are making a fully informed decision with regard to that choice.
The principle shortcomings of HEMS are inextricably linked to its dual life. On the one hand, it's an unforgiving exception that allows a beneficiary/trustee to retain some control over trust principal while still avoiding inclusion in the federal gross estate. On the other hand, it's a strict limitation on the discretion of trustees to make distributions out of trust principal. Problems arise in the tax realm when drafters hastily stray from the four “chosen words” and thereby lose the substantial tax benefits of the ascertainable standard. In the realm of trust, problems arise when trustees are hamstrung by ambiguous standards that can pit the interests of present beneficiaries against the remaindermen. Given the inherently competing considerations of each area of the law, these problems may be inexorable.
- 26 U.S.C. Section 2041(b)(1)(A) (1976).
- Trent S. Kiziah, “Four Chosen Words,” Trusts & Estates (August 2006) at p. 26.
- 26 U.S.C. Section 2041(a)(2) (1976).
- Treasury Regulations Section 20.2041-1(c)(2).
- Ibid. (emphasis added).
- See, e.g., First Virginia Bank v. United States, 490 F.2d 532 (4th Cir. 1974) (rejecting “comfort” under Virginia law); Lehman v. U.S., 448 F.2d 1318 (5th Cir. 1971) (rejecting “comfort” and “welfare” under Texas law); Miller v. U.S., 387 F.2d 866 (3d Cir. 1968) (rejecting “comfort” under Pennsylvania law); Forsee v. U.S., 76 F. Supp.2d 1135 (D. Kan. 1999) (rejecting “happiness” under Kansas law).
- Estate of Vissering v. Commissioner, 990 F.2d 578 (10th Cir. 1993).
- Ibid. at p. 580 (emphasis added).
- Ibid. at p. 581.
- Restatement (Third) Trusts Section 50, Comment d(3) (2003) (emphasis added). The Comment goes on to note that “comfort” would raise the standard for a beneficiary who lived a more modest lifestyle. Ibid.
- Stafford v. U.S., 236 F. Supp. 132, 134 (D. Wisc. 1964) (using Black's Law Dictionary to define “enjoyment”).
- Strite v. McGinnes, 330 F.2d 234 (3d Cir. 1964). Applying Pennsylvania law, the court found it significant that the trustee had discretion to invade the principal if it was either “necessary or advisable” for the “comfort” or “benefit” of the beneficiaries. Ibid. The court specifically declined to interpret “comfort” and found the power to be a general power of appointment on the basis of “benefit” alone. Ibid. at p. 240.
- See, e.g., Restatement (Third) Trusts Section 2 (2003).
- Restatement (Third) Trusts Section 50, Comment d(2) (2003).
- Restatement (Third) Trusts Section 50, Comment d(3) (2003). As before, this is implied given the position of the Restatement (Third) Trusts that these terms “fall beyond the usual scope of a purely support-related standard.” Ibid.
- 26 C.F.R. Section 20.2041-1(c)(2).
- Restatement (Third) Trusts Section 50, Comment d(3) (2003). Note, however, that while “health” is wholly encompassed by “support,” the reverse isn't true. “Health,” as a distribution standard, might still be desirable to settlors wishing to provide only for the medical expenses of beneficiaries.
- Restatement (Third) Trusts Section 50, Comment d(3) (2003).
- Southern Bank & Trust Co. v. Brown, 246 S.E.2d 598, 603 (S.C. 1978) (citing Epstein v. Kuvin, 95 A.2d 753 (N.J. Super. Ct. App. Div. 1953); see also Steeves v. Berit, 832 N.E.2d 1146, 1152 (Mass. App. Ct. 2005) (adopting a similar definition of “college,” though in the context of a divorce case).
- Epstein, supra note 21 at pp. 753-54. Note that this case was in the context of a will, not a trust, but is instructive nevertheless.
- Lanston v. Children's Hospital, 148 F.2d 689 (D.C. Cir. 1945).
- See a survey conducted by the National Association of Independent Schools reporting that the median cost of attendance at a member school in 2010 was $29,163. National Association of Independent Schools, NAIS Facts at a Glance, www.nais.org/files/PDFs/NAISMemFacts_Salaries_200910.pdf.
- Restatement (Third) Trusts Section 50, Comment d(3) (2003).
- C.F.R. Section 20.2041-1(c)(2).
- See, e.g., In re Trust Created Under Last Will and Testament of Stonecipher, 849 N.E.2d 1191, 1197 (Ind. App. 2006) (finding that it wasn't an abuse of discretion for a trustee to decline to invade trust principal to pay for in-home nursing care for the present beneficiary given consideration of her income and of the remaindermen beneficiaries).
- Restatement (Third) Trusts Section 50, Comment d(2) (2003). Obviously this wouldn't be binding on any court, but it's useful for illustrative purposes.
- Robison v. Elston Bank & Trust Co., 48 N.E.2d 181, 189 (Ind. App. 1943).
- Restatement (Third) Trusts Section 50, Comment d(2) (2003).
- Edward C. Halbach, Jr., “Problems of Discretion in Discretionary Trusts,” 61 Colum. L. Rev. 1425, 1437 (1961).
- In re Family Trust of Windus, 2008 WL 3916438, *2 (Iowa Ct. App. 2008)
- In re Estate of Morgridge, 2007 WL 1874332, *6 (Cal. Ct. App. 2007).
- Ibid. (quoting Canfield v. Security-First Nat. Bank, 13 Cal.2d 1, 21 (Cal. 1939)).
- Windus, supra note 32 at *2, Morgridge, supra note 35 at *6; see also Stonecipher, supra note 27 at 1197 (finding consideration of a beneficiary's income but not her assets to be appropriate when making trust distributions).
- Estate of Wells v. Sanford, 663 S.W.2d 174, 177 (Ark. 1984).
- Thomas v. Gustafson, 45 Cal. Rptr.3d 639, 644 (Cal. Ct. App. 2006). Colorado is in accord. See generally Dunklee v. Kettering, 225 P.2d 853 (Colo. 1950).
- Compare Restatement (Second) Trusts Section 128, Comment e (1959) (noting that “[i]t is a question of interpretation whether the beneficiary is entitled to support out of the trust fund even though he has other resources. The inference is that he is so entitled.”) with Restatement (Third) Trusts Section 50, Comment e(1) (2003) (taking the position that “[t]he trustee has a duty to act in a reasonable manner in attempting to ascertain the beneficiary's … other resources that may be appropriately and reasonably available … ”).
- C.F.R. Section 20.2041-1(c)(2).
- See Kiziah, supra note 2.
Brian K. Duffey, far left, is a shareholder at the Duffey Law Firm in Boca Raton, Fla. Patrick J. Duffey will graduate from the University of Florida Levin College of Law in Gainesville, Fla. in May 2011
This William Medcalf illustration (40 in. by 30 in.) titled “Pin-Up in Yellow Dress,” sold for $17,925 at Heritage Auctions Signature Illustration Art auction in Beverly Hills, Calif. on Feb. 11, 2011. In 1950, Medcalf said of his work, “I look for the things that make a girl appear feminine … the way she fixes her hair the way she handles her eyes, her buttons and bows.” A resident artist at Brown & Bigelow in St. Paul, Minn., Medcalf painted pin-ups for more than 20 years.