Dynasty Trusts

As I'd mentioned in the discussion of the Rule Against Perpetuities, quite a few states have replaced or supplemented the Rule's complicated and counter-intuitive limit on the duration of a private trust with a fixed term of years. In Florida, for example, a contingent interest is valid if it vests (becomes certain) within 90 years, or within the traditional "life plus 21 years" period of the Rule. In Wyoming, they've replaced the Rule with a rather impressive fixed time limit.  Regardless of when its contingent interests vest, a private trust governed by Wyoming law cannot last more than 1,000 years!

In some other states, of which Ohio is one, a trust can "opt out" of the Rule so long as the trustee has an unrestricted power to sell trust assets.  (The power of sale means you don't have to worry about the problem that inspired the Rule in the first place: unresolved contingent interests interfering with the free transferability of property.)   In other words, an Ohio trust can last, if you so desire, until the Second Coming, or until the sun swells up into a red giant, or until whatever other future event constitutes "the end of the world" in your personal belief system..

This has led to the development of what is commonly called a "dynasty trust."  A dynasty trust is a trust for the benefit of one's descendants which has either a very long period (200 years or more) or no fixed termination date at all.  The trustee has discretion to make distributions to any of the grantor's descendants from time to time in whatever amounts the trustee finds to be appropriate, and the trust may contain language further directing or restricting the trustee's exercise of discretion.

The trust is funded with an amount equal to what can be protected from the federal generation-skipping transfers tax by the use of the grantor's available GST exemption.  It's possible for multiple grantors, such as a husband and wife or a group of siblings, to make contributions to the same trust and thus "pool" their GST exemptions.  The grantor either uses up part of her unified credit, or pays the necessary gift or estate tax.  The effect of the dynasty trust is to place the trust property beyond the reach of the federal wealth transfer tax system for as long as the trust lasts--the transfer subject to gift or estate tax occurs when the trust is created.  Because we've used GST exemption to protect the assets of the trust from GST upon funding, it doesn't matter whether it's a "direct skip" right now or whether there are going to be "taxable distributions" and a "taxable termination" somewhere down the road. 

This makes the dynasty trust a particularly good vehicle for protecting family business assets from future transfer taxes.  Through the end of 2012, every individual has a $5 million GST exemption and a unified credit equal to the tax on $5 million, allowing for some spectacularly large dynasty trusts to be created--provided that you have assets in those amounts and can afford to give away that much.

Drafting a trust like this is an interesting exercise.  The client will often want to give the trustee some guidance on what distributions would or would not be appropriate; my job is to put this down on paper in a way that accurately captures the client's intent while (we hope!) still being understandable to some future bank trust officer 500 years from now and being sufficiently flexible to allow that future trust officer to adapt to several centuries' worth of cultural and tax law changes.

The Rule Against Perpetuities

The Rule Against Perpetuities is an old doctrine from the English common law which limits the duration of a private (noncharitable) trust.  The most widely accepted statement of the Rule comes from Professor John Chipman Gray's classic 1886 treatise on the subject:

No interest is good unless it must vest, if at all, not later than twenty-one years after the death of some life in being at the creation of the interest.

If you're not quite sure what that means, don't feel bad.  It took Professor Gray 496 pages to explain the Rule and its application to lawyers who were already familiar with the subtleties of property law.  The complexities were such that the Supreme Court of California, in a 1961 case, ruled that it was not malpractice if a lawyer drafted a will that violated the Rule because the Rule Against Perpetuities was too difficult to master!

The Rule applies to contingent interests--that is, where the question of whether you get anything from the will or trust depends on some future event. An example would be a trust distribution where Alice receives the trust income for life, and when Alice dies, it goes to the children of Alice who are then living.  We don't know if any particular one of Alice's children will get anything from the trust until either Alice or that child dies.  Alice's children are therefore what we call "contingent beneficiaries."  (Alice is a "vested beneficiary.")

To really, really, really (over)simplify it, the Rule requires that the interests of all contingent beneficiaries be resolved--that is, we know for sure if they'll get anything or not--before the end of a "measuring life"--the life of some person who was living when the trust was created--plus 21 years.  In the example I gave in the previous paragraph, we have no problem.  Alice could be our "measuring life," and when Alice dies we will know which of her children outlived her, and therefore who gets the trust property, well within the Rule's time limit.  A trust with a more complex future distribution involving generations yet unborn could, however, very easily crash into the Rule.  In order to avoid violating the Rule, a trust couldn't attempt to reach too far into the future.

The original purpose of the Rule was to allow for the free transfer of property.  If a piece of land--which was the primary source of wealth back in the 1600s when the Rule got started--had too many contingent interests, it became impossible to transfer it because either you couldn't identify all the dozens of people who might have an interest in the land, or you couldn't find all of them, or you couldn't get them all to agree to sell the land, or you couldn't figure out how to split up the proceeds afterward, or some combination of all that.

In a modern trust with contingent interests, this is not an issue because the trustee, the sole owner of all the trust's assets, will have the power to sell those assets at any time.  Even though the problem the Rule was attempting to solve wasn't a problem any more, the Rule still applied to modern day trusts.  In recent years, however, most state legislatures have overridden the Rule with a statute that either replaces the "life in being plus 21" period with a fixed time limit, or allows a trust to ignore the Rule completely.  We'll talk about some planning arrangements that take advantage of that change in the next post.

If you'd like to learn more about the Rule Against Perpetuities and want to have some fun doing it, I recommend you read three delightful law review articles written by Professor W. Barton Leach (1900-1971): "Perpetuities in a Nutshell" (1938), "Perpetuities in the Atomic Age: The Sperm Bank and the Fertile Decedent" (1962), and "Perpetuities: the Nutshell Revisited" (1965).

Federal Estate and Gift Taxes -- the Annual Exclusion

The purpose of the gift tax is to prevent people from "sneaking" around the estate tax by giving away assets before death.  There's no official definition of a gift, but the general understanding is that a gift is any transfer of property that makes your estate smaller.  The gift tax part of the Internal Revenue Code expressly says that it is not a "gift" to pay someone's medical or educational expenses.  There's no exemption for everyday living expenses, but as far as I know the IRS has never tried to characterize basic consumption, such as the cost of feeding and housing your kids, as a taxable gift.

Even with those exceptions, every Christmas present and birthday card would still be a taxable gift, and only the most miserly among us would not be required to file Form 709 every year.  To avoid the resulting absurdity, Congress wrote in something called the "annual exclusion."  It's presently $13,000 per recipient per year, and that number adjusts for inflation every so often.  Put simply, the first $13,000 in gifts you make to a person in any one year are "freebies," ignored for gift tax purposes.  If you have two children, you can give each of then $13,000 and not owe any gift taxes.  A married couple can combine their exclusions (something called "gift splitting") and give $26,000 per year to each recipient tax free--it's considered to come equally from both, no matter who wrote the check or made the transfer.

Now here's the tricky part: the annual exclusion only applies to a "present interest" gift; that is, something that the recipient can enjoy immediately.  A gift of a right to receive something in the future, or a gift in trust that won't be distributed immediately, is not a present interest, and doesn't get the benefit of the annual exclusion.

It's often not a good idea to make a substantial gift outright to a young person, or an adult with maturity or creditor problems.  You'd want to hold the property in trust so the beneficiary can't mishandle it--and, in the case of a minor, so you don't have to establish a guardianship to hold the property.  Section 2503(c) of the IRC sets out a specific exception for gifts in trust to a minor, but section 2503 trusts have to terminate when the beneficiary reaches age 21.  21 is the traditional age of majority, but not always a comfortable age to be distributing substantial wealth to someone.

So does that mean that if you want to make a gift in trust to, say, age 30 you can't use the annual exclusion?  No; there's a work-around called a "Crummey power," named after the United States Tax Court case which validated the tactic.  The trust will give the beneficiary a legal right to withdraw property as soon as it's added to the trust, but that right expires one month after the date the beneficiary (or, if a minor, her parent or guardian) is advised that a contribution has been made.  That's a present enough present interest to qualify the gift for the annual exclusion.  As you might expect, this is something we use a lot in my business.

Estate Planning for Guardians

The title of this post is also the topic of a CLE presentation I'm giving next Tuesday in Cleveland.  Adult guardianships are something I deal with pretty regularly, and the intersection between estate planning and guardianship law is an interesting subject (at least to me).

The law presumes that adults are competent. In a sense, "competency" is a synonym for "autonomy." A competent adult is free to use or dispose of his or her property in whatever manner he or she sees fit—subject to certain constraints which we won't go into right now.

A person is "incompetent" if, as the statute says, he or she is

...so mentally impaired as a result of a mental or physical illness or disability, or mental retardation, or as a result of chronic substance abuse, that the person is incapable of taking proper care of the person's self or property or fails to provide for the person's family or other persons for whom the person is charged by law to provide....

An incompetent person is legally unable to act for themselves.  Unless he or she has appointed an agent under a durable power of attorney or placed property in trust, it will be necessary to appoint a guardian to manage the individual's property.  Guardians have most of the same powers over property as their ward would have if competent, but everything the guardian does is subject to court approval in advance.

The guardianship statutes explicitly state that the guardian cannot make or change a will, and the courts interpret that to prohibit the guardian from making any kind of change to a trust or other estate planning arrangements. A guardian can obtain authority to make lifetime gifts, but only if the court finds that the ward would have wanted to make the gift if competent.

Changes in Delaware Trust Law

Clients with complex estate planning needs, including those with significant liability exposure who need to take "asset protection" measures, will often set up their trusts in the state of Delaware, which is the home of some of the nations oldest trust companies and has a highly developed law of trusts. 

Delaware has made some significant changes to its trust laws which take effect this coming Monday, August 1, 2011.  The changes include improved protection from creditors for assets held in trust, and revisions to the "decanting" statute which allows a trustee to create another trust and transfer assets to it.  You can read or download a detailed summary of the changes here.

Federal Estate and Gift Taxes -- the Unified Credit, Today and Tomorrow

The federal wealth transfer taxes are imposed on any gift (with certain exceptions), and any estate, no matter how small. In order that these taxes only actually get paid by "the wealthy," everyone is given a "unified credit" against these taxes.  We usually do not talk about the credit itself; rather, we refer to the "exemption equivalent," which is the amount of wealth that the credit "pays" the tax on.

When I started practicing law, and for a long time thereafter, the exemption equivalent was $600,000; that is, the credit was equal to the tax on $600,000 of lifetime gifts and/or wealth transmitted at death. Once the credit ran out, the tax rate on the 600,001st dollar was 37%, and the rate brackets topped out at 55% once you got to $3 million.

By making full use of both spouse's credits, a married couple could transmit $1.2 million to the next generation before incurring a federal tax.  At the time these numbers were established, $1.2 million was a net worth that few couples could attain.  After fourteen years of cumulative inflation and rising standards of living, however, the tax was starting to hit a lot of farmers, small business owners, and other upper middle class taxpayers who were rich enough, in terms of assets, to be hit by the tax, but who often weren't liquid enough to raise the cash with which to pay the tax without selling or borrowing against their main assets--the house, the farm, or the business.

The 1997 tax act.addressed this by scheduling a series of irregular increases in the unified credit that would eventually raise the exemption equivalent to $1 million.  The increase was "back-loaded" so that most of it occurred in later years.  By 2001, we were about halfway through the process, and the exemption equivalent was $675,000.

The 2001 tax act--which enacted what reporters, pundits, and politicians like to refer to as the "Bush tax cuts"--provided for the complete phase-out of the federal estate tax over a ten year period.  The exemption equivalent for estates was increased immediately to $1 million, and scheduled to go to $1.5 million in 2004, $2 million in 2006, and $3.5 million in 2009.  In 2010, the estate tax was scheduled to disappear completely.  While this was going on, the top rate was decreasing from 55% to 45% in a series of irregular jumps.  The exemption equivalent for lifetime gifts was capped at $1 million, and after the estate tax went out of existence there would still be a 35% tax on lifetime gifts, with a $1 million exemption equivalent.

The 2001 tax act also contained a "sunset" clause under which all the changes it worked in the tax code would be undone on January 1, 2011, which would un-repeal the estate tax and cause a return to what the 1997 tax act was working toward: an estate and gift tax with a $1 million exemption equivalent and a 55% top rate.  The reason for this is because one of the rules governing the federal budget process provides that no legislation affecting revenue can be in effect for more than ten years unless it passes with at least 60 votes in the Senate.  As you might remember, we had a closely-divided Senate at that time, and the 2001 tax act passed by only a small majority.

Those of us in the estate planning business expected that Congress would change things again well before 2010 so we wouldn't have that strange temporary repeal, but that didn't happen.  In late 2009, there had been several bills introduced to extend the estate tax past 2009 with a $3.5 million exemption equivalent (and one that would have reduced it to $2 million!), but none of these got through the legislative process because Congress was then focused intensely on the pending "Obamacare" health care reform bill.

Consequently, there was no estate tax for nearly all of last year, but with a scheduled automatic reinstatement of the tax (and a lot of other changes to other parts of the tax code) on January 1, 2011.  In December, Congress passed, and the President signed into law, legislation which prevented the sunset from taking place.  For the most part, it provided that the changes to the tax code made by the 2001 tax act would continue in effect through the end of 2012--what the media, pundits, and politicians described as "an extension of the Bush tax cuts."  Part of this bill reinstated the estate tax--but with a $5 million exemption equivalent, a 35% top rate, and a new "portability" provision which allows a widowed spouse to make use of any unified credit the deceased spouse did not use on his estate tax return or on lifetime gifts.  This is the most taxpayer-friendly that the federal estate tax has been since 1931.

However, things may soon change for the worse.  The 2010 tax act was a bundle of compromises, and one of those compromises was a provision that "sunsets" the 2010 act at the end of 2012.  Unless Congress changes the tax code again before the end of next year, we will "snap back" to the 1997 version of the estate tax--an estate and gift tax with a $1 million exemption equivalent and a 55% top rate--on January 1, 2013.

There are many members of Congress who have come out in favor of making the 2010 estate tax scheme permanent.  President Obama has stated on numerous occasions that he is opposed to "further extensions" of the "Bush tax cuts," which seems a pretty clear signal that he would oppose making the 2010 estate tax scheme permanent.  It is probable that any legislation to address the estate tax would be introduced and debated next year--in the middle of a long and contentious national election campaign.

No one can safely predict what will happen next, and estate planning for families with small businesses and farms has gotten a lot more complicated as a result.

Federal Estate and Gift Taxes -- Trusts for the Non-Citizen Spouse

As mentioned in the last installment of this series, the unlimited marital deduction is only available if your spouse is a U.S. citizen.  If your spouse is not a U.S. citizen, transfers to that spouse at death will be subject to the estate tax unless you use a "qualified domestic trust," or "QDOT."

A QDOT trust must pay all of its income to the surviving spouse, and can have no other beneficiaries while the spouse is living.  So far, this looks a lot like a QTIP marital deduction trust, but a QDOT is subject to additional restrictions intended to prevent the non-citizen spouse from leaving the country with the assets and thereby escaping estate taxation:

• At least one of the trustees must be an individual U.S. citizen or a U.S. trust company.
• No more than 35% of the assets of the trust may be foreign real estate.
• The U.S. trustee has the power to withhold taxes from any distribution of principal.

That last power is very important, because the principal of the QDOT trust (but not the income) is subject to an estate tax if it is distributed while the spouse is living (other than for reasons of "hardship"), and any principal remaining in the trust is taxed at death.

How do you prevent taxation of principal distributions?  If the spouse becomes a U.S. citizen, the special QDOT restrictions and the tax on lifetime principal distributions no longer apply.

Federal Estate and Gift Taxes -- the Marital Deduction

A baseline policy of the federal estate and gift taxes is to tax wealth once every generation. For that reason, transfers from one spouse to another are made deductible, and therefore not taxed--subject to some important qualifications.  You'll often see this referred to as the "unlimited marital deduction."

The unlimited marital deduction applies to any outright transfer to a spouse, and any transfer in trust where the assets of the trust will be included in the spouse's gross estate, and subject to tax, at the spouse's death.  Before 1988, there were three trusts that qualified for the marital deduction:

• Any trust where the spouse has a lifetime right to income and a "general power of appointment"--a right to withdraw assets from the trust, or direct them to his estate or creditors at death.  Often called a "life estate plus power of appointment" trust, this was the most common arrangement.
• A trust where the spouse has a lifetime right to income and the property passes at the spouse's death to charity.  (In this instance, there will be no tax on the second death because the property will qualify for a charitable deduction.)
• An "estate trust," which accumulates income while the spouse is living and pays it to her estate at death.  These were used as investment vehicles back in the days when trusts paid income taxes at much lower rates than individuals. In about 20 years of private practice, I have yet to encounter one.

Most married people want to devote assets to the care of their spouse, and then pass them on to the next generation after both spouses are deceased.  If, in order to take advantage of the marital deduction, you left property to the spouse outright or in a trust with a general power of appointment, you ran the risk that the spouse might divert the assets to someone else--this was a particular concern of spouses in blended families, or in situations where a relatively young widow remarries.  If you designed the trust to prevent this by restricting the spouse's control, or providing for a forfeiture of benefits if the spouse remarried, you gave up the marital deduction and incurred a tax.

The response to this was the "qualified terminable interest property" election added to the tax code in 1988, which is nicknamed "QTIP.".  To qualify for the QTIP election, a trust must meet three criteria:

• The spouse must receive all of the income of the trust while living.
• The trust may not have any other beneficiary while the spouse is living.
• The estate must make a "QTIP election" on the estate tax return.

The QTIP rules allow for a fair bit of flexibility in trust design.  The spouse can have no right to principal at all, or a right to principal distributions in the trustee's discretion, or even a limited right to make annual withdrawals.  The right to principal distributions can terminate, or be restricted, on remarriage.  Because it allows for more control than the old life estate plus power of appointment trust, the QTIP trust is the one I use the most in my practice.

One last little detail: the marital deduction is only available if the spouse is a U.S. citizen.  For non-citizen spouses, there is still a marital deduction of sorts, but the rules are a lot more complicated.  We'll discuss that topic in our next installment.

Federal Estate and Gift Taxes -- the Gross Estate

The federal estate tax is a tax imposed on the "privilege" of transferring property at death.  Because it's imposed on transfers of property, it taxes more than just the property in your probate estate.  The "gross estate," as we call it, consists of the probate estate, plus all sorts of arrangements that are intended to avoid probate, such as:

• Joint and survivorship assets.
• Payable-on-death and transfer-on-death assets.
• A revocable trust.
• Any irrevocable trust you've created, if you retain control over the disposition of wealth at your death--what we sometimes call a "taxable string" power--either as trustee or by some other means.
• Retirement accounts and annuities with a death benefit or survivor benefit.
• Assets which you have technically given away, but retain the right to use during lifetime.  The classic example of this is a life estate in real property.
• Assets whose disposition you control through a power of appointment, but only if that power lets you appoint the assets to yourself, your estate, or your creditors.  Powers of appointment have a lot of uses in sophisticated estate planning, and we'll go into detail about how they work in a future post.

Life insurance is something of a special case: it's only part of your gross estate if you hold what are called "incidents of ownership" in the insurance policy--the right to name beneficiaries, or the right to borrow against or take out the cash value of the policy.  If you don't hold the incidents of ownership, it doesn't matter if you're the insured, or if you pay the premiums--it's not in your gross estate.  For many of my higher net-worth clients, we take advantage of these rules in a way that allows the family the benefit of the life insurance proceeds without having to pay estate tax on them.  The insurance is held in trust by an independent trustee, and the insured has no power to change the terms of the trust.  We'll go in to how these "irrevocable life insurance trusts" work in more detail in a future installment.

Probate and How to Avoid It

Many clients come to me wanting, among other things, to "avoid probate"--that is, to avoid having assets in their estate administered in the probate court.  There are several reasons why you might want to do this:

• Privacy is the biggest reason: anything that gets filed in probate court, including an inventory or account showing the value of assets, is part of the public record and accessible to everyone.
• In Ohio, where I practice, assets in a probate estate are subject to the claims of creditors of the deceased, while most non-probate assets are not.  This is not true in some other states.
• Probate administration is a slow-moving process, and keeping assets out of probate often permits them to be distributed faster.  This is not necessarily true in large estates, where the preparation, filing, and possible auditing of the federal estate tax return is usually the most important factor determining the speed of distribution.

So how do you tell if something is going to go through probate, or avoid probate?  If an asset is in your name individually and does not pass to someone other than your estate at death by contract or operation of law, it’s a probate asset.  If any asset you don't own directly passes to your estate at death, it’s a probate asset.  Anything else is not a probate asset.  For example:

• Things you've given away before you die are not probate assets because, well duh!, you no longer own them at death.
• Property in a revocable trust is owned by the trustee, and not by you individually.  Even if you are serving as your own trustee, you hold the trust property in a fiduciary, not individual, capacity.  So long as the trust document tells us what to do with the property when you die, the trust will not be a probate asset.
• What you have saved in a retirement plan account or IRA is technically owned by the plan trustee or IRA custodian in trust for your benefit.  Like the revocable trust corpus, it will not be a probate asset so long as you've named a beneficiary.
• If you have insurance on your life, it doesn't matter whether you own the policy or someone else does--so long as you've designated a death beneficiary, the proceeds will not go through probate.
• Real estate held in a joint & survivor or survivorship tenancy, or for which you've designated a transfer-on-death beneficiary, does not go through probate because title passes by operation of law at your death.
• Securities or bank accounts titled “joint & survivor” or which have transfer-on-death beneficiary designations, do not go through probate either, though in this instance it's because title passes by contract (the account agreement with whatever institution you're dealing with) rather than operation of law.
• Property interests which terminate at death do not become part of the probate estate because the property no longer exists.  Examples of this would be an old-style pension that pays you an annuity for life, but has no death benefit.

Intestate Succession

What happens if someone dies "intestate"--that is, without having made a will?  Who gets their property?

The answer is provided by something called the "statute of descent and distribution."  This law tells us what to do with a deceased person's property. It's the legislature's attempt to guess what the deceased would have wanted if he or she had been asked the question or had bothered to tell us, and it's not an unreasonable guess in most instances. The people who take under the statute of descent and distribution are known as "heirs at law" or, in some situations, "next of kin."

We'll take a look at how one such statute works after the jump.

What is a Trust?

Trusts are a common estate planning device, but many people (including a few lawyers!) don't completely understand what one is.  We’ll start the discussion with a definition of a trust that I've used in several CLE presentations I've given:

A trust is a relationship created by a grantor who transfers legal title to property (known as the trust corpus or trust principal) to a trustee, who holds it as a fiduciary for the benefit of one or more beneficiaries.   The beneficiaries’ rights of enjoyment are set forth in the terms of the trust, which are usually contained in a governing document (which may be called a “Declaration of Trust” or “Trust Agreement” or a “Declaration and Agreement of Trust” or sometimes just a “Trust.”)

There are several important concepts contained in that definition: 

• A trust is a fiduciary relationship between the trustee and the beneficiaries, not a separate legal entity (person) like a corporation or LLC. 
• Since the trust is a relationship and not an entity, legal title to the trust corpus is held by the trustee.  While we often casually speak about "the trust" doing something (conveying property, making a distribution, or so on) as if it were an entity, it's actually the trustee who is the actor.
• Since the trustee is a fiduciary for the beneficiaries, it naturally follows that beneficiaries are the persons with standing to enforce the terms of the trust—that is, they’re the ones who sue the trustee when the trustee fails to follow the terms of the trust.

The terms of a trust do not need to be written down in order for there to be a valid trust,  but they usually will be found in a governing document.  At the minimum, a trust’s governing document should do all of the following:

• Clearly identify the parties to the trust: the grantor, trustee, beneficiaries, and any trust advisors.
• Indicate if the trust is revocable or irrevocable, and identify who may hold powers to amend the terms of the trust (reserved powers to amend; powers of appointment).
• Clearly set forth the dispositive (enjoyment) terms of the trust (including those circumstances where the distribution is subject to review or approval by a trust advisor or other outside party) so that the trust accomplishes the grantor’s objectives.
• Provide a mechanism for succession in the office of trustee.
• Confer powers on the trustee to permit him to efficiently manage the trust. While the dispositive provisions of every trust--who gets what, when--will be unique, basic trustee powers and other “administrivia” will not vary much from document to document.  (The Ohio Trust Code has a nearly-comprehensive set of statutory trustee powers which drafters may incorporate by reference, and most of us who practice in this area have standard language we use for nearly every trust document. Some trust companies have their own standard trustee power language which they will require in the document as a condition of accepting the trust.)
• Do all of these things with sufficient clarity that both the trustee and the beneficiary can understand what the trustee is supposed to do and who receives what without having to ask a judge to construe or interpret the document.

Fiduciary Duty

The terms "fiduciary" and "fiduciary duty" get used a lot in estate planning. The legal term "fiudciary" derives from the Latin words fides, meaning "faith", fiducia, meaning "trust," and fiduciarius, meaning "holding in trust." As a generic term, a "fiduciary" is a person who has ownership or control of property for the benefit of someone else.

A trustee owns title to the property in a trust, but holds it for the benefit of the trust's beneficiaries, not himself. We would therefore say that the trustee is a fiduciary over the trust property. While a trustee is the classic example of a fiduciary, there are others: the executor or administrator of an estate is a fiduciary with respect to the estate; a guardian is a fiduciary with respect to the property of the ward (person under guardianship); an agent under a power of attorney is a fiduciary with respect to the property of her principal; and the officers and directors of a corporation are fiduciaries with respect to the corporation's assets (which are owned by the shareholders).

If you're a fiduciary, you have a "fiduciary duty." Fiduciary duty is often described as the highest duty of loyalty in the legal system. My shorthand explanation I use with clients is that "fiduciary duty" means "it ain't your money!"  For instance, a trustee owes a "fiduciary duty" to the trust beneficiaries to manage that property for their benefit in accordance with the terms of the trust. If the trustee breaches that duty by using the trust property for his own benefit, that is a rather serious matter. The trustee will be liable to the beneficiary for damages caused, and for any profits he made, will very likely be removed by the court, and in certain situations may be hit with punitive damages, statutory penalties, and even criminal prosecution.

Durable Powers of Attorney

Durable powers of attorney, which appoint someone as your agent and grant them authority to transact business on your behalf, are a commonly-used estate planning device. They can be used to appoint an agent to handle your affairs if you are disabled, thus saving the expense and complexity of a guardianship. Even if you are not disabled, having a trusted individual available who has formal authority to act for you can make it easier to conduct your affairs.

The key phrase there is "trusted individual." While your agent under a power of attorney has the same basic fiduciary duty to you as a guardian or trustee, the agent is not subject to the active supervision of a court like a guardian would be. A recent article in the Wall Street Journal discussed some of the problems that can arise if your agent decides to work for his own benefit instead of yours. Because there's no active supervision, and fewer formalities than with a trust, it can be difficult to detect when an agent is misusing his powers, and the problem is often not discovered until a lot of damage has been done. I've been involved in litigation over the misuse of powers of attorney on several occasions, and I've seen it first-hand.

Does that mean you shouldn't use a durable power of attorney? I wouldn't say that, but you do need to think about who you select as your agent and what authority you give that agent. The terms of the power of attorney can restrict the agent's authority to certain transactions or certain types of activity, or even condition the existence of that authority on certain events. I have also had clients escrow their powers of attorney with me, to be released to the agent only at the client's direction, or in the event the client becomes disabled.

These are all matters you should discuss with your estate planning advisor.