In the world of estate planning, you may come across the acronym HEMS from time to time. HEMS stands for “health, education, maintenance, or support” and is frequently included in trust agreements to guide a trustee on the types of distributions they may make to a trust beneficiary. When a trustee is limited to this type of distribution standard, often called an ascertainable standard, they must ensure that whatever they distribute to the beneficiaries falls within one of the four categories. Failure to do so can have a variety of negative results, including tax consequences and loss of asset protection.
Why Use the HEMS Standard in Trusts?
Tax Purposes
One important reason the HEMS standard is frequently used in trusts is that, from a tax perspective, if a trust beneficiary is also the trustee, the HEMS standard prevents the value of the accounts and property in the trust from being included in the beneficiary’s gross estate for federal estate tax purposes.[1] Likewise, if a trustmaker has created a trust to transfer accounts and property out of their taxable estate but also wants to act as a trustee to make distributions to the other trust beneficiaries, the HEMS standard, if included, prevents the trust’s property from being included in the trustmaker’s taxable estate.[2] The HEMS standard is an Internal Revenue Service (IRS) safe harbor rule and can prevent the property in the trust from being subject to estate taxes at the death of the beneficiary or the trustmaker, respectively.
Asset Protection
Another very important reason to use a HEMS distribution standard in trusts is that, when combined with a spendthrift provision, it can prevent a beneficiary’s creditors from obtaining trust property by filing a lawsuit against the beneficiary. By legally limiting the purposes for which the trustee can make distributions to the beneficiary, the trustmaker has built important asset protection features into the trust.
For example, if a beneficiary were being sued and the opposing party demanded that the trustee or beneficiary use trust property to pay the lawsuit judgment, the beneficiary and the trustee could both truthfully refuse because the trust clearly does not allow distributions for that purpose. In other words, a trustee would have a very hard time trying to include payments to a beneficiary’s creditors in the standard of allowable distributions for the beneficiary’s “health, education, maintenance, or support.” And because the trustee has a fiduciary responsibility to the trust beneficiary and not to the beneficiary’s creditors, the HEMS standard becomes a very effective tool to prevent lawsuit plaintiffs and creditors from reaching the trust property. This effect is generally true even if the trustee and the beneficiary are the same person.[3]
Practical Application of HEMS
“What exactly fits within the standard?” is a common question among trustees making trust distributions that are limited to the HEMS standard. Unfortunately, there is no clear bright-line definition of what fits and what does not. Such ambiguity, while frustrating, also allows enough flexibility that a trustee has some discretion to do what is in the beneficiary’s best interest. Following are some examples of the types of expenses that the HEMS standards might include:[4]
Health
● eye care, glasses, contact lenses, vision correction surgery
● allergen cleaning services
● cosmetic surgeries
● alternative medical treatments (e.g., acupuncture, massage therapy, etc.)
● substance abuse rehabilitation programs
● extended vacations or retreats to improve mental health
● health-related home improvements or renovations
● home healthcare or long-term care expenses
● gym, spa, golf club memberships
● exercise equipment
● healthcare supplements
● psychiatric treatments
● handicap-related transport and mobility services and items
● regular healthcare checkups and exams
● emergency and regular medical treatment
● healthcare, dental, vision insurance premiums
● mental health counseling
Education
● tuition for all levels of public or private schools
● graduate or professional degrees including medical school, law school, etc.
● study-abroad programs and related travel expenses
● a beneficiary’s support between semesters or during unpaid internships
● school-related expenses including room, board, books, computer, etc.
● private tutoring
● extracurricular-activity related expenses
● graduation costs, proms, class rings, announcements, robes, etc.
● career training
● daycare for dependents to allow a parent time to attend classes and study
● uniforms and school clothes
Maintenance and Support
● rent or mortgage payments
● down payment on a home
● living expenses and support for a beneficiary engaged in charitable work or low-income vocations that provide social and community benefits
● insurance premiums including life, auto, disability, or homeowner’s policies
● vehicles and related repairs and maintenance
● charitable contributions
● continuation of family gifting for birthdays, weddings, holidays, baby showers, etc.
● property taxes
● legal fees
● supporting family members
● continuation of typical and periodic vacations
● home repair and maintenance
● seed money to start a business
Again, it is important to remember that the examples above are only some of the expenses that can commonly be justified under the HEMS standard. A trustee must exercise some judiciousness when making distributions to demonstrate to potential lawsuit plaintiffs, judges, and the IRS that the HEMS standard is in fact preventing the beneficiary from having complete control over the trust property.
For example, if the trustee distributes enough money for the beneficiary to purchase and drive a Ferrari when the beneficiary normally drives a Toyota, or to take a six-month vacation to Greece each year instead of the typical one week at Disney World that the beneficiary and their family are accustomed to, the trustee may be putting the trust’s tax and asset protection properties at risk by disregarding its terms.
The HEMS standard is widely used in drafting trusts for good reason. Used properly, not only can it be a powerful and effective tool to reduce the risk of unnecessary taxation at each generation as wealth passes through the family, but it can also protect trust property from people who should not have access to it, such as creditors, divorcing spouses, and predators.
If you have questions about what qualifies as an appropriate distribution under the HEMS standard, please reach out to us. We have the experience and knowledge to guide you through these consequential decisions.
[1] Treas. Reg. § 20.2041-1(c)(2). [2] Christian S. Kelso, But What’s an Ascertainable Standard? Clarifying HEMS Distribution Standards and Other Fiduciary Considerations for Trustees 6, Independent Trustee Alliance Conference (May 13, 2021) https://www.trusteealliance.com/wp-content/uploads/Paper-HEMS-and-Fiduciary-Duties-2021-ITA-Conference.pdf. [3] Id. at 7. [4] Id. at app. A.