Effective January 1, 2009, Arizona has a new set of statutes governing how trusts operate, referred to as the Arizona Trust Code (“ATC”).  The ATC establishes statutory guidelines about trust creation, administration, modification and termination and is intended to provide clarity for many areas of Arizona trust law. 

            While the ATC was not designed to radically change Arizona trust law, it does provide certain new rules with respect to Arizona trusts and also allows for some customization of trusts to reach more preferable results than under current law.  The following is a summary of a few of the more important provisions of the ATC.

1.                  Notice Provisions.  The ATC includes new notice provisions that may apply to an irrevocable trust or revocable trust that subsequently become irrevocable.  These provisions affect what information children, grandchildren, and other trust beneficiaries are entitled to receive with regard to the trust. 

Here is a common client fact pattern:  Parents set up a trust which provides that on the first death, part of the trust is held in an irrevocable trust for the benefit of the surviving spouse during his or her lifetime, with the children and grandchildren as successor beneficiaries.  Father dies, resulting in one-half of the trust becoming irrevocable.

Under the new ATC, the trustee must notify only Qualified Beneficiaries of the existence of the trust within 60 days, including telling the beneficiary of his or her right to obtain a copy of the relevant portions of the trust, and copies of the trustee’s annual reports unless the trust provides otherwise.  A “Qualified Beneficiary” is someone who may receive trust distributions or who would receive trust distributions if those currently entitled to trust distributions died and all of the people who would receive assets from the trust if it terminated.  This would include the Parents’ children and possibly their grandchildren.

The good news is that these new notice provisions can be overridden by provisions of the trust itself.  Depending on the ages and circumstances of the children and grandchildren, parents may not want certain children or grandchildren to know of the existence of, and information about, the trust until they have matured sufficiently.  This duty to notify them can be changed if the trust instrument provides that notice need not be given to a beneficiary under a certain age or circumstance, or notice may be provided to a third party such as a trust protector on behalf of Qualified Beneficiaries until the trust protector believes those beneficiaries are sufficiently mature to know about the trust.

2.                  Enhanced Creditor Protection.  The ATC makes significant changes to Arizona’s spendthrift laws.  These include additional provisions to protect trust assets from the creditors or divorcing spouses of children, grandchildren or other beneficiaries. 

Commencing January 1, 2009, a former spouse of a beneficiary may no longer seek payment of spousal maintenance from the assets of a trust if the trust is drafted properly.  (Child support continues to be an exception to spendthrift protection of a trust.)  Under the ATC, new provisions may prevent a former spouse of a child or grandchild from obtaining an order for spousal maintenance which is then paid out of a trust set up by their parent or grandparent.  The assets must stay in trust to provide this protection, but the child or grandchild can be given control over their trust fund and still have the spendthrift protection.

The ATC also solves an existing problem with respect to life insurance.  Under current law if a life insurance policy was made payable to a trust for the benefit of a spouse, child, parent, sibling or other family member, the cash value was subject to the owner’s creditor’s claims.  The ATC now permits life insurance policies to be payable to a trust for the benefit of a spouse, child, parent or other family member and still be exempt from creditor’s claims, so long as the policy has been held for two years.

3.                  Irrevocable Trust Modification and Termination.  The ATC provides some much needed flexibility to amend or terminate irrevocable trusts.  Irrevocable trusts are sometimes set up with the best of intentions, but things change or there are ambiguities in the trust instrument that may cause friction among beneficiaries or between the beneficiaries and the trustee.  Under the ATC an irrevocable trust may be modified upon the consent of all of the beneficiaries in a court proceeding, for example, if the court concludes that modification is not inconsistent with a material purpose of the trust. 

As a result of these new and flexible means of modifying or terminating irrevocable trusts, revocable trusts should be amended to include a statement regarding the intent of the person creating the trust in establishing the trust.  By including a clear statement as to the material purposes of the trust, such as retaining property in trust to protect the beneficiaries from creditors or adverse tax consequences, future beneficiaries can be thwarted from later rewriting or terminating the trust in ways that are inconsistent with the specific purposes intended for the trust.

            4.         Maximum Duration of Trust.  A trust can now last for up to 500 years.  The rule known as the “rule against perpetuities” has been changed so that a trust formed in Arizona can now last for up to 500 years.  This allows individuals to keep property in trusts to last for multiple generations.

            5.         Additional Tax Law Changes.  In addition to the new improvements to Arizona law that the ATC provides, there are also changes to Federal estate and gift laws effective as of January 1, 2009:

Estate Tax Exemption.  The estate tax exemption per individual has increased from $2 million to $3.5 million as of January 1, 2009.  Unless Congress amends the law prior to 2010, there is no estate tax in 2010 and then the estate tax exemption amount will revert to $1million on January 1, 2011.  There is a good chance that the current $3.5 exemption will be extended indefinitely or at least for two more years, giving Congress additional time to decide the future of the estate tax.

Annual Gift Tax Exclusion.  The annual gift tax exclusion has increased from $12,000 to $13,000 allowing each individual to gift up to $13,000 in 2009 to as many persons as he or she may choose without any gift tax consequences.

Required Minimum Distributions.  The Worker, Retiree, and Employer Recovery Act of 2008 has temporarily suspended required minimum distributions from Individual Retirement Accounts (“IRAs”) and qualified defined contribution plans (but not defined benefit plans) for 2009.  Minimum distributions must begin when the account holder turns age 70½, and the IRS imposes a 50% excise tax for not taking at least the minimum amount.  This tax law change will have the effect of helping individuals preserve their capital in the face of the depressed markets, preventing people from being required to pull money out at a time when many investments have lost significant value.  The change applies only to the 2009 year at this time.

            6.         Other Matters.  In addition to the new ATC and recent tax law changes, there are two other items which should be noted.

                        Health Care Powers of Attorney.  All Health Care Powers of Attorney should permit the agent to receive information otherwise protected under the privacy provisions under the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”). 

                        Qualified Plan and IRA Beneficiary Designations.  In recent years, the IRS has modified the rules governing distributions from IRAs and qualified plans following an individual’s death if he or she has named a trust as beneficiary.  Any beneficiary designations naming a trust as primary or secondary beneficiary should be reviewed.

            7.         What Should Be Done?  There is nothing that absolutely must be done as a result of the new ATC; however, individuals should consider amending existing revocable trusts to take advantage of the new provisions offered under the ATC.  Specifically, with respect to issues of (i) when beneficiaries should be notified, (ii) taking advantage of new creditor protection provisions available, (iii) adding a statement of material purpose to provide future guidance as to the intent in establishing the trust, and (iv) taking advantage of the 500 year rule against perpetuities.

            The statements or recommendations in the foregoing article cannot be relied upon by any individual as tax or legal advice concerning the matters addressed in the article.  The readers are each urged to seek their own legal and tax counsel to review their specific situation.  If anyone would like to discuss the article or discuss their individual situation further with the author, please contact Chuck at 602-200-7365.

Chuck is the principal of the law firm of Charles W. Whetstine, PC, and is of counsel to Frazer Ryan Goldberg & Arnold LLP. As of counsel, Chuck's primary areas of practice are estate planning, retirement plans and employee benefits. He also assists clients in business organization (corporations, limited partnerships, limited liability companies), business transactions, and individual income tax planning. Chuck has been certified as a tax law specialist by the Arizona Board of Legal Specialization.

            Pursuant to Federal Regulations imposed on Practitioners who render tax advice ("Circular 230"), we are required to advise you that any tax advice contained herein is not intended or written to be used for the purpose of avoiding tax penalties that may be imposed by the Internal Revenue Service. If this advice is or is intended to be used or referred to in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement, the regulations under Circular 230 require that we advise you as follows: (1) This writing is not intended or written to be used, and it cannot be used, for the purpose of avoiding tax penalties that may be imposed on a taxpayer; (2) The advice was written to support the promotion or marketing of the transaction(s) or matter(s) addressed by the written advice, and (3) The taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.