The Lawletter Vol 38 No 8
Jim Witt, Senior Attorney, National Legal Research Group
When Sopranos actor James Gandolfini died on June 19 of this year from a heart attack while he was on a vacation trip with his family in Italy, the media reported trivial facts surrounding his death, such as the details of his last meal and drinks. After a month or so had passed, however, attention turned to the details of Gandolfini's estate plan, with the focus on criticism of the plan. The plan became open to comment because Gandolfini had left a 17-page will, which, like every will, had to be filed in probate court, thereby making it public.
A general point of the criticism was that Gandolfini had left a $70 million probate estate, with only 20% of the bulk of the estate's value passing to his widow tax-free under the Internal
Revenue Code's unlimited marital deduction and 80% passing to his sisters and his infant daughter. This plan resulted in a federal estate tax liability of approximately $30 million.
Criticism of the plan can itself be questioned: (1) The belief that the estate is worth $70
million is speculative; (2) it may well be that Gandolfini had other substantial assets that he placed in estate planning devices such as trusts and corporations (which might serve as a receptacle for future royalties received by the estate from the Sopranos); it is believed that there is a $7 million life insurance trust fund for Gandolfini's 13-year-old son from a prior
marriage; and (3) it is unfair to criticize the disposition of an estate solely on the basis that the estate tax liability is not minimized: A decedent should not necessarily allow the objective of tax savings to have precedence over the disposition that he or she desires.
Yet some of the points of criticism made in regard to Gandolfini's estate plan are valid. First, there is the matter of privacy. If Gandolfini's assets had been placed in a revocable trust, with the trust spelling out the disposition of the assets at Gandolfini's death, the trust would not have been filed with the probate court and could have been kept private. A simple pour-over will could have been used to transfer assets not subject to the trust to the revocable trust.
Additionally, a tax calculation problem is created by the fact that the will, after bequeathing $1.6 million worth of assets to friends, used percentages to divide the estate among Gandolfini's widow, two sisters, and daughter. The problem is that because the 20% passing to the widow is not subject to federal estate tax, the calculation of the tax on the remaining 80% becomes complicated.
Also, the will does not include a trust to govern the disposition of the share of the estate that Gandolfini's daughter will receive. She is not to receive her share until age 21, but the prospect of having her receive a multimillion dollar sum outright at that age raises questions. A trust under the will could have protected her share by setting ages (such as 30, 35, and 40) at which she would receive percentages of the principal, with the trustee having discretion over the distribution of principal and income to her for her current needs.
Gandolfini also owned a home in Italy, and the will directed the ownership to be divided equally between his son and his daughter when the daughter turns 25. The will further expressed Gandolfini's wish that his children hold on to the home. According to an estate planning authority who deals with foreign properties, despite the devise in the will, Italian law
requires that the disposition of the property be one-half to the children and one-quarter to the surviving spouse, leaving Gandolfini the freedom to have disposed of only one-quarter of the property as he desired. The expert observed that an Italian lawyer should have been consulted, with the possibility that a separate Italian will might have been executed to cover the Italian property. Moreover, the will contained no provision establishing a fund for the upkeep of the Italian property. There is the possibility of friction as to the payment of the maintenance of property where it has been left to more than one party.
Gandolfini also owned a co-op in Manhattan, said to be worth $3.5 million. He put his son in a difficult position by giving him a right of first refusal to purchase the property at fair market value. Here is a 13-year-old boy, with a beneficial interest in $7 million in insurance proceeds, under pressure to have one-half of the value of the insurance trust fund spent in order to comply with his late father's wishes.
While the media may have become overexcited about the shortcomings of James Gandolfini's estate plan, there is clearly room for criticizing it.
The Lawletter Vol 38 No 7
Brad Pettit, Senior Attorney, National Legal Research Group
The courts of the various states are quite busy addressing issues that arise in the context of same-sex marriage. This activity will certainly increase, given the U.S. Supreme Court's recent ruling in United States v. Windsor, 133 S. Ct. 2675 (2013).
A recent decision by a New York State appellate court, while not relying on Windsor, is illustrative of the kinds of issues that can arise in administering the estate of a decedent who was involved in a same-sex marriage that was recognized in some states but not in others. In the case of In re Ranftle, 969 N.Y.S.2d 48 (App. Div. 2013), the court held that for purposes of probating the will of a deceased married person, the decedent's surviving same-sex spouse had met his burden of proof in showing that the deceased testator had changed his domicile from
Florida (does not recognize same-sex marriages) to New York (recognizes same-sex marriages) in the months prior to his death.
In reaching its decision, the Ranftle appellate court stated that "[w]e see no basis for disturbing the Surrogate's Court's finding that Ranftle changed his domicile to New York in the months before his death," id. at 51, even though the decedent's will contained a statement declaring that he was a resident of Florida. Rather than focusing solely on what the decedent's will said about the testator's residence, the probate and appellate courts in the Ranftle case both relied on New York's rules for determining the domicile of a decedent at the time of his or her death. The Ranftle court's ruling reads as follows:
The Surrogate's Court Procedure Act defines domicile as "[a] fixed, permanent and principal home to which a person wherever temporarily located always intends to return" (SCPA 103). "The determination of an individual's domicile is ordinarily based on conduct manifesting an intent to establish a permanent home with permanent associations in a given location" (Matter of Clute v. Chu, 106 A.D.2d 841, 843, 484 N.Y.S.2d 239 [3d Dept 1984]). A person's domicile is generally a mixed question of fact and law, which the court must determine after reviewing the pertinent evidence (see Matter of Brunner, 41 N.Y.2d 917, 918 ). No single factor is dispositive (Matter of Kartiganer v. Koenig, 194 A.D.2d 879, 881, 599 N.Y.S.2d 312 [3d Dept 1993]), and the unique facts and circumstances of each case must be considered (Ruderman v. Ruderman, 193 Misc. 85, 87, 82 N.Y.S.2d 479 [Sup Ct, N.Y. County 1948], affd, 275 A.D. 834, 89 N.Y.S.2d 894 [1st Dept 1949]). A party alleging a change of domicile has the burden of proving that change by clear and convincing evidence (Gletzer v. Harris, 51 A.D.3d 196, 199, 854 N.Y.S.2d 10 [1st Dept 2008], affd, 12 N.Y.3d 468 ).
We agree with the Surrogate that Leiby met his burden of proof as to the change of domicile. As noted, petitioner's scattered evidence that Ranftle remained a Florida domiciliary is overwhelmed by the large and consistent body of evidence showing that Ranftle moved back into the New York City apartment he shared with his husband with the intent of permanently remaining there, and that his change of domicile was motivated both by his grave illness and New York's recognition of same‑sex marriages.
It will be interesting to follow the evolving case law as to the rights of persons who enter into same-sex marriages. There is little doubt that cases like the Ranftle
decision will become more commonplace as long as there is a split among the states as to recognition of same-sex marriages.
The Lawletter Vol 38 No 6
Brad Pettit, Senior Attorney, National Legal Research Group
The so-called "innocent spouse relief" provisions of the Internal Revenue Code provide that if, upon
taking into account all the facts and circumstances, it is inequitable to hold the other individual liable for the deficiency in tax for such taxable year attributable to [the] understatement [of one of the joint filers], . . . then the other individual shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year to the extent such liability is attributable to such understatement.
26 U.S.C. § 6015(b)(1)(D) (Westlaw current through P.L. 113‑13 approved 6‑3‑13) (paragraphing omitted). Section 6015 goes on to say that if relief is not available to the other individual under subsection (b) (or (c)), "the Secretary may relieve such individual of such liability." Id. § 6015(f).
Currently, there is some confusion as to which of two administrative rulings by the Internal Revenue Service ("IRS") should be applied when evaluating whether a taxpayer qualifies for equitable innocent spouse relief under § 6015(f): IRS Notice 2012‑8, 2012‑4 I.R.B. 309; or Rev. Proc. 2003‑61, 2003‑2 C.B. 296. Both of these rulings by the IRS describe in detail the
procedures that must be followed and the standards that are to be applied in a case in which a taxpayer petitions the IRS for innocent spouse relief. However, according to at least three decisions by the U.S. Tax Court, the guidelines of Revenue Procedure 2003‑61 must be followed unless and until the recommended changes in the procedures and standards set forth in IRS Notice 2012‑8 are "finalized" via the issuance of a formal Revenue Procedure. Hudgins
v. Comm'r, T.C. Memo. 2012‑260, T.C.M. (RIA) ¶ 2012‑260, 2012 WL 3964890; Deihl v. Comm'r, T.C. Memo. 2012‑176, T.C.M. (RIA) ¶ 2012‑176, 2012 WL 2361518; Sriram v. Comm'r, T.C. Memo. 2012‑91, T.C.M. (RIA) ¶ 2012‑091, 2012 WL 1021315. Therefore, although IRS Notice 2012‑8 purportedly "superseded" Revenue Procedure 2003‑61, an attorney or accountant representing a taxpayer seeking innocent spouse relief under § 6015 is advised to consult with the IRS to make sure that both the client and the IRS are following the same guidelines and rules for determining whether the client is entitled to relief from joint and several liability under a jointly filed federal tax return.
A recent Chief Counsel Notice issued by the IRS provides insight as to what to expect when
litigating a case involving a married taxpayer's claim for so-called "innocent spouse" relief from joint and several liability on a joint federal income tax return. In IRS Chief Counsel Notice
("C.C.N.") CC‑2013‑011 (June 7, 2013), the IRS provided Chief Counsel attorneys with guidance regarding the standard and scope of review that the Tax Court applies when reviewing requests for relief from joint and several liability under § 6015(f) and litigation guidance for cases that involve claims for relief under § 6015. C.C.N. CC‑2013‑011 points out to all IRS attorneys that a de novo standard of review is applied in innocent spouse relief cases that are argued before the Tax Court:
In all section 6015(f) cases, the scope of review is de novo as provided in Porter v. Commissioner, 130 T.C. 115 (2008), and the standard of review is de novo as provided in Porter v. Commissioner, 132 T.C. 203 (2009). Chief Counsel attorneys should no longer argue that the Tax Court should review the Service's section 6015(f) determinations for abuse of discretion or that the court should limit its review to evidence in the administrative record. Although Chief Counsel attorneys are no longer required to preserve the standard and scope of review issues for appeal, they should continue to work with petitioners to stipulate to evidence in the administrative record that is relevant to the court's determination regarding section 6015 relief.
In sum, apart from the statutes, regulations, and case law that deal with innocent spouse relief from liability for federal tax, an attorney or accountant who advises a married taxpayer seeking relief from joint and several liability under a joint federal tax return should consult IRS Notice 2012‑8, Revenue Procedure 2003-61, and C.C.N. CC‑2013‑011 in order to know what to expect when arguing his or her client's case before the IRS or a court.
July 8, 2013
Jim Witt, Senior Attorney, National Legal Research Group
While the designation of beneficiaries and the requirements for changes thereto are normally spelled out in clear terms, complications can arise. In the North Carolina Court of Appeals case, Smith v. Marez, 719 S.E.2d 226 (N.C. Ct. App. 2011), a dispute arose over the proper disposition of the proceeds of two IRAs (a Rollover IRA and a Traditional IRA) owned by the decedent. The plaintiff, in her individual capacity and as executrix of the decedent's will, filed a complaint in a declaratory action against the defendants, alleging that the proceeds of the Rollover IRA had been properly distributed to her and that the proceeds of the Traditional IRA should have been distributed to her. The defendants, three of the decedent's children, contended that the proceeds from the two IRA accounts were the property of the decedent's estate and did not belong to the plaintiff. The defendants filed a counterclaim, asserting that the decedent had intended the two IRA accounts to go to them in the percentages set forth in his will or, in the alternative, that if the changes to his IRA beneficiary forms were not effective (directing that the IRA proceeds be distributed in accordance with his will, which included the defendants as beneficiaries), the IRA accounts should have been distributed pursuant to the original designation forms, which gave the defendants specific percentages.
In affirming the grant of the plaintiff's motion for summary judgment, the court of appeals found that, as per the record before it, the decedent had executed both IRAs in 2006, making beneficiary designations to the defendants in specific percentages. In 2007, after the decedent had been diagnosed with cancer, he executed his will, under which he bequeathed $100,000 to the plaintiff and the residue of his estate to the defendants in specific percentages, different from those in the IRAs. On the same day, the decedent executed new designation-of-beneficiary forms for the IRA accounts. In the space provided on each form, he directed that the proceeds of the accounts be distributed pursuant to his last will.
In December 2007, the decedent was informed that his cancer was terminal. He married the plaintiff on December 16, 2007 and died on February 29, 2008.
In reviewing the grant of the plaintiff's motion for summary judgment, the court applied New York law, the jurisdiction designated by the decedent on the IRAs. The court broke down its discussion into three categories: contract interpretation, doctrine of dependent relative revocation, and incorporation by reference.
The court's basic finding as to contract interpretation was that, given that there was no evidence that the custodian of the IRAs had waived strict compliance with the requirement of the IRAs that the beneficiary designations include information such as the beneficiary's name, date of birth, and Social Security number, the decedent's direction that the IRA proceeds be distributed in accordance with his will was not in accord with the beneficiary designation requirements; the court also found that the decedent's original designations of individual beneficiaries could not stand, because they had been explicitly revoked by the decedent on the change-of-beneficiary forms.
The court rejected the defendants' assertion of the doctrine of dependent relative revocation (under which, if a revocation of a beneficiary is proven to have been conditioned upon the validity of a subsequent designation, the revocation is found to be ineffective), because the application of the doctrine has been limited to wills.
Finally, the court rejected the application of incorporation by reference, because the decedent's reference in the IRA change-of-beneficiary forms to the document to be incorporated, the decedent's will, was insufficiently precise in that the general direction of payment of the proceeds pursuant to the will was not clear either as to which beneficiaries under the will were to share the proceeds or as to the amounts or percentages each was to receive.
The case thus stands as a warning to those executing IRAs, or trying to effect changes as to the beneficiaries of IRAs, to pay strict attention to requirements on the form as to the designation of beneficiaries. This is especially true where the intent is to distribute the IRA proceeds in accordance with a scheme of disposition under a will.
The Lawletter Vol 38 No 4
Jim Witt, Senior Attorney, National Legal Research Group
On Tuesday, October 23, 2012, the Court of Appeals of New York, in a 4‑3 decision, ruled that lap dances do not qualify for the same sales tax exemption as do other "dramatic or musical arts performances," such as a Madonna concert or a Broadway show. 677 New Loudon Corp. v. State Tax Appeals Tribunal, 979 N.E.2d 1121 (N.Y. 2012).
The court's ruling stemmed from a 2005 audit of the Nite Moves strip club in Latham, New York. After an investigation, the New York Tax Appeals Tribunal demanded $124,921, based on unpaid sales taxes on cover charges and "performance fees," which were construed to mean fees for private dances. The petitioner/appellant, the operator of an adult "juice bar," contended that the admission charges and private dance performance fees that it collected from patrons were exempt from state sales and use taxes. The court of appeals agreed with the appellate division's ruling that the petitioner had failed to meet its burden of proof that a tax exemption applied to those charges.
The portion of the sales tax in question imposes a sales tax on "'[a]ny admission charge' in excess of 10% for the use of 'any place of amusement in the state.'" Id. at 1122 (quoting N.Y. Tax Law § 1105(f)(1)). The legislature defined places of amusement that are subject to this tax to include "[a]ny place where any facilities for entertainment, amusement, or sports are provided." Id. (quoting N.Y. Tax Law § 1101(d)(10)). As the court of appeals observed, the tax therefore applies to a vast array of entertainment, including attendances at sporting events such as baseball, basketball or football games; collegiate athletic events; stock car races; carnivals and fairs; amusement parks; rodeos; zoos; horse shows; arcades; variety shows; magic performances; ice shows; aquatic events; and animal acts. Plainly, no specific type of recreation is singled out for taxation.
The court went on to explain that the legislature had created the exemption from taxation for admission charges to "dramatic or musical arts performances," N.Y. Tax Law § 1105(f)(1), for the purpose of promoting cultural and artistic performances in local communities. The petitioner argued that performances regarded as "adult entertainment" qualified for the exemption because exotic stage and couch dances were musical arts performances. The court, pointing out that it was the petitioner/taxpayer's burden to prove the applicability of any exemption from taxation, ruled that a determination by the Tax Appeals Tribunal could not be overturned unless "erroneous, arbitrary or capricious." 979 N.E.2d at 1123 (quoting Grace v. N.Y. State Tax Comm'n, 332 N.E.2d 886 (N.Y. 1975)). The court found that given the fact that the performances in question were carried out in "private rooms," the petitioner had failed to prove that the performances qualified as choreographed dance routines presented in a stage performance.
The court further concluded that it was not arbitrary, capricious, or an error of law for the Tax Appeals Tribunal to have discredited the petitioner's expert witness's opinion that the private performances qualified for the exemption because they were the same as the routines presented on the main stage. The evidence showed that the witness had neither seen nor had personal knowledge of what occurred in the private areas. As the court stated:
[S]urely it was not irrational for the Tax Tribunal to conclude that a club presenting performances by women gyrating on a pole to music, however artistic or athletic their practiced moves are, was also not a qualifying performance entitled to exempt status.
In the dissenting judge's view, the exemption included no requirement that the performance be technically "choreographic," and there was no valid distinction between highbrow dance and lowbrow dance. As stated in the dissenting opinion:
"We question how much planning goes into attempting a dance seen on YouTube," the Tribunal remarked. It is undisputed that the dancers worked hard to prepare their acts, and that pole dancing is actually quite difficult, but the Tribunal decided that they were not artists, but mere athletes: "The degree of difficulty is as relevant to a ranking in gymnastics as it is in dance." The Tribunal seems to have missed the point that "ranking," either of gymnasts or dancers, is not the function of a tax collector.
Id. at 1124 (Smith, J., dissenting).
As the dissent succinctly stated: "Under New York's Tax Law, a dance is a dance." Id.
The Lawletter Vol. 38 No. 3
Matt McDavitt, Senior Attorney, National Legal Research Group
When a decedent dies without a will, leaving no living spouse, descendants, parents, or siblings or their issue, the intestacy statutes generally divide the estate into two halves, called "moieties," with one half passing to the collateral relatives of the decedent's maternal kindred and the other half passing to the paternal kindred. This distribution is complicated where (1) there are relatives of half blood among either the paternal or maternal kindred, and (2) the estate is administered in one of the seven states that still reduce the intestate share of half-blood relatives (usually by half the value of whole-blood beneficiary shares), namely Florida, Kentucky, Louisiana, Mississippi, Missouri, Texas, and Virginia. Though intestate distribution is often simple once the heirs at law are identified, a problem arises in these states that reduce the intestate shares of half-blood takers, specifically, whether to reduce the shares of collateral-relative half-blood takers before or after division of the estate into the maternal and paternal moieties. Only a handful of cases nationally appear to have addressed this issue, but, importantly, each has held that division of the estate into moieties necessarily precedes the reduction in value of any half-blood beneficiary shares—a reduction that will occur only (if at all) where there is a mix of whole-blood and half-blood takers within the individual moiety.
For example, in the Florida Supreme Court opinion Estes v. Nicholson, 39 Fla. 759, 23 So. 490, 493 (1898), a dispute had arisen between the beneficiaries of an intestate estate as to when the reduction in value of the shares of half-blood collateral relatives was to occur. There were only three beneficiaries of the estate: a paternal aunt of the half blood and a maternal grandmother and a maternal aunt of the whole blood. The Florida intestacy course-of-descents law at the time divided the estate into two moieties for the paternal and maternal lines where the decedent had left no surviving spouse, children or their descendants, parents, or siblings or their descendants. The trial court, prior to dividing the estate into the requisite maternal and paternal moieties, reduced the share of the half-blood aunt, so that she received one-fifth of the estate, while the two whole-blood maternal collateral relatives each received a two-fifths share.
On appeal, the question was presented as to whether the statutory reduction of a half-blood relative's share was to occur prior to division of the estate into moieties, as the trial court had done in its distribution plan, or afterward. The Estes
court held that the statutory division of the estate passing to collateral relatives always precedes application of the half-blood reduction-in-share provision, and, thereafter, the half-blood reduction-in-share statute is applied separately
to each moiety, where applicable. Therefore, the court below had erred in reducing the half-blood paternal aunt's share prior to separation of the estate into moieties. The proper distribution was therefore as follows: (1) the intestate estate was divided in half, with one portion going to the paternal side, the other to the maternal side; (2) the sole heir on the paternal side was the half-blood aunt, who therefore took the full one-half of the estate, as there were no whole-blood relatives in her moiety to reduce her share; and (3) the two whole-blood heirs in the maternal moiety therefore split the one-half interest in the estate passing to their moiety, so that the maternal aunt and grandmother each received a one-fourth share of the estate.
The Lawletter Vol 38 No 2
Brad Pettit, Senior Attorney, National Legal Research Group
The Internal Revenue Code ("I.R.C.") provides that
[e]xcept in the case of a rollover contribution described in [§ 408](d)(3) . . . , no contribution [to a qualified individual retirement account or a retirement plan] will be accepted unless it is in cash, and contributions will not be accepted for the taxable year on behalf of any individual in excess of the amount in effect for such taxable year under section 219(b)(1)(A).
26 U.S.C. § 408(a)(1) (emphasis added). A key requirement for a "rollover contribution" is that "the entire amount received" by an individual upon a payment or distribution from a retirement account or plan must be "paid into" an individual retirement account, an individual retirement annuity, or an eligible retirement plan for the benefit of the individual "not later than the 60th day after the day on which" the payment or distribution is received. Id. § 408(d)(3)(A).
Since we live in an imperfect world, mistakes can be made when an individual seeks to achieve a timely tax-free rollover of money or securities from one tax-favored retirement account or plan into another. Accordingly, the I.R.C. provides that "[t]he Secretary [of the Treasury] may waive the 60‑day [rollover] requirement under subparagraphs (A) and (D) where the failure to waive such requirement would be against equity or good conscience, including casualty, disaster, or other events beyond the reasonable control of the individual subject to such requirement." Id. § 408(d)(3)(I) (emphasis added). In an administrative ruling, the Internal Revenue Service ("IRS") stated that "a taxpayer must apply for a hardship exception to the 60‑day rollover requirement using the same procedure as that outlined in Rev. Proc. 2003‑4 for letter rulings, accompanied by the user fee set forth in Rev. Proc. 2003‑8." Rev. Proc. 2003‑16, § 3.01, 2003‑1 C.B. 359 [after clicking on this hyperlink, scroll down to page 359].
In determining whether to grant a waiver, the Service will consider all relevant facts and circumstances, including: (1) errors committed by a financial institution, other than as described in Section 3.03 below; (2) inability to complete a rollover due to death, disability, hospitalization, incarceration, restrictions imposed by a foreign country or postal error; (3) the use of the amount distributed (for example, in the case of payment by check, whether the check was cashed); and (4) the time elapsed since the distribution occurred.
Id. § 3.02. According to the IRS, there is an automatic waiver of a defect in an attempt to carry out a tax-free rollover into an IRA, and no formal application for a discretionary waiver is necessary
if a financial institution receives funds on behalf of a taxpayer prior to the expiration of the 60‑day rollover period, the taxpayer follows all procedures required by the financial institution for depositing the funds into an eligible retirement plan within the 60‑day period (including giving instructions to deposit the funds into an eligible retirement plan) and, solely due to an error on the part of the financial institution, the funds are not deposited into an eligible retirement plan within the 60‑day rollover period.
Id. § 3.03. But the IRS cautions that "[a]utomatic approval is granted only: (1) if the funds are deposited into an eligible retirement plan within 1 year from the beginning of the 60‑day rollover period; and (2) if the financial institution had deposited the funds as instructed, it would have been a valid rollover." Id.
In a very recent Private Letter Ruling, the IRS denied a taxpayer's petition for a waiver of a defect in his attempt to roll over a retirement account distribution in the form of a check into an IRA, on the ground that the taxpayer could not establish that any of the factors that are listed in Revenue Procedure 2003-16 were present in his case. P.L.R. 2012-50-031 (Sept. 19, 2012). Thus, an individual who seeks to overcome a defect in his or her attempt to achieve a tax-free rollover of funds or securities from one retirement account or plan to another must make sure that the petition to the IRS sets forth facts and circumstances that indicate that a waiver by the IRS of the defect in completing the rollover contribution is justified.
March 26, 2013
Brad Pettit, Senior Attorney, National Legal Research Group
The Uniform Trust Code ("U.T.C.") provides that a "court may reform the terms of a trust, even if unambiguous, to conform the terms to the settlor's intention if it is proved by clear and convincing evidence that both the settlor's intent and the terms of the trust were affected by a mistake of fact or law, whether in expression or inducement." U.T.C. § 415 (Thomson Reuters, Westlaw current through 2011 annual meetings of the Nat'l Conf. of Comm'r on Unif. State Laws & A.L.I.) (emphasis added). More specifically, the U.T.C. states that "[t]o achieve the settlor's tax objectives, [a] court may modify the terms of a trust in a manner that is not contrary to the settlor's probable intention[, and a] court may provide that the modification has retroactive effect." Id. § 416 (emphasis added). The comment to section 416 seeks to explain the subtle distinctions between a court's discretionary power (1) under section 415 to approve the reformation of an irrevocable trust to conform to the settlor's intention by correcting a mistake of fact or law, and (2) under section 416 to modify an irrevocable trust in order to achieve the settlor's tax objectives:
"Modification" under this section is to be distinguished from the "reformation" authorized by Section 415. Reformation under Section 415 is available when the terms of a trust fail to reflect the donor's original, particularized intention. The mistaken terms are then reformed to conform to this specific intent. The modification authorized here allows the terms of the trust to be changed to meet the settlor's tax‑saving objective as long as the resulting terms, particularly the dispositive provisions, are not inconsistent with the settlor's probable intent. The modification allowed by this subsection is similar in concept to the cy pres doctrine for charitable trusts (see Section 413), and the deviation doctrine for unanticipated circumstances (see Section 412).
Id. § 416 cmt.
The Restatement (Third) of Property also provides that "[a] donative document may be modified, in a manner that does not violate the donor's probable intention, to achieve the donor's tax objectives." Restatement (Third) of Property: Donative Transfers § 12.2 (Tentative Draft No. 1 promulgated and adopted Mar. 28, 1995).
A recent Private Letter Ruling ("P.L.R.") by the Internal Revenue Service ("IRS") illustrates difficulties that an executor or trustee might encounter in trying to get the IRS to recognize and give effect to a state court's approval of a postmortem reformation or modification of a decedent's trust. In P.L.R. 2012-43-001 (July 10, 2012) (under 26 U.S.C. § 6110(k)(3), a P.L.R. may not be used or cited as precedent), the IRS considered a request for a ruling on the issue of whether a state court's postmortem reformation of a decedent's trust could be recognized for federal gift, estate, and generation‑skipping transfer ("GST") tax purposes. In response to the request for a ruling, the IRS acknowledged that under state law a unilateral mistake by the settlor of a trust may be a sufficient ground to reform a trust. But the IRS went on to point out that under the U.S. Supreme Court's landmark decision in Commissioner v. Estate of Bosch, 387 U.S. 456, on remand, 382 F.2d 295 (2d Cir. 1967), there are rules that apply in a case where a petitioner wants the federal government or an agency thereof to recognize and give effect to a state trial court's decision on a matter of state law:
It follows here then, that when the application of a federal statute is involved, the decision of a state trial court as to an underlying issue of state law should a fortiori not be controlling. This is but an application of the rule of Erie R. Co. v. Tompkins, [304 U.S. 64 (1938)], where state law as announced by the highest court of the State is to be followed. This is not a diversity case but the same principle may be applied for the same reasons, viz., the underlying substantive rule involved is based on state law and the State's highest court is the best authority on its own law. If there be no decision by that court then federal authorities must apply what they find to be the state law after giving 'proper regard' to relevant rulings of other courts of the State. In this respect, it may be said to be, in effect, sitting as a state court. Bernhardt v. Polygraphic Co., 350 U.S. 198, 76 S. Ct. 273, 100 L. Ed. 199 (1956).
Id. at 465.
After applying the principles that were enunciated in Bosch, the IRS determined that since the highest court and the appellate courts in the state in question had not considered the issue presented by the petitioner, the IRS was free to give "proper regard" to the state court's order when deciding whether to recognize the retroactive reformation of one of the trusts that were at issue in the case. P.L.R. 2012-43-001. Accordingly, the IRS gave proper regard to the state court's order to reform the trust in question and also considered the facts alleged and the representations made by the petitioner. The IRS then concluded that "the reformation of Trust 2 [was] not consistent with applicable State law, as applied by the highest court of State." Id. Accordingly, the IRS ruled that "the reformation of Trust 2 [could] not be recognized retroactively for gift, estate, or GST tax purposes." Id.
The difficulties in trying to get the IRS to recognize and give effect to a postmortem modification of a decedent's trust are further illustrated by a 1990 decision in which the U.S. Tax Court disregarded a postmortem modification of a decedent's intervivos trust that was intended to enable the trust to qualify for the federal estate tax marital deduction. Estate of Nicholson v. Comm'r, 94 T.C. 666 (1990). In Nicholson, the trust, as it was drafted, failed to qualify for the federal estate tax marital deduction under 26 U.S.C. § 2056(b)(7) (estate tax deduction for a qualified terminable life interest in property that is bequeathed to a surviving spouse), because the instrument did not grant the decedent's widow the right to receive all the trust income for life. 94 T.C. at 674-75. A Texas probate court modified the trust to give the widow the right to receive all of the trust income for life. Id. at 671. In deciding not to recognize the state probate court's postmortem modification of the trust in question, the Nicholson court stated:
As to the parties to the reformed instrument the reformation relates back to the date of the original instrument, but it does not affect the rights acquired by non‑parties, including the Government. Were the law otherwise there would exist considerable opportunity for 'collusive' state court actions having the sole purpose of reducing federal tax liabilities. Furthermore, federal tax liabilities would remain unsettled for years after their assessment if state courts and private persons were empowered to retroactively affect the tax consequences of completed transactions and completed tax years.
Under the terms of the trust at issue, the decedent's wife is not 'entitled to all the income from the property, payable annually or at more frequent intervals' as is required by section 2056(b)(7). Instead, the unambiguous language of the trust only allows her 'so much of the net income * * * as * * * [she] may from time to time require to maintain * * * [her] usual and customary standard of living * * *.' See Ithaca Trust Co. v. United States, 279 U.S. 151, 154 (1929).
* * *
Accordingly, even a consideration of the extrinsic evidence fails to show that the decedent intended that his wife be 'entitled to all the income' from the trust.
Id. at 674, 678.
The Tax Court's decision in Nicholson imposes a heavy burden upon an executor or trustee who wants the IRS to recognize and give effect to a state court's decision to modify or reform a decedent's trust in order to achieve federal tax savings. Under that decision, an executor or trustee must be able to point to evidence that a deceased settlor's intentions with respect to the disposition of the trust assets were consoistent with the postmortem federal tax savings that are being sought. For example, if the language of a deceased settlor's trust suggests that the decedent did not want his or her surviving spouse to have the right to receive all of the income of the trust, the Tax Court will not give effect to a postmortem modification or reformation of the trust that has given the survivor the right to all trust income.
The IRS's decision in P.L.R. 2012-43-001 similarly presents a good news/bad news scenario for executors and trustees. On the one hand, the IRS was willing to look at the facts and circumstances of the case in order to decide whether to recognize the state court's approval of a modification or reformation of an irrevocable trust. But after examining the facts and circumstances of the case, the IRS rendered an unfavorable decision from the petitioner's standpoint.
In sum, it appears that in an appropriate case, the IRS will recognize and give effect to a state court's decision to allow an executor or trustee to modify or reform a decedent's trust. However, an executor or trustee faces a decidedly uphill battle when trying to get the IRS to go along with a state court's decision to approve a postmortem modification or reformation of a decedent's trust and allow the decedent's estate to obtain federal tax savings as a result of the judicial change in the language of the trust.
The Lawletter Vol 37 No 12
Jim Witt, Senior Attorney, National Legal Research Group
With the proliferation of will substitutes (vehicles such as revocable trusts, IRAs, and pensions, used to pass assets to beneficiaries at the owner's death but outside the will), a problem can arise with possible duplication between the will substitute and the will. Such a problem was litigated in the Court of Appeals of South Carolina case, Estate of Gill ex rel. Grant v. Clemson University Foundation, 725 S.E.2d 516 (S.C. Ct. App. 2012).
In Estate of Gill, the testatrix bequeathed $100,000 to Clemson University to establish the "Scholarship." The income earned by the fund (but none of the principal) was to be used to provide scholarships for "academically deserving football players." Almost one year after executing the will, the testatrix established an IRA with Morgan Stanley. She specifically designated the Scholarship as the beneficiary of $100,000 in the IRA. The Estate contended that her intent had been to provide a funding mechanism for the Scholarship under the will, not for Clemson to receive two separate $100,000 gifts. Clemson contended that it was entitled to both the $100,000 from the IRA and the $100,000 bequest under the will.
The Estate brought suit for a declaratory judgment, and a special referee found that because the will was unambiguous as to the $100,000 bequest to establish the Scholarship, the bequest was not ambiguous and extrinsic evidence could not be considered. The referee therefore ruled that Clemson was entitled to both the $100,000 Scholarship bequest and $100,000 from the IRA as a nontestamentary asset passing outside the will.
On appeal, the Estate alleged that the referee had erred in failing both to consider extrinsic evidence regarding the testatrix's intent as to the funding of the Scholarship, because the will was ambiguous in that respect, as well as to admit the extrinsic evidence, because such evidence was relevant and satisfied the "state of mind" exception to the hearsay rule.
The Estate further argued that the referee had erred in failing to recognize that a latent ambiguity arose under the will because of the circumstance that the IRA was not in existence when the will was executed, thereby requiring that the terms of the bequest for the Scholarship and the beneficiary designation under the IRA had to be construed together as part of an overall plan. The extrinsic evidence consisted of the IRA agreement and the testimony of witnesses to the effect that (1) the testatrix had designated Clemson as a beneficiary under the IRA in order to obtain the charitable deduction on her income tax for that year; and (2) according to Linda Fraser, a financial advisor at Morgan Stanley, the testatrix was not familiar with the terms of the will at the time she established the IRA and nothing in the will stated that the IRA account was to satisfy the bequest to Clemson. The court of appeals ruled that the referee's failure to consider extrinsic evidence could not be the basis for the Estate's appeal, because the Estate had failed to preserve the issue on appeal.
The court of appeals also rejected the Estate's hearsay exception argument because the proferred testimony did not satisfy the requirement of Rule 803(3) of the South Carolina Rules of Evidence. To be admissible under Rule 803(3), a statement as to the declarant's state of mind, emotion, sensation, or physical condition must relate to his or her state of mind at the time of the statement but cannot include "[a] statement of memory or belief to prove the fact remembered or believed unless it relates to the execution, revocation, identification, or terms of declarant's will." Id. at 521.
As the court of appeals found, the testimony of the financial planner related to a statement made by the testatrix almost a year after she had executed her will. Additionally, the court rejected the argument that the IRA qualified as a "contemporaneous writing" under section 62-2-610 of the South Carolina Code, manifesting the testatrix's intent that Clemson's status as a beneficiary under the IRA serve as satisfaction of the $100,000 bequest. The court found no evidence of such intent in that neither the will nor the IRA instrument mentioned the possibility of satisfaction of the bequest prior to the testatrix's death.
The court thus affirmed the referee's conclusion that Clemson was entitled to both the $100,000 bequest and the $100,000 under the IRA. The obvious lesson here is that where a lifetime transfer, such as the establishment of an IRA, is intended to satisfy a testamentary gift, the manifestation of that intent should be made clear in either the will or the instrument embodying the lifetime transfer, or in both.
The Lawletter Vol 37 No 11
Matt McDavitt, Senior Attorney, National Legal Research Group
The situation occasionally arises wherein one or more parties interested in a decedent's estate or trust challenge the right of certain other beneficiaries to take via the will or trust on the ground that these other beneficiaries were allegedly recently adopted through adult adoption for the express purpose of creating a beneficial interest in the estate or trust. Two recent opinions reveal the factors reviewing courts examine to resolve such claims, which, if proven true, would amount to fraudulent interference with a gift or inheritance.
In Otto v. Gore, 45 A.3d 120 (Del. Super. Ct. 2012), for instance, a woman with three children from her former marriage adopted her 65-year-old ex-husband as her fourth "child." This adult adoption potentially created an interest in the ex-husband in a family trust created by the woman's parents, a trust granting shares to the settlors' "grandchildren." The court observed, however, that an ambiguity existed in the trust instrument because, while the descriptor "children" was defined as including adopted children, no such definition was included regarding "grandchildren," so extrinsic evidence was properly examined to determine whether the settlors intended adult adoptees to take. To find this intent regarding the adoption of grandchildren, the court referenced a letter sent by the settlors to their drafting attorney, which the court interpreted as indicating settlor intent that the class of grandchildren was to include solely minors who had a parent-child relationship with their parents.
The Otto court concluded that the adult adoption at issue had been effectuated specifically to create an interest in the trust and that, as this intention would have thwarted the settlors' intent to benefit only minor grandchildren in a true parent-child relationship, equity would intervene to prevent the ex-husband's taking under the trust, despite the fact that the adoption complied with state law.
A contrary result was reached in In re Estate of Fenton, 901 A.2d 455 (N.J. Super. Ct. App. Div. 2006). Whereas the court in Otto examined the timing and impact of the adult adoption to determine whether an ulterior motive demanded that equity prevent that adoption from creating a beneficial interest in the subject trust, the court in Fenton refused to speculate regarding the motives of the adoptive child and/or parent, instead relying on the adoptive mother's own statements in court indicating that she had effectuated the adoption of her 37-year-old second cousin in order to create a close family.
The Fenton court noted that the adoption was valid under the applicable state law and that the adoption statutes do not demand inquiry as to the purpose of the adoption. The adult adoption in Fenton created $30,000 in annual income in the adoptee for life. The court noted that the plaintiffs had failed to offer evidence of an ulterior motive, aside from the circumstantial evidence that the adoption created a substantial interest in the trust, although evidence was developed indicating that the adoptive mother had, prior to the adoption, specifically written to the trustee to see if the adoption would create an interest in her new daughter.
In the end, the Fenton court concluded that the trust language creating the class of beneficiaries expressly included adopted children, so there was no conflict between settlor intent and the outcome at hand. The plaintiffs in Fenton asked the court to annul the adoption, not interpret the trust to exclude the adult adoptee, but given the court's stated rationale that the trust terms allowed adopted children to take, the result seemingly would not have been different had the plaintiffs requested more appropriate relief.