Bar News - July 19, 2017
More Power to You: A Quick Look at Powers of Appointment and Powers of Attorney
By: Nina T. Dow
Powers of appointment can be particularly elusive and rich with nuance.
Recognizing a power of appointment in a set of documents can be tricky. A Boston University law professor attempted to convey this point during a class in 2012 when she held up a sample trust agreement, shook it with fervor and exclaimed, “Powers of appointment are not going to introduce themselves in documents and say, ‘Hi, I am here! I am a power of appointment!’” These powers seem to chameleon their way into wills and trusts and apparently, powers of attorney. But can a power of attorney really create a power of appointment?
First, a bit of background may be helpful.
As trust and estate lawyers know, a power of appointment is not true ownership of an asset; it is a power to grant ownership to someone else. Imagine that Robert owns an “abbey.” In Robert’s will or trust, Robert gives Henry a power of appointment over Robert’s home when Robert dies. Robert has given Henry a general power of appointment. That means that at Robert’s death, Henry does not own the property, but has a power to “appoint” the property to anyone, including Henry himself.
There are two types of powers of appointment: general and non-general, or limited. Robert gave Henry a general power of appointment in this example, because the power, as drafted, allows Henry to appoint the property to anyone in the world, including Henry himself. A general power is specifically defined as a power to appoint to Henry, Henry’s estate, Henry’s creditors, or to the creditors of Henry’s estate. If a power is drafted to include any one of these four recipients, then the document is waving its general power flag. Furthermore, a power is limited if Robert and Henry must exercise the power in conjunction, which in simple terms means that Henry cannot exercise the power without Robert.
Continuing with our hypothetical, if a power of appointment is limited, Robert’s power of appointment would have indicated that Henry could appoint the abbey to a specific person, or to a class (Robert’s children, Mary and Edith, for example), and would exclude Henry, as well as his estate, creditors, and the creditors of his estate.
A general power carries tax implications for Henry’s estate at his death. The IRS views a general power as true ownership. If that party owns it, it is taxed on it. Because Robert gave Henry a general power, when Henry dies, his estate will include the value of the property subject to the power for estate tax purposes. Say that Robert’s house is valued at $1 million. In Massachusetts, an estate valued at $1 million or more may be subject to tax, or at the very least, will require filing a Massachusetts estate tax return. So these powers could have unintended tax implications for the grantee.
Recognizing General Powers in Other Documents
General powers are not usually revealed openly in documents. Drafters can create one unintentionally. For example, say Robert, in his trust, gives Mary a limited power. Robert is Mary’s parent. His trust indicates that Mary has the power to appoint Robert’s house to “any of my (Robert’s) descendants.” In this example, Mary holds a general power because she is one of Robert’s descendants. The “magic word” here is “descendant,” which includes Mary.
What about other estate planning documents where powers of appointment could make a cameo? How about powers of attorney? A power of attorney is a potent document. It allows A (the principal) to appoint another person B (attorney-in-fact) to act on A’s behalf, especially in the event of A’s incapacity.
Trust and estate attorneys have pondered whether, in a power of attorney document, drafters could be unwittingly granting general powers of appointment. Such an outcome could arise if the principal grants the attorney-in-fact the power to give gifts of the principal’s property on the principal’s behalf. If an attorney-in-fact has the power to gift to anyone – including him or herself – then the attorney-in-fact may have a general power over the principal’s assets. This means the value of the property will be included in the estate of the attorney-in-fact at his or her death and in the principal’s estate as well. Depending on the value of the property, estate tax liability could be triggered.
In many powers of attorney documents, the power to gift is limited precisely to keep general powers at bay. But are these types of limitations necessary? Although there appears to be no case law on point, the answer seemingly is no. To conduct this analysis, we must first define the legal relationship that arises when a power of attorney is executed and then examine examples of how statutes constrain the scope of powers of attorney in ways that makes the creation of general powers unlikely.
Under agency law, which governs the relationship between a principal and an attorney-in-fact, the attorney-in-fact necessarily acts in conjunction with the principal. Thus, the principal retains the power to revoke the relationship at any time. One way a non-general power, as explained above, exists is where the power is exercisable only in conjunction with the donor of the power, i.e., the principal. If an attorney-in-fact is acting in conjunction with the principal, and the principal can revoke the power at any time, no general power of appointment can arise.
The same result occurs when the principal is incapacitated. Under the law of agency, the agency relationship terminates if the principal is incapacitated, and because the principal is incapacitated, he cannot legally revoke the power of attorney. However, we now have statutes that fill the shoes of common law agency principles. The various statutes I have reviewed impose duties and court oversight over the attorney-in-fact, even when the principal is incapacitated. The effect of these statues is to tighten the leash the principal would have held on the attorney-in-fact under the law of agency, had the principal remained competent.
Powers of attorney are founded on the basis of an agent-principal relationship as described in the “Restatements of Agency.” When a true agent-principal relationship exists, the agent owes fiduciary duties to the principal.
The principal has the right to revoke the power of attorney. A non-general power of appointment is a power that “is not exercisable... except in conjunction with the creator of the power...,” according to IRC Section 2041(b)(1)(C). Based on this definition in the tax code, it is clear that if the principal grants a gifting power to the attorney-in-fact, no general power exists, because the principal and the attorney-in-fact are acting “in conjunction.”
What if the principal, i.e., the client, is incapacitated? The legal waters get murkier. Properly executed powers of attorney historically were terminated when the principal became incompetent. See Catherine Seal, Power of Attorney: Convenient Contract or Dangerous Document? (2010). A series of laws, namely the Uniform Probate Code and the Uniform Durable Power of Attorney Act, came to the rescue. They serve to keep a power of attorney effective notwithstanding incapacity and to offer alternatives to the cumbersome conservator/guardianship process. Of course, these are only uniform statutes; states retain discretion over whether to adopt all, most, or any of them.
With those developments, the law was graced by durable powers of attorney. Does that necessarily mean that an incapacitated principal does not act in conjunction with the attorney-in-fact and, therefore, that any gifting powers would result in a general power to the attorney-in-fact? Answering that question requires a dive into state provisions.
Take, for example, Massachusetts, which has adopted the Uniform Probate Code (MUPC). Section 5-503 of Massachusetts General Laws, Chapter 190B, provides that if a guardian or conservator is assigned to oversee the principal’s general affairs, the attorney-in-fact then must account to that fiduciary. Moreover, this new fiduciary may revoke the power of attorney on behalf of the original principal.
Florida’s take on durable powers is a bit more involved. The Sunshine State imposes additional duties regarding the principal’s estate plan, including consistency with the principal’s history of gift-making. An agent “[m]ust keep a record of all receipts, disbursements, and transactions made on behalf of the principal” and “[m]ust create and maintain an accurate inventory each time the agent accesses the principal’s safe-deposit box, if the power of attorney authorizes the agent to access the box.”
New Hampshire’s law, NH RSA 506:6, provides that gift-making powers granted to the attorney-in-fact must be expressly granted in the power itself or permitted by a court; it also provides that the gift must not leave the principal without sufficient assets. North Carolina’s statute also directly addresses the attorney-in-fact’s power to gift to himself. It exists so long as such power is consistent with the principal’s history of making gifts to the same agent.
Although traditional principles of agency law would sever a power of attorney when the principal is incompetent, some states have mended that break by enacting overriding statutes.
These laws were created to chaperone attorneys-in-fact who might abuse their power when a principal is incompetent by defining the parameters of gifting powers, imposing duties owed to the principal, and allowing a court’s power (through conservators and guardians) to monitor attorneys-in-fact when the incapacitated principal cannot.
Such an outcome is analogous to the relationship between a competent principal and his agent acting in conjunction under agency law where no general power can exist. If that is indeed the case, then the power to make gifts under durable powers of attorney would fall under the exception to a general power of appointment, because such powers would be “in conjunction” with the creator of the power pursuant to the tax code.
If all of this dense legal analysis doesn’t hit with the intended immediacy, perhaps a colleague’s observation will do the trick. He reminded me not to forget the purely practical and quipped: “If the IRS enforced general powers through powers of attorney, married couples could always get a step up in basis, and the Service would lose out on millions of dollars in capital gains!” Whether the argument is based on reverse logic or doctrinal sleuthing, general powers will continue to dazzle.
Nina T. Dow
Nina T. Dow is a trusts and estates attorney who has her own practice based in Boston and central Massachusetts. She focuses on estate and tax planning for domestic and international clients.