The Rise of Pet Trusts
The Rise of Pet Trusts
The Rise of Pet Trusts
Clients of all incomes and all net worths are interested in pet trusts. Irrespective of the news headlines, pet trusts are not just for the very rich or the terribly eccentric.
Today, there has been a societal shift to recognizing the importance of caring for pets after the death of the owner. The ability for practitioners in a variety of jurisdictions to create a pet trust has expanded due to many states incorporating Uniform State Laws in their legislation. Both the Uniform Trust Act and Uniform Probate Code have created provisions legitimizing trusts for the care of an animal after the owner's death. Nearly 40 states have adopted one or the other, either as proposed by the National Conference of Commissioners on Uniform State Laws, or modified. Section 2-907 of the Uniform Probate Code provides for a governing instrument caring for a pet to be liberally construed and enforced as opposed to a precatory or honorary request of the governing instrument, while Section 408 of the Uniform Trust Act provides for legitimizing a trust (or portion thereof) specifically designed for an animal.
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Inter Vivos Trusts
A pet trust may be established as part of a multifaceted trust or as a stand-alone pet trust. The trust may be revocable or irrevocable. Consideration might also be given to the use of an irrevocable life insurance trust.
If an irrevocable life insurance trust is used, unknown is whether the pet would be deemed to have an insurable interest in the trust. Traditionally an insurable interest is found if there is: (1) one so closely related by blood or affinity that he or she wants the other to continue to live, irrespective of monetary considerations; (2) a creditor; and (3) one having a reasonable expectation of pecuniary benefit or advantage from the continued life of another. State statutes and case law have modified the definition of an insurable interest expanding it so that it may be feasible in certain locales for a policy to be purchased which names the trust as the owner and the beneficiary, even if the ultimate beneficiaries of the trust are pets, without running afoul of the insurable interest rule. Assuming that an insurance institution will issue such a policy and after issuance they challenge the policy by claiming that there is not an insurable interest, the policy may be treated by the court as a voidable contract. However, in some states, the insurance policy is not invalid merely because the policyholder lacks an insurable interest. A court with appropriate jurisdiction may order the policy paid to someone else who is equitably entitled or may create a constructive trust thereby saving the policy for the pet. For those who are not comfortable with assuming that a pet has an insurable interest (or if the insurance company will not issue the policy) the alternative is to purchase insurance directly. As a general rule, if the initial owner is the insured, he or she always has an insurable interest in his or her own life. The insured can then assign the policy to anyone he or she wishes, whether or not the assignee otherwise has an insurable interest and, thus, can subsequently transfer the policy to an irrevocable life insurance trust. Obviously, this approach of transferring an insurance policy to a trust after the initial owner-insured purchases it exposes the estate to estate taxation if the insured dies within three years after the assignment. But the use of life insurance to fund a pet trust is certainly worth considering.
One of the major advantages of using an inter vivos trust, regardless of the type of trust, is that there is no delay between the date of death and the establishment of the trust. On the other hand, in the event that the funds are improperly being used or that the trustee is not properly supervising the caretaker there is no outside supervision without affirmative action being taken by a third party to bring the matter to the court's attention.
An inter vivos trust has an added benefit in that it can also name a pet guardian or agent and provide funds for the care of a pet while the owner is incapacitated just as trusts do for a human who is incapacitated.
Drafting Considerations
In general, some considerations, no matter what type of trust instrument is selected are drafting so that there is a means of identifying the pet; identifying the circumstances for removal of the caretaker; providing for a named successor caretaker; and using an independent monitor to oversee the care of the pet -- most likely the pet's veterinarian. The independent monitor may not only have the final say on how the pet is being cared for, but also the final word on medical and end of life decisions. Include whether the caretaker can or cannot have other pets, and if so what type and/or how many. Such mundane and routine things as specific care of the pet (for example, type of food, grooming and where to obtain grooming, or not allowing a cat outside); grounds for the caretaker's removal (for example, failing to take the pet for annual checkups, failing to cooperate with the trustee, or allowing a cat outside); or the use of a pet sitter or boarding facility when the caretaker is on vacation or temporally unavailable should also be included. There should be a provision which provides that the trustee is authorized to have regular communication with the independent monitor and the right to randomly check on the pet. With the growing use of pet health insurance, the trustee should have the ability to purchase such insurance at their discretion particularly if the corpus of the trust is limited. Liability insurance and/or an umbrella policy should also be a consideration, particularly for an animal that will interact with other animals or humans. The trustee can either purchase such insurance or may be authorized to reimburse the caretaker for the purchase of such. There should also be a provision for where the funds go in the event a court deems that the funds for the pet trust are in excess of the amount reasonably necessary for the care of the pet. Other provisions in this type of trust would be similar to any other trust such as providing for a successor trustee, limiting the liability of trustee and trustee's fees. There may also be directions on what type of documentation is required for reimbursement to the caretaker for out-of-pocket expenses paid by the caretaker or a provision on how the trust should be billed directly by providers. Do not omit trustee investment choices, standard of care, accounting and bond clauses.
Selection of a trustee may be predicated upon the amount of funds available for funding the trust. Naturally, if the resources are quite large, an institutional trustee is a viable option. If drafting in such a manner that the trustee is to actually have contact with the pet a local institution or one with branch offices in the place where the pet resides might be a better choice so that regular visits can be arranged.
As an aside, make sure the caretaker understands his or her responsibilities and duties. This should be clearly spelled out even before undertaking the trust drafting and perhaps even put in writing.
Taxation
As with all types of trusts, income, gift and estate taxes are all a consideration to be factored into the decision making process. Income taxes are probably the most encompassing taxes to deal with. Taxes may be imposed on not only the income generated by the trust, but additional taxes may be due as a result of the type of assets used to fund the trust. For example, retirement benefits, such as an IRA, will trigger an income tax on the corpus by December 31 of the calendar year that contains the fifth anniversary of the date of death as there is no designated human beneficiary.
If the trust beneficiary is the pet, such as under the types of trust created by the UPC or UTA (i.e. I leave my cat, Charlie, $100,000 in trust), all of the income, whether distributed or not in any give year, is taxed at the trust rate. However, if the trust holds an asset that requires repairs or maintenance, such as the residence, then the payments for repairs or maintenance of the trust asset should be deemed to be an administrative cost or expense. Arguably this payment would then in fact be a deductible administrative cost.
Care must be paid to the overall amount of taxes paid as a result of the steep bracket climb of a trust versus the slower bracket climb imposed on an individual.
If the trust is designed to distribute funds to the caretaker who is also a beneficiary, the caretaker will pay the taxes on the income distributed while the trust receives a corresponding deduction. The income to the caretaker-beneficiary is reported to them on a K-1. Although the overall income taxes paid may be lower in this type of a trust this may result in a fiscally unsound position for the caretaker. If the caretaker must also use the funds distributed to pay for the pet's care for such items as food, grooming and veterinarian bills, the net amount to them is significantly reduced. In addition, the caretaker may be in a tax bracket where the income received places them in a higher overall bracket diminishing any benefit they would receive. The trust could provide additional sums to make up for that dilemma.
The next tax issue raised is the gift tax question: both the federal and state gift tax. (Note: today only a very few states have a state gift tax). Accordingly a grantor trust is the preferred method as such a design eliminates an imposition of gift taxes. However, if there is a gift tax, such as the tax, which occurs with an insurance trust, the federal applicable credit may be applied to the transfer to eliminate the federal gift tax. It is pretty clear that the federal gift tax annual exclusion would not be available for a gift to a pet.
More likely to occur are estate or inheritance taxes. Consequently, if the estate is sufficiently large so as to incur an estate tax or an inheritance tax, a tax apportionment clause in the estate planning documents is imperative to ensure that the pet trust is not eviscerated by the estate or inheritance taxes imposed.
Creative planning, and possibly a device which would appeal to clients who are interested in a pet trust, would be the use of a charitable remainder trust. Unfortunately a trust for a pet with the remainder to charity does not qualify as a charitable split interest trust for purposes of an estate tax or income tax charitable deduction. There has been some public discussion of amending or changing the Code to allow for a charitable deduction for a split interest pet trust and perhaps that will come to fruition in the not too distant future.
To summarize, a pet trust is not an unusual request from a client in this day and age nor is it a difficult document to draft. There are however so many variables and ways to structure it that it takes some thought and thorough discussions with the client so as to incorporate all of the technical and nontechnical factors to ensure its viability.
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