Powers of Appointment – An incredibly flexible estate planning tool

Share This Article

To cut to the chase, Power of Appointment means the power to declare who gets what, how much and when. “Power of appointment” is a term of art which is often misunderstood. Even lawyers, unless they are trust and estate practitioners, may initially think of the so-called “Appointments Clause” in the United States Constitution which gives the president the right to appoint public officials. In contrast, under the Probate Code, Power of Appointment refers to an older now largely forgotten meaning of the word appointment: agreement, declaration. This meaning is still implicit in the context of an agreed upon meeting.  More narrowly, the word appointment as used in law means “The act of declaring the destination of any specific property” (Oxford English Dictionary, 1989 ed.).

Even more specifically, the California Probate Code defines the term as follows: “Power of appointment” means a power that enables a powerholder acting in a nonfiduciary capacity to designate a recipient of an ownership interest in or another power of appointment over the appointive property. The term does not include a power of attorney.” CA Probate Code 610(f).

Let us look at an example: Anna creates a trust for the benefit of her child Bella for life. At Bella’s death the trust would terminate, and the remainder distributed according to the provisions of the trust instrument which usually cannot be changed. By giving Bella a power of appointment, more flexibility is possible. For example, the power of appointment could state that at Bella’s death the trust is terminated, but property will be distributed to such of Bella’s children in such proportions as Bella designates. This is a testamentary power of appointment because it can only be exercised through the provisions of a will. Powers of appointment can also be exercised in life (inter vivos). This makes powers of appointment an incredibly flexible estate planning tool.

Now we are prepared to fully understand the Probate Code definition above. “Appointive Property” means the property or interest in property that is the subject of the power of appointment. “Acting in a nonfiduciary capacity” means that the Power of Appointment is different from the powers held by a trustee in his or her capacity as trustee. For example, in a discretionary support trust the trustee controls the distributions to the beneficiary or beneficiaries but must do so in a fiduciary capacity and not for his or her own benefit. In contrast, a Power of Appointment is a power that can be exercised freely without regard to the constraints a fiduciary relationship may impose. Occasionally, a trustee may have fiduciary powers and a Power of Appointment at the same time. This may lead to counterintuitive results as illustrated in the following case, Tubbs v. Berkowitz 47 Cal.App.5th 548 (2020). The surviving husband had a dual role as trustee and holder of a power of appointment permitting the husband to allocate trust assets to himself while effectively divesting contingent beneficiaries, something he could not have done in a fiduciary capacity.

As per Probate Code definition of “Power of Appointment” the powerholder can, in addition to declaring who gets the appointive property now, create another power of appointment in somebody else.

The tax consequences of Powers of Appointment – General Versus Special Powers of Appointment

Powers of Appointment may or may not result in transfer tax consequences for the powerholder, i.e., the donee. Transfer taxes are gift and estate taxes. The Internal Revenue Service has divided all powers of appointment into two classes: general and special powers. General Powers are conceptually those that allow the donee to use the appointive property as if it was his or her own. Indeed, per IRS, a General Power is a power that is exercisable in favor of the donee, the donee ‘s estate, the donee’s creditors, or the creditors of the donee’s estate (the magic quartet) unless certain exceptions apply (see below). Special Powers are all other powers. Special powers do not have tax consequences.

Property subject to a General Power of Appointment held by the powerholder at death is included in the estate of the powerholder. The exercise or release of the general power of appointment during the powerholder’s lifetime is a transfer of the property subject to the power. Property subject to a General Power of Appointment is generally treated as owned by the powerholder for income tax purposes.

Mostly, but not always, drafters of estate plans try to avoid creating a General Power in order to avoid these tax consequences. This can be done by subjecting the power to the following conditions, closely following the IRS language, with the result that “such power shall not be deemed a general power of appointment” (26 U.S. Code § 2041). In substance these exceptions state.

  1. the power is limited by an ascertainable standard
  2. the powers held jointly with the creator of the power
  3. the power is held jointly with an adverse party

An ascertainable standard must be “reasonably measurable in terms of his needs for health, education, or support (or any combination of them.)” California has one of the so-called saving statutes that automatically interprets instruments with discretionary distributions as not being General Powers unless the instrument clearly indicates that a broader power is intended CA Probate Code 16081(c).

The unwary may still create General Powers that are not wanted and there are other details and exceptions. The reader should consult a Trust And Estates attorney when it comes to Powers of Appointment and other estate planning details.

We don’t spam! No more than five mailings per year.

More Articles

Schedule a free consultation with Klaus Gottlieb

© 2024 wealthcarelawyer.com. All rights reserved.

Wealth care is an orchestrated approach to your estate planning needs that considers multiple dimensions and coordination with your existing financial and tax professionals.