By Steven J. Oshins, Esq., AEP (Distinguished)
Thanks to the generosity of Leimberg Information Services, we are pleased to provide you this recently published article on LISI.
EXECUTIVE SUMMARY
Nearly Everybody
Nearly every estate planning attorney uses “health, education, maintenance and support” (“HEMS”) as a distribution standard in the trusts they draft. This language is probably found in more than 95% of the trusts that are drafted nowadays. Some trusts use it as the sole method of making trust distributions, whereas others have provisions giving an interested trustee the ability to distribute under this standard and also allow an independent trustee to make fully discretionary distributions.
Trust “Forms”
The primary reason HEMS language is used is because it’s found in almost all trust “forms” and/or because trust drafting software encourages its use.
The “forms” and drafting software don’t warn the users that this language can make the trust susceptible to certain creditors, including divorcing spouses, and that it can cause an otherwise avoidable state income tax if a beneficiary resides in California, Georgia or North Carolina.
The technical reason for its inclusion in trust “forms” is that if a beneficiary has the power as trustee to distribute to him or herself, then HEMS (or similar) language must be used to avoid estate inclusion.
It’s simply not good language and rarely should be used in trusts.
COMMENT
Why Is HEMS So Bad?
There are two primary reasons it is bad:
- Less protection from creditors and divorcing spouses, including divorce and/or alimony; and
- Causes state income tax on undistributed taxable income if any beneficiaries are residents of California, Georgia or North Carolina.
Let’s look at both reasons, but with the primary focus being on the divorce and alimony protection issues.
1. Less Creditor and Divorce/Alimony Protection
The primary reason HEMS trusts are bad is that they’re generally classified as “support trusts” for creditor protection purposes, thereby exposing the trust assets to certain “exception creditors”, such as divorcing spouses, depending upon the applicable state’s statutory and/or case law.
For substantially stronger creditor, divorce and alimony protection, a trust should always be drafted as a “discretionary trust” (using an independent co-trustee as the distribution trustee) rather than being drafted as a “support trust”. A third-party discretionary trust is protected from all creditors of the beneficiaries under the laws of all states, except for an exception under Florida law allowing for a writ of attachment for divorce, alimony and child support creditors under Berlinger v. Casselberry and FL Stat § 736.0503 (2023).
A discretionary trust can be drafted with multiple trustees where the primary beneficiary can be the investment trustee and the primary beneficiary’s close friend (or a bank or trust company) can be the distribution trustee. The primary beneficiary can be given the power to fire and hire trustees. This provides the greatest degree of control without sacrificing creditor and divorce protection.
Discretionary Support Trust
Notwithstanding the above, it is possible to draft a trust that is classified as a “discretionary trust” but where distributions have a “ceiling” of HEMS. This is called a “discretionary support trust”. If a trust is drafted in this manner, then it should be protected. However, here is a U.S. Court of Appeals case where the court found that even a discretionary support trust isn’t protected: U.S. v. Harris (2017). Therefore, this isn’t as protected as many people may think and therefore takes a risk that can be avoided.
It Causes Divorce Exposure
This newsletter puts most of the emphasis on exposing a trust to divorcing spouses simply because the person to whom you’re married is a person’s most likely creditor.
According to Divorce Rate by State 2024 (worldpopulationreview.com),
“In the United States, between 35%-50% of first-time marriages end in divorce, increasing to approximately 60% for second marriages and 70+% for marriages after the second. This gives the US one of the highest divorce rates in the world.”
Because of statistics like these, one can assume that spouses of our clients’ intended beneficiaries are real threats to their inherited assets.
Therefore, it is not okay to ignore this simply because nearly every estate planning attorney’s trust “forms” contain spendthrift trusts with health, education, maintenance and support as the distribution standard.
In this author’s opinion, protection from future ex-spouses is so important that it should usually be the primary consideration. Let’s take a look at states that have statutes and/or case law affecting a “support trust” with respect to matrimonial issues.
Alabama: §§19-3B-503(b)(1), (c)
Arizona: §14-10503(A)
Arkansas: §28-73-502; Council v. Owens (1989)
California: Prob. Code §§15305(c)(d); Blech v. Blech (2019)
Connecticut: §52-321; Spencer v. Spencer (2002)
Delaware: Garretson v. Garretson (1973)
Florida: §736.0503(2)(a), 3; Bacardi v. White (1985)
Georgia: §53-12-80(d)
Indiana: §30-4-3-2(a); Clay v. Hamilton (1945)
Kentucky: §381.180(6)(a)
Louisiana: §9:2005(1)
Maryland: §Safe Deposit & Trust Company of Baltimore v. Robertson, 65 A.2d 292 (Md. 1949)
Massachusetts: Lauricella v. Lauricella (1991)
Michigan: Converston v. Kellogg (1984)
Missouri: §456.5-503(2)
Nebraska: §§30-3848(b), (c)
New Hampshire: §564-B:5-502(f)(1)(A)(ii), (iv)(B)
New Mexico: §46A-5-503(B)(1), (C)
New York: §5205(c)(4)
North Dakota: §§59-13-03(2)(a), (4)
Ohio: §§5805.02(B)(1)(C), (D)
Oklahoma: tit. 60, §175.25(B)(1)(a)
Oregon: §130.310(2)
Pennsylvania: 20 Pa.C.S. §7743(b)(c)
Just because a state isn’t listed doesn’t mean that it isn’t possible that a court might one day rule in a future case that the state’s public policy is such that a divorcing spouse should be an exception. Therefore, it isn’t 100% certain that a HEMS trust under the laws of a state not listed above will be safe.
Author Request: The foregoing list may be missing some states, case law and/or statutes. Please email soshins@oshins.com with any additions, subtractions and/or other corrections so the list can be perfected in the future.
2. It Causes State Income Taxes if CA, GA or NC Resident Beneficiary
There are three states that tax non-grantor trusts when the only contact is that one or more beneficiaries reside in that state.
California taxes the undistributed taxable income in such a trust on a prorated basis based on a number of California resident beneficiaries versus non-California resident beneficiaries, but not if the beneficiary is “contingent” (i.e., discretionary).
Georgia and North Carolina tax all of the undistributed taxable income in such a trust if there is even one resident beneficiary. This was ruled unconstitutional for a discretionary trust (but not for a support trust such as a HEMS trust) by the Supreme Court of the United States in the famous Kaestner case.
As of July 1, 2023, California, Georgia and North Carolina were the #1 (CA), #8 (GA) and #9 (NC) most populated states as noted by Wikipedia at List of U.S. states and territories by population – Wikipedia. This includes more than 18% of the population of the entire United States.
With so many potential California, Georgia and North Carolina trust beneficiaries, it simply makes no sense to draft a trust to cause a state income tax that could have so easily been avoided.
Is it Malpractice to Draft a HEMS Trust?
It is definitely nowhere close to malpractice to draft a trust with HEMS provisions.
It is very likely that roughly 95% of trusts are drafted with HEMS language. Therefore, it would be nearly impossible to conclude that there has been malpractice when the accepted standard, and one used in roughly 95% of all trusts, is to use this language.
That doesn’t make it good. It simply means that the attorneys aren’t doing anything per se wrong.
Fixing a HEMS Trust
Assume that a new client comes to you with a HEMS trust and you’re horrified after reading this article. One simple fix for creditor and divorce protection purposes is to change the trust’s situs to a better, more protective trust jurisdiction. This can often be done either by using a change of situs provision found in the trust agreement, by using a very simple non-judicial settlement agreement or by using a very simple decanting.
However, changing the jurisdiction of the trust doesn’t fix the state income tax problem if a beneficiary resides in California, Georgia or North Carolina. This should be done via a decanting. However, very few jurisdictions have statutes allowing a support trust to be decanted into a discretionary trust. Therefore, you must first move the trust to one of the decanting jurisdictions that allows this type of decanting. Those jurisdictions are South Dakota, Nevada, Tennessee, New Hampshire, Indiana, Wyoming, Georgia and Arizona.
Some Exceptions when HEMS might be Okay
This newsletter suggests that no trust should ever be drafted with HEMS language. There are certainly some exceptions, although this language should be used very, very rarely.
One example would be a client who isn’t sophisticated and who is willing to accept simplicity in exchange for lesser benefits. I have occasionally used HEMS trusts in this situation.
Conclusion
It’s time to stop using HEMS language in trusts! Just because nearly every attorney does it doesn’t make it good for clients.
HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!
ABOUT THE AUTHOR
Steven J. Oshins, Esq., AEP (Distinguished) is a member of the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011. He was named one of the 24 “Elite Estate Planning Attorneys” and the “Top Estate Planning Attorney of 2018” by The Wealth Advisor and one of the Top 100 Attorneys in Worth. He is listed in The Best Lawyers in America® which also named him Las Vegas Trusts and Estates/Tax Law Lawyer of the Year in 2012, 2015, 2016, 2018, 2020, 2022 and 2024. He was named the “Estate Planning GOAT (Greatest Of All-Time)” by internet poll conducted by the Ultimate Estate Planner in March of 2024. He can be reached at 702-341-6000, ext. 2 or soshins@oshins.com. His law firm’s website is www.oshins.com