Not too long ago, I was called to help out the remainder beneficiaries of a Trust. These beneficiaries were siblings and their dad had passed away. Before he died, Dad had been an income beneficiary of a separate Trust for a number of years – Dad’s bank had served as the Trustee. After some investigation, it was discovered that the Trustee had mistakenly calculated certain distributions to Dad a few years before Dad passed away and the Trustee was attempting to correct it before anyone really noticed what was going on.
The mistake that the Trustee made had to do with how the “net income” was calculated. Dad was entitled to all of the “net income” of the Trust. Idaho, as well as all of the other states in the country, has specific rules regarding which receipts and disbursements are “income” and which are “principal”. In this case, the Trustee erred in allocating receipts of business income and the distribution to Dad was wrong.
Payments received from investments, such as rental properties, pass-through business entities (e.g., LLCs, partnerships, sub-S corporations, etc.), or mutual funds, are not necessarily income – some or all of the receipts could be principal. Many times there are different income and principal beneficiaries of a Trust, and allocating these receipts correctly is an important part of a Trustee’s job.
In the case I described above, a Court eventually decided that the Trustee was personally liable and the Trustee even was ordered to pay the cost of the beneficiaries’ attorneys out of the Trustee’s own pocket. I’ll talk about Trustee liability another time, but suffice it to say that it doesn’t take much for a Trustee to trip up with consequences that can be quite costly for all concerned.