POWERS OF APPOINTMENT
Powers of appointment are the lifeblood of trusts’ adaptability over time. A power of appointment is a power one person has to designate who will take property subject to the power or what shares the takers will receive. See Restatement (Second) of Prop. § 11.1. A trustee’s powers to allocate income among various beneficiaries or to invade the trust principal on someone’s behalf are powers of appointment. This chapter concerns powers individuals have to allocate the shares of a trust long after it was created.
A. Postponed Decisionmaking
Powers of appointment are useful because they can buy time. Suppose Edna wants to set up a trust for her son, James, a young adult without children. She might give James the trust income for his life, with the principal distributed equally among his (yet unborn) children at James’ death. The problem is that Edna cannot know if James will have children, or how many, or what their needs will be by the time James dies. Rather than arbitrarily fixing the shares ahead of time, Edna instead could give James (or someone else) a power of appointment to identify who should take the trust principal, and in what shares. By creating a power of appointment, Edna can keep her trust adaptable to changed circumstances.
B. The Players
The donor is the person who creates the power. The person who gets the power is called the donee. The donee can give the property only to people the donor identifies as objects of the power, which may or may not include the donee. If the donee exercises the power, the recipient is called an appointee. To the extent the donee does not exercise the power, the property goes to a taker in default, if the donor so provided. The same person may assume several roles.
C. Classification of Powers
1. Permissible Donees
The breadth of the class of objects is one criteria for dividing powers:
· A general power is one in which a donee can give the property to himself, his creditors, his estate, or creditors of his estate.
· A special power is one in which a donee is limited to a particular class of objects.
· A hybrid power (usually created for tax savings) is one that can be exercised to benefit anyone except the donee, his creditor, his estate, or its creditors.
Lawyers and courts usually refer to either “general” or “special” powers. In most situations, “general” probably means a power exercisable in favor of the donee, his estate, his creditors, or the creditors of his estate. If the question involves tax, “special” probably means “not general.” If the question does not involve tax, “special” means “for a limited class of objects” (excluding the donee, the donee’s creditors, the donee’s estate or creditors of the donee’s estate as class members).
2. Method of Exercise
Powers are also classified by how and when they can be exercised:
· Inter vivos powers are ones exercisable by a deed during the donee’s lifetime
· Testamentary powers are exercisable by a will at death
These two basic lines of division overlap. We can have general inter vivos powers and special inter vivos powers. We can also have general testamentary powers and special testamentary powers.
D. Estate Tax Treatment
The details can get very complex, but the general principles are straightforward. If a donee dies holding a general power of appointment, the property subject to that power will be included in the donee’s gross estate for tax purposes. Property subject to a special power will not suffer the same fate. I.R.C. § 2041.
E. Who Owns the Property?
Traditionally, the law viewed a donee of a power almost as an agent of the donor, who retained ownership of the property until the donee exercised the power. Under this view, the exercise of the power then relates back to the power’s creation, so the exercise fills in blanks which had been left in the document creating the power. The appointee thus gets the property from the donor, not the donee. Because the property subject to the power was not the donee’s, claimants against the donee came away empty-handed. See Quinn v. Tuttle, 177 A.2d 391 (N.H. 1962).
The relation-back theory makes sense in the context of a special power. Because the donee cannot appoint the property to herself, the property is not in any practical sense hers.
2. General Powers
Because the donee of a general power is only a paper-thin line away from absolute ownership, however, treating the property as the donor’s, and thus not subject to claims against the donee, is hard to justify.
The law is split. Property subject to general powers is part of the donee’s gross estate under the federal estate tax. I.R.C. § 2041(a). In many states, however, creditors of the donee of a general, presently exercisable power cannot force the donee to exercise the power in their behalf. See Restatement (Second) of Property § 13.2. Several state statutes and UTC § 505(b) have reversed the rule so creditors can to get the appointive property after they have exhausted the donee’s property.
3. Choice of Law
Because donors and donees often live in different places, choice of law issues are often critical to powers of appointment cases. For example, disputes may arise about whether the donee of a general power properly exercised the power. The relation-back doctrine, which views the donee as merely filling in blanks in the donor’s document, leads to the traditional view that the law of the donor’s domicile controls. See Beals v. State St. Bank & Trust Co., 326 N.E.2d 896 (Mass. 1975). A less doctrinaire approach recognizes, however, that the donee’s will is likely to be drafted with the law of the donee’s domicile in mind, so the donee’s law should control questions surrounding the adequacy of the exercise. See White v. United States, 680 F.2d 1156, 1160 (7th Cir. 1982).
A careful draft of the document creating a power of appointment can avoid many of the problems which can arise when a donee executes the power. Sadly, testators sometimes say something like “to my son, Keoka, for life, and at his death to his executors.” From the context it is clear that the executors are not meant to take a remainder in their personal capacities, but guessing at what the testator really intended can be difficult. Compare In re Thompson’s Estate, 80 N.Y.S.2d 1 (N.Y. App. 1948), with Bredin v. Wilmington Trust Co., 216 A.2d 685 (Del. Ch. 1965). Powers are wonderful tools, but like most tools, you should treat them with respect.
A. Getting It Done
The first step for someone about to exercise a power of appointment is to check carefully the document creating the power. It can (and should) specify not only who has the power, but the steps the donee must take to exercise it. Failure to follow the instructions probably means failure of the attempted exercise. See Catch v. Phillips, 86 Cal. Rptr. 2d 584 (Cal. App. Ct. 1999).
Among the most common problems involving powers of appointment is whether a residuary clause in a donee’s will exercises a power. The will may use general, “all of my property” language, or a “blending” clause like “including all property over which I have a power of appointment.” Sometimes a donee’s residuary clause refers to “the rest of my property,” but does not mention the power of appointment in question. Courts reach a variety of conclusions. See Beals v. State Street Bank & Trust Company, 326 N.E.2d 896 (Mass. 1975). Under UPC § 2-608, a general residuary clause, without more, will not exercise a power.
B. Problems of Scope
1. General Powers
The donee of a general, presently exercisable power can use the power to create new property interests just as if she owned in fee simple the property subject to the power. The same rule applies, although perhaps somewhat less universally, to general testamentary powers. Restatement (Second) of Property § 19.1.
2. Special Powers
The most common approach to interpreting special powers is that a donee has the power to create whatever interests she desires, except as the donor has restricted that use. Because special powers limit donees’ choices of appointees, however, some courts have viewed special powers as somehow smaller than general powers in other respects as well. For example, in Loring v. Karri-Davies, 357 N.E.2d 11 (Mass. 1976), the holder of two special powers was not allowed to exercise them to create trusts for the appointees.
A special power can be either exclusive or nonexclusive. “Exclusive” means having the power to exclude some of the objects of the power in favor of others. Courts disagree as to whether a donee should be presumed to have the power to exclude. See Harlan v. Citizens National Bank of Danville, 251 S.W.2d 284 (Ky. 1952). If a special power is nonexclusive, the donee must give each object something. Courts disagree about whether each object must get a substantial part of the assets subject to the power or whether nominal gifts to some will do.
C. Failure to Appoint
Well-drafted powers of appointment include takers in default. To the extent that the power is unexercised, they usually will take the appointive property. Sometimes, however, a donor will not name takers in default, or the takers in default will be unable take the property, or the donee will indicate a desire to claim the property for herself if the appointment fails.
1. General Powers
An unexercised general power simply leaves the property where it was, in the hands of the donor.
An ineffective exercise of a general power, however, raises the question of whether the donee intended to assume control over the property for more than the limited purpose of exercising the power. If so, the donee may have “captured” the property for his own estate. See Talbot v. Riggs, 191 N.E. 360 (Mass. 1934). Commentators have identified four factors that may convince a court that a donee intended to capture the property:
· a blending clause
· a residuary clause that is presumed to exercise a power
· a residuary clause revealing an intent to exercise the power because the donee’s estate would otherwise be insufficient to satisfy the donee’s gifts
· an appointment in trust.
2. Special Powers
If there are no takers in default, the property of an unexercised special power usually will go equally to the objects of the power, rather than return to the donor. Some courts imply a gift in default to the objects. See Loring v. Marshall, 484 N.E.2d 1315 (Mass. 1985). Others say the donee has a “power in trust,” sometimes called “an imperative power,” with a duty to exercise the power. See Daniel v. Brown, 159 S.E. 209 (Va. 1931).
Careful drafting can avoid most of the problems discussed in this chapter. For an example, see the form (and commentary) on text pages 228-229.