CPA as Client Trustee: Is the Compensation Worth the Liability?
By Christopher D. Carico
Published: WebCPA, July 28, 2009
The family CPA is often the best choice as successor trustee of the family trust.
As a group, CPAs are highly educated, detail oriented, tax-sensitive and cost conscious. Since a trustee’s duties include preparing an annual accounting, filing yearly tax returns, monitoring trust investments and determining distribution amounts to be given to beneficiaries, CPAs ordinarily possess all the needed skills. While it may make the most sense for the family members to select the CPA to act as successor trustee, the same may not be true for the CPA. Before saying “yes,” the CPA should have answers to the following questions:
- How will the trustee’s compensation be determined?
- What is the standard for trustee liability?
- Is there fiduciary liability insurance protecting the trustee from claims by beneficiaries?
How will the trustee’s compensation be determined?
The trustee’s compensation is ordinarily determined by the terms of the trust instrument. In certain instances, the trustee may petition the court for modification of trust provisions setting unreasonably low compensation. However, the court-ordered modification to the fee provision will generally apply prospectively and not retroactively.
If the compensation clause in the trust instrument sets an unreasonably low fee, then the CPA should request that the settlor modify the provision or refuse to accept the responsibility. If the trust is already irrevocable, then the CPA should insist that a beneficiary or other interested party (through legal counsel) petition the court for modification of the trustee compensation provision.
The CPA’s written acceptance of the office of trustee should be expressly contingent on the court’s approval of the petition modifying the compensation provision.
If the trust instrument is silent about the trustee’s compensation, then the trustee is generally entitled to “reasonable” compensation. California courts use the following eight factors in determining “reasonable compensation” for a fiduciary:
- The gross income of the trust estate;
- The success or failure of the administration of the trustee;
- Any unusual skill or experience that the trustees in question may have brought to their work;
- The fidelity or disloyalty displayed by the trustee;
- The amount of risk and responsibility assumed by the trustee;
- The time consumed by the trustee in carrying out the trust;
- The custom in the community as to allowances to trustees by settlors or courts, and as to charges exacted by trust companies and banks; and,
- The character of the work done in the course of administration, whether routine or involving skill and judgment.
In practice, trustees typically determine “reasonable” compensation based on either the actual time/hours spent on trust matters or as a percentage of the assets under management. Individuals, who are in the profession of administering trust, conservatorship and guardianship estates, referred to as private professional fiduciaries, use hourly rates ranging from $80 to $140 per hour.
Most CPAs would go out of business if they were paid based on such rates. Corporate trustees, including banks and trust companies, generally set their annual compensation at 0.8 to 1.25 percent per year of the asset value. The percentage is usually a sliding sale — the larger the portfolio, the lower the percentage of compensation.
These rates include most trust services (i.e., accounting, investments and tax preparation), with the exception of extraordinary work such as litigation or the sale of real property. Corporate trustees will generally accept estates only if they exceed a minimum value. Depending on the bank, the minimums range from $1 million to $5 million.
If the trust instrument is silent about how to determine the trustee’s fees, then the CPA acting as trustee may have difficulty justifying fees in excess of $140 per hour — the highest private professional fiduciary rate. The corporate trustee rates are only relevant when the CPA is providing the same level of service as the corporate trustee.
Most CPAs are uncomfortable (and rightly so) giving investment advice and will properly look to guidance from outside investment advisors. These advisors will need some form of compensation as well.
Banks and trust companies provide the investment advice as part of their ordinary fee. If the CPA wants to base the trustee’s fee on the “assets under management” approach used by corporate trustees, then the CPA may need to reduce his or her fee by the amount being paid to outside investment advisors.
Before agreeing to act as successor trustee, the CPA should ask to see a copy of the trust agreement and review the terms relating specifically to trustee compensation. If the trust agreement hasn’t been signed yet, or if it is subject to modification, then the CPA should ask the client to include a compensation provision, which entitles any CPA acting as trustee to be compensated based on the hourly rate normally charged by the CPA for tax work for other clients.
Ideally, the trust instrument will also be drafted to state that the trustee may hire outside investment advisors and that any compensation paid to outside investment advisors will not reduce the compensation payable to the trustee.
What is the standard for trustee liability?
Under the Probate Code, trustees owe administrative duties, investment duties and accounting duties to the beneficiaries, making them a fiduciary with respect to each beneficiary. Collectively, these fiduciary duties require that the trustee exercise the reasonable care, skill and caution of a prudent person in a like capacity. However, California law also requires that each trustee use his or her specialized skill to further the interests of the trust.
With their specialized training and experience, CPAs acting as trustees are likely to be held to a higher standard than the ordinary family member willing to serve as trustee. This is true even if the CPA elects to waive trustee compensation.
The trust instrument, if drafted correctly, can reduce the CPA’s exposure to liability. The Probate Code specifically permits the settlor (through the trust agreement) to lessen the standard of care placed upon the trustee. This type of clause is typically referred to as an “exculpatory clause” or “hold harmless clause.” It protects the trustee against acts of ordinary negligence. “Negligence” is simply acting below the standard of care for prudent trustees.
Since CPAs acting as trustees are held to the standard of a prudent CPA, acting below the standard of care is relatively easy to do. An exculpation clause will generally protect the trustee against mistakes and errors in judgment, unless they are intentional, grossly negligent or reckless.
The exculpation clause may read something like the following: “No Liability for Errors in Judgment. No individual Trustee shall be liable for errors in judgment or for what constitutes ordinary negligence. A Trustee shall only be liable for damages resulting from gross negligence, recklessness or an intentional wrongdoing.”
Is there fiduciary liability insurance protecting the trustee from claims by beneficiaries?
As part of their normal tax practice, CPAs will carry professional liability insurance to cover their errors and omissions. This doesn’t necessarily mean that their errors or omissions as trustees are also covered.
Professional liability policies vary from insurer to insurer and contract to contract. Some policies do not cover errors by the CPA acting in the capacity of trustee. Others may cover only those trustee errors that relate to services ordinarily performed by a CPA.
In short, the CPA acting as trustee may have coverage under the policy for a tax or accounting error, but not for a poor investment decision. If the CPA works for a larger firm, the firm may even prohibit the CPA from taking on the added liability of acting as trustee for a client.
Before accepting a trusteeship, a CPA would be wise to look into the possibility of purchasing separate professional liability insurance for errors and omissions committed in the capacity of trustee. However, this may be easier said than done. If available at all, this coverage is usually found under the category of “miscellaneous professional liability” through excess and surplus lines brokers, who have traditionally covered unusual risks. The premiums therefore may be quite high.
The Probate Code specifically permits the trustee to use trust funds to purchase liability insurance for the trustee, which covers actions against the trustee by “third persons.” It is silent about the ability to use trust funds to pay for insurance protecting the trustee against claims by beneficiaries. Without specific authorization in the trust agreement, purchasing insurance to protect the trustee against his or her own errors would violate the trustee’s duty to administer the trust solely in the interests of beneficiaries and to avoid conflicts of interest.
However, a provision in the trust agreement specifically authorizing the trustee to use trust funds to purchase fiduciary liability insurance would be enforceable. Before signing on, the CPA will want to be certain that the trust agreement clearly states that the premiums are not to be deducted from the compensation payable to the trustee. Otherwise, since the fiduciary liability insurance benefits the trustee, as opposed to the beneficiaries, the cost may be an offset against the trustee’s compensation.
Christopher D. Carico is a partner at Carico Glowacki Macdonald Kil & Benz LLP, a law firm based in El Segundo, Calif.
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