People create trusts for a variety of reasons: to remove assets from their probate estate; to reduce the size of their taxable estate; to provide for loved ones; and to protect those loved ones' assets from waste. Often, which goal takes priority determines what type of trust is selected. In recent years, something called a "secret trust" has become available from some estate planners. What is a secret trust, and is it something you should consider?
To understand what a secret trust is, it's important to understand what might motivate someone to create a trust and want to keep it secret from the people it is intended to benefit. Let's say you want to make gifts to your grandchildren, and you want to get a tax benefit from those gifts: maximizing your gift and estate tax exclusions, and perhaps even getting an income tax benefit. At the same time, you are not quite comfortable making an outright gift. Perhaps your grandchildren are still minors, or young adults who might be tempted not to work as hard as they might have if they didn't know they had a trust fund.
Whatever your reasoning, you would like to make gifts to your grandchildren that they not only cannot reach, but would not even be aware of until some future time. Enter the secret trust: you make gifts to a trust for the benefit of each grandchild, but they are not notified of the gifts until they are older.
On its face, this looks like it could be a great idea: you get the tax benefits of making the gifts, the knowledge that you are helping to secure your grandchildren's futures, and protecting the assets you've given them from reckless spending. What could possibly go wrong?
There are a couple of things that make this plan less than ideal. First is the matter of who will be the trustee. In order to reap the tax benefits of a trust, the creator (settlor) of the trust cannot serve as trustee. The next most obvious choices, the settlor's spouse, or adult children who are parents of the grandchildren/donees, are also not ideal trustees; their service in that capacity would offer the settlor only limited tax benefits.
That leaves professional trust companies, accountants, and attorneys, most of whom would be disinclined to handle trusts of this size and nature. So, the most likely option for a trustee of a secret trust would be a more distantly related relative or friend, who may or may not have the desired knowledge or experience.
Assuming that you, as settlor, could find someone willing outside your immediate family to serve as trustee, they would have to be willing to violate Ohio trust law in order to keep your trust secret from the grandchildren/donees. Ohio Revised Code 5808.13 requires notice of the creation of the trust and annual reports on the trust. Failure to comply with these notice requirements are breaches of trust, which could expose the trustee to liability or removal. Furthermore, there is no identified statute of limitations for this liability, so the exposure is open-ended.
In theory, a surrogate could be appointed for the donee, and your trustee could give the required notices to that person. However, it is likely that rather than eliminating potential liability for the trustee, liability would just be extended to the surrogate as well.
Beyond the notice requirement, secret trusts pose other liability risks as well. A trustee has a duty to obtain information on the needs of the donee. Will he or she be able to do this effectively if the trust is secret? Similarly, the point of such a trust is often that no distributions will be made to the donee, at least for several years. If the trust provides as much, then you, as settlor, could lose the tax benefit of the trust. But if the trust doesn't provide that there are to be no distributions, the trustee's discretion is an illusion. The trustee would be promising you not to make distributions in violation of the terms of the trust: another breach.
Let's say your trustee does make distributions, perhaps for the benefit of your donee, rather than directly to him or her. Those distributions would have income tax consequences, of which the donee would have to be informed. That would, obviously, reveal the "secret."
Also, there are some circumstances, such as applying for financial aid, in which a donee has to give a statement of his or her assets. Without knowledge of the trust, such a certification would be false and could cause legal problems for the donee.
In sum, a "secret trust," even if technically legal, could cause as many problems as it solves. Are there other options?
One alternative to a secret trust might be to give the donee an interest in a limited partnership or LLC. Doing so could both protect assets and eliminate the need to tell the donee of the gift, or keep him or her updated on it. To discuss this possibility, or other options for achieving your estate planning goals, we invite you to contact our law office.
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