Estate Planning

Thursday, May 20, 2010

Inconsistent Testamentary Instruments

A recent case from Alameda County, California, highlights why it is so important to be clear and unambiguous when drafting testamentary instruments, especially where there are inconsistent dispositive provisions between the documents.

In September, 2002, Bud Krusi, a widower, executed a revocable trust and pour-over will. Bud was the father of four adult children: Paul, Peter, Karl and Joan. Bud nominated his son, Paul, to serve as successor trustee of the trust. Attached to the back of the trust instrument was an Exhibit 'A' which referenced the following assets owned by the trust: (1) Bud's 100% interest in the closely-held corporation operating the Krusi family business; (2) a parcel of commercial real estate on which the family business was located; (3) a parcel of residential real estate; and (4) various investment accounts at financial institutions. The assets listed on Exhibit 'A' were properly transferred to the trust at the time of its creation. The trust instrument provided that after Bud's death the residential real property and its furnishings were to be distributed to his son, Paul, and one, Sarah Gersper, and that the remaining trust assets were to be distributed in equal shares to Paul, Peter and Joan (or to their surviving issue by right of representation).  Bud's son, Karl, and all of his lineal descendants were expressly disinherited. As settlor Bud retained the right to revoke the trust, in whole or in part, or to amend any of its provisions, in either case by means of a signed written instrument delivered to the trustee during Bud's lifetime.

Under the contemporaneous pour-over will, Bud devised to the trust the remainder of his estate, including tangible personal property, such as household goods, automobiles or personal effects, to be added to the trust corpus and thereafter held, administered and distributed in accordance with the terms of the trust.

In September, 2007, just seven months prior to his death, Bud executed a new will, the preamble of which contained boilerplate language stating that all of Bud's previous wills and codicils were thereby revoked.  Under the 2007 will, Bud's business partner, Barbara Simi ("Bobbie"), was named as executor and given a 51% interest in both the family business and the parcel of commercial real estate on which the business was located, making her the largest single beneficiary under the 2007 will.  The 2007 will explained that it was Bud's intention to give Bobbie a controlling interest in the family business in the event that any disagreements might later arise with respect to the conduct of the business. In a separate provision of the 2007 will, Bud stated his intention to give the remainder of his estate to his surviving issue by right of representation.  The 2007 will made no reference to the 2002 trust.

Bud died on March 7, 2008. Four days later, on March 11, 2008, Bobbie filed a petition with the probate court seeking a declaratory judgment that Bud, by making the 2007 will, intended to dispose of all his assets as part of a new estate plan and effectively revoked the 2002 trust in its entirety (not merely carving out the 51% interests in the business assets), and that, as a consequence, the record titles of the various assets held in the trust should be ordered changed to show title in Bobbie's name as executor of the 2007 will.  Decedent's son, Paul, in his capacity as trustee of the trust, filed an objection to Bobbie's petition, contending that the 2007 will did not revoke the 2002 trust in its entirety. Paul argued that, notwithstanding that the 2007 will was inconsistent with the 2002 trust in certain particulars (i.e., the disposition of a 51% interest in the family business and associated real estate), that fact did not, by itself, constitute clear and convincing evidence that Bud intended to revoke the trust as to those assets.  

The trial court held that Bud's 2007 will amended, modified or revoked the 2002 trust, but only with regard to a 51% interest in the family business and a 51% interest in the associated real estate, finding that the 2007 will did not contain a clear and unambiguous manifestation of Bud's intent to revoke the trust in its entirety. In other words, the court held that the effect of the 2007 will on the 2002 trust was limited to the amendment, modification or revocation required with respect to the specific trust assets mentioned in the 2007 will; the other assets in the 2002 trust, including the remaining 49% interest in the family business and associated real estate, were unaffected by the 2007 will and thus were to pass equally to Paul, Peter and Joan (except for the residential real estate, which was devised to Paul and Sarah). Bobbie appealed the trial court's ruling.

The appellate court affirmed the trial court's decision, stating that the pivotal question in this case is the extent to which the distribution provided for under the 2002 trust should be deemed to have been changed by the provisions of the 2007 will. Like the lower court, the appellate court could not find any clear and unambiguous manifestation of Bud Krusi's intent to revoke the 2002 trust in its entirety.  The words of the boilerplate preamble in the 2007 will, regarding revocation of all prior wills and codicils, do not, by themselves, reflect an intention to revoke any other kind of testamentary instrument, such as a trust.

Had the terms of the 2002 trust stated that the instrument could only be amended, modified or revoked by a signed written instrument other than a will or a codicil, Bobbie would have been entitled to take nothing and decedent's children would have been entitled to the entire estate. This, in my opinion, is how the 2002 trust should have been drafted.  Just a few words inserted at the right place in the document by a careful draftsman can mean the difference between your heirs receiving millions of dollars or receiving best wishes.

For additional information please contact the writer, Keith Codron, toll-free, at (800) 497-0864, or via email at keith@octrustlawyer.com. Mr. Codron, whose main office is located in Orange County, California, welcomes your comments and questions.


Tuesday, April 13, 2010

9th Circuit Holds ERISA Spousal Protection Requirements Inapplicable to IRAs

According to a recent federal appeals court decision, a surviving spouse who was not named as a beneficiary of her deceased husband's IRA had no rights in or to that IRA, notwithstanding that the IRA was funded by an indirect rollover from an ERISA-qualified retirement plan providing for spousal protection, where the rollover from the qualified plan occurred prior to the spouse's marriage to decedent.  Charles Schwab & Co., Inc. v. Debickero (9th Cir. 2010), 593 F.3d 916, 2010-1 USTC ¶50,180.

Section 205 of the Employee Retirement Income Security Act of 1974 ("ERISA"), as amended by the Retirement Equity Act of 1984, provides that "in the case of a vested participant who dies before the annuity starting date and who has a surviving spouse, a qualified preretirement survivor annuity shall be provided to the surviving spouse of such participant." [29 U.S.C. §1055(a)(2)].  As applied to a 401(k) plan, this requirement generally means that the surviving spouse is entitled to the entire plan balance as a matter of right, absent the spouse's written consent to waive that right.

Wayne Wilson ("Wilson") was employed by Siemens/GTE and participated in the company's 401(k) plan, an ERISA-qualified retirement plan.  Wilson's participation in the plan terminated when he left Siemens, in 1992, to work for another company.  In 1994, Wilson elected to close his Siemens 401(k) account and take a lump sum distribution, which he rolled over to an IRA with the investment firm, Smith Barney. In 2000, Wilson married Katherine Chandler ("Chandler"), a woman with whom he had been living since 1990.  In 2002, Wilson opened another IRA, this time with Charles Schwab & Co. ("Schwab"). Wilson funded the Schwab IRA by transferring to it approximately half of the proceeds from his Smith Barney IRA. Despite his marriage to Chandler, Wilson named his four adult children from his previous marriage as primary beneficiaries of the Schwab IRA, telling Schwab personnel that he was divorced. In 2005, at the age of 65, Wilson unexpectedly died, survived by his children and Chandler. Because he died at the age of 65, Wilson had not yet reached the required beginning date for taking required minimum distributions from his IRA.

Decedent's adult children and Chandler asserted competing claims to the Schwab IRA. As a result, Schwab filed an interpleader action in federal district court naming Chandler and the children as co-defendants.  Chandler then filed a cross-claim against the children, asserting that the surviving spouse protections under ERISA continued to apply to the 401(k) benefits even after they were rolled over to the IRA, and that, therefore, she, alone, as Wilson's surviving spouse, was entitled to the Schwab IRA. On cross-motions for summary judgment the trial court ruled in favor of Wilson's children, finding it significant that Wilson and Chandler were not married until several years after Wilson ended his participation in the Siemens 401(k) plan, and rejecting Chandler's argument that the surviving spouse protections under ERISA continued to apply even after the funds were rolled over to an independently managed IRA.

The trial court's ruling was affirmed by the U.S. Court of Appeals for the Ninth Circuit, which held as follows: "Although Wilson was at one time a participant in an employee benefit plan subject to ERISA's protections and limitations, ERISA ceased to apply when, long before his marriage to Chandler, Wilson terminated his participation in the employee benefit plan and transferred the proceeds to an independent IRA." [593 F.3d at 919].  The appellate court reasoned that insofar as the Schwab IRA was established and maintained by Wilson personally, and not by his former employer or any employee organization of his former employer, the IRA fell outside the spousal protection rules of ERISA.  The court noted that IRAs are specifically excluded from ERISA's participation and vesting provisions, which include the joint and survivor annuity requirements, and concluded that "it is beside the point that the IRA proceeds originated as employee benefits within an ERISA-qualified plan." [Id.]

For additional information please contact the writer, Keith Codron, toll-free, at (800) 497-0864, or via email at keith@octrustlawyer.com. Mr. Codron welcomes your inquiries.

Monday, April 5, 2010

New 10-Year Minimum Requirement for Grantor Retained Annuity Trusts

On March 24, 2010, by a vote of 246-178, the U.S. House of Representatives passed H.R. 4849, the Small Business and Infrastructure Jobs Tax Act of 2010.  All Republicans voted against this bill, the stated purpose of which is to provide tax relief and infrastructure incentives to small businesses. As with most government assistance programs, this bill will cost a lot of money. In order to help offset that cost, the bill contains a seemingly innocuous and easily overlooked revenue raising provision aimed squarely at limiting the tax benefits of grantor retained annuity trusts ("GRATs"). These irrevocable term-certain trusts are one of the favorite transfer tax reduction tools used by advanced estate planners, particularly those attorneys servicing the needs of high net worth business owners, key executives, professional practitioners and investors.

If the bill becomes law the following new restrictions will be added to Section 2702 of the Tax Code, effective as of the date of enactment of the legislation: (1) GRATs will be required to have a minimum term of ten years; and (2) annuity payments from a GRAT will not be permitted to decrease during the first ten years of the trust.  As with any GRAT, failure to outlive the term may cause the trust's assets to be includible in the grantor's taxable estate, thereby defeating the transfer tax reduction objective in creating the GRAT. Under current tax law there is no minimum required term for a GRAT; in general, the older the grantor the shorter the term selected for the GRAT.

Final passage of this legislation would effectively eliminate GRATs as a viable estate planning strategy for older age clients who may not outlive the required minimum term of 10 years.  Furthermore, for older age clients this legislation would limit the use of a GRAT as a roll-out strategy for life insurance financing techniques, such as premium financing or split-dollar arrangements.

Assuming the bill becomes law, clients may have a very limited timeframe in which to implement shorter-term GRATs so as to reduce their federal transfer tax bite.

For additional information please contact the blog writer, Keith Codron, toll-free, at (800) 497-0864, or email him at keith@octrustlawyer.com.

Tuesday, March 23, 2010

The Importance of Proper Vesting on Deeds

A recent Tax Court decision in favor of IRS highlights the critical importance of proper grantee-vesting on deeds and other instruments of transfer, and the potentially dire tax consequences of improper vesting.  The case involved the joint interest of a decedent's predeceased spouse in two parcels of real property, an interest that was held to be includible in decedent's gross estate for federal estate tax purposes. Because the transfer deeds creating the joint interest in each property did not expressly state the manner in which the spouses were to hold title, such interest was treated by the Tax Court as a tenancy by the entirety, which, under applicable state law, cannot be devised under a will.

In 1968, Oscar Goldberg, a resident of New York, acquired from his mother a fractional interest in each of two parcels of real property.

In 1977, Oscar, desiring to hold title to the property jointly with his wife, Judith, executed a deed transferring his fractional interest in each property as follows: "to Oscar Goldberg and Judith Goldberg, as wife" (sic). The property interests remained titled in that manner until after Judith's death.

In 2001, Judith died testate, and her will did not explicity mention either of the properties. Judith's will simply split her estate between Oscar and a family trust.

On December 31, 2001, Oscar, acting as executor of his wife's estate, executed a deed on behalf of the estate purportedly conveying to the family trust his wife's one-half interest in the properties.

In 2004, Oscar died. On the federal estate tax return filed for Oscar, his son, Mitchell, acting as executor, included only half the value of Oscar's interest in the properties as part of Oscar's gross estate, believing that the other half belonged to Oscar's predeceased wife, Judith. IRS, however, claimed that the entire interest in each property, not just half, was includible in Oscar's gross estate for federal estate tax purposes, and determined a deficiency against Oscar's estate in the whopping sum of $384,432.96.  IRS based its position on the fact that Oscar's 1977 transfer deed to himself and his wife had created a tenancy by the entirety between the spouses, such that Oscar automatically became the full owner of the property interests once Judith died, notwithstanding any provision in Judith's will to the contrary. In other words, if, in fact, a tenancy by the entirety existed under N.Y. state law, the property interests were not devisable under Judith's will.

On February 16, 2010, in a memorandum decision entitled, Estate of Oscar Goldberg, deceased, Mitchell D. Goldberg, Executor, v. Commissioner [T.C. Memo 2010-26, 99 T.C.M. 1120], the U.S. Tax Court held that IRS was indeed correct.  The Tax Court looked to the laws of New York governing trusts and estates, and ruled that the wording used in the 1977 transfer deed to vest title in the grantees created a tenancy by the entirety between Oscar and Judith. As a result, upon Judith's death, Oscar, as the surviving spouse, succeeded by operation of law to Judith's half of the property interests, becoming the owner again of his original (full) fractional interest in the properties. The purported transfer of property interests to the family trust by Judith's estate, on 12/31/2001, was null and void because Judith's tenancy-by-the-entirety interests were not subject to devise under her will.  Furthermore, because the 1977 transfer deed, on its face, clearly and unambiguously created a tenancy by the entirety under applicable state law, the Tax Court could not consider extrinsic ("parol") evidence to interpret what, if any, Oscar's intent may have been in wording the deed in the manner that he did.

To learn how the 1977 deed should have been worded in order to avoid this unfortunate result, please contact the writer, Keith Codron, Esq., at (800) 497-0864, or email him at keith@octrustlawyer.com.

Thursday, January 21, 2010

New Gift Tax Provision for Transfers to Irrevocable Trusts

Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16), as amended in part by the Jobs Creation and Worker Assistance Act of 2002 (P.L. 107-147), collectively referred to as the Bush tax cuts, a new provision was added to the federal gift tax law, requiring that any transfer of money or other property to a trust after 12/31/2009 be deemed a taxable gift, subjecting the transferor to gift tax ramifications, unless the trust qualifies as a grantor trust of the transferor for income tax purposes (i.e., unless the trust is considered as wholly owned by the transferor or the transferor's spouse under the grantor trust rules of the income tax law).

This newly effective gift tax provision, codified as subsection (c) of Internal Revenue Code section 2511, was enacted by Congress with the intent of preventing higher-bracket taxpayers from shifting the income tax bite on their passive investment income to an irrevocable nongrantor trust created for the benefit of their children or other lower-bracket family members, while avoiding gift tax on the transfer. Legislators were concerned that the gift tax law could be circumvented simply by having the transfer made to a nongrantor trust with respect to which the transferor would retain sufficient control over the beneficial interests as to make the transfer "incomplete" (and thus nontaxable), for gift tax purposes.  

IRC §2511(c), though seemingly straightforward, has in fact caused a tremendous amount of confusion and consternation among tax practitioners across the nation. Whereas the statute, on its face, provides that any post-12/31/2009 transfer to a nongrantor trust is automatically to be treated as a completed gift, thereby triggering gift tax consequences, the statutory language may be interpreted conversely to mean that any post-12/31/2009 transfer to a grantor trust is necessarily to be treated as an incomplete gift, thereby precluding gift taxation of such a transfer under any circumstances. If that interpretation were to be held valid by a federal court, then such commonly used estate planning strategies as the Grantor Retained Annuity Trust (GRAT) and the installment sale to an Intentionally Defective Irrevocable Trust (IDIT) may no longer be viable tax reduction techniques, as both require the underlying gift transfers to be deemed "completed" for gift tax purposes. Indeed, a literal reading of the statute raises the question of whether a post-12/31/2009 transfer to an irrevocable grantor trust can ever be subject to gift tax, even where the grantor trust is drafted for the specific purpose of excluding the gifted assets from the transferor's taxable estate upon death. In other words, under §2511(c), a transfer to a grantor trust which has been drafted so as to exclude the trust corpus from the transferor's taxable estate upon death may avoid gift taxes at the time of transfer, and then, upon the death of the transferor, avoid estate taxes as well!  Clearly, this result does not appear to have been the intent of Congress in enacting the statute. It is yet one more classic example of the law of unintended consequences which often arises when politicians try to remedy a specific tax problem without considering the larger picture.

IRC §2511(c) also fails to address the tax ramifications of a gift transfer to a grantor trust which later becomes a nongrantor trust during the transferor's lifetime. It would seem that a taxable gift should occur as of the date on which the trust changes its status from "grantor" to "nongrantor," the amount of the gift being determined by the gifted asset's fair market value as of the date of change.  But what if the trust no longer holds that particular asset at the time the change of status occurs? Determining the value of the gift under such circumstances may become extremely burdensome, if not impossible.

IRS, for its part, has publicly stated that it is well aware of the confusion surrounding section 2511(c), and that it will attempt to issue guidance and clarification on the statute as soon as possible.  Moreover, antiticpated new legislation by Congress this year to address estate tax reform may also impact the treatment of gifts to irrevocable trusts.

For further information contact the writer, Keith Codron, toll-free, at (800) 497-0864, or online at keith@octrustlawyer.com.

Tuesday, January 12, 2010

New Rules in California for No-Contest Clauses

Effective January 1, 2010, the rules in California regarding no-contest clauses have dramatically changed, severely limiting their enforceability in wills and trusts, and doing away with the old declaratory relief procedure (commonly known as a "safe harbor petition") available under prior law to prospective litigants contemplating certain contests to a will or trust. As under prior law, the new law applies notwithstanding any contrary provision in the contested instrument.

Under the new law, a no-contest provision in a testamentary instrument will be enforceable only against direct contests lacking probable cause. For this purpose:  (1) a "direct contest" refers to any court pleading alleging that the will or trust instrument was procured by forgery, fraud, menace, duress or undue influence, or that the person making the instrument lacked sufficient mental capacity to sign the instrument, or that he or she did not properly execute the instrument or subsequently revoked the instrument, in whole or in part; and (2) "probable cause" exists if, at the time of the filing of a contest, the facts known to the contestant would cause a reasonable person to believe that there is a reasonable likelihood that the requested relief will be granted after an opportunity for further investigation or discovery.

An "indirect contest" refers to any court pleading other than a direct contest.

Under the new law, a no-contest provision in a testamentary instrument will be enforceable only against the following two types of indirect contests, and only if the instrument's no-contest clause expressly provides for such application: (1) a pleading to challenge a transfer of property on the grounds that it was not the transferor's property at the time of transfer; or (2) the filing of a creditor's claim or prosecution of an action based on a creditor's claim.

Although this leglislation is brand new, its application is retroactive to any will or trust instrument, regardless of when signed, which became irrevocable on or after January 1, 2001. Thus, for example, a will or revocable trust declaration signed in 1975, which became irrevocable 27 years later, in 2002, by reason of the signer's death in 2002, is subject to the new law.

For further information about the new no-contest clause statutes in California, contact Keith Codron, toll-free, at (800) 497-0864, or online at keith@octrustlawyer.com.

Monday, December 7, 2009

U.S. House of Representatives Passes Estate Tax Relief Bill

On December 3 2009, the U.S. House of Representatives, by a vote of 225 to 200, passed long-awaited legislation concerning proposed changes to the federal estate tax. The new bill, H.R. 4154, officially titled the Permanent Estate Tax Relief for Families, Farmers and Small Businesses Act of 2009, would, if eventually signed into law, permanently extend the 2009 top federal estate tax rate of 45% and provide for an estate tax exemption of $3.5 million ($7 million for married couples with properly drafted estate planning documents fully utilizing each spouse's exemption). The bill would also continue the 2009 rules permitting estates to pass on property with a stepped-up cost basis for income tax purposes.

As for the U.S. Senate, its schedule in December has been so dominated by the debate on health care reform that little time has been left for action on estate & gift taxes.  As a result, the estate tax is repealed for 1 year, effective January 1, 2010, returning in 2011 with a 55% top rate, while the gift tax is retained witha a 35% rate. Further, there is a step-up in basis for estates valued at up to $1.3 million. Because there is no basis step-up for estates values in excess of $1.3 million, children and other heirs of larger estates who later sell the inherited property may have to pay large capital gains taxes on the proceeds.

House Republicans were joined by 26 Democrats in voting against the bill. The Ranking Minority Member of the House Ways and Means Committee, Rep. Dave Camp (R-MI), stated: "Death should not be a taxable event. Death should not force the sale of family farms or the dissolution of small businesses."  Mr. Camp believes that the extension of the 45% rate is confiscatory and that no American should have the federal government take away nearly half of his or her net worth upon death. In addition, Rep. Camp stated his serious concerns with respect to the fact that the $3.5 million exemption would not be indexed for inflation. He noted that as property values increase in the future more family farms and small businesses will fall subject to the estate tax.

Rep. Earl Pomeroy (D-ND), supported the House bill to permanently extend the $3.5 million exemption and 45% estate tax rate. He noted that the repeal of the estate tax will result in larger capital gains taxes for many children and other heirs.

The congressional Joint Committee on Taxation estimates the cost of the bill to be $233.6 billion over 10 years.  Nevertheless, under an exception to the House of Representatives' typical pay-as-you-go ("PAY-GO") rules, this particular bill is not being offset by any tax increases.

A permanent extension of estate tax rates and exemptions was proposed by House Majority Leader Steny Hoyer (D-MD), who suggested that eliminating the estate tax would add billions to the federal deficit and cause even further economic inequality among Americans.

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