FINANCIAL DISCLOSURE

MEMBER OF THE COMMISSION ON ETHICS
DISCLOSING TRUSTS ON CE FORM 6

To: Laird A. Lile, Commissioner (Naples)

SUMMARY:

A Form 6 filer who is the beneficiary of a trust is not required to disclose their beneficial interest in that trust as an asset when there is a legal instrument that prevents them from selling, borrowing against, or otherwise alienating their beneficial interest. Guidance is also provided regarding the disclosure of a grantor's interest in a particular trust. Referenced are CEO 74-3, CEO 78-1, CEO 78-37, CEO 78-95, CEO 83-3, CEO 87-84, CEO 89-5, CEO 04-8, CEO 12-10, and CEO 14-18.

QUESTION 1:

Is a filer required to disclose his beneficial interest in a trust when the trust has a spendthrift clause that prevents him from borrowing against trust property and income or from otherwise alienating his interest in the trust?

This question is answered in the negative.

You are a recently-appointed Commissioner of the State of Florida Commission on Ethics. As a result of a recent change in the law, the members of the Commission on Ethics will be required to file CE Form 6, "Full and Public Disclosure of Financial Interests," beginning on January 1, 2024. § 112.3144(1)(e), Fla. Stat. (2023); Ch. 2023-049, § 3, Laws of Fla.¹

You explain that you are the beneficiary of a trust and that the trust has a spendthrift clause. The spendthrift clause operates to prevent you from accessing the trust corpus and from selling or otherwise alienating your beneficial interest or a portion of your beneficial interest. You express difficulty in assigning a value to such an interest given that you have no ability to market it. According to you, the trust instrument empowers the trustee, who is not you, to make distributions to the beneficiaries and, can act to make distributions that satisfy the debts of the beneficiaries. With that background, you ask whether such a beneficial interest in a trust must be disclosed and, if so, how to valuate it.

Article II, Section 8(j)(1), Florida Constitution, requires all Form 6 filers to disclose all assets valued in excess of $1,000. The Commission has consistently opined that, in the contexts of both CE Form 6 and CE Form 1, an asset is anything that can be sold, alienated, or otherwise made available to settle debts. See, e.g., CEO 78-1, CEO 78-95, CEO 87-84, CEO 89-5, CEO 12-10, and CEO 14-18.

We have had but few opportunities to opine on the application of the financial disclosure requirements to various holdings in trusts. We first examined the disclosure of beneficial interests in trusts as assets in CEO 78-1, where we found that a filer's beneficial interest in a testamentary trust was an asset requiring disclosure if its value exceeded the disclosure threshold. In that opinion, we recognized the difficulty the filer might have in valuating the beneficial interest, given "the lack of an established market for such interests," but because the interest was technically marketable, we proposed the filer employ valuation methods in the federal regulations for estate and gift taxation. We confirmed our view that a beneficial interest in a trust is an asset in CEO 83-3, when we examined a filer's interest as a life beneficiary in real property owned by two family trusts. Once again, we advised the filer to apply the applicable guidelines of the Department of the Treasury to valuate the beneficial interest. We have not had the opportunity since then to opine on the disclosure of beneficial interests in trusts.²

The situation you present, however, is distinguishable from CEO 78-1 and CEO 83-3. While the interests held by the filers in those opinion requests were difficult to valuate due to a scarcity of buyers and "the lack of an established market for such interests," they were technically marketable. You, on the other hand, are not legally capable of marketing your beneficial interest. According to you, a spendthrift clause in the trust instrument operates to prevent you from alienating your rights to future distributions from the trust. Because you do not have a legal right to sell, borrow against, or otherwise alienate your beneficial interest in the trust, your beneficial interest in the particular trust with the spendthrift clause is not an asset and, therefore, is not subject to disclosure on CE Form 6 as an asset.³

The ability of the trustee to make distributions to settle the debts of the beneficiaries will not cause this trust to be your asset for purposes of CE Form 6. The trustee, who acts as a custodian of a trust and in accordance with any instructions provided in the trust instrument, makes these determinations alone and we have never said that the assets of another, if used to settle a filer's debts, will be considered to be the filer's assets, though it would very likely be considered to be income to the filer.

The trust with the spendthrift clause, however, may still be subject to disclosure as a primary source of income on your financial disclosure form. You will be required to disclose the trust as a primary source of income if (1) you receive distributions from the trust that constitute "gross income" for purposes of filing your federal income tax return and (2) the amount of gross income you received from the trust exceeds the applicable disclosure threshold, which, in 2024 (for disclosing the 2023 year) is $1,000 for CE Form 6 and $2,500 for CE Form 1.

Question 1 is answered accordingly.

QUESTION 2:

Is a filer who is the grantor of an intentionally defective grantor trust required to disclose the trust as a primary source of income when the filer is responsible for paying income taxes due from income earned from trust property?

This question is answered in as follows.

You inform us that you are the grantor of a different trust. You are not a beneficiary of this other trust. Of note, you explain that the trust is an intentionally defective grantor trust (IDGT). You ask whether you will be required to disclose the trust as a primary source of income if you pay income taxes due from income earned from trust property.

To understand what an intentionally defective grantor trust is, one must understand how income derived from trust property is taxed. In the typical case, a grantor establishes a trust and, when the trust is established such that the grantor no longer retains the power to control or direct the trust's income or assets, the trust, rather than the grantor, is responsible for paying taxes owed on income derived from trust property. When, however, a trust is set up in such a way that the grantor may exhibit control over the trust's income or assets, the Internal Revenue Service (IRS) refers to that as a "grantor trust," which is a designation indicating that the trust is ignored as a separate legal entity and the grantor becomes responsible for income taxes derived from trust property. 26 U.S.C. § § 671-679. By paying the income taxes of the IDGT, the grantor can enable the trust to retain the income its property had earned, thereby growing the future distributions to the beneficiaries, and because tax payment is not taxed as a gift to the beneficiaries, though it is really for their benefit, it is more efficient for a grantor to pay the trust's income taxes than to gift the same amount of money to the beneficiaries. For that reason, grantors might intentionally establish a trust that fails to protect them from income tax liability (a grantor trust), hence the name "intentionally defective grantor trust."

There are several common defects that grantors might employ in a trust to establish an IDGT. Most commonly, an IDGT can be established if a provision is added to the trust instrument allowing: (1) the grantor or a nonadverse trustee to have the power to add beneficiaries to the trust; (2) a nonadverse party to have the power to appoint trust income or principal during the grantor's lifetime; (3) the grantor or a nonadverse trustee to apply trust income to the payment of premiums for life insurance for the grantor or the grantor's spouse; (4) the grantor to have the right to acquire trust property by substituting assets of equivalent value; or (5) the grantor to have the right to borrow from the trust without proper interest or security. Michael V. Bourland, Estate Planning for the Family Business Owner, CV004 ALI-ABA 21 (July 10 - 12, 2013).

You inform us that, as a grantor, you established an IDGT that has been rendered a grantor trust by the inclusion of a provision in the trust instrument that allows you, as the grantor, to substitute assets of equivalent value from the trust. You explained to Commission staff that this essentially affords you the opportunity, before your demise, to swap high-basis property into the trust for low-basis property—probably cash—to achieve a favorable tax outcome for the beneficiaries. Although the trust instrument grants you the right to perform these asset substitutions, you have not availed yourself of the option and do not plan to use it in the near future; you have included it to create the defect in the trust so that you become responsible for the income tax liability derived from trust property.

To make a proper disclosure of their income, Form 6 filers are required to disclose "each separate source and amount of income which exceeds $1,000." Article II, Section 8(j)(1)b., Florida Constitution. In the instructions for the 2023 CE Form 6,⁴ which are promulgated through rulemaking, explain:

"Income" means the same as "gross income" for federal income tax purposes, even if the income is not actually taxable, such as interest on tax-free bonds. Examples of income include: compensation for services, gross income from business, gains from property dealings, interest, rents, dividends, pensions, IRA distributions, distributive share of partnership gross income, and alimony if it is considered gross income under federal law, but not child support. Where income is derived from a business activity you should report the income to you, as calculated for income tax purposes, rather than the income to the business.

(Emphasis added.) Similarly, in CEO 04-8, we considered the request of a member of the Legislature (Form 6 filer) who sought to report his income where he had declined to accept the salary from his private employment during the days he spent engaged in legislative session and district duties. We informed him that "the correct manner in which to report income on the Form 6 is the same way it is reported it to the IRS, i.e., the gross income actually received, rather than the position's annual salary." (Emphasis added.)

Your scenario, however, is distinguishable from CEO 04-8. In CEO 04-8, the gross income reported to the IRS was representative of the gross income the filer actually received. For you, however, the gross income you will report to the IRS (which will include the tax liability derived from the property of the grantor trust) is not representative of the gross income you actually received. Although you are responsible for the tax liability associated with the gross income of the IDGT as the grantor of a grantor trust, you have not actually received, will not receive, and are not entitled to any of the income earned by the trust.

As we have said before, "[t]he intent of the [f]inancial [d]isclosure [laws] is to make the public aware of instances where a conflict of interest might arise between a public duty and a private business transaction or professional activity." CEO 74-3. We do not see how your disclosure of this IDGT as a primary source of income would serve that purpose, given that it is not, in reality, providing any income to you and you are not entitled to any income from it.

We distinguish the particular IDGT you describe from a typical limited liability company (LLC), the gross income of which passes through to the LLC members for purposes of taxation. While an LLC can retain or disburse to its members the income it earns, the actual income from the IDGT you describe will never enrich you personally.

A review of the different methods of creating a grantor trust makes obvious that some allow the grantor the option of accessing the income, for example, to effectuate interest-free borrowing without security or to purchase life insurance for the grantor and the grantor's spouse. In those instances, where the defect in the IDGT allows the grantor to access the income for which he or she is paying the income tax, the gross income should be disclosed as a primary source of income.⁵ In your situation, where you are not able to access the trust income and where you have no ability to direct the use of the trust's income, we find that you are not required to disclose the gross income associated with this specific IDGT as a primary source of income. In conclusion, you are not required to disclose the particular IDGT you describe as a primary source of income or as an asset. If you establish other IDGTs and render the trust as a grantor trust by some other method, please contact Commission staff for further ethics guidance.

Question 2 is answered accordingly.

ORDERED by the State of Florida Commission on Ethics meeting in public session on December 1, 2023, and RENDERED this 6th day of December, 2023.

____________________________________

Ashley Lukis, Chair

^[1] Under this same change in the law, mayors and elected municipal officers also will be required to file CE Form 6, "Full and Public Disclosure of Financial Interests," beginning January 1, 2024.