Florida's Proposed Directed Trust and Community Property Trust Statutes: What You Need to Know

Co-authored with Osvaldo Garcia, Executive Director, J.P. Morgan Private Bank.

The Florida legislature is currently in the advanced stages of enacting legislation that will make critical changes to the Florida Trust Code. The legislation (SB 1070/HB 609) would enact the Florida Uniform Directed Trust Act ("FUDTA") and the Community Property Trust Act ("CPTA"). Here is what you need to know about these proposed laws.

1. Florida Uniform Directed Trust Act

The use of directed trusts has increased exponentially in recent times, driven in large part by clients seeking to reduce their overhead cost, take an active role in the management of trust assets, or both. A directed trust is generally one in which the duties or powers of a trustee are segregated so that someone other than the trustee, which we shall refer to as a trust director,¹  performs certain functions of the trust by "directing" the trustee. The most common directed function is the investment management of trust assets, but it could also include other substantive duties such as the decision to pay distributions to beneficiaries. In a fully directed trust, the trustee performs the administrative functions of managing the trust while following the directions of the trust director. Naturally, the only manner in which a trustee would agree to serve in a directed trust is if it would not be held liable or have limited liability for following the orders of the trust director.

While Florida has some form of directed trust statutes on the books (i.e., Fla. Stat. § 736.0703(9) and § 736.0808(2)), such provisions have been found deficient in several aspects by Florida practitioners and Florida professional trust companies. In what may be perceived as an effort to be more competitive with the trust laws of other states,²  the Florida legislature now aims to enact FUDTA, which adopts the Uniform Directed Trust Act ("UDTA") drafted by the Uniform Law Commission, with some key modifications.

FUDTA would be added as new Fla. Stat. § 736.1401 et seq. FUDTA would apply to trusts for which the principal place of administration is Florida and that are created after July 1, 2021, or, if created before then, with respect to actions or decisions concerning such trust taken after such date.

Generally, FUDTA would adopt the following key provisions: 

• Expand (stet)the concept of “principal place of administration” to include Florida if: (i) the trust terms so provide, and (ii) a trust director’s principal place of business is located in Florida, or a trust director is a resident of Florida.
• Allow (stet) the trust to grant a power of direction to a trust director (which can be any type of individual and does not require such person to be specifically named as a trustee). Notably, FUDTA adds to the UDTA by specifying that the power of direction includes only those powers granted by the terms of the trust and further powers not expressly granted that are appropriate to the exercise or non-exercise of an expressly granted power. Notwithstanding the foregoing, FUDTA does not apply to certain powers provided by the trust, including a power of appointment, a power to remove a trustee or trust director, and the powers of a settlor over a revocable trust, such as the power to amend or revoke the trust.
• Holds a trust director to the same fiduciary duty and liability as a sole trustee in a like position. This deviates from the position taken by some jurisdictions that simply mention that the trust director is treated as a fiduciary without further specification as to which type of fiduciary is being referenced or which duties would apply.
• Limits the trustee of liability for taking reasonable actions to comply with a direction from a trust director. Notably, FUDTA appears to provide an additional safeguard for beneficiaries compared to the UDTA (and other directed trust states) by requiring the trustee to first assess whether the direction is within the scope of the trust director's power of direction before complying with such. A trustee may refuse to comply with a direction if it would result in the trustee's own willful misconduct. It does add the caveat that a direction is not outside the director's scope of authority just because it would constitute a breach of trust.
• Requires the trustee to furnish information to the trust director to the extent such information is reasonably related to the scope of the power, and vice versa. Here, FUDTA adds to the UDTA by requiring a trust director to provide information within its knowledge or control to a qualified beneficiary that makes a written request for such information, to the extent such request relates to the powers or duties of the trust director.
• Eliminates any duty of the trustee to (i) monitor a trust director or (ii) inform or give advice to a settlor, beneficiary, trustee, or trust director concerning an instance in which the trustee might have acted differently than a trust director. The trust director likewise does not have such duties to monitor or inform these parties or another trust director.
• Subjects the trust director to the personal jurisdiction of Florida courts.
• Establishes limitations on actions against trust directors, imposing a six-month statute of limitations and authorizing a trust director to assert the same defenses in a breach of trust action as a trustee could assert.

 

The new legislation would be a significant improvement over the existing statutes and would expand an individual's succession planning opportunities. As increasingly more individuals move to Florida, these changes are expected to make Florida an even more attractive option for establishing trusts and transferring wealth. Existing trust arrangements should be reviewed to determine if these improvements should be incorporated into an existing plan.

2. Community Property Trust Act

Nine states follow a community property approach to marital property, with the remaining states, including Florida, following a separate property regime. In community property jurisdictions, assets of a married couple obtained during the marriage are generally deemed to be owned in equal parts by each spouse and are divided as such in the event of a divorce. Upon the death of a spouse in a pure community property jurisdiction, there is freedom of testamentary disposition with respect to that spouse's 50% share in the marital property.

From a U.S. tax planning perspective, there is one significant benefit for married couples subject to a community property regime. Under Internal Revenue Code § 1014(b)(6), if a spouse dies owning community property, the deceased spouse's 50% share and the surviving spouse's 50% share of such property (i.e., 100%) obtain an adjustment to the property's historical tax basis equal to the fair market value on the date of death of the first spouse. If there has been significant appreciation in such community assets, this "double step up in basis" can result in a tremendous tax benefit. Contrast this result with the result in a separate property regime in which a couple owns property as joint tenants. Under such a regime, the half owned by the decedent spouse receives a step-up in basis equal to fair market value as of date of death, but the tax basis of the half owned by the surviving spouse remains unaffected, thereby resulting in a larger tax burden upon disposition of the asset.

Similar to the adoption of FUDTA, Florida seeks to become a more competitive trust law jurisdiction through the proposed adoption of the CPTA, which would purportedly allow Florida residents to avail themselves of this tax benefit available in other jurisdictions.³  This effect would be achieved through the establishment of a community property trust, which would allow couples to "opt-in" to have property contributed to the trust treated as community property for all effects and purposes.

The legislation would add new Fla. Stat. § 1501 et seq. Under the CPTA, spouses would be able to jointly settle a community property trust by:

• Expressly declaring the trust to be a community property trust.
• Having at least one qualified trustee, meaning a natural person residing in Florida or a company authorized to act as trustee in Florida.
• Having both spouses execute the trust with all the requisite formalities.
• Having conspicuous language at the beginning of the trust agreement in substantially the same form set forth by the statute warning each spouse of the legal consequences of signing the agreement and urging the spouses to seek competent and independent legal advice if he or she has any questions about the trust agreement.

 

The CPTA further gives the settlor spouses broad discretion to structure the trust as they wish, including determining whether the trust shall be revocable or irrevocable and how the trust property shall be disposed upon death or divorce. It also allows a surviving spouse to amend the trust with respect to his or her one-half of the property, even if the trust is irrevocable. Notably, the spouses do not have to be domiciled in Florida in order to settle a community property trust.

Furthermore, many married individuals migrate to Florida following marriage, with a significant portion of such individuals coming from Latin American jurisdictions where community property is the dominant marital property regime. Thus, even though Florida is not by default a community property state, it is home to many individuals who were formerly subject to a community property regime. Prior to the adoption of the CPTA, planners were faced with uncertainty regarding the creation of "joint trusts" as a means of preserving the community property nature of these assets. The CPTA would offer more guidance for structuring such trusts.

There are three potential issues with the concept of a community property trust. The first is a practical issue, which is that the plan would only be successful if the parties remain married, which is impossible to predict. Spouses may be wary of transmuting non-community property if they are not confident about the prospects of their marriage.

The second is the uncertainty regarding how the Internal Revenue Service ("IRS") will treat these arrangements. The intent behind the CPTA is to allow a couple to be able to contribute as much property as it wishes to a community property trust and thereafter obtain a double step-up in basis upon the death of one spouse under § 1014(b)(6). The CPTA has a specific provision expressly providing that a community property trust is to be treated as a trust established under the community property laws of a state. However, there has been debate within the tax field (without an ultimate consensus), as to whether community property trusts settled in a non-community property state such as Florida are, in fact, entitled to the double basis adjustment.⁴

Note as well the risk of a downward adjustment to the community property's tax basis (which is a result unlikely to be challenged by the IRS). Due in part to continuous volatile markets (pre-pandemic and currently), it is possible that a built-in loss asset could be adjusted downward, thereby resulting in the elimination of such built-in loss. If the property is treated as community property, this means that the basis of the value of the entire asset would be adjusted downward upon the death of one spouse.⁵ Thus, there needs to be careful consideration of these issues if the basis adjustment feature is one of the primary reasons for establishing a community property trust.

The third and last issue is the U.S. federal gift tax implications of creating a community property trust. If both of the spouses are United States citizens, there should be no U.S. federal gift tax consequences when settling a community property trust as a result of the unlimited marital deduction. However, because Florida is a migratory jurisdiction, there is a prevalence of married couples who are only U.S. lawful permanent residents (green card holders). If one such spouse is not a United States citizen, then the contribution of separate property by the other spouse would not qualify for the unlimited marital deduction benefit and could trigger a U.S. federal gift tax situation.

Nevertheless, the CPTA could still be useful without factoring in the tax component. In particular, Florida continues to attract out-of-state couples lured by the lack of a state income tax. Many of these come from high-tax states like California, which have a community property regime. The settling of a community property trust would provide an elegant solution for such migrating couples. Additionally, it is possible that a community property trust may be more compatible with civil law matrimonial regimes, as discussed above, so that their use may be appealing to foreign clients seeking to settle a Florida trust.

Ultimately, these are two exciting pieces of legislation for the Florida wealth planning community. As of the date of publication, the legislation is separately scheduled for a second reading in the Florida House of Representatives and Florida Senate. We will provide an update to this post if and when the legislation passes.

¹Other common terminology is "Trust Advisor" or "Trust Protector."
²According to the Florida House of Representatives Staff Analysis, "the bill may also encourage persons to keep their assets in Florida rather than transferring such assets outside the state." See https://www.flsenate.gov/Session/Bill/2021/609/Analyses/h0609c.IBS.PDF.  
³According to the Florida House of Representatives Staff Analysis, the CPTA gives "Florida residents an opportunity to avail themselves of a federal income tax benefit for community property." See https://www.flsenate.gov/Session/Bill/2021/609/Analyses/h0609c.IBS.PDF.
⁴In Commissioner v. Harmon, 323 U.S. 44 (1944), the United States Supreme Court ruled that an Oklahoma statute that allowed couples to opt-in to a community property regime would not be recognized for federal income tax purposes. Furthermore, it is the position of the IRS that the Harmon decision should also apply to the Alaska system for income reporting purposes. See https://www.irs.gov/irm/part25/irm_25-015-005.
⁵Compare this to a situation where separate property is not contributed to a community property trust and continues to be maintained separately by each spouse. Upon the death of the first spouse, the surviving spouse's separate property would not be affected by this downward adjustment on the death of the first spouse.

*This article was republished in Steve Leimberg's Estate Planning Newsletter #2883