Jack and Leticia are establishing a trust. They would like to help their son, Jack Jr., through college but want to retain control of their financial help. Jack Jr. is not known for his financial aptitude. He regularly blows through his allowance and is caught short-handed when it is time to pay his bills.

Jack and Leticia have met with their estate attorney and want to include health, education, maintenance, and support for Jack Jr, but want him to earn his spending money on his own. Accordingly, their estate attorney has written their trust documents to specify that any financial support provided to Jack Jr. through the trust must fall into one of these four categories. When a trustee is limited to this type of distribution standard, often called an ascertainable standard, failure to do so can have significant negative consequences regarding taxes and loss of asset protection.

The Potential Benefits of the HEMS standard in Trusts

Tax Benefits

The HEMS standard is frequently used in trust for its potential tax benefits. The HEMS standard is important when the trust beneficiary is also the trustee or if a trustmaker has created a trust to transfer accounts and property out of their taxable estate into the trust while still acting as the trustee of the trust. It prevents the value of the accounts and property in the trust from being included when calculating the beneficiary’s gross estate for federal tax purposes. The HEMS standard is an Internal Revenue Standard (IRS) safe harbor rule, which can prevent the property in the trust from being subject to estate taxes upon the death of the beneficiary or the trustmaker in the two scenarios described above.

Asset Protection

The HEMS distribution standard, when combined with the spendthrift provision, can prevent a beneficiary’s creditors from suing the beneficiary to obtain trust property. By legally limiting the purposes for which trust distributions can be made, Jack and Leticia have asset protection features as part of their trust agreement.

For example, if Jack Jr. were to get into an automobile accident while intoxicated and then be sued, Jack Jr. and his parents could truthfully refuse any demands to use trust property to pay the lawsuit judgment because the trust does not allow trust distributions that do not meet the HEMS standard. The trustee has a fiduciary responsibility to the trust beneficiary, Jack Jr., not to his creditors. This responsibility makes the HEMS standard a powerful tool to prevent plaintiffs and creditors from reaching the trust property. This rule holds even if the trustee and the beneficiary are the same person.

What Purposes Fit the HEMS Standard?

There is no definitive list of purposes that fit the HEMS standard, which may be frustrating for those looking for clear-cut guidelines. On the other hand, having some ambiguity in the guidelines provides some flexibility. The trustee can use this flexibility to do what is in the beneficiary’s best interest.

Here are some examples of the types of expenses that might fit in each category of the HEMS guidelines.

Health

• Health, dental and vision insurance
• Conventional and unconventional medical treatment
• Routine healthcare exams
• Emergency medical treatment
• Routine medical treatment
• Extended vacations to relieve tension and stress
• Lasix surgery
• Psychiatric treatment
• Dental care and orthodontics
• Golf club memberships
• Gym or spa memberships
• Eyecare
• Handicap transport
• Specialized cleaning services to remove allergens
• Rehab for physical injuries
• Rehab for alcoholism
• Health-related home renovations
• Cosmetic surgery
• Home health care

Education

• Daycare
• Grammar, secondary, and high school tuition
• Uniforms and school clothes
• Career training
• Study abroad
• Support of a beneficiary while in school or between semesters
• Tutoring
• Speech or language therapy
• Graduation, prom, and class ring costs
• Support of beneficiary between semesters
• Medical, law, or other professional schools
• Study abroad programs for college
• Long-term studies
• Extracurricular activity fees and expenses
• Technical school training
• Room and board

Maintenance and Support

• Rent or mortgage payments
• Automobiles
• Down payment on a home
• Property, casualty, and liability insurance
• Life insurance
• Charitable giving
• Property taxes
• Support for a beneficiary engaged in charitable endeavors
• Support for family members
• Money to start a business
• Legal fees
• Continuation of accustomed patterns of vacations

This list is incomplete. The most important thing to consider is that the trustee must be able to demonstrate to potential lawsuit plaintiffs, judges, and the IRS that they were judicious in their distributions and are using the HEMS standard to prevent the beneficiary from having complete control over the trust money and property.

If the trust money is distributed to the beneficiary in a way that contradicts past buying patterns, the trustee may be putting the trust’s tax and asset protection properties at risk.

The HEMS standard is widely used when drafting trust documents because of its effectiveness as a tax and asset protection tool. Used properly, it can protect a family from unnecessary taxation as assets in the trust are passed from generation to generation. It can also protect trust property from people who should not have access to it, such as creditors, divorcing spouses, or predators.

If you have questions about trusts and the HEMS standard, we welcome your call.

You can schedule a call with us or reach us directly at 855.631.3457 to learn more about how best to plan today to protect those most important to you.