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.
The Uniform Principal and Income Act (UPIA36) is another statute that affects the administration of both trusts and estates. The purpose of the UPIA is to provide procedures by which fiduciaries administering trusts and estates account for receipts and payments to principal and income of a trust or estate (also known as fiduciary accounting).
Finally, the UPIA deals with guidance in regard to the exercise of fiduciary investment decisions. The UPIA has been adopted in 44 states and the District of Columbia. Other states have adopted parts of the act, but not the entire act. The approach under UPIA allows fiduciaries to use modern portfolio theory to guide investment decisions and requires risk versus return analysis. As a result, a fiduciary's investment performance is evaluated based on the performance of the entire portfolio, rather than individual investments.
Situs
Where a trust has situs determines the jurisdiction of the courts regarding matters involving a trust.37 Situs is generally established by a provision in the trust instrument provided either
the trustee's principal place of business is located in or a trustee is a resident of the designated jurisdiction;
all or part of the trust administration occurs in the designated jurisdiction; or
one or more of the beneficiaries resides in the designated jurisdiction.38
Absent a trust provision, establishing situs in a particular jurisdiction will depend on such factors as whether the trust was a testamentary or inter vivos trust, where the trustee has its principal place of business, and where all or part of the trust administration occurs.39
