By Leah Morrison, Attorney
English, Lucas, Priest and Owsley, LLP
When it comes to planning to avoid or minimize Federal Estate tax, there are four (almost) magic words that frequently appear in trust documents: health, education, support and maintenance, known in the trust and estate law industry as HEMS. Outside of the tax advantages of including HEMS in a trust document, these words also impact the administration of the trust. When a trust includes HEMS language, beneficiaries from the trust may receive funds from the trust for those type of expenses, and those only.
A trustee is placed in charge of the trust. That trustee usually has broad latitude in determining how many distributions are made from the trust and in what amounts – but HEMS language is included to limit what those distributions may be used for. Trustees must ensure that the distributions fall under those categories. Trustees are often a lay person, and in many cases, a family member. This can make things particularly sticky and confusing, especially if there are disagreements among family members.
What’s tricky about health, education, support and maintenance is that it is tough to know what can fall under these categories. The terms “health” and “education” appear clear, but are actually deceptively difficult. Certainly it is easy to envision that the creator of the trust (known as the settlor) intended to allow the trust to pay for a beneficiary’s health insurance premiums, hospital visits, etc., but does the term “health” include long-term nursing care? Likewise, does the term “education” presumptively include the tuition for post-graduate study?
Support and maintenance are especially broad terms without a firmly understood definition under the law. But generally speaking, courts have interpreted these words to mean that the person benefiting from the trust should be living about the same lifestyle as they were previously. A husband might establish a trust to help his wife live in the same home, keep the same type of vehicles, etc., as when they were living. The same could be done by a parent for a child.
Let’s say for example a couple had a house here in Kentucky and a home in Florida. The husband dies and leaves the estate to his wife in a trust. It would be permissible for the wife to continue to pay for those two houses from distributions from the trust. How about paying for a third home? Well, probably, but this is where it gets tricky, and where a trustee may be pushing the outer boundaries of what is allowable. A fourth and fifth home? Definitely not.
Common sense standards
Essentially, what the courts have applied to trust disputes is a common sense standard that tilts heavily in favor of keeping things more or less the same, or a little improved, following the death of the person who established the trust. So, in the example I used above, if you have a $250,000 house here in Kentucky, a $400,000 house in Florida, but you next want to buy a $10 million house in Southern California, you can’t use a trust distribution to do so. But you may be able to purchase a third home that’s much more in line in terms of cost with the homes you already own. A $350,000 home, for example, in Southern California would likely be permissible (if you can find one that cheap, that is).
Trustees should also be mindful that remainder beneficiaries can challenge distributions made if they do not comply with the terms of the trust – including the HEMS directive. So while the current beneficiary may be perfectly content with a distribution that falls under the gray area of HEMS – or one that does not comply at all – there are other people who can challenge a trustee’s decision to make a distribution, and not complying with the terms of the trust can be a trustee in hot water fast.
In one case, Peter established a trust for his wife, Wendy, with the balance of the trust going to his son, Michael. Wendy was Peter’s second wife, and did not have a good relationship with Michael. Michael would only receive the balance of whatever was left in Wendy’s trust. Michael challenged every distribution to Wendy, believing she shouldn’t receive any distributions because they were not permissible under the HEMS standard, which would preserve more of the trust for him to receive upon Wendy’s death. Michael was ultimately unsuccessful, but he did have legal standing to challenge her, and trustees should keep in mind that not every challenge will be baseless.
With HEMS distributions from trusts, the truth of what you can or can’t do is somewhere in the middle. Common sense standards apply – and not everyone agrees about what that might be. One person’s common sense is another person’s austerity – and someone else’s lavish spending.
Our firm often works with families and business owners establishing trusts and estate plans. If we can help you, please contact me. You can reach me, Leah Morrison, at email@example.com or (270) 781-6500. I would be happy to help you.