Recently I gave a lecture on the valuation of trusts. While I am not an accountant nor am I a valuation expert, I live and breathe trusts… and frequently the question comes up, what is value of a particular beneficiary’s interest in a trust.
Keep in mind, just because a trust is worth $1M, it does not mean that the beneficiary’s interest is worth $1M if they have limited rights to invade the trust or control it. Here’s a few reasons to value a trust:
- When a person dies, that person may have a beneficial interest in a trust. Depending upon the type of interest a person has, it may or may not be includible in his/her taxable estate. If the interest is includible in the deceased beneficiary’s taxable estate, then the executor of the deceased beneficiary must report it on federal and state estate tax returns.
- Similar to the above, but slightly different, when a person dies, he or she may leave a beneficial interest in a trust to another person. Particularly in New Jersey and Pennsylvania, you see this come up a lot when a person leaves money to a class A beneficiary in trust (such as a spouse), and then the remainder interest to an non class A beneficiary (such as a nephew or niece). This triggers something known as the Compromise tax.
- Financial Aid – Some colleges and schools will look at the trust terms, others won’t. Each school is different regarding the questions they ask on their forms.
- Divorce. Depending upon the state, a person’s interest may be subject to equitable distribution, alimony and especially child support.
- New Jersey tends to be fairly friendly to a trust beneficiary. See Tannen vs. Tannen, where the Appellate Court ruled that a beneficiary’s income interest should not be imputed for purposes of alimony. The general rule was already that such an interest was not subject to equitable distribution. (NOTE: This case law is likely to be challenged in light of the fact that NJ recently enacted the Uniform Trust Act.
- Pennsylvania is far less friendly to trust beneficiaries. The general rule in Pennsylvania is that marital property does not include trust property acquired by gift, bequest, devise or descent prior to or during the marriage, but it does include the increase in value of such property. See 23 Pa. Cons. Stat. 3501(a.1)
- As far as I am aware, both Florida and New York follow the NJ rule and generally considers trust property as separate property, not subject to equitable distribution.
- Massachusetts recently came down with a terrible case: See Pfannenstiehl. (Note: I’m not licensed in MA)
Regardless of the reason why you need to value a trust, the first step in determining the value is to figure out what type of interest that person has. Usually a beneficiary’s interest includes one or more of the following:
- An income stream
- The right to receive income or principal for health, education, maintenance and support
- An annuity stream (such as $2000/month)
- Principal distributions once the beneficiary reaches a certain age
- The right to take out $5000 or 5% per year
- A discretionary interest