,,

How to Draft Invasion Clausesfor Marital and Credit

Shelter TrustsA provision that permits the invasion of trust principal for the surviving spouse's health,

support, education, and maintenance must be drafted carefully to achieve the bestresults and avoid possible disputes with other trust beneficiaries.

common provision in mostmarital and credit shelter trusts is

one providing for payments to thesurviving spouse of amounts nec-essary for the spouse's health,support, education, and mainte-nance. This type of provision isimportant when the income of thetrust and the surviving spouse'sother income might not be suffi-cient to provide adequately for herduring the rest of her life. If sucha provision is included in thetrust, the surviving spouse canreceive distributions of addition-al funds which-when added tothe trust's income and the

spouse's own income-shouldproperly and adequately providefor her. If this sort of provision isnot properly drafted, however, itcan result in numerous problemsfor both the trustee and the ben-eficiaries.

The purpose of this article is notto discuss the tax effects of the lan-

PETERB.TIERNANpractices law in Margate,

Florida. He specializes in estate planning and

taxation, and has previously written for ESTATEPLANNING.

PETERB.TIERNAN,ATTORNEY

guage used in a specific power,such as a power for a survivingspouse's comfort or happiness.Rather, this article addresses onlythose powers that clearly restrictthe payment of trust principal forthe surviving spouse's health, sup-port, education, and maintenance.

An improperly drafte? health, sup-port, education, and maintenanceprovision can (1) frustrate thedecedent's intentions, (2) cause

unexpected estate and gift taxconsequences, and/or (3) lead toconflicts among the trustee, thesurviving spouse, and/or theremaindermen.

This article focuses on the plan-ning of the husband's estate. It isassumed that the husband will

predecease his wife and three chil-dren. It is further assumed that the

husband opts not to use a corpo-rate trustee. Instead, the survivingspouse is chosen as trustee in all

those situations involving a firstmarriage, and the husband's old-est son is selected as trustee of boththe marital and the credit shelter

trusts when a second marriage isinvolved.

259

FactorstoconsiderIndraftinganinvasionclause

In drafting any invasion provisionfor a trust, the estate planner musttake certain considerations intoaccount. First and foremost is

whether the provision will be ade-quate to meet the spouse's needs.A provision for the spouse's health,support, education, and mainte-nance is broad enough to covermost if not all of the spouse'sneeds, particularly because thelaw of most states requires thetrustee to consider the spouse's sta-tion in life in making a distribu-tion. If, however, the trustee is giv-en discretion over whether or notto make a distribution-or whatthe amount of a distributionshould be-then the settlor's inten-

tion of adequately providing for hisspouse may not be realized.

A second consideration is whoshould be named as trustee. A

bank or trust company is one pos-sibility. The advantage of using abank is the professionalism, expe-rience, and impartiality that abank provides. This impartialitywould be especially helpful in asecond marriage, when naming a

260

bank trustee may be the only wayto maintain peace in the family. Insome situations, the potential sav-ings in litigation expenses maymore than outweigh the trustee'sfees that must be paid.

On the other hand, if the settlorwants his wife to serve as either sole

trustee or a co-trustee, certain pos-sible tax problems under Sections2041 and 2514 must be analyzed.Moreover, when the survivingspouse is the trustee, an invasionprovision may give rise to potentialconflicts of interest, particularlywhen a second marriage is involved.No matter how these conflicts are

resolved, family peace could suffer.If the settlor wants to name a

child as trustee, then especially ina second marriage situation, therecould be disputes with the step-mother. The child is usually aremainder beneficiary of the trust,and it soon becomes evident to himthat he can increase the amountthat will be left for him and the

other remaindermen by not mak-ing invasions for his stepmother orby limiting any distributions to herto the absolute minimum.

There is also the issue of draft-

ing the invasion power so as to pro-vide the necessary structure andguidance to the trustee in exercis-ing the power. Most states indicatethat in invading a trust, the trusteemust follow the settlor's intentionas set forth in the will or trust doc-

ument, and that language used inthe trust instrument should be giv-en its ordinary and usual meaning.A properly drafted invasion pro-vision should therefore include

appropriate language clearly spec-ifying who is to be favored, whetherand the extent to which the

spouse's income or other assets areto be considered, and whether edu-cation includes post-graduate stud-ies. Precatory language can be veryhelpful in this regard.

Taxellects 01Invasion powerThe obvious starting point in anyanalysis of a provision for con-suming or invading principal forthe power holder's health, support,education, and maintenance isReg. 20.2041-1(c)(2). The firstsentence of this Regulation pointsout the primary estate tax benefitof limiting trust distributions to anascertainable standard relating tohealth, support, education, andmaintenance. If a power is so lim-ited, it is not a general power ofappointment, which means thatthere will be no estate or gift taxconsequences to the power hold-er. Characterization of a power asa nongeneral power of appoint-ment is absolutely essential in thecase of a credit shelter trust.

Reg. 20.2041-1(c)(2) is alsoimportant for clarifying that thedetermination of whether a par-ticular power qualifies as limitedby an ascertainable standard is atwo-part test. First, the powermust be ascertainable and, second,it must relate to the beneficiary'shealth, support, education, ormaintenance. (This ascertainableaspect of a power is discussedmore later.)

The Regulation contains exam-ples of powers that either are or arenot limited by an ascertainablestandard. The most interestingaspect of these examples is that apower to distribute principal forsomeone's "comfort" is not limit-

ed by an ascertainable standard,but a power to distribute for "sup-port in reasonable comfort" or"maintenance in health and rea-sonable comfort" is so limited.

Mandatoryvs.discretionarylanguageThe first decision that must be

made in drafting a power to payprincipal for a spouse's health, sup-port, education, and maintenanceis whether it is better to use the

mandatory term "shall" or thediscretionary term "may" in theprovision. The use of the word"shall"-in most cases-gives thesurviving spouse (and persons act-ing on behalf of the survivingspouse) an absolute right to the dis-tribution, which can be enforcedin court.

On the other hand, the use ofthe word "may," standing by itself,has not always been found by thecourts to be the determining fac-tor in deciding whether a trust pro-vision is discretionary.1 In makingsuch a determination, a courtwould rely on the primary purposefor which the trust was created. Ifit is determined that the settlor's

intention, as indicated by the entiretrust instrument, was to providefor the support and maintenanceof the spouse during the rest of herlife, then a court might indicatethat "justice may not be the slaveof grammar"2 and require thatdistributions be made to complywith the settlor's intention.

The type of language used ingranting the trustee's discretion isalso significant in determiningwhether the trustee abused his dis-

cretion by making or not makingdistributions. If so-called simplediscretion (such as the words "may"or "may, in his discretion") is used,the test for determining abuse by thetrustee is whether "reasonable judg-ment" was exercised under the cir-

cumstances.3 If, however, the trustinstrument uses such language as "inthe trustee's uncontrolled andabsolute discretion" or "in thetrustee's total and unlimited dis-

cretion," the Restatement Second ofTrusts indicates that the correct test

for abuse is the "good faith" test.

1 Ellisv.Aldrich, 70N.H.219,47A.95(1900).

2 Black's Law Dictionary, definition of "may."3 Scott, Law of Trusts, §187 (4th ed.) (here-

inafter "Scott").

ESTATE PLANNING JULY 1998 VOL 25 / NO 6

Under this "good faith" test,even if the trust instrument sets

forth a standard by which the rea-sonableness of the trustee's actionscan be measured (e.g., support),the trustee's action would not beoverturned "as long as the trusteeacts in a state of mind in which it

was contemplated by the settlorthat he would act."4 Therefore, as

long as the trustee exercises goodfaith and acts judiciously in exer-cising the invasion power, themere fact that the trustee acted

beyond the bounds of reasonablejudgment (i.e., he has acted unrea-sonably) is not sufficient groundfor intervention by the court.5Nevertheless, the trustee's failureto act would be sufficient groundsfor court interference.6 Other con-duct that would fail this "goodfaith" test includes the trustee's

acting in bad faith, acting dis-honestly or arbitrarily in exercis-ing his discretion, or acting for

4 Restatement of Trusts, Second, §187, com-mentj.

SId.

6 In re Sullivan's Will, 144 Neb. 36,12 N.W.2d148 (1943).

7 Note 3, supra.8 Garesche v. Levering Inv. Co., 146 Mo. 436,

48 S.w. 653 (1898).

9 Doty, 148 F.2d 503, 33 AFTR 973, 45-1USTC 119248 (CA-1, 1945).

10 Keating v. Keating, 182 Iowa 1056, 165NW. 74 (1917).

11 In re Estate of Koos, 269 Wis. 478, 69N.W.2d 598 (1955); In re Sullivan's Will, supranote 6; In re Ferrall's Estate, 41 Cal. 2d 166,258 P.2d 1009 (1953).

12 Halbach, "Problems of Discretion in Discre-tionaryTrusts," 61 Colum. L. Rev. 1425, 1432(1961).

13 Scott. supra note 3, §187.2.

14 Scott, supra note 3, Ch. 7, §187, p. 16. Seealso Raffety v. Parker, 241 F.2d 594 (CA-8,1957); Greer, 448 F.2d 937,28 AFTR2d 71-6244,71-2 USTC 1112,805 (CA-4, 1971).

1S First Nat'l Bank of Beaumont v. Howard, 149Tex. 130,229 S.W.2d 781 (1950).

16 Mesler v. Holly, 318 So. 2d 530 (Fla. Dist. Ct.App. 2d Dist., 1975); Funk, 185 F.2d 127,39AFTR 1249, 50-2 USTC 119507 (CA-3, 1950).

17 Cal. Prob. Code §16081 (a).

18 Wis. Stat. §701.19 (10). N.Y. Real Prop. Law§141, Garfield, 47 AFTR2d 81-1583, 80-2USTC 1113,381 (DC Mass., 1980).

19 Scott, supranote 3, §187.2,p. 32; Funk,supranote 16.

some motive other than the accom-

plishment of the trust's purposes.7In deciding whether to grant a

trustee "absolute, unlimited oruncontrolled" discretion, certainconsiderations should be analyzed.One consideration is that courts

generally do not favor grants of"absolute discretion,"8 and a court

might not give this term its literalmeaning in determining whetherthe trustee has abused his discre-

tion. Depending on the circum-stances, courts have chosen toconstrue narrowly a grant ofabsolute or uncontrolled discre-

tion,9 or even to declare it contraryto public policy in certain cases-particularly when the trust provi-sion attempts to preclude thecourts from considering and rul-ing on the trustee's exercise of theinvasion power.10

Further, although a few statecourts appear to have accepted theRestatement approach (i.e., the"good faith" test) for determiningabuse of discretion when "absoluteor uncontrolled" discretion is

granted to the trustee,11 one com-mentator has suggested that thetrue test would occur when a courtis faced with a situation in which

an unreasonably small amount isbeing paid to a beneficiary who isnot being adequately maintained.12Although Scott on Trusts agreeswith the Restatement that the

requirement of reasonableness canbe dispensed with in certain situ-ations,13 Scott states that the prop-er test for upholding the trustee'saction is "whether it appears thatthe trustee is acting in that state ofmind in which it was contemplat-ed by the settlor that he shouldact. "14 The substitution in the

Scott test of (1) the word "that"for "a" in the Restatement test,and (2) the word "should" fortheword "would" in the Restatement

test is significant, and has result-

261

ed in at least one judicial decisionthat the trustee must use "reason-

able judgment" in exercisingabsolute discretion.15

Even if the Restatement view is

followed, there are exceptions tothis rule. When the trustee is also

the income beneficiary of the trust,some courts have held16-andsome state statutes mandate17-

that notwithstanding a grant ofabsolute or uncontrolled discre-

tion, the trustee still has a duty toact "reasonably" in the exercise ofthe invasion power. This require-ment of reasonableness is entire-

ly logical and appropriate (prob-ably even in states that follow theRestatement approach), given thefact that certain other states, whichrecognize the definite conflict ofinterest that exists when the trustee

is also an income beneficiary, donot even allow trustees to exercise

a power to pay corpus to them-selves.18

The requirement to act reason-ably can probably also be extend-ed to a situation in which a child-remainderman serves as trusteebecause a similar conflict of inter-est exists here. Moreover, as point-ed out in Scott, and contrary to theRestatement view, if there is a stan-dard by which the reasonablenessof the trustee's judgment can betested, a court will control theexercise of the trustee's discre-tion within the limits of that stan-dard.19

In most instances, there is like-ly nothing to be gained by grant-ing absolute discretion when eitherthe surviving spouse or a child-remainderman serves as a trustee

and a health, support, education,and maintenance provision is used.Further, even if someone otherthan the surviving spouse or achild-remainderman is trustee,

possibly the only advantage ofgranting the trustee absolute or

JULY :1998 VOL 25 / NO 6 INVA510N CLAUSES

262

uncontrolled discretion (asopposed to simple discretion) isthat courts seem more inclined tofind an abuse of discretion when

"simple discretion" is involvedthan in the case of absolute oruncontrolled discretion.20

DIscretionovertheamount01adistributionIroma creditsheltertrust

A health, support, education, andmaintenance provision similar tothe following is sometimes usedwhen there is a corporate trustee:

The trustee may also pay to mywife so much or all of theprincipal of the trust estate asthe trustee, in its sole andabsolute discretion, deems nec-essary or desirable, from timeto time, for her health, support,education and maintenance,considering her income, fromall sources known to thetrustee.

When the above provision ISused, there are two discretionarydecisions that the corporate trusteemay be required to make. Thefirst is whether to make any dis-tribution at all. The trustee's dis-

cretion over deciding this questionis based on the inclusion of the dis-

cretionary word "may" at thebeginning of the above provision.Assuming that the trustee decidesthat a distribution is warranted,the second decision that the trusteemust make concerns the amountthat should be distributed. Noestate tax effects result from the

above two discretionary decisionswith respect to a credit shelter trustbecause a corporate trustee, ratherthan the surviving spouse, is thepower holder.

While the above sample lan-guage works reasonably well in acredit shelter trust when a corpo-rate trustee acts, there is a poten-tial tax problem if this provisionis used when the surviving spouse

- - -- -- -- ---ESTATE PLANNING

--

is either sole trustee or a co-

trustee. If the surviving spouse isa trustee, the estate planner mustbe concerned with how broad to

make the power. Consider, forexample, the following provision:

The trustee may also pay to mywife so much or all of theprincipal of the trust estate asthe trustee, in her uncontrolledand absolute discretion, deemsnecessary or desirable, fromtime to time, for her health,support, education and main-tenance, considering herincome, from all sourcesknown to the trustee.

As in the previous example, thetrustee has two discretionary deci-sions to make. With respect to thefirst decision, there appears to beno potential tax problem sincethis is merely discretion over "thedecision of whether or not tomake the distribution." But as to

the second decision, the survivingspouse-trustee has been grantedtotal and absolute discretion over"the amount that can be distrib-uted" to her from the credit shel-ter trust.

Sections 2041 and 2514 relate

to the breadth of a power. Whenthe surviving spouse is sole trustee,the issue is whether the language"in her uncontrolled and absolute

discretion, deems necessary ordesirable" broadens the survivingspouse's power to the point that itis no longer based on an ascer-tainable standard for measuringher needs, and thereby constitutesa general power. This is an unan-swered question that has con-cerned estate planners for years.21

There are no reported casesaddressing whether language likethat quoted above excessivelybroadens the trustee's power. Butthe IRS's position regarding theabove phrase can be inferred fromthe first two sentences of Reg.20.2041-1(c)(2), which state:

A power to consume, invade,or appropriate income or cor-pus, or both, for the benefit ofthe decedent which is limitedby an ascertainable standardrelating to the health, educa-tion, support or maintenanceof the decedent is, by reason ofsection 2041(b)(1)(A), not ageneral power of appointment.A power is limited by such astandard if the extent of theholder's duty to exercise andnot to exercise the power isreasonably measurable interms of his needs for health,educarion,orsupport(oranycombination of them).(Emphasis added.)

The first sentence of the Regu-lation makes clear that it is not

enough that the trustee's power todistribute principal be limited tothe health, support, education,and maintenance of the beneficia-

ry. As noted earlier, there are twotests involved; the second test isthat the power must be one that is"ascertainable." The second sen-

tence of Reg. 20.2041-1(c)(2)explains that to be ascertainable,a standard must be capable ofbeing measured; it must be a stan-dard that-although perhaps notcompletely definite and certain-is at least limited to some degreeor restricted by definite bounds.

The Regulation envisions thatthe spouse make an objective deter-mination of her needs based on anobjective ascertainable standard.But by giving the trustee total andabsolute power to determine theamount that can be distributed, thesettlor has made this-on paper atleast-a totally subjective stan-dard that depends on the thoughts,emotions, whims, and desires ofthe spouse-trustee. The language

20 Scott, supra note 3. §560, pocket part, p. 18.

21 See Stout, "Should the Surviving SpouseServe as Trustee of the Nonmarital Trust?,"17 EP 168 (May/Jun 19901; Horn, "PlanningFlexible Trusts for Nonprofessional Trustees:Analysis of Choices for Draftsmen," 4 EP(Mar 1977).

JULY 1998 VOL 25 / NO 6

"in her uncontrolled and absolute

discretion, deems necessary ordesirable" indicates the settlor's

intention to permit the spouse-trustee to create her own standard

rather than merely following thestandard set forth in the invasion

provision. Such a subjective stan-dard clearly would not be "rea-sonably measurable" under theRegulation and therefore wouldseem to cause the power to fallwithin the literal definition of a

general power under Section 2041.Even though the above trust

provision fits the Regulation's def-inition of a general power, thereare additional questions that mustbe resolved to determine the tax

ramifications of this provision.The first question involves theeffect of state laws22 or state court

decisions23 prohibiting the exerciseof any power of appointment bya trustee to benefit herself. In

New York, for instance, a trusteemay not participate in a decisionto distribute trust corpus to her-self.24 Accordingly, in the aboveexample, such a state statute wouldprevent her from exercising thispower to benefit herself, and no

22 Wis. Stat. §701.19 (10).

23 Garfield. supra note 18.

24 N.Y. Real Prop. Law §141.25 See Rev. Rul. 54-153. 1954-1 CB 185.

26 Fla. Stat. §737 .402(4)(a).

27 Mesler v. Holly. supra note 16; Cal. Prob.Code §16081(a).

28 See Funk. supra note 16. a case interpretingNew Jersey law and involving absolute dis-cretion over the payment of trust income toa trustee-beneficiary, based on the settlor'sand the trustee's "respective needs." Thecourt in Funk stated. "Nor does it follow.when the settlor lays down a standard. here'respective needs,' that the designation of thetrustee as .sole judge: or even the grant tohim of 'absolute discretion: obviates thenecessity of exercising his judgment in asound and honest manner. or relieves him ofthe duty to act in good faith and with a prop-er motive within the reasonable boundariesof such standard."

29 Strite v. McGinnes. 330 F.2d 234. 240. 13AFTR2d 1863. 64-1 USTC 1112,223 (CA-3.1964).

----- - - - ._-JULY :1.998 VOL 25 / NO 6

transfer tax consequences willresult.25

An interesting aspect of theNew York statute is that it pre-vents a trustee from exercising

such a power only over corpus. Ifthe income of the credit shelter

trust is being accumulated andthe surviving spouse has the pow-er to distribute both corpus andincome to herself pursuant to theabove unlimited discretion, then

her power to appoint the incometo herself would not be prohibit-ed by the New York statute andshe might be considered to have ataxable general power of appoint-ment with respect to this incomeinterest. Depending on the age ofthe surviving spouse, an incomeinterest can have a significant val-ue, which could have a consider-able tax impact under Section2041.

Florida has also adopted astatute that prohibits the exerciseby a trustee of a power to benefitherself.26 But Florida has taken a

different approach from NewYork's. The Florida statute states:

Any power conferred upon atrustee:

l.To make discretionary dis-tributions of either principal orincome to or for the benefit ofsuch trustee, except to providefor that trustee's health, edu-cation, maintenance or supportas described under InternalRevenue Code ss. 2041 and2514;.. .

cannot be exercised by suchtrustee.

Hence, if the surviving spouse-trustee has a discretionary powerto make distributions for her

health, support, welfare, and hap-piness, the Florida statute prohibitsthe trustee from exercising thispower. But the problem with theFlorida statute is that the power as

263

drafted in the earlier sample lan-

guage is clearly and solely limitedto the surviving spouse's health,support, education, and mainte-nance. As a result, the Floridastatute does not bar the trustee

from exercising her power in thissituation. Thus, there is still apower that can be exercised by thespouse-trustee with possible taxconsequences under both Sections2041 and 2514.

Other questions must be'addressed in determining the pos-sible tax effects of granting thespouse-trustee absolute discretion.What is the tax result if there is astate court decision or a state law

requiring the surviving spouse-trustee not only to exercise goodfaith and to act judiciously, but alsoto use "reasonable judgment" inexercising the "absolute anduncontrolled" discretion?27 Fur-

ther, are the possible tax conse-quences affected by the fact thatbecause there is a standard

involved, a court will restrict theexercise of the trustee's discretionto within the limits of the stan-

dard?28 Or lastly, what is the out-come if the surviving spouse-trusteeis granted only "simple discre-tion" instead of "uncontrolled andabsolute" discretion over theamount of the distribution?

Courts have recognized thateven though a trustee must use"good faith" in exercising absolutediscretion, such good faith exerciseof a power has been found not tobe determinative of the breadth of

the power.29 The distinction, how-ever, with regard to the above sit-uations is that the trustee has an

obligation to use "reasonable judg-ment"-not just "good faith"-inmaking any decision concerningdistribution. Does the duty toexercise "reasonable judgment"mean that the power holder has aduty that is "reasonably measur-

-------- ---. ---,- -- -INVASION CLAUSES

264

able" as provided in Reg. 20.2041-1(c)(2)? Because there are no deci-sions directly addressing this issue,this is still an unanswered question.There are, however, decisions deal-ing with the estate tax charitablededuction in which a duty to actreasonably salvaged the deduc-tion.3D

This requirement of acting rea-sonably might cause a court to con-clude that the surviving spouse-trustee does not have a powerthat she can exercise beyond theboundaries of the standard used (itis a standard that is "reasonablymeasurable"). Nevertheless, theearlier provision granting absolutediscretion to a spouse-trusteeshould still be of concern to estate

planners. A court could alwaysfocus on the language "deemsdesirable" in that provision asindicating an intention to permitthe spouse to distribute to herselfnot only amounts that are neces-sary but also additional amountsthat she considers desirable. This

reasoning would support a findingthat the spouse is able to create herown standard of the amounts she

can receive, which should result intaxation under Section 2041.

A health, support, education,and maintenance provision such asthe above could trigger unfavor-able tax effects or at least cause an

expensive estate tax audit when thesurviving spouse is either soletrustee or a co-trustee of the cred-

,it shelter trust. To avoid thesedrawbacks, the trust provisionmight be drafted similar to the fol-lowing:

The trustee may also pay to mywife so much or all of theprincipal of the trust estate asthe trustee shall determine tobe necessary, from time totime, for her health, support,education and maintenance,in the manner of living towhich she is accustomed at thetime of my death, taking into

-- --ESTATE PLANNING

account my wife's otherincome and other resourcesfrom all sources known to thetrustee.

Even though the survivingspouse is the person who willdecide the amount of the distri-bution, the words "shall deter-mine" in this provision indicatethat the trustee has essentially aduty- as opposed to discretion-in computing the proper amountof the distribution. Thus, this lan-guage should provide a standardthat is "reasonably measurable" asrequired by the Regulation.

Continuationofaccustomedmannerof livingReg. 20.2041-1(c)(2) cites as anexample of a permissible non-general power, a power to payprincipal for "support in his accus-tomed manner of living." This isimportant when the spouse is thesole trustee or a co-trustee. This

type of language is important toinclude in the health, support,education, and maintenance pro-vision because it gives neededguidance to the trustee in decidingthe proper amount to distribute. Ifthe trustee knows that the decedent

and his spouse were buying a newcar every two years, dining at theclub twice a week, taking a tripevery six months, etc., this clausegives the trustee a point of refer-ence as to the amount that shouldbe distributed.

At one time, it was uncertainwhether a clause dealing with thespouse's manner of living could bedrafted to reflect a high standardof living without running afoul ofReg. 20.2041-1(c)(2). In Ltr. Rut.7836008, the IRS concluded that

the words "consistent with a highstandard and quality of living"-when included in a provision con-cerning someone's health, support,education, or maintenance-did

not broaden the power so that itbecame a general power ofappointment.

Even if a clause includes lan-

guage setting forth a high standardof living, what is the practicaleffect of this language? Such aclause is rather vague unless thedrafter modifies it by referring tosome criteria that the trustee can

follow. One possibility would beto reword the clause to state "sup-port consistent with my wife'shigh standard and quality of liv-ing at the time of my death." Butis this language that much broad-er than stating "in accordancewith my wife's manner of living atthe time of my death" when thewife is in fact enjoying a high stan-dard of living? It appears that this"high standard of living" lan-guage does not add that much tothe provision and therefore isunnecessary in most cases.

Assuming that, notwithstandingthe above, it is still desired to

modify a health, support, educa-tion, and maintenance provision toreflect a high standard of living, itis necessary to include languagetying such high standard of livingto the beneficiary's health, support,education, or maintenance. Anexample of the consequences of nottying the language to the benefi-ciary's health, support, education,or maintenance is found in Rev.Rul. 77-60.31

There, the IRS ruled that apower to invade corpus "to con-tinue the donee's accustomed stan-

dard of living" was a general pow-er of appointment. The IRS'sconclusion stemmed from the fact

that even though the power was

30 Estate of Robertson. 141 F.2d 855.32 AFTR502. 44-1 USTC 1110.111 (CA-4, 1944); WellsFargo Bank & Union Trust Co., 145 F.2d 130.32 AFTR 1453. 44-2 USTC 1110.147 (CA-9.1944).

31 1977-1 CB282.

-- - --JULY 1.998 VOL 25 I NO 6

predictable and measurable basedon past experiences, this standardcould permit distributions forexpenditures not required to meetthe donee's needs for health, edu-cation, or support. Presumably, ifthe provision had stated that theinvasion power was for thespouse's "maintenance in healthand reasonable comfort so as to

continue my surviving spouse'saccustomed standard of living," itwould have been a nongeneralpower.

ConsideringIncomeandotherresources

Although it is immaterial from thestandpoint of Section 2041whether the spouse's income andother resources are to be consid-

ered before a distribution is made,this consideration provides usefulguidance to the trustee in deter-mining whether to make a distri-bution and, if so, the amount thatshould be distributed.

The first question that arises iswhether the trustee must consid-

er the spouse's income and otherassets before making a distributionif there is no clause in the provi-sion requiring consideration ofthese items. The Restatement Sec-

ond of Trusts states that the gen-eral rule is that the trustee is not

to consider the spouse's incomeand other resources in the absence

of such a clause.32 Although theRestatement position might be thegeneral rule when the powerinvolved is only a power to dis-tribute "trust income" to the ben-

eficiary, the Bogert treatise and thecases cited therein do not supportthis position when the power inquestion is a power to distribute"principal" to the beneficiary.33

32 Restatement of Trusts, Second, §128, com-ment e.

33 Sagerl, Trusts and Trustees, 2d ed. revised,ch. 39, §811, p. 229-238.

There is always the possibilitythat a court in a state where thisissue has not been decided could

adopt the Restatement approach.Consequently, if language requir-ing consideration of the spouse'sincome and other resources is not

included in the trust instrument,the spouse could receive significantadditional amounts that mightnot have been intended by thesettlor. This result could have par-ticular significance in the case ofa second marriage (discussed morelater).

Assume that the settlor wants

his spouse's income and otherresources to be considered and thathe resides in a state that either fol-lows the Restatement rule or hasnot decided this issue. In such a sit-

uation, the inclusion of a clauserequiring consideration of the sur-viving spouse's income and otherresources is a necessity in anytrust that requires mandatory dis-tributions of principal for thehealth, support, education, ormaintenance of the survivingspouse.

Moreover, a court could alwaysdetermine that, even though thetrust provision uses the words"may" or "may, in his discre-tion," the settlor really meant toprovide for mandatory distribu-tions. For this reason, it is strong-ly suggested that language requir-ing consideration of the spouse'sincome and other resources be

included in a trust that, on its face,appears to be a discretionary trust.Even if a trust is clearly discre-tionary as to distributions of prin-cipal (whether that discretion is"simple discretion" or "absolutediscretion"), the inclusion of thiscla use is still recommended be-

cause a court could always decidethat the trustee has abused his dis-

cretion by not making a distribu-tion. In such a case, the presence

JULY 1998 VOL 25 I NO 6

265

of this clause might at least limitthe amount of the distribution byrequiring that the spouse's incomeand other assets be taken into

account in computing the amountthat should be distributed.

There are various ways to draftthis type of clause, and each vari-ation can have different and sig-nificant consequences. One possi-ble variation states that the trustee

is to "consider my spouse's otherincome from all sources known tothe trustee. " This clause is the bare

necessity that should be consideredfor every trust. A second variationis to "consider my spouse's incomeand other resources from allsources known to the trustee. "

Including the descriptive phrase"other resources" should protectagainst the situation where the sur-viving spouse has substantialwealth of her own but is attempt-ing to obtain additional amountsfrom the trust. In this circum-

stance, the trustee should not haveto make any distributions to thespouse. But the phrase "otherresources" is rather vague, and oneof the unanswered questions aboutthis second variation of clause is

whether the family home must bemortgaged or sold before any dis-tributions are made. Althoughthere is no perfect answer to thisproblem, the use of the words"considering my spouse's incomeand my spouse's readily mar-ketable assets" may be the bestchoice because this language pro-tects the home and other non-marketable assets from sale.

SecondmarriagesIn the case of a second marriage,the potential for conflict betweenthe stepmother and the husband'sdescendants is always a possibili-ty after the husband's death.Despite this possible conflict, a typ-ical approach in a second marriage

INVASION CLAUSES

266is for the husband's will to contain

a QTIP marital trust and a creditshelter trust. Such an estate planwould obtain the maximum mar-ital deduction for the husband's

estate while ensuring that theassets of both trusts pass to thehusband's descendants at the sur-

viving spouse's death.If, however, an inappropriate-

ly drafted provision of invasion forthe spouse's health, support, edu-cation, and maintenance is includ-ed in the QTIP trust and the cred-it shelter trust, it can lay thegroundwork for friction and liti-gation between (1) the survivingspouse and (2) the trustee and thehusband's descendants, assumingthey are the remaindermen. Con-sider, for example, the impact ofthe following provision:

The trustee may also pay to mywife so much or all of theprincipal of the trust estate asthe trustee, in his sole andabsolute discretion, considersto be advisable, from time totime, for her health, support,education and maintenance.

There are simply too manyuncertain aspects to this provision.From the perspective of the trustee(who is assumed to be the hus-band's son from a prior marriage),this clause grants him absolute dis-cretion over the amount of the dis-

tribution to the spouse. But if heis a remainder beneficiary of thistrust, he has a conflict of interestthat might cause a court to requirehim to act "reasonably" in mak-ing any decision regarding distri-butions. In addition, the words"taking into account the mannerof living to which she is accus-tomed at the time of my death"have been omitted from this clause.Therefore, even if the trustee does

make a distribution to the step-mother, he will feel obligated topay for only the bare necessities of

- -"----ESTATE PLANNING

life while the stepmother willexpect to be maintained in themanner that she enjoyed whileher husband was alive. Last, thesample provision does not indicatewhether the trustee is to consider

the stepmother's income and oth-er assets in determining anyamount that may be distributed.

From the stepmother's view-point, the trustee is required to use"reasonable judgment" in makinga decision about distributions. In

most cases, "reasonable judgment"does not mean the same thing tothe stepmother that it means to thetrustee. Obviously, if no distribu-tion is made, the stepmother willcontend that the trustee has abused

his discretion. On the other hand,even if a distribution is made, shemay again allege an abuse of dis-cretion unless the amount distrib-

uted approximates her total expen-ditures. Accordingly, the trusteewould feel obligated to get a courtorder before making any distri-butions to avoid any objections notonly from his stepmother but alsofrom his siblings. The result willbe a very costly administration ofthe trust and bad feelings amongall the parties.

Because of the problems con-nected with the above provision,the husband might consider usinga provision similar to the follow-ing if his intent is to provide wideinvasion of the trust on behalf ofhis spouse in order to avoid mostconflicts between her and thetrustee after the husband's death.

The trustee shall also pay to mywife so much or all of theprincipal of the trust estate asis necessary, from time to time,for her health, support, edu-cation and maintenance, inthe manner of living to whichshe is accustomed at the timeof my death, [taking intoaccount my wife's income fromall sources known to thetrustee]. In making any distri-

bution, I direct the trustee tobe concerned only with theinterest of my wife rather thanthe remaindermen.

This provision turns the tables180 degrees and puts the step-mother in complete control. Shecan subvert the settlor's intent byinvesting her money in zerocoupon bonds or U.S. savingsbonds to manipulate and reduceher "income." Moreover, if thebracketed language above is delet-ed and the settlor resides in astate that follows the Restatement

rule, the trustee is not permitted toconsider the spouse's other income.This could result in the spousereceiving substantial distributionsfrom the trust even though shemight be independently wealthy.Further, the provision does notrefer to any other resources of thestepmother. The overall result ofa clause like the above could be the

unnecessary depletion of both theQTIP and the credit shelter truststo the detriment of the husband'schildren.

Therefore, in second marriages,it is essential that the drafter of the

distribution provision be very spe-cific as to all the facts and cir-cumstances that affect the exercise

of the invasion power and theamount distributed to the spouse.Assuming that the husband wantsto strike a balance between his sec-ond wife's interests and those of hischildren, and that he wants dis-tributions to be made to his wife,consider the following provision:

The trustee shall also pay to mywife so much or all of theprincipal of the trust estate asis necessary, from time to time,for her maintenance in healthand reasonable comfort, in themanner of living to which sheis accustomed at the time of mydeath, considering her incomefrom all sources known to thetrustee.

JULY 1998 VOL 25 / NO 6

It is my intention to adequatelyprovide and care for my wifein accordance with the abovestandard, and that my wifeshould not have to invade heravailable cash savings or sellher other resources to providefor her maintenance in themanner of living to which sheis accustomed at the time of mydeath. However, it is not myintention to benefit her bene-ficiaries and/or her descen-dants to the detriment of thetrust estate and my descen-dants. Therefore, in addition tothe trustee reducing theamount of any principal dis-tribution to the extent of mywife1sincome, he shall considerand take into account in mak-ing any distribution and shallreduce any distribution to theextent it is determined that (1)the investment strategy of mywife stresses capital apprecia-tion versus income realizationwhich would significantlyincrease the amount she isentitled to from the trust estate;(2) my wife's investmentsinclude unproductive or under-productive assets which wouldsignificantly increase theamount she is entitled to fromthe trust estate; (3) my wife hasgiven away or is in the processof giving away substantialassets to her beneficiariesand/or descendants whichwould entitle her to addition-al significant distributionsfrom the trust estate; (4) thevalue of my wife's estate at anytime during the continuation ofthis trust is greater than thevalue of my remaining estate;(5) any other significant actionor inaction taken by or onbehalf of my wife which ben-efits my wife's beneficiariesand/or her descendants at theexpense of the trust estate.

In making the above determi-nation, the trustee is autho-rized and directed to requestand review full income andfinancial information from mywife prior to making any dis-tribution pursuant to this pro-vision. Failure of my wife tosupply this full and completeinformation shall be sufficientgrounds for denying any dis-tribution hereunder.

-- ----JULY 1998 VOL 25 / NO 6

--

Although this provision may beadministratively difficult and bur-densome, some situations may jus-tify this language. This provision,however, is a compromise thathopefully will keep peace in thefamily. The use of the word "shall"in the initial part of the clause clar-ifies that the trustee has no dis-

cretion about making a distribu-tion.

The fact that the amount to bedistributed is the "amount neces-

sary," rather than the "amount thetrustee considers to be necessary,"should make clear that the trustee

has no discretion in this regard andthat what is necessary must be theamount of the distribution. Anoth-

er compromise in this provision isthat, in most cases, the wife is notrequired to invade her savings orsell her assets, but she will have todo this if her estate becomesgreater in value than her hus-band's estate.

The second paragraph of theprovision advises the wife at theoutset of what she can and cannot

do. It is hoped that she will followthe rules and avoid conflict. But if

the spouse chooses to play gamesand manipulate her income, theson will not make any distribu-tions. To exercise this discretion,though, he first must have hard evi-dence that the stepmother is indeedplaying games.

Because even the above provi-sion is not perfect, the use of a cor-porate trustee is always a possibleway to preserve family harmony ina second marriage. If, however, thesettlor is unwilling to use a cor-porate trustee, there is somethingto be said for deleting a health,

267

support, education, and mainte-nance clause entirely from both theQTIP trust and the credit sheltertrust, and replacing that clausewith something similar to the fol-lowing:

The trustee shall also pay to mywife, in quarterly installments,such sums from principalwhich, when added to theincome of the trust estate, shallequal $X per year. Thisamount shall be increased eachyear by Y%.

Assume that the above provi-sion is used. As long as the sur-viving spouse is given all theincome from the QTIP trust, thehusband's estate will receive amarital deduction for that trust.

When a child of the first marriageserves as the trustee, the advantageof the above provision is that itmay prevent most of the fightingand bickering that is almost certainto occur about what is the properamount that should be distrib-

uted to the stepmother. All thatmay be needed to keep peace withthe above clause is to be sure the

check is sent promptly to thespouse each quarter.

Conclusion

Like any other trust provision, animproperly drafted health, sup-port, education, and maintenanceprovision can lead to adverse con-sequences to all individualsinvolved. Although form books arean excellent beginning point fordrafting these provisions, the pro-visions in such books should notbe used verbatim. There is no sub-

stitute for careful and thoughtfuldrafting to achieve the best resultsin each situation. Only by con-sidering all factors and circum-

stances can the appropriate pro-vision be drafted to handle the

many differences in each case. .--- -----

INVASION CLAUSES