What You Need to Know About the New Arizona Trust Code

by Steven D. Baker, CPA

On May 27, 2008, the Arizona Trust Code (Arizona Revised Statutes §§14-10101 through 14-11102) was enacted with the signature of the governor. For the most part, the statute will go into effect on Jan. 1, 2009. In many respects, the new statute represents an overhaul of Arizona trust law, and this article discusses some of the more important changes that affect CPAs who advise clients with respect to estate planning and trust administration.

Duty of Trustee to Inform and Report to Beneficiaries

The Arizona Trust Code provides more concrete rules with respect to a trustee’s duty to account and keep beneficiaries informed. The new statute retains the general duty to keep beneficiaries “reasonably informed about the material facts necessary for them to protect their interests” and to promptly respond to a beneficiary’s reasonable request for information. However, this general duty now applies only with respect to a “qualified beneficiary”— a distributee or permissible distributee of income or principal or would be a distributee or permissible distributee if the interests of the current distributees or the trust terminated. The statute also imposes certain specific duties upon the trustee, any of which may be prospectively waived by the beneficiaries, and in some cases, under the terms of the trust instrument.

With respect to the duty to account, the trustee must prepare a report of the trust property, liabilities, receipts and disbursements, including the source and amount of the trustee’s compensation, a listing of the assets, and if feasible, their respective fair market values. The report must be sent annually and upon termination of the trust to distributees or permissible distributees and any other beneficiary who requests it. Unless a co-trustee will continue to serve, any trustee who is removed or is resigning must send such a report to the qualified beneficiaries.

The trustee also has specific obligations to respond to a beneficiary’s request for a copy of the portions of the trust instrument that are necessary to describe the beneficiary’s interest, provide a 60-day notice to the qualified beneficiaries of the trustee’s acceptance of the trust by a trustee or the fact that a revocable trust has become irrevocable, and provide a 30-day notice to the qualified beneficiaries of any change in the method or rate of the trustee’s compensation.

Trust Modifications, Reformations and Terminations

Under prior law, the legal standards for modifying, reforming or terminating irrevocable trusts were based upon restrictive, if not nonexistent, common law standards applied by the courts. The Arizona Trust Code now provides several procedures that may serve useful with respect to trust administration:

A trustee and beneficiaries of an irrevocable trust may petition a court, with the consent of all of the beneficiaries or upon a determination of the court that the beneficiaries who have not consented are adequately protected, to: (a) modify the terms of the trust if the modification is not inconsistent with a material purpose of the trust; or (b) terminate the trust if continuance is not necessary to achieve a material purpose of the trust and distribute the assets as agreed by the beneficiaries.

A trustee or other party may, in light of circumstances not anticipated by the settlor, petition a court to: (a) modify the administrative terms of a trust if continuation on its existing terms would be impracticable or wasteful or would impair the trust’s administration; (b) modify the dispositive terms of the trust in accordance with the settlor’s probable intent to the extent practicable; or (c) terminate the trust and order the distribution of property in a manner consistent with the purposes of the trust.

A disinterested trustee may, after providing prior notice to qualified beneficiaries, terminate a trust with a value of less than $100,000, if the trustee concludes that the costs of administration are no longer justified, and distribute the remaining assets in a manner consistent with the purposes of the trust. Alternatively, any trustee or other party may petition a court to terminate a trust, or replace a trustee, if the court determines that the value of the trust property is insufficient to justify the costs of administration.

A trustee, or other party, may petition a court to reform the terms of a trust, even if unambiguous, to conform those terms to the settlor’s intent if there is clear and convincing evidence that both the settlor’s intent and the terms of the trust were “affected by a mistake of fact or law, whether in expression or inducement.”

A trustee or other party may petition a court to modify the term of a trust, even with retroactive effect, “to achieve the settlor’s tax objectives … in a manner that is not contrary to the settlor’s probable intention.”

Total Return Unitrust

Effective for trusts in existence on or created after Oct. 1, 2008, the Arizona Trust Code now allows for the conversion of an “income trust,” which directs or permits the trustee to distribute the net income to one or more persons, to a “total return unitrust,” which pays a fixed percentage of the fair market value of the trust assets to such persons. The statute also allows for the reconversion of a total return unitrust back to an income trust. This change provides an avenue of flexibility for trustees to invest for total return, including capital appreciation, rather than having to focus on generating enough fiduciary accounting income, such as interest and dividends.

A conversion or reconversion, as well as any change to the applicable unitrust percentage, may be made by a petition to the probate court or without judicial intervention by a disinterested trustee, or by an interested trustee with the relevant determinations made by a disinterested person, upon providing advance notice of the change to the settlor and vested beneficiaries. The trustee who in good faith takes or fails to take any action is not liable to any person affected, regardless of whether that person received notice, and an affected person’s exclusive remedy is to obtain a court order to convert an income trust to a total return unitrust, reconvert from a total return unitrust to an income trust, or change the unitrust percentage.

The unitrust percentage, as set forth in a written policy adopted by the trustee, must constitute a “reasonable current return,” between three and five percent, taking into account the intent of the settlor as expressed in the governing instrument, the needs of the beneficiaries, general economic conditions, projected current earnings and appreciation for the trust, and projected inflation and impact on the trust. The statute also provides for the determination of fair market value, the allocation of items of income and capital gains to unitrust payments, and other procedures.

Any conversion to a total return unitrust under the new statute does not affect any trust provisions for distribution of principal. Furthermore, the statute does not apply to charitable remainder trusts, pooled income funds, or any trust for which the terms expressly state that income is not to be calculated based upon a unitrust amount. With respect to a marital trust representing qualifying terminable interest property pursuant to IRC §§2056 or 2523, the surviving spouse may always prohibit conversion to a total return unitrust or compel reconversion to an income trust.

Trust Protector

Over the last several years, an increasing number of settlors of irrevocable trusts have included trust provisions appointing an independent party, such as a friend, attorney, CPA, or other professional, as a “trust protector” to provide the flexibility in exercising certain discretionary powers over the trust, such as amending the terms or removing and appointing successor trustees. The use of trust protectors has been limited, and trust protectors are often reluctant to serve, because of the uncertainty over whether, and to what extent, a trust protector has fiduciary duties to the beneficiaries with respect to the exercise or nonexercise of such powers.

With respect to trusts that become irrevocable on or after Jan. 1, 2009, the Arizona Trust Code now expressly states that a trust protector is not a fiduciary and is not liable or accountable as a trustee or fiduciary because of an act or omission when performing or failing to perform its duties. The new statute also contains provisions addressing the scope and limitations of the powers of a trust protector, which may be modified by the terms of the trust instrument.

Steven D. Baker, Esq., CPA, is an attorney at Frazer Ryan Goldberg & Arnold, LLP. He is a certified specialist in Estate and Trust Law by the State Bar of Arizona. He can be contacted at sbaker@frgalaw.com.

AZ CPA – October 2008