This is a little bit of inside baseball for the pointy-headed trust aficionados among you. We draft tons of trusts. Domestic trusts. Foreign trusts. Revocable and irrevocable. There is plenty of stuff in a trust that is non-obvious, both in the trust language and the tax implications of what you do after the trust is written. Here’s one instance where you can create an accidentally taxable gift when you’re not intending to.
Limited powers of appointments are provisions in a trust that give someone other than the trustee a power to take trust property and give it to someone.
For example, Dad sets up a trust for the benefit of Daughter. The money is in the trust for Daughter, but if she wants she can exercise this limited power of appointment and cause the trust to give the money to someone else instead.
Why do this? Flexibility. What Dad decides to do in 2009 might be not so useful in 2045 — economic or family circumstances might have made this trust obsolete. Daughter has the ability to decant the money out of the trust and into the hands of humans — or into a new trust — by using the limited power of appointment.
We here out on the wild and desolate prairies of Pasadena like limited powers of appointment. They can be exceedingly useful.
But they also create tax problem. Gift tax problems. For Daughter.
Moral of the story? (1) Drafting a trust isn’t a boilerplate game; and (2) exercising a limited power of appointment should be done only with eyes wide open.