Endowment Spending – What’s a University to Do?
Should Brandeis University sell off its art collection to meet expenses?
Why can’t it use its endowment instead? What if the endowments used to fund
professorships or scholarships drop in value? Should a university spend more
from its endowment to tide it over during these difficult economic times? Should
a university spend less and try to preserve what’s left in its endowment?
These are all pressing questions, but none of them have easy answers.
Legal rules provide guidance - not answers - but understanding the guidance is
instructive. Misunderstandings about what the laws say – and do not say - have
confused the discussions about endowment spending. A clearer understanding
may help.
A number of incorrect statements have circulated recently:
 A university or other charity cannot spend from an endowment fund that is
“underwater” (i.e., with a value below the value of the original gift).
 UMIFA was created to protect money in endowment funds; UPMIFA
allows charities to spend whatever they want.
 UPMIFA changes donor intent.
A bit of history will help explain why these statements are not accurate.
Two versions of a state law apply to many endowment funds. UMIFA (the
Uniform Management of Institutional Funds Act (1972)) is the older version,
adopted in 47 states and the District of Columbia, and UPMIFA (the Uniform
Prudent Management of Institutional Funds Act (2006)), is the newer version,
adopted in 28 states plus DC and under consideration in many more states.
Both statutes apply to charities organized as nonprofit corporations, and in most
states the statutes apply to colleges and universities or, in the case of public
universities, to the endowment funds held for them by university foundations.
UMIFA and UPMIFA both provide interpretations of donor intent
concerning spending from endowment funds. The statutes apply only when a
university and donor have not reached some other agreement about the “rules”
that will govern endowment spending. Many endowment funds need not use the
statutory guidance.
Imagine that a university says to a donor, “Here’s how we operate the
endowment – we apply a spending rate of four percent to the total value of the
fund and that’s what we distribute each year. We review the spending rate every
year and we may adjust it up or down, but we won’t make huge adjustments.”
The donor responds, “Great. That sounds like a good way to operate. Here’s
$100,000 for the endowment.” (Would that it were always that easy.) In this
case, assuming that the information is written down by the university and given to
the donor, UMIFA (or UPMIFA) will not apply – the university and donor have
written their own rules.
But what if a donor makes a gift to a university and says, “hold this as an
endowment” or maybe instead says, “spend only the income from this gift.” If
income had one, clear definition, we would know what that donor meant, but
income may mean trust accounting income (the rules that determine income and
principal for a trust), taxable income, corporate income, or something else. In the
1960s, most people assumed that “income” for a university meant trust
accounting income. The trust accounting rules defined income as interest,
dividends, rents, and royalties and assigned all capital gains to principal. An
endowment that could only distribute “income” might be tempted to invest
primarily in bonds to generate interest. A decision not to invest in stocks meant
more income in the short term, but also meant that the value of the fund eroded
over time.
In 1972 the Uniform Law Commission (aka the National Conference of
Commissioners on Uniform State Laws) produced UMIFA to respond to the
problem. UMIFA did not define income or principal and left a lot of open
questions, but it did make investing for total return possible and enabled charities
to create balanced portfolios for their endowments. UMIFA facilitated the
successful growth of many endowments. It also indirectly encouraged the
development of the spending rates that many universities and other charities now
use.
UMIFA created a concept called historic dollar value (“hdv”), to represent
the dollars contributed to an endowment. Hdv did not represent “principal” and
UMIFA did not suggest that a fund should spend everything above hdv. The
concept simply provided a way to say that a charity could spend appreciation the amount above hdv – and thus authorized the spending of capital gains. An
endowment fund is said to be “underwater” when the value of the fund falls below
its hdv. A fund cannot spend capital gains while it is underwater. UMIFA said
nothing about when a charity could spend interest and dividend income, and the
right to spend that income appears to continue under other law, even when a
fund is underwater.
UMIFA worked reasonably well, but using hdv as a way to explain
spending created some odd results. For an old fund, hdv becomes meaningless.
An endowment created in 1930 with $100,000 might be worth $1 million in 2009.
An hdv of $100,000 does not provide any useful guidance on what the
endowment should spend. For a recently established fund, hdv may prevent the
university from spending capital gains, if a drop in stock market follows soon after
the gift. An endowment created in 2007 with $100,000 may be worth $70,000 or
even less in 2009. The hdv remains at $100,000, and the university will be
unable to spend appreciation until the value of the fund exceeds that amount.
UPMIFA changes the guidance for charities trying to do right by their
donors. UPMIFA does not (and could not, constitutionally) change donor intent.
Rather UPMIFA changes the way a university interprets donor intent.
As discussed, when a donor says “pay only the income,” the donor has
not clearly indicated what that means. Before UMIFA, universities interpreted it
to mean “pay only interest and dividend income.” UMIFA then changed the
interpretation and interpreted it to mean “spend the amount of appreciation above
hdv that the university determines to be prudent.” UPMIFA changes the
interpretation again and interprets the donor to mean “spend some amount each
year but hold enough back to preserve the long-term viability of the fund.” Both
UMIFA and UPMIFA require the university to act prudently in deciding how much
to spend, but UPMIFA provides more and better guidance for making that
determination.
Here again are those incorrect statements, this time followed by
explanations of why the statements are incorrect.
 Under UMIFA, a university cannot spend from an endowment fund that is
“underwater.”
UMIFA does not prevent a university from spending interest or dividend
income earned by an underwater endowment. Guidance on the website of the
New York Attorney General’s Charities Bureau takes this position, and this
position is consistent with the language of UMIFA.
A university may also be able to spend from an underwater endowment if
the university authorized the spending before the fund went underwater. UMIFA
and UPMIFA both use the language “appropriate for expenditure” rather than
“spend.” The distinction is intentional. The board of a university will typically
make a decision to spend from an endowment at some time, perhaps some
months, before the actual spending takes place. The board must be able to act
based on information available at the time the board makes the decision. If a
decision to spend is prudent at the time the board votes to appropriate, then the
university can spend that amount even if the endowment goes underwater after
the appropriation.
 UMIFA was created to protect money in endowment funds; UPMIFA
allows charities to spend whatever they want.
John Hechinger and Jennifer Levitz discussed endowments in the Wall
Street Journal (Feb. 11, 2009) and described UMIFA as “laws passed decades
ago to keep charitable gifts from disappearing too rapidly . . . .” As explained
above, UMIFA actually increased the ability of a university to spend from an
endowment fund by authorizing the spending of capital gains. Hdv was not
created to protect the funds of an endowment; hdv was created to provide a
mechanism for determining what constituted appreciation.
UPMIFA provides better guidance on spending from an endowment and
establishes more clearly the rules of prudence that govern that spending. For old
funds, hdv is meaningless, and although UMIFA requires the university to be
prudent, UPMIFA provides a list of factors for the university to consider in making
a prudent decision. The duration of the fund is key among those factors and
reminds the university not to spend too much or too quickly. UPMIFA permits
spending when a fund’s value falls below hdv, but only if spending under those
circumstances is prudent, keeping in mind the long-term nature of an endowment
fund.
 UPMIFA changes donor intent.
Neither UMIFA nor UPMIFA change donor intent, although both change
the interpretation of what an endowment means. When UMIFA first appeared,
the New Hampshire Legislature asked the New Hampshire Supreme Court
whether UMIFA would violate the contracts clause of the constitution if it applied
to gifts that pre-dated the statute. The court concluded it would not, because the
statute merely interprets intent and does not change it. Like UMIFA, UPMIFA
changes the interpretation of what it means to be an endowment.
Anecdotal evidence suggests that many donors want an endowment to
continue spending during economic downturns. Continuation of a university’s
programs is more important to these donors then maintenance of any particular
amount in the fund. But donors presumably also hope that the university will
weather current conditions and will have enough left in its endowment to continue
to grow and build.
UPMIFA allows a university to spend appreciation when a fund goes
underwater, and for that reason interest in UPMIFA has grown. Under UPMIFA a
university will not need to change its investment strategy to generate interest and
dividend income in order to continue spending, and a university can use its
endowments sensibly during these difficult economic times. But UPMIFA will not
solve a university’s economic woes and still leaves the university with hard
decisions. One university may find spending from an endowment necessary to
continue funding important programs. As long as the university complies with
any purpose restrictions on the endowment, spending may be prudent, even if
the value of the fund drops further. Another university may have enough other
funds to manage in the short-term, and may decide to reduce or limit spending
from the endowment, to preserve the amount that remains until the market
recovers. Either decision may be correct legally, and the board must decide
which is better for the university. UPMIFA improves the law, both by providing
flexibility to universities to allow them to make good decisions and by providing
better guidance about what it means to be “prudent.”
Susan N. Gary, Orlando J. and Marian H. Hollis Professor of Law, University of
Oregon. Prof. Gary served as Reporter to the Drafting Committee to Revise
UMIFA.
GIFT TAX 101
Bruce D. Steiner
Kleinberg, Kaplan, Wolff & Cohen, P.C.
I.
Benefits of Making Gifts.
A.
The taxable transfer is generally limited to the value of at the time of the
gift.
B.
The future income and growth are generally removed from the estate.
C.
The estate tax is on the gross amount, while the gift tax is only on the
net amount.
D.
II.
1.
Example: decedent has 100, pays estate tax of 45 (or 53.8
in New York), net to beneficiaries 55 (or 46.2 in New York).
2.
Example: donor has 100, makes a gift of 69, pays gift tax of
31. The tax has been reduced by 31% (or 42% in New
York). The net amount to the beneficiaries has been
increased by 25% (or 49% in New York).
Some states, such as New York and New Jersey, have an estate tax
but no gift tax.
Limitations and Tradeoffs of Making Gifts.
A.
Assets included in the estate generally receive a basis step-up. Section
1014.
B.
Gifts generally take a carryover basis. Section 1015.
C.
There is a basis adjustment for gift tax paid on the appreciation.
Section 1015(d).
D.
Gift tax paid on gifts made within three years of death is included in the
estate. Section 2035(b).
E.
If the donor retains an interest and dies before the expiration of the
retained interest, the property is included in the donor’s estate. Section
2036(a)(1). This applies to a grantor retained annuity trust (“GRAT”) or
a qualified personal residence trust (“QPRT”).
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F.
III.
IV.
The gift tax exempt amount is limited to $1 million, even though the
estate tax exempt amount is presently $3.5 million. Section 2505(a).
The Gift Tax Statute of Limitations.
A.
The gift tax statute of limitations is generally three years. Section
6501(a).
B.
The statute of limitations is six years if there is an omission of more
than 25% of the gifts shown on the return. Section 6501(e)(2).
C.
For gifts before August 6, 1997, prior years’ gifts could be revalued for
purposes of a subsequent gift tax return unless (i) the statute of
limitations had run on the prior gift, and (ii) gift tax had been assessed
or paid for the prior year. Section 2504; Rev. Rul. 84-11, 1984-1 Cum.
Bull. 201.
D.
For gifts after August 5, 1997, the value of a prior gift that was
adequately disclosed on a gift tax return is final after the statute of
limitations expires. Section 2001(f)(2).
E.
For gifts after 1996, the statute of limitations remains open unless the
gift is adequately disclosed. Treas. Reg. § 301.2501(c)(1).
F.
A donor can provide disclosure on an amended gift tax return. Rev.
Proc. 2000-34, 2000-2 Cum. Bull. 186.
Gift Tax Statute of Limitations for Estate Tax Purposes.
A.
For gifts before August 6, 1997, even if gift tax was paid, the Internal
Revenue Service takes the position that gifts can be revalued in
determining the adjusted taxable gifts for estate tax purposes. Treas.
Reg. § 20.2001-1(e).
B.
The Tax Court agreed with the Service, but allowed credit for the gift tax
that would have been paid based upon the revalued taxable gift. Estate
of Frederick R. Smith, 94 T.C. 872 (1990); acq., 1990-2 Cum. Bull. 1.
C.
For gifts after August 5, 1997, if the gift was adequately disclosed, it
cannot be revalued for estate tax purposes. Treas. Reg. § 20.20011(b), effective for gift tax returns filed after December 3, 1999.
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V.
VI.
VII.
The Generation-Skipping Transfer Tax Statute of
Limitations.
A.
The gift tax value is used for GST exemption allocations made on timely
filed gift tax returns. Section 2642(b)(1).
B.
The gift tax value is likewise used for deemed allocations of GST
exemption. Section 2642(b)(1).
C.
The estate tax value is used for allocations of GST exemption to
transfers at death.
D.
The inclusion ratio for a direct skip becomes final when the statute of
limitations expires as to the GST tax on the direct skip. Treas. Reg. §
26.2642-5(a).
E.
With respect to a taxable distribution or taxable termination, the Service
takes the position that the inclusion ratio becomes final on the later of
the expiration of the statute of limitations for the first GST tax return
filed using that inclusion ratio or for the transferor’s estate tax return.
Treas. Reg. § 26.2642-5(b).
Whether to Disclose a Transaction That May Not Be a
Taxable Gift.
A.
Disclosure provides finality.
B.
The finality extends to other issues such as Crummey withdrawal
powers.
C.
However, disclosure may raise issues that might not otherwise come to
light.
D.
There is now a question on the estate tax return that asks about
transfers to grantor trusts.
Gift-Splitting.
A.
A husband and wife can elect to treat gifts to third parties as if made
one-half by each of them. Section 2513(c).
B.
Whether a gift to a trust in which the spouse is a discretionary
beneficiary is eligible for gift-splitting is a complicated issue.
1.
Where the trustees had complete discretion as to income
and principal, the Service ruled that the value of the
spouse’s interest could not be determined, so that gift3
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splitting was not available. Rev. Rul. 56-439, 1956-2 Cum.
Bull. 605.
2.
In William H. Robertson, 26 T.C. 246 (1956), the Tax Court
allowed gift-splitting for the principal where the wife received
the income and the trustees could distribute principal to her
for her maintenance and support. Given the wife’s other
assets “and the provisions of the trust agreement which limit
the discretion of the corporate trustee to invade the trust
principal for the wife’s maintenance and support,” the Tax
Court concluded “that there is no likelihood of the exercise
of this power as disclosed by the facts.”
3.
In O’Connor v. O’Malley, 57-1 USTC ¶ 11,690 (D. Neb.
1957), the court allowed gift-splitting as to the principal
where the trustees had discretion as to the principal, but the
donor testified that she did not intend for any principal to go
to her husband, he disclaimed his interest in the principal,
and no principal was distributed to him.
4.
In Max Kass, T.C. Memo 1957-227, the Tax Court did not
allow gift-splitting where the trustees could invade for the
wife’s “general welfare,” and the donor “failed to prove
sufficient facts by which to measure the probability of the
exercise of the power.”
5.
In Sands G. Falk, T.C. Memo 1965-22, the trustees had
discretion to distribute the income and principal to the wife if
necessary for her “adequate care, comfort, support and
maintenance.” The Tax Court allowed gift-splitting for the
principal but not the income, saying that the possibility of
invasion of principal was so remote as to be negligible, but
that the possibility of invasion of income was not so remote.
6.
In Stanley L. Wang, T.C. Memo 1972-143, the wife received
the income, and the trustees could distribute principal to her
“for her proper support, care and health, or for any
emergency.” The Tax Court said that “emergency” was not
an ascertainable standard, so that the wife’s interest was
not severable, so that gift-splitting was not available.
7.
In PLR 200422051, the wife received all of the income, and
the trustee could distribute principal for her “reasonable
support and medical care.” The Service held that the wife’s
right to receive income and principal was susceptible of
determination, so that gift-splitting was available for the
remaining portion.
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8.
C.
In PLR 200616022, the wife would receive all of the income
of the trust if the husband died within three years. The
Service held that the wife’s interest was susceptible of
determination and severable, so that gift-splitting was
available for the remaining portion.
Caution: if gift-splitting is elected in the year in which one spouse
creates a QPRT, and the donor dies during the QPRT term, so that the
residence is included in the donor’s estate, the spouse’s unified credit
used on the gift is not restored.
VIII. The Lifetime QTIP Election.
IX.
A.
The QTIP election is available for lifetime gifts in which the spouse is
entitled to all of the income for life. Section 2523(f).
B.
The QTIP election must be made on a timely filed gift tax return.
Section 2523(f)(4).
C.
This can be a useful technique to take advantage of the poorer
spouse’s unused estate tax exempt amount if he or she dies first.
1.
To the extent of the donee spouse’s unused estate tax
exempt amount, the trust assets can come back to the
donor spouse in the form of a credit shelter trust.
2.
The Internal Revenue Service has approved this.
3.
Query whether the trust must be established in an asset
protection jurisdiction.
The Noncitizen Spouse.
A.
There is no marital deduction for gifts to a noncitizen spouse. Section
2323(i)(1).
B.
The annual exclusion for gifts to a noncitizen spouse is $125,000
(indexed). Section 2523(i)(2).
C.
It is generally desirable to make annual exclusion gifts to the noncitizen
spouse to utilize his or her estate tax exempt amount.
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X.
XI.
Gifts by Nonresident Aliens.
A.
A nonresident alien is generally only subject to gift tax on gifts of real or
tangible personal property located in the United States. Sections
2501(a)(2) and 2511(a).
B.
“Residence” means “domicile” for gift tax purposes. Treas. Reg. §
25.2501-1(b).
C.
A nonresident alien does not get the unified credit ($1 million gift tax
exempt amount). Section 2505(a).
D.
A nonresident alien is not eligible for gift-splitting. Section 2513(a).
E.
However, a nonresident alien gets the annual exclusion. Section
2503(b).
Allocating GST Exemption.
A.
B.
Direct skips.
1.
There is a deemed allocation to a direct skip. Section
2632(b)(1).
2.
Example: a transferor gives $100,000 to a grandchild. A
$13,000 annual exclusion is available. There is a deemed
allocation of $87,000 to the balance of the transfer.
3.
A transferor can elect out of the deemed allocation (and pay
GST tax). Section 2632(b)(3).
Indirect skips.
1.
Before 2001, the default rule was no allocation to an indirect
skip.
2.
Beginning in 2001, there is a default allocation to an indirect
skip. Section 2632(c)(1).
3.
An indirect skip is a transfer (other than a direct skip) to a
GST trust. Section 2632(c)(3)(A).
4.
The term “GST trust” is defined in Section 2632(c)(3)(B).
5.
The transferor can elect out of the automatic allocation.
Section 2632(c)(5).
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C.
Consider whether it is desirable to allocate GST exemption to a transfer
to a trust.
D.
Note that for transfers to a trust after March 31, 1988, Crummey powers
are generally not effective for GST purposes. There is an exception for
trusts that do not permit distributions to be made to anyone other than
the beneficiary, and that are included in the beneficiary’s estate.
Section 2642(c).
E.
Effective date of allocation.
Allocations on a timely filed gift tax return are effective as of
the date of the transfer.
2.
Late allocations are effective as of the date of allocation.
3.
A late allocation can be made effective as of the first day of
the month of the allocation. However, in the case of life
insurance, the insured must be living at the time of the
allocation.
F.
Clean up trusts that have an inclusion ratio between zero and one.
G.
Estate tax inclusion period (“ETIP”) rules.
H.
XII.
1.
1.
GST exemption cannot be allocated during the transferor’s
retained term.
2.
This affects GRATs and QPRTs.
Gift-splitting.
1.
If a husband and wife elect gift-splitting for gift tax purposes,
the election is effective for GST tax purposes.
2.
Unless GST exemption is allocated to all (or no) transfers to
a trust, determining the inclusion ratio can be difficult if giftsplitting is elected for some but not all years.
Taking Advantage of Low Interest Rates.
A.
Interest rates are at an unusually low level.
B.
The applicable Federal rates (“AFRs”) for April 2009 (when this outline was
prepared) were as follows:
1.
The short-term AFR (for terms of up to three years) was 0.83%.
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XIII.
2.
The mid-term AFR (for terms of over three years but not over
nine years) was 2.13% for monthly or quarterly payments,
2.14% for quarterly or semi-annual payments, and 2.15% for
annual payments.
3.
The long-term AFR (for terms of over nine years) was 2.92%
for monthly payments, 2.94% for quarterly payments, 2.95% for
semi-annual payments, and 2.96% for annual payments.
C.
The Section 7520 rate for March 2009 was 2.4%.
D.
The Section 7520 rate for April 2009 was 2.6%.
E.
The Internal Revenue Service announces the AFRs and the Section 7520
rate each month on or about the 20th of the previous month.
F.
Some estate planning techniques, such as loans, grantor retained interest
trusts (“GRATs”), and sales work better when interest rates are lower. These
techniques are discussed below.
Grantor Retained Annuity Trusts
A.
In a GRAT, the grantor retains an annuity interest for a specified term.
B.
If the present value of the annuity payments is equal to the value of the
property contributed to the GRAT, there is no taxable gift.
C.
For this purpose, the value of the annuity payments is determined based
upon the Section 7520 rate.
D.
The annuity payments can be level, or can increase by up to 20% each year.
E.
For example, if you created a GRAT in April 2009, with level payments of
35.08155% per year of the initial contribution for three years, or 26.64605%
per year of the initial contribution for five years, the value of the annuity
payments is equal to the value of the initial contribution, so that there is no
gift.
F.
Advantages of the GRAT compared to other techniques:
1.
It is specifically permitted by statute. Section 2702.
2.
There can be little or no taxable gift.
3.
If the value of the contribution is increased on audit, there is no
corresponding increase in the gift. Instead, the annuity
payments are increased.
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G.
XIV.
4.
It is essentially “heads you win, tails you break even.”
5.
The GRAT is particularly useful for volatile assets.
6.
You can create a series of GRATs. Each time you receive an
annuity payment, you can contribute it to a new GRAT.
7.
After the annuity term ends, the trust can continue as an
intentionally defective grantor trust (“IDGT”), as discussed
below.
Disadvantages of the GRAT compared to other techniques.
1.
Under the estate tax inclusion period (“ETIP”) rules, a transferor
cannot allocate GST exemption to the GRAT until the annuity
term expires. Section 2642(f).
2.
The Section 7520 rate is 120% of the mid-term AFR, rounded
to the nearest 0.2%, so it is by definition higher than the midterm AFR, and generally higher than the short-term AFR.
3.
If the grantor dies before the expiration of the annuity term,
then the capitalized value of the annuity payments (or the entire
value of the GRAT, if less) is included in the grantor’s estate.
4.
There is some cost and complexity to doing a series of GRATs.
Gifts, Loans or Sales to Intentionally Defective Grantor Trusts
A.
An IDGT is a trust that is intentionally a grantor trust for income tax
purposes, but is a completed gift for gift tax purposes and is not
included in the grantor’s estate for estate tax purposes.
B.
The grantor is taxable on the income of the IDGT for income tax purposes.
C.
By paying the income tax on the trust income, the grantor is effectively
making additional nontaxable gifts.
D.
In Rev. Rul. 2004-64, the Service conceded that the grantor’s payment
of the income tax on the income and gains of an intentionally defective
grantor trust does not constitute an additional gift for gift tax purposes.
E.
The benefit of the IDGT can be leveraged by lending money or selling assets
to the trust. For this purpose, the interest rate must be at least equal to the
AFR (or else interest will be imputed).
F.
Most practitioners believe that the IDGT should have at least 10% equity, or,
in other words that the debt/equity ratio should not be more than 9:1.
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G.
H.
XV.
XVI.
Advantages of the sale or loan to an IDGT compared to other techniques:
1.
The transferor can allocate GST exemption at inception.
2.
The mid-term AFR is lower than the Section 7520 rate, and the
short-term AFR is generally lower than the Section 7520 rate.
The long-term AFR is sometimes lower than the Section 7520
rate.
3.
If the seller or lender dies before the note is repaid, only the
balance due on the note should be included in his or her estate.
Disadvantages of the sale to an IDGT compared to other techniques:
1.
There is no statutory authorization for a sale to an IDGT.
2.
While the 10% equity rule is common practice, there is no
assurance that 10% equity is sufficient.
3.
If the donor makes a gift equal to 10% of the total assets (in
other words, a gift of 10% and a sale of 90% of the assets
transferred to the IDGT), the gift is wasted if the value of the
assets declines such that the payments on the note exhaust the
trust.
4.
If the seller dies before the note is fully paid, the income tax
treatment of the gain portion of the remaining note payments is
uncertain.
Loans to Individuals.
A.
Instead of lending money to an IDGT, the lender can lend money to his or
her children or other borrowers.
B.
This is simpler than creating a trust, but does not provide the benefit of the
lender paying the income tax on the IDGT’s income and gains.
Charitable Lead Trusts
A.
A charitable lead trust (“CLT”) provides an annuity (“CLAT”), or unitrust
(“CLUT”) interest to charity for a period of time, followed by a remainder to or
in trust for noncharitable beneficiaries.
B.
By providing a charitable annuity interest equal to 100% of the value of the
trust, any balance remaining at the end of the annuity term can pass to the
donor’s family free of estate or gift tax.
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C.
For this purpose, the value of the annuity payments is determined based
upon the Section 7520 rate. However, a donor can elect to use the Section
7520 rate for the month of the transfer, or either of the two preceding months.
D.
Based upon the 2.4% Section 7520 rate in effect in March 2009, an annuity
of 8.017382% for 15 years or 6.354290% per year for 20 years will result in
no taxable gift.
E.
F.
1.
If the CLAT earns more than the annuity payments, the value of
the CLAT will increase.
2.
If the earnings of the CLAT are exactly equal to the annuity
payments, the value of the CLAT will remain constant.
3.
If the CLAT earns more than the Section 7520 rate but less
than the annuity payments, the value of the CLAT will decline.
4.
If the earnings of the CLAT are exactly equal to the Section
7520 rate, then the last annuity payment will exhaust the CLAT.
The CLAT can be a grantor trust for income tax purposes.
1.
The donor will get an income tax deduction for the value of the
charity’s interest, subject to the limitations on the charitable
deduction.
2.
The donor will be taxable on the income and gains of the CLAT,
with no further charitable deduction for the annuity payments to
charity.
Alternatively, the CLAT can be set up so that it is not a grantor trust.
1.
The grantor will not get an income tax deduction for the value of
the charity’s interest.
2.
The trust will pay its own income tax, and will get a charitable
deduction for the annuity payments to charity.
11
BSTEIN\116607.3 - 4/12/09
Bruce D. Steiner is an attorney with Kleinberg, Kaplan, Wolff & Cohen, P.C., in New
York City, and is a member of the New York, New Jersey and Florida Bars.
Mr. Steiner has thirty years of experience in the areas of taxation, estate planning,
business succession and wealth transfer planning, and estate and trust administration.
Mr. Steiner has lectured for the American Bar Association, the New York State Bar
Association, the New York City Bar Association, the New Jersey Institute for Continuing
Legal Education, BNA Tax Management, the Rockland, Essex and Middlesex County Bar
Associations, the New York and New Jersey State CPA Societies, the New York City, the
Rockland County, the Hudson Valley, the Western Connecticut, the Northern New Jersey,
the Middlesex-Somerset, the Central New Jersey, and the Greater New Jersey Estate
Planning Councils, the Financial Planning Association, the New York University and
Baruch College Schools of Continuing Education, the C.W. Post Tax Institute, the Farleigh
Dickinson Tax Institute, the New York City, the Greater Newark and the Fairfield County
CLU Chapters, JP Morgan Chase Bank, Bank of America, Wachovia Bank, Hudson Valley
Bank, Merrill Lynch, Metropolitan Life, Cornell University, Consumers Union, Lawline, and
many other professional and community groups.
Mr. Steiner has written articles for Estate Planning, BNA Tax Management, Trusts &
Estates, the Journal of Taxation, the CPA Journal, Probate & Property, TAXES, the
Journal of Corporate Taxation, the CLU Journal, and other professional journals.
Mr. Steiner writes a column for the CCH Journal of Retirement Planning, and is a
commentator for Leimberg Information Services, Inc., a technical advisor for Ed Slott’s IRA
Advisor, a member of the editorial advisory board of Trusts & Estates, and a deputy editor
of the Bergen Barrister. He has served as a director of the Estate Planning Council of New
York City, and on the professional advisory boards of several major charitable
organizations.
Mr. Steiner has been quoted in various publications including Forbes, the New York
Times, Lawyers Weekly, Bloomberg’s Wealth Manager, Financial Planning, Kiplinger’s
Retirement Report, Medical Economics, Newsday, the New York Post, the Naples Daily
News, Individual Investor, TheStreet.com, and Dow Jones (formerly CBS) Market Watch.
Mr. Steiner received an A.B. from Cornell University, a J.D. from the State
University of New York at Buffalo, and an LL.M. in taxation from New York
University, where he was a Gerald L. Wallace scholar.
Copyright © 2009
Bruce D. Steiner
Kleinberg, Kaplan, Wolff & Cohen, P.C.
12
BSTEIN\116607.3 - 4/12/09
551 Fifth Avenue
New York, New York 10176
Telephone: (212) 986-6000
Facsimile:
(212) 986-8866
E-mail:
[email protected]
13
BSTEIN\116607.3 - 4/12/09
IRS Issues Guidance on Sales of Insurance Policies (and Related Transactions)
By Mark Silverstein
Partner
Wolf Haldenstein Adler Freeman & Herz LLP
New York, New York
In recent years, a large industry has developed around investor acquisitions of life
insurance contracts. The tax ramifications (and other considerations) concerning such
“stranger owned life insurance” (SOLI) have been much debated, but were unclear. On
May 1, 2009, the IRS issued Revenue Rulings 2009-13 and 2009-14 that discuss tax
issues for, respectively, the owner/insured who sells a life insurance contract and the
investor who purchases a life insurance contract. The two Rulings use relatively parallel
examples, but do leave some gaps to fill in by extrapolation. More significantly, the IRS
position leads to an anomalous tax result to the owner/insured based on whether a
policy is surrendered or sold.
The assumed facts common throughout most of the Rulings are that:
“A” is a US citizen residing in the US who owns a “life insurance contract” as defined in
IRC §7702 on his own life issued on January 1 of Year 1.
“B” is a US person as defined in IRC §7701(a)(30).
A and B each determine taxable income using the cash method of accounting and file
income tax returns on a calendar year basis.
The life insurance contract is in the face amount of $100,000. As of June 15 of Year 8,
the policy has a cash surrender value (CSV) of $78,000 and A has paid a total of
$64,000 in premiums. The “cost-of-insurance” charges collected by the insurer are
$10,000.
A has not borrowed against the policy or received any distributions under it.
As of June 15 of Year 8, A was not a “terminally ill individual” or a “chronically ill
individual” as such terms are defined in IRC §101(g)(4).
Finally, to the extent it otherwise qualifies as a “capital asset,” the insurance contract in
A’s hands or B’s hands is not excluded from the definition of “capital asset” under the
provisions of IRC §1221(a)(1)-(8).
The anomalous result mentioned above derives from the distinction between the
specific statutory provisions that apply upon the death of an insured versus the basic
rules that apply upon the sale of an asset.
IRC §72(e)(5) provides that for life insurance contracts such as the one in the examples,
proceeds received are included in gross income “to the extent it exceeds the investment
in the contract.” IRC §72(e)(6) defines the “investment in the contract” as “(A) the
aggregate amount of premiums or other consideration paid for the contract before such
date, minus (B) the aggregate amount received under the contract before such date, to
the extent that such amount was excludable from gross income under this subtitle or
prior income tax laws.” The component of premiums that represents “cost-of-insurance”
is not included in this statutory definition.
On the other hand, under IRC §1001(a) “gain from the sale or other disposition of
property shall be the excess of the amount realized therefrom over the adjusted basis
provided in section 1011 for determining gain.” IRC §1011 provides that “adjusted basis”
is typically the basis under IRC §1012 adjusted as provided in IRC §1016. Under IRC
§1016(a)(1), adjustment is to be made “for expenditures, receipts, losses, or other
items, properly chargeable to capital account.” As discussed below, the IRS concludes
that A’s adjusted basis in the policy is determined by subtracting the “cost-of-insurance”
since that is an expense “properly chargeable to capital account.”
With this background, we can examine the specific situations discussed in the Revenue
Rulings. For each example, the IRS first analyzes the amount realized and recognized
in the transaction and then the character of that amount as ordinary income or long term
capital gain.
Rev Rul 2009-13, Situation 1 addresses the simple surrender of the policy in
consideration of the CSV. The amount received is $78,000 and the “investment in the
contract” is $64,000 so that the amount recognized as income is $14,000. While the IRS
notes that the contract is a “capital asset,” the Ruling states that “the surrender of a life
insurance contract does not, however, produce a capital gain.” The presumed basis for
this statement is that surrender is not a “sale or other disposition” under IRC §1001(a).
Accordingly, the IRS concludes that the $14,000 in recognized income is taxable as
ordinary income.
In concluding that capital gains treatment does not apply, the IRS states that §1234A,
which provides capital gains treatment to “the cancellation, lapse, expiration, or other
termination” of certain rights or obligations “does not change this result.” While not cited
in Rev Rul 2009-13, this conclusion follows TAM 200452033.
Rev Rul 2009-13, Situation 2 addresses the sale of the policy by A to B for $80,000.
However, to highlight the anomaly in the Ruling, I would like to change this to $78,000;
the same amount as the CSV received in Situation 1.
The amount realized is $78,000 and the adjusted basis is $54,000 (the $64,000 paid
less the $10,000 “cost-of-insurance” that benefitted A as other than an investment) for
an amount recognized of $24,000. While this transaction is clearly the sale of a capital
asset permitting long term capital gain treatment, the IRS then applies the “substitute for
ordinary income doctrine” to hold that the amount that would be ordinary income were
the policy simply surrendered should still be ordinary income on the sale.
Thus, the $24,000 recognized is taxed as $14,000 of ordinary income and $10,000 of
long term capital gain. Note, that A’s receipt of the same $78,000 in Situation 1 and
Situation 2 (as I have modified it) has produced a completely different result based on
whether the policy was surrendered or sold.
Rev Rul 2009-13, Situation 3 changes the assumed facts to provide for A to sell a term
life insurance contract that has a premium cost of $500 per month. The policy has no
CSV and is sold for $20,000. A has paid $45,000 in premiums over 90 months, but
because the sale takes place on June 15 of Year 8, there is one half month ($250) that
represents premium paid for insurance coverage not received by A.1 This is allowed as
A’s adjusted basis. Hence, on the sale, A recognizes $19,750.
Because there is no amount that is a “substitute for ordinary income,” the entire $19,750
is treated as long term capital gain.
Rev Rul 2009-14, in looking at consequences to B, assumes only a term life insurance
contract with no CSV (that is, Situation 3 from Rev Rul 2009-13), but it is possible to
extrapolate how the IRS might analyze a situation involving CSV. After acquiring the
policy from A for $20,000 on June 15 of Year 8, the IRS assumes that B holds it until
December 31 of Year 9 having paid 18 months of premiums at $500 per month.
In Rev Rul 2009-14, Situation 1, A dies on December 31 of Year 9 and B collects
$100,000. IRC §101(a)(1) generally provides that “gross income does not include
amounts received … under a life insurance contract, if such amounts are paid by reason
of the death of the insured.” However, IRC §101(a)(2) contains an exception that where
there has been a “transfer for a valuable consideration … the amount excluded from
gross income by paragraph (1) shall not exceed an amount equal to the sum of the
actual value of such consideration and the premiums and other amounts subsequently
paid by the transferee.”
Accordingly, B can exclude only $29,000 from gross income and must recognize
$71,000. While the policy is a “capital asset,” the IRS concludes that the receipt of the
death benefit under a life insurance contract does not produce a capital gain. The
$71,000 recognized is taxed to B as ordinary income.
Since the entire amount recognized is ordinary income, there is no need to extrapolate
to a policy with CSV. That would also produce only ordinary income.
In Rev Rul 2009-14, Situation 2, B sells the policy for $30,000. B’s adjusted basis in
the policy is the full amount paid, including premiums, $29,000. Unlike in Situation 2 of
Rev Rul 2009-13, there is no subtraction for the cost of insurance coverage obtained
because B is holding the policy “solely with a view to profit” and not for the insurance
protection that had been available to A. Accordingly, the amount recognized is $1,000.
Further, since this is a sale of a capital asset, the $1,000 recognized is taxable to B as
long term capital gain.
In reaching this conclusion, the IRS notes that “the contract was a term contract without
any cash value. Hence the substitute for ordinary income doctrine … does not apply.”
This strongly suggests that, if B had purchased from A a policy with CSV and
surrendered it for the CSV, then the IRS would conclude that the surrender produces
ordinary income to B. Following that logic means that if B resold the policy after
purchasing it from A, the sale would produce ordinary income to the extent B would
have ordinary income on surrender and capital gains for any excess.
Note that in Situation 1 and Situation 2, the IRS does not address borrowings to acquire
or maintain the policies or policy loans and whether or not B could include interest
charges in basis. Under IRC §264(a)(4), B would not be allowed to deduct interest costs
as an expense.
Finally, Rev Rul 2009-14, Situation 3, changes the assumed facts from Situation 1 to
provide that B is a foreign corporation. The same recognized amount of $71,000 is at
issue. Pursuant to IRC §881(a)(1) this recognized amount is “fixed or determinable
annual or periodical … income” and is taxable if “received from sources within the
United States.” For purposes of that issue, in addition to the assumed facts described at
the start of this article, the IRS assumes that the policy was issued by an insurer that is
a domestic corporation. On this basis, because A is a US citizen residing in the US and
the insurer is a domestic corporation, the IRS concludes that the death benefits are US
sourced. As in Situation 1, the $71,000 recognized is taxed as ordinary income.
In conclusion, Revenue Rulings 2009-13 and 2009-14 provide much needed guidance
to persons interested in selling or purchasing life insurance contracts. In deciding
between alternatives, it is important to consider the resulting basis determination and
character of income. Since different structures will have different results, planning
opportunities may exist. For the seller, the basis difference between surrendering and
selling a policy may make surrender the more attractive alternative, even for a lower
amount. For the buyer, the fact that proceeds upon the death of the insured will result
entirely in ordinary income while sales proceeds should result at least partially in capital
gains may make a sale more attractive than holding a policy.
1
The IRS analysis actually reaches this conclusion from the opposite direction. A has paid $45,000 in
premiums, and his basis is that amount less the cost of insurance he has received. Since the IRS assumes that the
value of the insurance is the contract amount of $500 per month and A held the contract for 89.5 months, the amount
to subtract is $44,750. The IRS uses this backward approach to leave open the possibility that the assumption may
not hold in every circumstance. In fact, the Ruling states that the assumption applies “[a]bsent other proof.”
Ethical Considerations for Trustees & Their Advisors
Sharon L. Klein, Esq.
Senior Vice President, Trust Counsel and
Director of Estate Advisement
Fiduciary Trust Company International
600 Fifth Avenue
New York, NY 10020
Copyright © 2009. All Rights Reserved
Sharon L. Klein
Senior Vice President, Trust Counsel and Director of Estate Advisement
Fiduciary Trust Company International
Sharon Klein heads the Estate Administration Department at Fiduciary. She is
responsible for overseeing the administration of complex estates and trusts, including
tax planning, reporting and valuation issues. She also acts as Trust Counsel, providing
advice regarding issues confronting executors and trustees and advice concerning all
aspects of estate planning, both domestically and internationally. Ms. Klein has 17
years’ experience in the area of trusts and estates and is a frequent speaker and author
on estate and trust planning, administration and management issues. Ms. Klein has
spoken for many professional organizations, including the American Bar Association,
the New York State Bar Association, the BNA Tax Management Advisory Board, the
Practising Law Institute, the American Heart Association, the FOX Family Office
Exchange, the Hadassah Business & Professional Council, Estate Planning Councils
and the New York University Summer Tax Institute. She is also a frequent seminar
presenter at continuing legal education seminars throughout the country. Ms. Klein’s
articles and quotes have appeared in prominent publications such as The Wall Street
Journal, Dow Jones Newswire, Trusts & Estates magazine, BNA Estate, Gifts and
Trusts Journal, Crain’s Investment News, Wealth Manager, Worth magazine,
Charitable Gift Planning News and Timothy Sammon’s Art & Tax News. Ms. Klein is
a member of the Trusts and Estates Steering Committee for the UJA-Federation of
New York.
Prior to joining Fiduciary Trust in January 2002, Ms. Klein was Special Counsel in the
Trusts and Estates Department at Rosenman & Colin LLP, New York, New York (now
Katten Muchin Rosenman LLP) for over 11 years. Previously, she served as law clerk
to the Hon. Chief Judge Fox of the Federal Court of Australia.
Ms. Klein earned B.A. and LL.B. degrees from the University of New South Wales,
Sydney, Australia, and an LL.M. from the Boalt Hall School of Law at the University
of California, Berkeley.
600 Fifth Avenue
New York, NY 10020
212-632-3373
[email protected]
Table of Contents
Conflicts of Interests and Other Ethical Issues in Trust Administration....... 1
I.
Investment Conflicts........................................................................... 1
II.
Distribution Conflicts ....................................................................... 9
III.
Tax Burden Conflicts..................................................................... 12
IV. Additional Ethical Considerations in Investing and Administering
Trusts ..................................................................................................... 15
A.
Qualified Domestic Trusts (“QDOTs”)........................................ 15
B.
Conflicts when a Remainder Beneficiary is a Trustee ............... 16
C.
Effective Date of Unitrust Election/Power to Adjust Determination
– Requires a State-by-State analysis.................................................. 18
D.
In Terrorem Clauses .................................................................. 21
E.
Identification of Clients – Multiple Representation Conflicts ...... 23
1.
Consider Diversification Issues and Retention Clauses: ........ 29
2.
Communication is Key ............................................................ 41
3.
The Duty to Diversify is not Absolute ...................................... 46
4.
Exculpatory Clauses/Indemnification Provisions .................... 52
5.
Derivative Strategies............................................................... 60
F.
Self-Dealing by Fiduciaries ........................................................ 60
G.
Attorney-Client Privilege ............................................................ 66
V.
Minimizing Fiduciary Risk.............................................................. 68
Appendix 1 — Uniform Prudent Investor Act – State-By-State
Analysis......................................................................................... 70
Appendix 2 — Uniform Principal and Income Act – State-By-State
Analysis......................................................................................... 73
Appendix 3 — Substantial Changes Made to New York’s Power to
Adjust and Unitrust Regimes, Effective August 5, 2008 ............... 76
Appendix 4 — “New Dilemmas,” Article by Sharon Klein, Published
in Trusts & Estate Magazine, 2006 .............................................. 84
Conflicts of Interests and Other Ethical Issues in Trust Administration
The law governing the administration of trusts creates dilemmas in how to resolve
numerous conflicts of interests between the income beneficiaries and the remainder
persons. Typically, these conflicts of interest fall into three broad categories:
„ Investments
­ How does the lawyer advise his/her client regarding how trust funds are to be
invested so as to satisfy the conflicting interests of the income beneficiaries and
the remainder persons and to insure that the trustee remains compliant with the
Prudent Investor Rule?
­ Who does the “family lawyer” represent – The settlor? The trustee? The income
beneficiary? The remainder persons?
„ Distributions
­ How does the lawyer advise his/her client regarding utilizing the power to adjust
or unitrust regimes so as to balance conflicting interests?
„ Taxes
­ Who is to bear the tax burden?
­ How does the lawyer advise the trustee in making tax elections when the results
may negatively impact one or more beneficiaries?
I. Investment Conflicts
Start with the Prudent Investor Act*
For many years, the investment of trust assets was guided by the prudent person rule.
The prudent person rule required trustees to examine trust investments on an asset-byasset basis. That evaluation involved an inquiry as to whether an asset was productive
of reasonable income and was safe to principal. Since trustees were judged on an
asset-by-asset basis, they were risk averse: they could be surcharged if an asset
decreased in value, even if the portfolio as a whole increased in value. Because there
was no specific skill required of fiduciaries, delegation of investment responsibility
was prohibited.
*See Appendix 1 for detailed state-by-state analysis
1
A model Uniform Prudent Investor Act (“UPIA”) was promulgated in 1994 and is now
the law governing the investment of trust assets in most states. The Prudent Investor
Act shifted the law away from the traditional prudent person rule to a modern portfolio
theory. In New York, the Prudent Investor Act can be found in Estates, Powers and
Trusts Law (“EPTL”) §11-2.3.
In Washington, D.C., the Prudent Investor Act can be found in D.C. Code. Ann. §§191309.01 to 19-1309.06. The Maryland Prudent Investor Act is found in Md. Code
Ann. Est. & Trusts §15-114. In Virginia, the Prudent Investor Act is found at Va.
Code Ann. §§26-45.3 to 26-45.14.
The Prudent Investor Act guides fiduciaries toward a total return approach to
investment decisions. Evaluation of a fiduciary’s conduct is based on a strategy for the
total portfolio, rather than on the selection of individual assets. The Act also makes
several fundamental changes to the criteria for fiduciary investment.
Under Prudent Investor Principles:
„ Trustees must formulate a strategy designed to meet the trust’s objectives:
­ The emphasis has moved away from individual security selection toward the
formulation of an overall asset allocation strategy in accordance with risk and
return objectives suitable to the trust.
­ Trustees must look at all the facts and circumstances, including the needs of the
beneficiaries, anticipated future distribution requirements and tax consequences.
„ Trustees must invest for total return:
­ Total return encompasses both income and growth.
­ This creates a conflict between the income beneficiaries, who are primarily
interested in a trust’s yield, and the remainder persons, who are primarily
interested in a trust’s growth.
„ The baseline, fundamental objective is to preserve purchasing power:
­ The portfolio must be invested to keep pace with inflation. Safety is no longer
measured in nominal terms.
„ Risk management:
­ Risk can be taken, as long as it is properly managed.
2
­ Diversification is required – a risk management technique.
„ Investment skill is required.
„ Delegation of investment responsibility is authorized:
­ Prudence must be used in selecting the delegee and establishing the scope of the
delegation.
­ Monitoring is necessary.
­ Costs must be reasonable.
3
Understanding Client Objectives Drives the Investment
Management Process: Devising a Strategy when Objectives Conflict
How does a Trustee develop a strategy where there is a conflict of interest between the
objectives of the income beneficiaries and remainder persons?
CLIENT STRATEGY
AND
INVESTMENT
OBJECTIVES
4
STRATEGIC
ASSET
ALLOCATION
SECURITY
SELECTION
Stocks, Bonds, Bills and Inflation, 1925—December 2008
Wealth Indices of Investments in the U.S. Capital Markets*
INDEX VALUE
$100,000.00
Large Stocks
Sm all Stocks
$10,000.00
Long-Term Governm ent
$9,550
Cash
Inflation
$2,045
$1,000.00
$99
$100.00
$20
$12
$10.00
$1.00
$0.10
1925 1929 1933 1937 1941 1945 1949 1953 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005
Source: Ibbotson Associates
* Values of $1 invested at year-end 1925.
(Assumes reinvestment of income and no transaction cost or taxes)
Historical performance data does not guarantee future results and results may differ over future time periods.
Indices are unmanaged and one cannot invest directly in an index.
5
World Equity Market Capitalization
1970
$0.9 Trillion
2008
$18.5 Trillion
Non-U.S.
34%
U.S.
45%
Non-U.S.
55%
U.S.
66%
Source: Factset/ Morgan Stanley Capital International All Country World
Fiduciary Trust International Long-Term Asset Class Expectations
Asset Class
Yield
Capital
Appreciation
Total
Return
Standard
Deviation
U.S. Large Cap Equity
2.0%
8.5%
10.5%
17.0%
U.S. Small Cap Equity
1.0%
12.0%
13.0%
22.0%
International Large Cap Equity
2.0%
9.0%
11.0%
19.0%
International Small Cap Equity
1.5%
12.0%
13.5%
22.0%
Global REITS
4.5%
4.0%
8.5%
17.0%
Emerging Markets Equity
1.0%
14.0%
15.0%
27.0%
U.S. Municipal Bonds
4.3%
0.3%
4.5%
4.0%
This analysis represents asset allocation strategies only and is not based on actual portfolios. Annualized yield,
capital appreciation, and total return expectations are for illustrative and discussion purposes only and are Fiduciary Trust
International’s outlook of future normalized performance over what we view as the long term, based on its own analysis of
business, currency, economic, geographic, political and other conditions affecting passive market indices and its own
assessment of various identified risk factors as of December 31, 2008. Standard deviation data is historical and the
potential effect of future market risk is not taken into account. The actual performance of any security, asset class or
portfolio may vary and could underperform or exceed Fiduciary Trust International’s expectations. Additional information
on the assumptions and methodologies underlying this analysis is available upon request.
This analysis is provided for illustration and discussion purposes only and does not guarantee future results.
6
Target Portfolio Objectives
„ High Income (75% Fixed Income, 25% Equities) Primary emphasis on income
production and low relative volatility with little regard for growth of principal.
„ Income (65% Fixed Income, 35% Equities) High emphasis on income production
with some regard for growth of principal.
„ Balanced (55% Fixed Income, 45% Equities) Generally, equal regard for
production of income and growth of principal with a goal of preserving purchasing
power of principal.
„ Balanced Growth (40% Fixed Income, 60% Equities) Emphasis on growth of
principal with due regard for the production of income.
„ Growth (20% Fixed Income, 80% Equities) High emphasis on growth of principal
with some regard for the production of income.
„ High Growth (100% Equities) Primary emphasis on growth of principal with little
regard for the production of income. Relatively high volatility acceptable.
Our investment strategies and the resulting portfolio holdings may change depending
on factors such as market and economic conditions.
7
Asset Allocation - Fulfilling the Obligations of Trustee Where the
Interests of the Income and Remainder Beneficiaries are in Conflict
The Trustee’s Obligations are:
1. To Preserve Purchasing Power
2. To Produce Reasonable Income
High Income
(75% fixed
income, 25%
equities)
Income
(65% fixed
income, 35%
equities)
Balanced
(55% fixed
income, 45%
equities)
Balanced
Growth
(40% fixed
income, 60%
equities)
Growth
(20% fixed
income, 80%
equities)
High Growth
(100% equities)
2.4%
3.4%
4.4%
6.1%
7.9%
9.9%
Yield
3.7%
3.4%
3.2%
2.7%
2.3%
1.8%
Total Return
6.1%
6.8%
7.6%
8.8%
10.2%
11.7%
Target
Portfolios
Capital
Appreciation
14%
12%
Target Return
10%
8%
6%
4%
Inflation 3.00%
(Assumed)
2%
0%
High Incom e
Incom e
Balanced
Capital Appreciation
Balanced Grow th
Yield
Grow th
High Grow th
Total Return
Note: This example illustrates split-interest trusts where yield is paid out to income beneficiary. Yield, capital appreciation,
inflation and total return targets are based on the assumptions set forth on the page entitled “Fiduciary Trust Long-term
Asset Class Expectations.” The potential effect of future market risk is not taken into account. The actual performance of
any security, asset class or portfolio may vary and could underperform or exceed Fiduciary Trust International’s
expectations. No performance results are guaranteed. Past performance does not guarantee future results and
results may differ over future time periods. In addition, your actual return will be reduced by advisory fees and other
expenses that you may incur as a client.
8
II. Distribution Conflicts
Principal & Income Act – The Basic Rules*
NY
DC
MD
VA
DE
FL
Default
Rule
Power to
Adjust**
EPTL §11-2.3
Power to Adjust
DC CODE §284801.04
Unitrust
MD CODE ANN.
EST. & TRUSTS
§15-502.1
Power to Adjust
VA. CODE ANN.
§55-277.4
Power to
Adjust
DEL. CODE
ANN.
tit. 12, §6113
Traditional
Principal and
Income Rules
(pre 1/1/03) or
Power to
Adjust (post
1/1/03)
Trustee
Opt Into
Rule
Unitrust**
EPTL §11-2.4
None
Power to Adjust
MD CODE ANN.
EST. & TRUSTS
§15-502.2
Unitrust
VA. CODE ANN.
§55-277.4:1
Unitrust
DEL. CODE
ANN.
tit. 12, §3527
Power to
Adjust (Pre
1/1/03) or
Unitrust
FLA. STAT.
ANN.
§738.104,
§738.1041
Amount
4% Unitrust
No guidelines
for Power To
Adjust
No guidelines
4% Unitrust***
4% Power to
Adjust***
3%-5% Unitrust
No guidelines
for Power to
Adjust
3% - 5%
Unitrust
No guidelines
for Power To
Adjust
3-5% Unitrust
or 50% of AFR
No guidelines
for Power To
Adjust
* See Appendix 2 for detailed state-by-state analysis.
** See Appendix 3 for substantial changes made to New York’s Power to Adjust and Unitrust regimes, effective August 5, 2008.
*** A different payout percentage can be authorized by court order. In order to utilize the power to adjust, the trustee must determine that conversion to a unitrust is inappropriate.
9
Principal & Income Act – Trustee Protection – Power to Adjust
NY
DC
MD
Standard
None provided in
Court must find
Principal and
abuse of
Income Act
discretion.
Anticipatory relief
may be available
Notice
requirement to
qualified
beneficiaries
Remedy
Court may restore
beneficiaries from
fund. If unable to
restore from fund
and, in addition,
fiduciary was
dishonest or
arbitrary and
capricious, pay an
appropriate
amount from own
funds
Sole remedy is to
direct, deny or
revise the
adjustment
10
VA
DE
FL
None provided in
Principal and
Income Act
Court must find
abuse of
discretion
Court must
find abuse of
discretion
Restore
beneficiaries
from fund. If
unable to restore
from fund, pay
an appropriate
amount from
own funds
Restore
beneficiaries
from fund. If
unable to
restore from
fund, pay an
appropriate
amount from
own funds
Principal & Income Act – Trustee Protection – Unitrust Regime
NY
Standard
Court approval
necessary*
Remedy
N/A
DC
N/A
MD
VA
DE**
FL**
Notice
requirement to
qualified
beneficiaries
1. Adopt written
1. Adopt written
1. Adopt written
policy
policy
policy
2. Send notice to
2. Send notice to
2. Send notice to
beneficiaries
beneficiaries
beneficiaries
3. At least one
3. At least one
3. At least one
person
person
person
receiving
receiving
receiving
notice is legally
notice is legally
notice is legally
competent
competent
competent
Sole remedy is to
direct, deny or
revise the
conversion or
reconversion
No liability if no
objection within
60 days
No liability if no
objection within
30 days
No liability if no
objection within
60 days
* For trusts created after January 1, 2002, a trustee can opt in within two years of creation without court approval (on
consent or at the trustee’s discretion with notice).
** If a trustee reasonably and in good faith takes or omits to take any action, and a person interested in the trust opposes the
act or omission, the person’s exclusive remedy shall be to seek an order from the court to convert, reconvert, or change
the payout percentage.
11
III. Tax Burden Conflicts
Tax Issues Can Exacerbate Conflicts of Interests
Who is to bear the tax burden? Conflicts regarding tax allocation among the
beneficiaries must also be addressed by the trustee.
Income Tax Considerations
Following the adoption of the UPAIA by many states, the IRS issued new regulations
under Section 643 applicable to trusts and estates for taxable years ending after
January 2, 2004.
Under the regulations, ordinary income is taxed to the recipient as “distributable net
income” (“DNI”).1 Internal Revenue Code of 1986 (“IRC”) Reg. §1.643(a)–3(a).
Capital gains are taxed to principal (remainder persons) unless:
­ Governing law and instrument provide otherwise; or
­ Pursuant to reasonable and impartial exercise of discretion by the fiduciary,
gains are:
ƒ Allocated to income;
ƒ Allocated to corpus but treated by the trustee as distributed to the recipient;
or
ƒ Allocated to corpus but actually distributed to the beneficiary or utilized by
the fiduciary in determining the recipient’s distribution amount. Reg.
§1.643(a)-3(b)
If using a unitrust, the discretionary power to allocate capital gains to income must be
exercised consistently. Reg. §1.643(a)-3(e), Examples 12-14.
Reg. §1.643(a)-3(e), Examples 11-14 provide:
Example 11: The applicable state statute provides that a trustee may make
an election to pay an income beneficiary an amount equal to four percent
of the fair market value of the trust assets, as determined at the beginning
1
DNI is a tax concept used to allocate taxable income to the beneficiaries and represents the maximum amount that can
be taxed to the beneficiaries.
12
of each taxable year, in full satisfaction of that beneficiary’s right to
income. State statute also provides that this unitrust amount shall be
considered paid first from ordinary and tax-exempt income, then from net
short-term capital gain, then from net long-term capital gain, and finally
from return of principal. Trust’s governing instrument provides that A is
to receive each year income as defined under state statute. Trustee makes
the unitrust election under state statute. At the beginning of the taxable
year, Trust assets are valued at $500,000. During the year, Trust receives
$5,000 of divided income and realizes $80,000 of net long term capital
gain from the sale of capital assets. Trustee distributes to A $20,000 (4%
of $500,000) in satisfaction of A’s right to income. Net long-term capital
gain in the amount of $15,000 is allocated to income pursuant to the
ordering rule of the state statute and is included in distributable net income
for the taxable year.
Example 12: The facts are the same as in Example 11, except the neither
state statute nor Trust’s governing instrument has an ordering rule for the
character of the unitrust amount, but leaves such a decision to the
discretion of Trustee. Trustee intends to follow a regular practice of
treating principal, other than capital gain, as distributed to the beneficiary
to the extent that the unitrust amount exceeds Trust’s ordinary and taxexempt income. Trustee evidences this treatment by not including any
capital gains in distributable net income on Trust’s Federal income tax
return so that the entire $80,000 capital gain is taxed to Trust. This
treatment of the capital gains is a reasonable exercise of Trustee’s
discretion. In future years Trustee must consistently follow this treatment
of not allocating realized capital gains to income.
Example 13: The facts are the same as Example 11, except that neither
state statutes nor Trust’s governing instrument has an ordering rule for the
character of the unitrust amount, but leaves such a decision to the
discretion of Trustee. Trustee intends to follow a regular practice of
treating net capital gains as distributed to the beneficiary to the extent the
unitrust amount exceeds Trust’s ordinary and tax-exempt income. Trustee
evidences this treatment by including $15,000 of the capital gain in
distributable net income on Trust’s Federal income tax return. This
treatment of the capital gains is a reasonable exercise of Trustee’s
discretion. In future years Trustee must consistently treat realized capital
gain, if any, as distributed to the beneficiary to the extent that the unitrust
amount exceeds ordinary and tax-exempt income.
Example 14: Trustee is a corporate fiduciary that administers numerous
trusts. State statutes provide that a trustee may make an election to
distribute to an income beneficiary an amount equal to four percent of the
annual fair market value of the trust assets in full satisfaction of that
beneficiary’s right to income. Neither state statutes nor the governing
instruments of any of the trusts administered by Trustee has an ordering
13
rule for the character of the unitrust amount, but leaves such a decision to
the discretion of Trustee. With respect to some trusts, Trustee intends to
follow a regular practice of treating principal, other than capital gain, as
distributed to the beneficiary to the extent that the unitrust amount exceeds
the trust’s ordinary and tax-exempt income. Trustee will evidence this
treatment by not including any capital gains in distributable net income on
the Federal income tax returns for those trusts. With respect to other
trusts, Trustee intends to follow a regular practice of treating any net
capital gains as distributed to the beneficiary to the extent the unitrust
amount exceeds the trust’s ordinary and tax-exempt income. Trustee will
evidence this treatment by including net capital gains in distributable net
income on the Federal income tax returns filed for these trusts. Trustee’s
decision with respect to each trust is a reasonable exercise of Trustee’s
discretion and, in future years, Trustee must treat the capital gains realized
by each trust consistently with the treatment by that trust in prior years.
Conflicts between income beneficiaries and remainder beneficiaries are
not obviated with the power to adjust or unitrust regimes:
„ Capital Gains Tax Allocation*
­ With a unitrust regime, the capital gains tax treatment must be consistent: A
trustee is locked into allocating capital gains the same way that the allocation is
made in the first year of the trust.
­ The allocation of capital gains creates a conflict of interest: If a trustee is locked
into one method of capital gains tax treatment for the duration of the trust, the
income beneficiary will want capital gains taxed to the trust and the remainder
persons will want the capital gains included in DNI and taxed to the income
beneficiary.
„ Unitrust Investment*
­ The imposition of the tax burden creates a conflict of interest.
­ How the trust is invested can make a substantial difference to the income
beneficiary:
ƒ If the fixed income portion of the portfolio is invested in tax-exempt
municipal bonds, the yield might be lower than if it was invested in taxable
bonds; but the income beneficiary will get the tax benefit.
ƒ In addition, assuming a fixed 4 percent unitrust regime, to the extent those
lower yielding bonds (and whatever other income and dividends are
* See Appendix 4 for detailed analysis of conflicts regarding capital gains tax allocation and investment
of the unitrust portfolio.
14
generated in the trust) produce less than the 4 percent payout the income
beneficiary is to receive, the difference will be made up with a tax-free
distribution from the principal of the trust (assuming gains are taxed at the
trust level).
ƒ If the fixed income portion of the trust is instead invested in taxable bonds,
the yield might be higher, but all of it will be taxable to the income
beneficiary.
ƒ Also, if the income yield is higher, less will have to be paid to the income
beneficiary (income tax free) from the trust’s principal.
ƒ Clearly, the income beneficiary would prefer to see tax-exempt bonds in the
fixed income portfolio and the remainder persons would prefer to see taxable
bonds.
­ How to resolve the conflict?
ƒ A trustee should consider all the facts and circumstances and make a
reasonable, reasoned determination.
„ More Flexibility with Power to Adjust
­ A trustee is not locked into one method of capital gains tax treatment.
­ The capital gains tax burden and the tax consequences of the trust’s investment
strategy are factors which can be taken into consideration by the trustee in
determining the appropriate adjustment amount.
IV. Additional Ethical Considerations in Investing and Administering Trusts
A. Qualified Domestic Trusts (“QDOTs”)
„ Marital Trust and QDOTs – The exercise of the power to adjust or a conversion to a
unitrust will not disqualify the marital deduction nor result in a QDOT tax. Regs.
§§20.2056(b)–5(f)(1) and 20.2056A–5(c)(2)
­ Consider opting into the unitrust regime or adjusting in a QDOT trust.
­ Ordinarily, a principal distribution from a QDOT trust to the non-resident alien
surviving spouse will generate an estate tax. IRC §2056A(b)
15
­ If an adjusted income payment or unitrust payment is made to the non-resident
alien spouse, to the extent that payment is comprised of a principal distribution
“redefined” as income, that payment is, in effect, a principal payment made
without an estate tax consequence.
­ This is one situation where the interests of the surviving spouse and the
remainder persons may be aligned. To the extent the surviving spouse needs
more funds, it is more efficient for all beneficiaries to define any extra payment
as income and avoid the imposition of an estate tax.
B. Conflicts when a Remainder Beneficiary is a Trustee
„ Matter of Jacob Heller, 800 N.Y.S. 2d 207 (App. Div. 2005), affirmed by, 849
N.E.2d 262 (Ct. App. 2006)
­ Proceedings were initiated on behalf of a stepmother to annul and set aside a
unitrust election made by her stepsons, the trustees of a trust set up by her
deceased husband. The stepsons were also the remainder beneficiaries of this
trust.
­ As a result of the election, the stepmother's income decreased from $190,000 to
$70,000 a year.
­ The stepsons also made the election retroactive to 2002, resulting in the
stepmother owing the trust $120,000 a year for the three preceding years.
­ Surrogate’s Court:
ƒ Denied summary judgment on a motion to annul the unitrust election, but
determined that an election could not be made retroactively.
­ Appellate Division:
ƒ Held that trustees are not prohibited from making a unitrust election even
when they are remainder beneficiaries who may benefit from such an
election. Even though trustees have a fiduciary duty to both income and
remainder beneficiaries, it is common, the Court said, for trustees to be
interested parties.
• The Court overruled the Surrogate on the issue of retroactivity.
16
• The Court noted that the statutory language is unambiguous in clearly
authorizing trustees who have made the unitrust election to specify its
effective date.
­ Court of Appeals: Affirmed
ƒ The Court notes a very interesting difference between the power to adjust and
the unitrust: An interested trustee is prohibited from exercising the power to
adjust, but there is no per se prohibition with respect to the unitrust regime.
ƒ The Court held:
EPTL 11-2.3(b)(5), the 2001 statute that gives trustees the power to adjust
between principal and income, expressly prohibits a trustee from
exercising this power if "the trustee is a current beneficiary or a
presumptive remainderman of the trust" (EPTL 11-2.3[b][5][C][vii]) or if
"the adjustment would benefit the trustee directly or indirectly" (EPTL 112.3[b][5][C] [viii]). Tellingly, the Legislature included no such prohibition
in the simultaneously enacted optional unitrust provision, EPTL 11-2.4.
Moreover, in giving a list of factors to be considered by the courts in
determining whether unitrust treatment should apply to a trust, the
Legislature mentioned no absolute prohibitions (see EPTL 112.4[e][5][A]), and created a presumption in favor of unitrust application
(EPTL 11-2.4[e][5][b]). We conclude that the Legislature did not mean to
prohibit trustees who have a beneficial interest from electing unitrust
treatment.
It is certainly true that the common law in New York contains an absolute
prohibition against self-dealing, in that "a fiduciary owes a duty of
undivided and undiluted loyalty to those whose interests the fiduciary is to
protect" (Birnbaum v Birnbaum, 73 NY2d 461, 466 [1989]). "The trustee
is under a duty to administer the trust solely in the interest of the
beneficiaries” (Restatement [Second] of Trusts § 170 [1]). In this case,
however, the trustees owe fiduciary obligations not only to the trust's
income beneficiary, Bertha Heller, but also to the other remainder
beneficiaries, Suzanne Heller and Faith Willinger. That these
beneficiaries' interests happen to align with the trustees' does not relieve
the trustees of their duties to them. Here, we cannot conclude that the
trustees are prohibited from electing unitrust treatment as a matter of
common law principle.
­ The Court also affirmed the ability of the trustees to make a retroactive election.
17
C. Effective Date of Unitrust Election/Power to Adjust Determination –
Requires a State-by-State analysis
Unitrust Regime
Note that New York law was changed in August 2008 to make the unitrust option
more fully prospective:
An election to opt into the unitrust regime can be made without court approval only for
trusts created after January 1, 2002, if made within two years. All other trusts require
court approval.
Before the law was changed, the statute provided that the unitrust election began on the
date specified in the governing instrument, or in a trustee’s election, or on the date
specified by the court or, if none of those specifications was made, on the date the
assets first became subject to the trust.
This was interpreted in the Heller case as permitting a retroactive election to be made.
As a result of the changes, the election date specified by a trustee (without court
approval) must now be within the year in which the election is made or the first day of
the following year. The court can still specify an election date, but the default
effective date for a court determination is no longer the first year of the trust in which
assets first became subject to the trust.
The revisions to the statute were signed into law on August 5, 2008 and are effective
immediately.
„ Different states have adopted different statutory language.
„ In Oregon, New Mexico, Colorado and Florida, for example, the effective date for
conversion may not be less than 60 days after notice of the conversion. Or. Rev.
Stat. §129.225(2)(c), N.M. Stat. Ann. §46-3A-105(A)(2), Co. Rev. Stat. §15-1404.5(1)(b).
„ In Maryland, for example, the effective date for the conversion must be at least 30
days after notice of the conversion. Md. Estates & Trusts Code Ann. §15502(d)(3),(4).
„ Florida has statutory language permitting a trustee to determine the effective date of
a unitrust election.
18
­ However, the Florida statute also provides that the trustee must adopt a written
statement providing that “future distributions from the trust will be unitrust
amounts”.
Power to Adjust Regime
„ Matter of Orpheus Trust, 179 P.3d 562 (Nev. 2008)
­ Following Nevada’s adoption of the Uniform Principal and Income Act in 2003,
trustees of a family trust created in 1934 sought to exercise their adjustment
power and petitioned the court to appoint a special trustee.
ƒ The trustees were also trust beneficiaries. Under the Nevada statute,
interested trustees are prohibited from making an adjustment and must seek
the appointment of a special, disinterested trustee to do so.
­ Whittier Trust Company was appointed as special trustee in February 2005. In
September 2005, it filed a petition for approval of an adjustment for the year
2004, the year prior to its appointment.
ƒ One of the four contingent remainder persons objected to the adjustment,
arguing that the special trustee could not make a retroactive adjustment
­ The District Court denied the petition, holding that a special trustee may only
adjust between income and principal accrued from its date of appointment.
­ Supreme Court reversed the District Court
ƒ The Court held that that due to (1) the corrective nature of the power to
adjust and (2) the fact that trustees need not formally adopt a new investment
strategy before exercising the power to adjust, “at a minimum, a special
trustee may adjust between principal and income accrued in the year
immediately preceding the special trustee’s appointment.”
ƒ Because of the ambiguous language of the statute, the Court examined the
statutory construction and legislative history of both the Nevada statute and
the uniform act, finding:
The determination of whether an adjustment between principal and income
distributions is necessary often will require a review of data related to trust
investment and returns at the close of the year…[the UPAIA] language clearly
indicates that the power to adjust may be exercised correctively, after the
19
trustee has an opportunity to review trust date and trustee investment
decisions for the immediately preceding year.
­ The Court was not asked to determine whether the power could be exercised
retroactively for any earlier years.
ƒ Given that the power to adjust is a corrective power, however, query whether
it may be possible to look back further in order to be fair and reasonable to
all beneficiaries.
­ In dicta, the Court noted that this corrective power did not only apply to special
trustees:
Although a special trustee must be appointed to make an adjustment when all
trustees are also interested trust beneficiaries, the special trustee is simply a
neutral party who ‘stands in the shoes’ of the interested trustees to make an
adjustment that a disinterested trustee would deem necessary at the close of
the year.
„ In many states, the power to adjust regime does not appear to have retroactive
application.
­ In New Jersey, for example, adjustments made with respect to any accounting
period must be made within 65 days of the end of that period. N.J. Stat. Ann.
§3B:19B-4(a).
­ In New York, for example, the statute provides:
Where the rules in article 11-A apply to a trust and the terms of the trust
describe the amount that may or must be distributed to a beneficiary by
referring to the trust's income, the prudent investor standard also
authorizes the trustee to adjust between principal and income to the extent
the trustee considers advisable to enable the trustee to make appropriate
present and future distributions in accordance with clause (b)(3)(A) if the
trustee determines, in light of its investment decisions, the consideration
factors incorporated in clause (b)(5)(B), and the accounting income
expected to be produced by applying the rules in article 11-A, that such an
adjustment would be fair and reasonable to all of the beneficiaries. EPTL
§11-2.3(b)(5)(A)(emphasis added)
­ In Maryland, an adjustment may not be made before the time within which
consents may be given to the trustee, which must be at least 30 days after notice
of the adjustment determination is mailed. Md. Estates & Trusts Code Ann.
§15-502.3(d)(3),(4).
20
„ Where beneficiaries have conflicting interests, is retroactivity a factor which should
be taken into consideration in determining which regime to utilize?
D. In Terrorem Clauses
„ McKenzie v. Vanderpoel, 151 Cal. App. 4th 1442 (2007)
­ A trust was created in 1959 with three tiers of beneficiaries, each with a distinct
interest
ƒ The first tier beneficiaries received fixed monthly payments for life (ranging
from $200 to $500). The remainder of the income was added to the
principal.
ƒ Following the death of the last to die of the first tier beneficiaries, the
remaining trust estate would be split into three equal trusts and the second
tier beneficiaries would receive the net income from their respective trusts
for life.
ƒ Upon the death of each second tier beneficiary, the remaining assets would
be distributed to that second tier beneficiary’s issue.
­ The trust instrument contained a no-contest clause directing that no trust assets
be paid to any beneficiary who “contested or sought to impair, object to or
invalidate this Declaration of Trust”.
­ The trust instrument also provided:
Except insofar as the Trustee shall exercise discretion herein conferred,
matters relating to the principal and income shall be governed by the
provisions of the Principal and Income Law from time to time existing.
­ By the end of 2004, the total value of the original trust exceeded $33 million.
­ In early 2004, an attorney for one of the second tier beneficiaries requested an
adjustment (pursuant to the California power to adjust) to increase the
beneficiary’s distribution for that year. The trustee wrote to all beneficiaries,
proposing to transfer approximately $130,000 from principal to income in the
beneficiary’s trust.
ƒ A number of beneficiaries objected to the proposal and the trustee did not
implement the adjustment.
21
­ The beneficiary then applied for a judicial determination as to whether a petition
to adjust between principal and income would violate the no-contest clause. The
beneficiary planned to petition the Court for an annual adjustment equal to 4%
of the trust principal.
ƒ The Probate Court determined that the petition would violate the no contest
clause because the petition “would change the characterization of property
i.e. from principal to [interest] thereby changing the intent of the settlor.”
­ The Court of Appeals affirmed the ruling of the lower court, holding that the
power to adjust under California law is not exempted from the scope of a nocontest clause.
The general provision providing that the trust should be governed by the
principal and income law does not override the express intent of the settlor
that the second tier beneficiaries receive net income only.
­ The Court concluded that an adjustment would impair the trust
This proposal is a major change which would impair the terms of the original
trust because it would provide more income to plaintiff than allowed by the
trust in years when net income falls below 4 percent of her trust interest…The
trust gave the trustee the power to invade the principal in order to make
payment to the first tier beneficiaries but did not provide the same authority in
the case of the second tier beneficiaries. The intent of the testator is clear: the
second tier beneficiaries were to receive only the net income from the trust.
The adjustment petition would significantly alter those terms.
­ The Court’s analysis leads to the conclusion that an adjustment to an incomeonly trust would violate a no-contest clause, except if the trust also permitted
principal invasions.
ƒ But if a principal invasion was permissible, exercise of the adjustment power
would be unnecessary.
­ Query the Court’s analysis of “impairing” the trust if the adjusted income payout
is not considered a principal distribution, but rather is the mechanism by which
the trustee determines to administer the trust impartially.
22
Other Recent Power to Adjust Litigation
„ Estate of Morse, Index No. 83862 (Sur. Ct., Dutchess Cty. 2006)
­ A testamentary trust was established for the benefit of a surviving spouse, the
remainder persons being the decedent’s children from a prior marriage.
­ When the trustee exercised the power to adjust, the remainder beneficiaries
objected, claiming the trustee was favoring the interests of the income
beneficiary to their detriment. They brought suit to block the adjustment.
­ The trustee filed a petition for advice and direction with the Surrogate.
ƒ The Surrogate found the adjustment to be appropriate.
• The remainder beneficiaries failed to show any abuse of discretion, bias,
or arbitrary action.
• The Surrogate further cited the statutory language of EPTL §11-2.3A.
○ A Court shall not change a fiduciary’s decision to exercise or not
exercise an adjustment power unless it determines that the decision
was an abuse of the fiduciary’s discretion.
E. Identification of Clients – Multiple Representation Conflicts
„ Effective April 1, 2009, the Code of Professional Responsibility is replaced with
the Rules of Professional Conduct (“RPC”) in New York. The Rules of
Professional Conduct are modeled after the American Bar Association’s Model
Rules of Professional Conduct.
­ The District of Columbia and 49 other states have professional conduct rules
adopted or modified from the ABA Model Rules.
ƒ California is the only state that has not adopted some form of the Model
Rules.
­ All references to the “Rule” or “Rules” herein, refer to the New York Rules of
Professional Conduct.
ƒ Unless otherwise noted, the New York Rules discussed are substantially
similar to the Model Rules.
23
„ There are a number of situations in which lawyers representing grantors, trustees
and beneficiaries may potentially violate the RPC.
­ May a lawyer for a grantor also represent the trustee?
ƒ Rule 1.7(a)(1) provides that a lawyer may not represent a client “if the
representation will involve the lawyer in representing differing interests”.
ƒ The Model Rule prohibits concurrent representation if “the representation of
one client will be directly adverse to another client.”
• Do grantors and trustees have differing or directly adverse interests?
ƒ A lawyer may be able to cure a potential violation with informed consent.
Rule 1.7(b) allows a lawyer to represent clients with differing interests if:
(1) the lawyer reasonably believes that the lawyer will be able to provide
competent and diligent representation to each affected client;
(2) the representation is not prohibited by law;
(3) the representation does not involve the assertion of a claim by one
client against another client represented by the lawyer in the same
litigation or other proceeding before a tribunal; and
(4) each affected client gives informed consent in writing.
ƒ
Informed consent is defined in Rule 1.0(j):
“Informed consent” denotes the agreement by a person to a proposed
course of conduct after the lawyer has communicated information
adequate for the person to make an informed decision, and after the lawyer
has adequately explained to the person the material risks of the proposed
course of conduct and reasonably available alternatives.
ƒ Informed consent under the Model Rule 1.0(e) is defined as:
…the agreement by a person to a proposed course of conduct after the
lawyer has communicated adequate information and explanation about the
material risks of and reasonably available alternatives to the proposed
course of conduct.
­ May the grantor’s lawyer also represent the beneficiaries?
24
ƒ Conflicting interests between grantors and beneficiaries may arise. The
grantor’s wishes may not necessarily be in the best interests of the
beneficiaries.
• For example, a grantor may wish to invest trust assets in a manner which
involves more risk than the beneficiaries can tolerate (a concentrated
stock position, for instance), or to prohibit principal invasions, or to
distribute principal for limited purposes, only.
ƒ Is it possible for a lawyer to cure these conflicts pursuant to Rule 1.7(b)?
• Assuming that the lawyer feels that he or she can provide diligent
representation to both the grantor and the beneficiaries, can the
beneficiaries give informed consent?
○ Will the beneficiaries understand that the lawyer may not be drafting
the document in what they consider to be their best interests?
○ If informed consent is not possible, the lawyer may not represent both
clients without violating Rule 1.7.
­ May a lawyer represent the interests of the trustee and the beneficiaries?
ƒ Asset allocation, discretionary distributions, accountings, exercise of trustee
powers – these are only some of the matters rife with potential conflict
between trustees and beneficiaries. Can a lawyer properly advocate for these
different, and potentially conflicting, interests?
• Stock concentration cases like In re Charles G. Dumont, Wood v. U.S.
Bank and Fifth Third Bank v. Firstar Bank, NA, discussed infra, provide
examples of situations in which the interests of the trustee and income
beneficiary are not aligned.
ƒ What Rules are potentially violated by this dual representation?
• Under Rule 1.1(c)(1), a lawyer may not intentionally fail to seek the
objectives of the client through reasonably available means (Pursuant to
Model Rule 1.1, a lawyer must “provide competent representation”).
Rule 1.2(a) requires a lawyer to abide by a client’s decision regarding the
objectives of representation.
25
○ Do these Rules create a potential violation for lawyers representing
trustees and beneficiaries with competing interests?
• Is Rule 1.7(b)(1) violated by such representation?
­ May a lawyer represent both the income beneficiaries and the
remainderpersons?
ƒ Trust litigation case law highlights many of the conflicts that can arise
between income beneficiaries and remainder persons. However, are these
conflicts so pervasive that a lawyer can never represent both interests under
Rule 1.7?
• In a second marriage situation, it is understandable that a lawyer may find
it difficult to represent the interests of both the second wife income
beneficiary and the children from the first marriage remainder persons.
See Matter of Heller, supra.
○ As a practical matter, a lawyer may find it difficult to obtain informed
consent from both parties.
• What about a family trust in which the remainder persons are the children
of the income beneficiaries?
­ May the drafting lawyer name himself as trustee?
ƒ Rule 1.8(c) prohibits a lawyer from soliciting gifts or drafting instruments
giving himself or his family gifts.
ƒ Rule 1.7(a)(2) prohibits an attorney from representing a client if the lawyer
concludes that “there is a significant risk that the lawyer’s professional
judgment on behalf of a client will be adversely affected by the lawyer’s own
financial, business, property or other personal interests.” The Model Rule
prohibits a lawyer acting if there “is a significant risk that the representation
of one or more clients will be materially limited by the lawyer's
responsibilities to another client, a former client or a third person or by a
personal interest of the lawyer.”
ƒ Is a fiduciary position considered a gift in violation of Rule 1.8(c)?
• The Comments to the Model Rules provide that Rule 1.8(c) does not
prohibit a lawyer from seeking to have himself or an associated lawyer
26
appointed to a “potentially lucrative” fiduciary position in the client’s
estate.
• The Comments provide that such appointments are subject to the general
conflict of interest provision of Rule 1.7 where “there is significant risk
that the lawyer’s interest in obtaining the appointment will materially
limit the lawyer’s independent professional judgment in advising the
client concerning the choice of an executor or other fiduciary.”
○ If the lawyer seeks to obtain the informed consent of the client to cure
the Rule 1.7 conflict, the lawyer should advise the client as to the
nature and extent of the lawyer’s financial interest in the fiduciary
appointment and the availability of alternative candidates for the same
appointment.
• Although not all states have adopted the Comments (New York, for
example, has not), they may provide useful guidance.
• New York’s Surrogate Court Procedure Act (“SCPA”) §2307-a provides
that an attorney (or affiliated attorney or employee) who drafts a will
appointing himself as executor is limited to one-half the commissions to
which he would otherwise be entitled unless he informs the client, prior to
the execution of the will that:
(a) subject to limited statutory exceptions, any person, including
the testator’s spouse, child, friend or associate, or an attorney, is
eligible to serve as an executor;
(b) absent an agreement to the contrary, any person, including an
attorney, who serves as an executor is entitled to receive an
executor’s statutory commissions;
(c) absent execution of a disclosure acknowledgement, the attorney
who prepares the will, a then affiliated attorney, or an employee of
such attorney or a then affiliated attorney, who serves as an
executor shall be entitled to one-half the commissions he or she
would otherwise be entitled to receive; and
(d) if such attorney or an affiliated attorney renders legal services
in connection with the executor’s official duties, such attorney or a
then affiliated attorney is entitled to receive just and reasonable
compensation for such legal services, in addition to the executor’s
statutory commissions.
27
• The acknowledgement of disclosure must be in writing and must be
witnessed by at least one witness other than the attorney.
○ In Matter of Moss, 863 N.Y.S.2d 588 (2008), the Surrogate held that
an acknowledgement of disclosure witnessed by the attorneyexecutor’s partner was invalid for purposes of SCPA §2307-a.
Under the express terms of section 2307-a, a nominated executor is
identified with the draftsman if the two are “affiliated”. In view of
the affiliation between the nominated executor and the Partner,
the…disclosure statement may reasonably be deemed to have been
“witnessed” not simply by the partner, but, in effect and contrary
to the purpose of the statute, by the nominee.
○ Following the reasoning of the Surrogate, can any employee of the
attorney-executor ever be considered an unaffiliated witness? Even an
administrative salaried employee who does not share in the firm’s
profits?
○ Consider the practical difficulties this presents: If the client signs his or
her will at the law firm of the attorney-executor, who can witness the
acknowledgement of disclosure?
­ May the grantor’s lawyer serve as successor trustee?
ƒ What if the grantor’s lawyer, who was not named in the instrument as a
successor trustee, is nonetheless appointed successor trustee pursuant to the
designation provisions of the governing instrument?
„ What if the lawyer representing two clients develops a conflict that cannot be
cured?
­ Rule 1.16(b)(1)/Model Rule 1.16(a)(1) requires a lawyer to withdraw from
representation of a client when the lawyer knows that the representation will
result in a violation of the RPC.
ƒ Which client must be dropped? Both?
„ Note that, if a lawyer is serving in a fiduciary capacity only, and is not performing
legal services, the lawyer may still be subject to the RPC.
­ Pursuant to Rule 5.7(a)(2), a lawyer who provides nonlegal services which are
distinct from legal services (such as acting as trustee), is subject to the Rules
28
with respect to the nonlegal services “if the person receiving the services would
reasonably believe that the nonlegal services are the subject to a client-lawyer
relationship”.
ƒ Will a beneficiary understand that a person who is a lawyer is not acting in
that capacity with regard to his/her trust?
• Fiduciaries who are lawyers should be careful to fully explain their role.
They should avoid sending correspondence on firm letterhead or
otherwise holding themselves out to be acting in their capacity as lawyers.
• Should the fiduciary advise the beneficiary to seek separate
representation?
­ Under the Model Rule 5.7(a)(2), the lawyer must take “reasonable measures to
assure that a person obtaining the law-related services knows that the services
are not legal services and that the protections of the client-lawyer relationship do
not exist” - otherwise, he is subject to the Rules with respect to the nonlegal
services.
1. Consider Diversification Issues and Retention Clauses:
„ What if there is a conflict between the provisions of the document and the realities
of the market or needs/wishes of the beneficiaries? Will a family trustee appreciate
that s/he will not necessarily be permitted to rely on the terms of the dispositive
instrument?
„ In Re Charles G. Dumont, 791 N.Y.S.2d 868 (2004), rev’d in part, 809 N.Y.S.2d
360 (App. Div. 4th Dep’t 2006), appeal denied, 813 N.Y.S.2d 689 (App. Div. 4th
Dep’t 2006), appeal denied, appeal dismissed, 855 N.E.2d 1167 (2006)
­ A trust created under Mr. Dumont’s will was funded almost entirety with
Eastman Kodak stock.
­ An action was brought against JP Morgan Chase (as successor to a former
trustee) for breach of fiduciary duty following significant declines in the stock’s
value.
­ The Bank had maintained a near-exclusive concentration of the Kodak stock
from 1958 until 2002.
29
­ During this time, the Bank had no meaningful investment review process in
place and failed to document the investment strategy, performance of Kodak
stock and reasons for maintaining the concentration.
­ The Bank rarely communicated with the beneficiaries and never addressed their
concerns regarding the concentration of Kodak stock.
­ The will contained the following retention clause:
It is my desire and hope that said stock will be held by my said executors
and by my said trustee to be distributed to the ultimate beneficiaries under
this will, and neither my executors nor my said trustee shall dispose of
such stock for the purpose of diversification of investment and neither
they nor it shall be held liable for any diminution in the value of such
stock.
­ The will also provided that:
The foregoing shall not prevent my said executors or my said trustee from
disposing of all or part of the stock of Kodak in case there shall be some
compelling reason other than diversification of investment for doing so.
­ Surrogate’s Court:
ƒ The retention language was “clearly precatory”.
ƒ The Surrogate noted that the Prudent Investor Act statutorily requires a
trustee to “diversify assets unless…it is in the interests of the beneficiaries
not to diversify, taking into account the purposes and terms and provisions of
the governing instrument.”
ƒ The Surrogate opined that there are three voices to which the trustee must
listen: the settlor (his/her intent and strength of wording); the beneficiaries
(regarding their economic situation and expressed desires); and the market
(realities of financial world and composition of trust corpus).
ƒ The Surrogate held that, where prudence dictates sale, a retention clause is
superseded: “…a retention clause does not exculpate [a fiduciary] from poor
judgment and laziness, but instead…a retention clause almost requires a
greater level of diligence and work…”
ƒ After scathing criticism of the Bank’s “on-going self-perpetuating
atmosphere of neglect”, the Surrogate surcharged the trustee $24 million.
30
ƒ The Surrogate held that the Bank’s “complete lack of documentation alone is
itself a breach of trust”.
­ Appellate Division:
ƒ The Appellate Court reversed the Surrogate – but on technical grounds,
holding that the Surrogate erred by finding that a compelling reason existed
to sell the stock on a date that was not pled and, further, that the Surrogate’s
determination was based impermissibly on hindsight.
ƒ The Appellate Court did not address the Surrogate’s determination that a
retention clause is superseded where prudence dictates sale. This casts doubt
on the ability of a grantor to ever exonerate a fiduciary from the duty to
diversify.
­ Court of Appeals:
ƒ Denied motions for leave to appeal.
„ Mary and Emanuel Rosenfeld Foundation Trust, 2006 Phila. Ct. Com. Pl. LEXIS
394
­ Emanuel Rosenfeld, the founder of Pep Boys, established a charitable trust
funded entirely with Pep Boys stock in 1952. He named three individuals cotrustees: Mr. Rosenfeld’s son Lester, his daughter Rita, and Lester’s son Robert.
Wachovia Bank was the corporate trustee.
ƒ Lester had worked for Pep Boys all his life. After his retirement in 1980, he
continued to serve as a consultant and board member.
­ Beginning in 1997, Rita and Wachovia both urged diversification of the trust
assets. Lester and Robert both opposed diversification, and both ignored the
bank’s attempt at communication regarding the issue. The trustees were
deadlocked. The Court found that:
ƒ Lester’s obdurate refusal to diversify stemmed from his position with the
company, the interests of which the Court found he put above those of the
charitable beneficiaries.
ƒ Robert abdicated any responsibility as trustee by inattention, his supine
submission to his father’s presumed inside knowledge and his fear of the
personal financial repercussions of failing to follow his father’s lead.
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­ In 2001, Lester and Robert agreed to sell some of the Pep Boy stock. By this
time, however, the stock had declined significantly in value.
­ In 2002, Rita sued Lester, Robert, and Wachovia for breach of their fiduciary
duty, based on the failure to diversify. Summary judgment was later granted for
Wachovia.
ƒ The Court noted that Wachovia (along with Rita) raised “contemporaneous
and vigorous” objections to Lester and Robert’s actions, actively monitored
and reviewed the trust investments and sent multiple letters to the co-trustees
urging diversification.
­ The Court noted that neither Lester nor Robert appreciated the responsibilities of
being a trustee.
­ The following excerpts from Lester’s disposition graphically illustrate this point:
Q: Do you consider yourself a trustee of the foundation to have any duties
to beneficiaries of the foundation, and by beneficiaries, I mean the
charities that will be receiving…
A: No.
Q: …distribution?
A: No.
Q: You have no duty to the beneficiaries?
A: No. I have no commitment to them, they’re very appreciative of what
we give them and I’m grateful for the fact that we’re able to do it.
Q: Now, I understand from your testimony that it didn’t matter what the
bank was recommending as to putting the proceeds into, you were against
diversification per se, correct?
A: Yes.
­ The Court surcharged Robert and Lester almost $600,000 for trust losses,
calculated from the date Rita and Wachovia objected to the concentration in Pep
Boys stock, and over $425,000 in legal fees.
32
„ In re Rowe, 712 N.Y.S.2d 662 (App. Div. 2000), appeal denied, 749 N.E.2d 206
(Ct. App. 2001)
­ In 1989, a charitable lead trust was funded entirely with IBM stock.
­ A few months after the trust’s funding, the corporate trustee’s Trust Committee
met to review the management of the trust. Although the trustee had a written
diversification policy, the Committee felt it would be imprudent to diversify the
IBM stock immediately because the value of the stock had dropped since the
funding of the trust. It agreed to diversify “at a later time when the stock
reached a higher price” (a tactic the beneficiaries’ expert witness described as
“wishful thinking”).
­ Following an intermediate accounting, the remainder persons filed objections
and brought suit for failure to diversify. At the time of the accounting, the trust
had diversified only a third of the IBM stock and the value of the trust assets had
dropped from $3.5 million to $1.8 million.
­ The Surrogate’s Court found that the trustee had been negligent, that it violated
its own policies, and that it should have diversified most of the trust assets soon
after funding.
­ The Appellate Division agreed with the findings of the Surrogate:
In addition…to testimony describing petitioner’s decision to delay
diversification as unwise and unreasonably risky…petitioner failed to
follow its own internal protocol during the administration of the
trust…failed to conduct more than routine reviews of the IBM
stock…[and gave] no particular consideration to the unique needs of this
particular trust…Neither adverse tax consequences nor any provision of
the trust instrument restricted petitioner’s freedom to sell the IBM stock
and diversify the trust’s investments.
„ Wood v U.S. Bank, 828 N.E.2d 1072 (Ohio Ct. App. 2005), appeal denied, 835
N.E.2d 727 (Ohio 2005)
­ John Wood created a trust valued at over $8 million, naming Firstar as successor
trustee after his death and his wife as beneficiary.
­ Nearly 80% of the trust was funded with Firstar stock.
­ The trust instrument authorized the trustee:
33
to retain any securities in the same form as when received, including
shares of a corporate trustee, even though all of such securities are not of
the class of investments a trustee may be permitted by law to make and to
hold cash uninvested as they deem advisable or proper.
­ Shortly after John’s death, Firstar decided to sell only ten percent of the Firstar
stock to pay the nearly $4 million in debts owed by the estate. Sales of other
stock generated the balance of the funds required.
­ After paying the debts, 86% of the trust portfolio was composed of Firstar stock.
­ Despite requests by John’s wife to diversify, Firstar did not diversify the
concentration.
­ Firstar stock plummeted and John’s wife sued the Bank for failure to diversify.
­ The jury returned a verdict in favor of Firstar, but the Court of Appeals
overturned the jury verdict and remanded the case for a new trial.
­ Court of Appeals:
ƒ To abrogate the duty to diversify, the trust must contain specific language
directing the trustee to retain in a specific investment a larger percentage of
trust assets than would normally be prudent.
ƒ Even if a trust authorizes a trustee to “retain” assets that would not normally
be suitable, the duty to diversify remains absent special circumstances. The
duty to diversify may be expanded, eliminated or otherwise altered only if
the trust instrument clearly indicates an intention to abrogate the duty to
diversify.
• The retention clause contained within the trust agreement merely
circumvented the duty of undivided loyalty and did not affect the duty to
diversify.
• The clause smacked of boilerplate language.
„ Fifth Third Bank v. Firstar Bank, N.A., 2006 Ohio 4506, appeal denied, 860 N.E.2d
768 (Ohio 2007)
­ This case involved a single stock portfolio, which was sold within one year.
­ Elizabeth Gamble Reagan, a descendant of one of the founders of Procter and
Gamble, established a charitable remainder unitrust (“CRUT”) with $2 million
34
of Procter and Gamble stock. One of the purposes of the trust was to diversify
out of the Proctor & Gamble stock.
ƒ The trust agreement contained the following retention clause:
Trustees shall have the…[right to] retain, without liability for loss or
depreciation resulting from such retention, original property, real or
personal, received from Grantor or from any other source although it may
represent a disproportionate part of the trust.
­ Under the terms of the CRUT, Reagan was to receive an 8 percent unitrust
payout, with the remainder to be distributed to three charities upon her death.
­ U.S. Bank (Firstar Bank) was appointed trustee and gradually began to reduce
the concentration of Procter & Gamble stock, but by the end of the year, the
value of the CRUT had dropped by 50 percent.
­ Reagan then replaced U.S. Bank with Fifth Third and filed suit against U.S.
Bank for breach of fiduciary duty.
­ U.S. Bank contended that the language of the CRUT both relieved it from the
duty to diversify and exculpated it from liability for losses.
­ The trial court awarded over $1 million in damages to Reagan.
­ Court of Appeals affirmed, holding:
ƒ The duty to diversify attaches to all investments, even those already held in
trust, absent special circumstances or explicit authorization not to diversify.
ƒ The language contained in the trust agreement did not clearly indicate the
intention to abrogate the duty to diversify.
ƒ A permissive provision or a mere authorization to hold a trust asset is not
sufficient to insulate a trustee from liability.
„ Night Watchman?
­ According to the Court in Saxton (discussed below):
A fiduciary must be as a watchman in the night, ever vigilant and always
dedicated to the best interest of the cestui que trust.
35
ƒ Will a family member trustee appreciate that s/he has agreed to be a “night
watchman”?
„ Americans for the Arts v. Ruth Lilly Charitable Remainder Annuity Trust #1, 855
N.E.2d 592 (Ind. Ct. App. 2006)
­ Ruth Lilly was a descendant of Eli Lilly, founder of Eli Lilly and Co.
­ In 1981, the Probate Court appointed National City to be conservator of Ruth’s
estate.
­ In 2001, National City petitioned the Probate Court to permit certain changes to
the estate plan. The plan was to streamline and simplify Ruth’s estate in order to
avoid unnecessary taxes and litigation relating to her disposition of more than $1
billion.
­ The plan involved the creation of two Charitable Remainder Annuity Trusts
(“CRATs”).
­ All interested parties, including three charitable remainder beneficiaries, were
given notice of the changes and copies of the proposed plan, and each had an
opportunity to raise objections. While many objections were raised and changes
were made, there were no objections to the retention clause, which provided:
To retain indefinitely any property received by the trustee and…any
investment made or retained by the trustee in good faith shall be proper
despite any resulting risk or lack of diversification or marketability and
although not of a kind considered by law suitable for trust investments.
­ In January 2002, the CRATs were funded as planned, entirely with shares of
Lilly stock.
­ By March, National City had developed an investment policy for the CRATs.
­ In July, National City had sold significant portions of the Lilly stock.
­ By October, most of the Lilly stock had been sold.
­ However, the value of the Lilly stock had declined considerably during this time
frame.
­ In November, National City sought court approval of its diversification of the
CRATs. Two of the charities objected, citing violations of the Prudent Investor
Act, and sought to surcharge National City for the losses.
36
­ Probate Court:
ƒ The Probate Court granted summary judgment in favor of National City. The
Court concluded the exculpatory clause was valid and binding upon the
parties, and that the investments made or retained by the trustee during the
accounting period were made or retained in good faith and were proper.
­ Court of Appeals:
ƒ The Court affirmed the granting of summary judgment.
ƒ The Court cited the level of sophistication of the attorneys involved and the
fact that no objections were raised to the retention clause despite the 400
hours they spent reviewing the proposed plan and the $250,000 incurred in
legal fees.
ƒ Since the charities were given the opportunity to object to the
retention/exculpatory clause and did not, they could not “turn back the clock”
and claim the provision was unenforceable.
ƒ The Court found no evidence of self-dealing by National City.
ƒ The Court found no evidence that National City benefited from the failure to
diversify.
ƒ The Court found no evidence that National City abused its fiduciary
relationship.
ƒ The general retention clause, combined with the clause explicitly lessening
the trustee’s duty to diversify, was sufficient to exempt National City from its
duty to diversify.
• The Court relied on Wood v. U.S. Bank, which held that the trust
instrument could have eliminated the duty to diversify, had it included the
requisite authorizing language.
ƒ The exculpatory clause was held enforceable.
• Absent a finding of self-dealing, breach of fiduciary duty or abuse of a
confidential relationship with the settlor, the Court could not conclude
that the exculpatory clause was invalid.
37
„ National City Bank v. Noble, 2005 Ohio 6484 (Ct. App.)
­ In 1965, the son of the founder of the J.M. Smucker Company established a trust
for the benefit of his two children, funded with life insurance policies and shares
of J.M. Smucker Company stock.
­ The trust agreement contained the following clause:
The Trustees are expressly empowered to retain an in investment, without
liability for depreciation in value, any and all securities issues by The J.M.
Smucker Company, however and whenever acquired, irrespective of the
proportion of the trust properly invested therein.
­ In 1980, a request was made to diversify the Smucker Company stock, which at
that time constituted 87% of the trust’s assets. In 1983 and 1985, the trustees
began to diversify and by 2001, Smucker Company stock constituted 25% of the
total value of trust’s equities.
­ In 2002, the trust was terminated and its assets were distributed. In the judicial
accounting proceedings, the trust beneficiaries objected, citing breaches of
fiduciary duty, including for failure to diversify and for conflict of interest.
• The individual trustee was a member of Smucker Company’s board of
directors.
­ The Probate Court denied summary judgment to the beneficiaries.
­ The Court of Appeals affirmed.
­ The Court noted (1) the clear retention language and (2) additional language
providing that the corporate trustee had no duty to review or make
recommendations without the specific request of the individual trustee and (3)
the overall increase in the trust assets over the life of the trust.
­ The Court of Appeals distinguished Wood, noting that in Wood concentrated
position was in the corporate trustee’s stock. Further:
There is no allegation that Welker Smucker’s Trust contained an
inordinate amount of [corporate trustee] stock. While the trust certainly
contained a large amount of stock in the family company, it is
unquestionable that the value of the trust increased since its inception –
providing both for the retention of Smucker stock and for the benefit of
the beneficiaries.
38
„ In re Ervin Estate, 2008 Mich. App. LEXIS 426 (Ct. App.)
­ John Ervin established a testamentary trust for the benefit of his daughter and
four grandchildren.
­ In 2001, one of the beneficiaries objected to an accounting, claiming that the
corporate trustee breached its fiduciary duty on multiple counts, including
breach of the duty to diversify the trust’s holdings.
ƒ The primary asset of the trust was stock in Ervin Industries, a family-owned
corporation. However, it is unclear from the decision what percentage of the
trust assets were invested in that stock.
­ The Court of Appeals held that the trustee was “exempt” from the prudent
investor rule.
ƒ The Michigan prudent investor rule provides that a trustee must act as a
prudent person would, “except as otherwise provided by the terms of the
trust”.
• In this instance, the trust agreement authorized the trustee “to invest and
reinvest…in income-producing assets in accordance with its judgment,
not being limited by any present or future investment laws…” (emphasis
added)
ƒ The Court found that this language alone made the prudent investor rule
inapplicable to any evaluation of the trustee’s management of trust assets.
ƒ Furthermore, the trust agreement contained a retention clause permitting the
trustee to retain Ervin Industries’ stock “without liability for any loss that
may be incurred, and without regard to the proportion that it may bear to the
whole…until any substantial amount of it shall be or become unproductive of
income.”
ƒ In response to this language, the Court noted:
Certainly, the Ervin Industries’ stock held by the Trust is not currently
‘unproductive of income’ and [the beneficiary] does not assert otherwise.
Therefore, [the trustee] has had no duty to diversify the Trust’s holding at
any time, and there is no basis for [the beneficiary] to complain that [the
trustee] has failed to do so.
39
„ Query whether a drafting lawyer may, without violating the RPC, represent a
beneficiary wanting to diversify trust assets if the grantor expressed an intent not to
diversify.
­ The prudent investor rules are typically default regimes. What if Firm A, at the
direction of the grantor, drafts a document which purports to obviate the duty to
diversify. A former attorney at Firm A who has no knowledge or involvement
with the drafting of the instrument later becomes employed by Firm B, the firm
representing the trust beneficiaries in an action to compel diversification. Is
Firm B precluded from representing the beneficiaries?
ƒ Rule 1.9(b) provides that, absent the former client’s written informed
consent, a lawyer is prohibited from knowingly representing another client in
the same or substantially related matter in which the lawyer’s former firm has
previously represented the former client (1) whose interests are materially
adverse to the prospective client and (2) about whom the lawyer had acquired
confidential information that is material to the matter.
• Although the lawyer was previously employed by Firm A, if he had no
knowledge of the transaction and gained no confidential information
material to the action to compel diversification, it appears Firm B would
not be precluded from representing the beneficiaries.
• The Comments to the Model Rules provide that the duty of loyalty to the
former client must be weighed against the ability of current clients to have
a reasonable choice of legal counsel and the ability of lawyers to form
new associations.
­ What if the grantor’s lawyer working at Firm A drafts a document which
purports to obviate the duty to diversify. The grantor’s lawyer later becomes
employed by Firm B, the firm representing the trust beneficiaries in an action to
compel diversification. Is Firm B precluded from representing the
beneficiaries?
ƒ In this situation, the lawyer was directly involved with the matter and the
former client’s representation. However, would the lawyer have gained
confidential information that is material to the diversification issue?
­ There is a stricter standard for a lawyer with direct involvement in the specific
transaction.
40
ƒ Rule 1.9(a) provides a one-prong test with respect to a lawyer who had direct
involvement in the specific transaction.
• Rule 1.9(a) prohibits a lawyer who has formerly represented a client from
representing another client in the same or substantially related matter in
which the prospective client’s interests are “materially adverse” to the
interests of the former client.
ƒ Rule 1.9(b) provides a two-prong test for disqualification with respect to a
lawyer who did not have direct involvement in the specific transaction, but
whose former firm was involved.
• In order to disqualify a lawyer because his prior firm represented a client
in the same or substantially related matter, it must be shown that (1) the
prospective client and former client’s matters are materially adverse and
(2) the lawyer acquired confidential information during his association
with his former law firm.
○ Rule 1.9(a) does not require that the lawyer have privileged
information material to the current matter to preclude him from
representing the current client.
­ Rule 1.9(a) and Rule 1.9(b) provide that the conflict between a former client and
a prospective client may be resolved by the former client’s informed consent.
• What if the former client is deceased?
­ Note that Rule 1.10 imputes conflicts of interest from lawyers to their firms.
2. Communication is Key
„ An integral part of a lawyer’s representation of a trustee is ensuring that the trustee
understand his or her fiduciary duties to the beneficiaries. If the lawyer fails to
inform the trustee of the need to communicate with the beneficiaries, is the lawyer
violating the RPC?
­ Rule 1.1(a) requires a lawyer to provide competent representation to a client.
­ Rule 1.3(a) requires a lawyer to act with reasonable diligence in representing the
client.
­ Rule 1.4(a)(2) requires a lawyer to reasonably consult with his client regarding
the means to achieve the client’s objectives.
41
„ McGinley v. Bank of America, 279 Kan. 426 (2005)
­ Settlor created a revocable trust in 1991, which provided she was to be consulted
by the trustee as to any purchase or sale and that the trustee had to abide by her
decision.
­ The trust was funded with Enron stock and other assets.
­ Seven months later, she signed a letter directing Bank of America, as trustee, to
retain the Enron stock. The letter exonerated and indemnified the Bank for all
losses as a result of the retention and relieved the Bank from responsibility for
analyzing and monitoring the stock. By the end of 2000, Enron stock comprised
77% of the trust assets.
­ After Enron stock plummeted in 2001, the settlor brought suit against Bank of
America for the lost value of the stock, claiming Bank of America failed to
comply with the prudent investor rule.
­ The Court rejected the arguments of the settlor.
ƒ Kansas statutory law specifically provides that a trustee who follows the
written directions of a settlor of a revocable trust is deemed to have complied
with the prudent investor rule and is authorized to follow such written
instructions.
ƒ In rejecting the settlor’s claims, the Court also relied on the retention of
investment powers by the settlor and the letter to the Bank.
ƒ However, the Court did note that the better practice of Bank of America
would have been to communicate the effects of the letter and to have notified
the settlor of the significant decreases in the value of the Enron stock.
„ Margesson v. Bank of New York, 738 N.Y.S.2d 411 (App. Div. 2002)
­ Francis Margesson was the sole income beneficiary of a trust, founded
predominately with large concentrations of four stocks. Bank of New York had
been a co-trustee since 1989 and became sole trustee in 1996.
­ Because sale of the highly appreciated stocks would result in substantial tax
liability, there was a long-standing understanding that the trust would be
managed to avoid unnecessary sale of these stocks. Francis was 74 years old
when Bank of New York became sole trustee.
42
­ In 1997, the Bank of New York sought to diversify the trust assets. Without
communicating with the trust’s administrative officer or Francis, the trust’s
investment officer sold a portion of the stock holdings. The sale resulted in
Francis being personally liable for over $22,000 in capital gains. Francis then
sued the Bank of New York for breach of fiduciary duty.
­ The bank claimed it was merely complying with the prudent investor rule and
the sale was made for the purpose of diversifying the trust’s investments.
­ The Appellate Division overturned a lower court’s grant of summary judgment,
finding that, although the bank complied with the prudent investor rule, a triable
issue of fact existed as to whether it breached its fiduciary duty by failing to
communicate:
“She [the administrative officer] had no conversation with [the investment
officer] regarding this sale or the plaintiff’s needs as income beneficiary.
[The investment officer] has a responsibility to communicate with [the
administrative officer]…to ensure his understanding of the investment
objectives.”
„ Rollins v. Branch Bank and Trust Co. of Virginia, 56 Va. Cir. 147 (2001)
­ In 1977, trusts were established for the benefit of the grantors’ children and
grandchildren. The trusts were funded predominately with stock of one
company.
­ The trust agreement contained the following language:
Investment decisions as to the retention, sale, or purchase of any asset of
the Trust fund shall likewise be decided by such living children or
beneficiaries, as the case may be.
­ At the time of the trust’s inception, the Bank obtained written approval to overconcentrate the trust. This concentration was held until 1997, when the trustee
sold the stock at the direction of the beneficiaries. By that time, however, the
stock had plummeted to one-twelfth of its highest value. The beneficiaries sued
the Bank for breach of duty for the failure to diversify assets and the failure to
communicate with the beneficiaries.
­ The Bank claimed that the language of the trust agreement insulated it from
liability, as the investment responsibility rested exclusively with others.
Additionally, the Bank relied on Virginia statutory law:
43
Whenever the instrument under which a fiduciary or fiduciaries are
acting…vests in…any other person…including a co-fiduciary…to the
exclusion of one or more of the fiduciaries, authority to direct the making
or retention of investments…the excluded fiduciary or co-fiduciary…shall
not be liable as fiduciary or co-fiduciary for any loss resulting from the
making or retention of any investment pursuant to such authorized
directions.
­ The Court agreed that the language of the trust agreement and the statute
protected the trustees from liability for failure to diversify.
­ However, the Court held, the trustee has a duty to (1) keep informed as to the
conditions of the trust and (2) fully inform beneficiaries of all facts relevant to
the subject matter of the trust and which are material for the beneficiary to know
for the protection of his interests. A trustee cannot rid himself of this “duty to
warn”.
­ Although the conduct of the beneficiary in requesting retention of the stock
prohibited them from complaining about that decision, the prohibition on
recovery does not excuse a trustee from liability for failing to participate in the
administration of the trust, which can include the duty to communicate.
­ The Court overruled the demurrer regarding breach of fiduciary duty, except as
it related to failure to diversify.
„ Hartman v. Walker, 73 Va. Cir. 245 (2007)
­ Separate testamentary trusts were established for the benefit of each of the
testator’s two children. Upon the death of one, the trust assets would pour over
to the surviving sibling’s trust. The remainder persons of both trusts were the
testator’s grandchildren. The testator’s son Leonard, daughter Barbara,
Barbara’s child, and a bank were named as co-trustees of Leonard’s trust.
­ Each trust was funded with equal shares of two family entities, a limited
partnership and a corporation, each holding unimproved real estate. Barbara
was the general and controlling partner of the partnership. The trusts were
valued at $14.5 million, but Leonard’s trust distributed to him only minimal
income. In 2005, after receiving only $19,000 in income, Leonard brought suit
against his co-trustees for lack of impartiality and failure to diversify trust
assets. He sought to remove the trustees and $800,000 by way of a surcharge.
ƒ Leonard claimed that the co-trustees breached their fiduciary duties by failing
to approve measures to increase his income payments, failing to disclose
44
offers to purchase partnership assets, and developing partnership land at
partnership expense without his knowledge or consent. He alleged all actions
were taken to deprive him of income in order to benefit the remainder
persons of his trust – his sister’s children. Leonard had no children.
­ The Court rejected the argument that the Will relieved the trustees from
complying with the Prudent Investor Act and permitted the trustees to maintain
trust assets for the remainder persons at Leonard’s expense.
ƒ In order to circumvent the diversification requirements of the Prudent
Investor Act, held the Court, the testator’s intent must be clear: “This intent
could be demonstrated in a variety of ways, though reliance on ‘a general
authorization in a will or trust authorizing a fiduciary to invest in such assets
as the fiduciary, in his sole discretion may deem best’ will not suffice…The
mere fact that she [the testator] permitted Trustees the ability to maintain
undiversified investments…would not have had the effect of waiving
application of the [Prudent Investor] Act.”
­ The Court also concluded that while neither the Prudent Investor nor Principal
and Income Acts “specifically demand that a beneficiary be paid ‘reasonable
income’, they do contemplate that the beneficiaries will be impartially favored
and that trusts will be managed so as to fulfill the intent of the testator, which
may in fact require that a reasonable ‘net income’ be provided.”
­ The Court noted that, as a co-trustee and beneficiary, Leonard must be provided
with adequate information to enforce his rights or prevent or redress a breach of
trust. Interestingly, the Court found that it was in failing to properly provide
information concerning offers made for partnership property that the trustees
may have breached their fiduciary duty to Leonard (by preventing a full
determination of whether the trust was better served by maintaining
unproductive property).
„ Welch v. Weiner, 2007 Mich. App. LEXIS 2704
­ Decedent established an inter vivos trust in 1976. In 2000, the trust was
amended to make her husband a trustee and purportedly a co-settlor of the trust.
The decedent died in 2003, leaving her husband as sole trustee.
­ In 2003, after the decedent died, the husband’s attorney sent Patricia Welch a
check for $50,000 from the trust funds. The accompanying letter explained that
he was the trustee, Patricia was a contingent beneficiary and the check
45
represented an “advance payment” of her legacy under the trust, which he would
continue to make annually until her legacy was satisfied.
­ Shortly thereafter, Patricia sought a copy of the trust agreement. After her
request was denied, she brought a petition for an accounting of the trust, a copy
of the trust agreement, the removal of the husband as trustee, and sanctions
against the husband as trustee. The Probate Court denied her request.
­ The Court of Appeals found that Patricia was entitled to an accounting and a
copy of the trust agreement. The Court found that Patricia was an interested
trust beneficiary, who was entitled to relevant information about the trust and an
accounting under Michigan law.
­ The Court of Appeals also ordered the Probate Court, on remand, to remove the
husband as trustee, finding he breached his fiduciary duty by failing to provide
Patricia with an accounting and other relevant information.
3. The Duty to Diversify is not Absolute
„ In re Sky Trust, 868 A.2d 464 (Pa. Super. 2005)
­ Settlor established a revocable trust pursuant to the terms of which marital and
family trusts were created for the benefit of her husband after her death.
­ The corporate trustee was a wholly owned subsidiary of Sky Financial Group, a
publicly traded company and the trust contained a large holding of Sky Financial
stock, which paid a generous dividend.
­ After the death of the settlor in 1999, without ever inquiring as to the health or
financial circumstances of the husband, Sky Trust began to diversify the assets
of the trust, decreasing the income yield, instituting a more equity-weighted
investment goal and lengthening the investment time horizon.
­ In fact, the health of the elderly husband rapidly deteriorated after his wife’s
death and he moved into a nursing home where he died in December 2000.
­ Remaindermen filed objections to the trustee’s accounting. The trial court found
the trustee liable for gross negligence.
­ On appeal, the Superior Court affirmed:
46
ƒ The trust became irrevocable prior to the enactment of the Uniform Principal
and Income Act in Pennsylvania and the Court concluded the diversification
requirements under the Act did not apply.
ƒ The Court found the trustee guilty of gross negligence in diversifying the
stock.
ƒ The Court held that “diversification cannot become a goal in and of itself.
Rather, diversification is a tool that can provide the means to effectuate a
settlor’s goals of a trust, if used properly and prudently with due regard to the
specific facts and circumstances that exist in a particular case”.
ƒ A trustee’s hypothetical good strategy does not satisfy its fiduciary duty.
„ In re Estate of Kettle, 423 N.Y.S.2d 701 (App. Div. 1979), affirmed after remand
434 N.Y.S.2d 833 (App. Div. 1980)
­ Testator’s will contained the following language:
I note that the bulk of my income-producing assets at the time of my
death will probably consist of securities of TRW, Inc…and I note
that I am particularly desirous that my TRW, Inc. securities be
retained by my Executrix and by my Trustee unless compelling
reasons arise for the disposal thereof. (emphasis added)
­ Within two months of the delivery of the securities, and over the objection of the
testator’s widow, the trustee sold approximately half of the shares.
­ The widow brought suit against the trustee for breach of trust and to require the
trustee to repurchase the shares.
­ The trustee argued that the will authorized it to sell the stock, and that it did so
in the interest of diversification.
­ The Surrogate rejected the argument of the trustee and ordered the trustee to
repurchase the shares and pay the widow’s attorneys fees and expenses.
­ Appellate Division affirmed:
ƒ The Court found that diversification was not a compelling reason to sell and
that the trustee breached its fiduciary duty when it sold the securities over the
objections of the widow.
47
„ In re Strong, 734 N.Y.S.2d 668 (App. Div. 2001)
­ Decedent established a testamentary trust. The purpose of the trust was to
provide suitable income to the decedent’s daughter. The remainder was to be
paid outright to the daughter’s son.
­ The trust was initially funded with a concentration of stock of the trustee bank,
along with stock in 18 other corporations. Eventually, the trustee liquidated all
of the stock and invested the proceeds in its common stock funds.
­ After the death of his mother, the son filed objections to the trustee’s final
accounting. He claimed that the trustee breached its fiduciary duty by
diversifying the trust assets.
­ The son relied on a clause in the trust agreement permitting the trust to retain the
stock of the trustee bank.
­ The Court rejected the claims of the son, noting that, just as a trustee cannot rely
on the terms of a retention clause to justify a failure to diversify assets, neither
may a beneficiary claim such clause supersedes the requirements of the Prudent
Investor Act:
Since a fiduciary’s maintenance of an undue concentration of a particular
stock…has been found to constitute a violation of the ‘prudent person
rule’, petitioner can hardly be faulted for selling the National Commercial
Bank stock and thereby insuring proper portfolio diversification…Neither
the trust language permitting retention of the stock nor the preference of
the trust beneficiaries would have insulated petitioner from a claim that it
breached its fiduciary duty had it failed to achieve appropriate
diversification.
„ Matter of Hyde, 845 N.Y.S.2d 833 (App. Div. 2007), appeal denied by, 881 N.E.2d
1197 (Ct. App. 2008)
­ Charlotte Hyde and Nell Cunningham were the daughters of Samuel Pruyn,
founder of Finch, Pruyn & Company, Inc., a closely-held family corporation. At
her death, Charlotte established testamentary trusts, and Nell established an inter
vivos trust in 1935. Two of Charlotte’s trusts and Nell’s trust were the subject
of accounting proceedings.
­ Each trust was funded with large concentrations of Finch Pryun common stock.
Each trust agreement granted the trustees absolute discretion in managing trust
48
assets, but contained no directions concerning the disposition of the Finch Pruyn
stock.
­ In addition to being closely-held, Finch Pruyn had an unusual capital structure in
which Class A shareholders held all voting rights and therefore controlled the
decision to liquidate, but were entitled to virtually no proceeds upon liquidation.
Class B shareholders held no voting rights and therefore no power to effect a
liquidation, but received almost all proceeds upon liquidation.
­ Beneficiaries alleged breach of fiduciary duty for failure to diversify by the
corporate fiduciaries (no objections were filed against the individual trustees).
The Surrogate’s Court dismissed all objections. Upon appeal, each accounting
was addressed individually.
­ As to one of the Hyde trusts, the Appellate Division held that the corporate
fiduciary “made a reasonable determination that it was in the best interests of the
beneficiaries not to diversify”. The corporate trustee examined the liquidity of
the stock, the fact that the company was closely-held with an unusual corporate
structure, its lack of marketability, the general economic situation of the trust
assets, the expected tax consequences of different investment decisions, the
needs of the beneficiaries, and the intent of the settlor.
ƒ The Bank met with various investment bankers and brokerage houses prior to
making a determination as to the liquidity and marketability of the stock, as
well as regularly reviewing the financial condition of the trust assets.
ƒ The Court also noted the Bank’s conclusion that the needs of the
beneficiaries militated against diversification. The stock paid considerable
dividends such that a discounted sale for the sake of diversification may have
been imprudent. Additionally, the Court noted that the intent of the settlor
for the stock to remain in the family was a “material consideration” in
determining whether to diversify.
­ As to the other Hyde trust, the Appellate Division affirmed the Surrogate
Court’s dismissal of the claims against the trustee. Although the corporate
trustee was appointed in 1995, it was not informed of its appointment until 2004,
and could not be surcharged for failure to exercise a fiduciary duty of which it
was unaware. The Court also held that, even if the trustee had known about the
appointment, it would have concluded, as it did with respect to the other Hyde
trust, that diversification was unnecessary.
49
­ Similarly, the Court upheld the Surrogate’s decision regarding the Cunningham
trust
ƒ One of the factors in the corporate fiduciary’s decision not to diversify was a
letter received from a Pruyn family member stating that the corporation was
willing to repurchase the shares at a heavily discounted price. The Court
found that the Bank reasonably determined that it was not in the best interests
of the beneficiaries to sell the stock at a heavily discounted price merely for
the sake of diversification.
ƒ The Court found that the trustee was cognizant of the lack of liquidity of the
stock, its lack of marketability and its unusual capital structure. Even so, the
Court noted, the Bank regularly explored the market for the stock and kept
well informed of the company’s financial condition.
„ In re Wege Trust, 2008 Mich. App. LEXIS 1259 (Ct. App.)
­ Decedent died in 1947, establishing a trust under his will that was funded
predominately with shares in his company.
ƒ When the company went public in 1998, the trust sold 10% of its holdings in
the company for approximately $52,000,000. The trust sold additional shares
in 2000 and 2001, but still maintained a concentration of over 40%.
ƒ The Will expressed the decedent’s desire that his trustees retain the stock and
provided:
[The trustees may] hold and retain bonds or shares of stock or other
securities or other properties held or owned by me at my death, if in their
discretion they shall deem it prudent and for the best interest of my estate
so to do, notwithstanding the fact that the retention of such investments
might, except for this express direction, be in violation of the laws of this
State governing investments.
­ In 2006, one income beneficiary brought suit against the corporate trustee for
failure to diversify and sought removal.
­ The Probate Court found that the language of the Will provided a “safe harbor”
protecting the trustee “from the diversification requirement that ordinarily would
be deemed prudent”.
­ The Court of Appeals upheld the decision of the lower court and reiterated that
the language of the Will expressly exempted the trustees from compliance with
50
the prudent investor rule, allowing them to retain the stock if they in their
subjective discretion deemed it prudent and in the best interest of the
beneficiary, notwithstanding the objective standards of prudence that might
otherwise be imposed under the statute.
ƒ The Court noted that the beneficiary presented no evidence that the trustee
acted other than as it deemed prudent and in the best interest of the
beneficiary.
ƒ The Court also noted that deposition testimony expressed the difficulties
inherent in diversifying this particular stock and that the beneficiary
disavowed an interest in diversifying when she found the price of the stock to
be too low.
­ The Court of Appeals did affirm the lower court’s removal of the trustee, based
upon an inappropriate principal place of administration.
„ O’Neill v. O’Neill, 169 Ohio App. 3d 852 (2006)
­ Beneficiary’s uncle was named successor individual trustee of a trust. Under the
terms of trust, the principal was to be fully distributed to the nephew upon his
40th birthday in 2001.
­ The uncle delegated investment duties to Merrill Lynch in 1999, who invested
heavily in high-tech stocks.
­ After the technology market crash in 2000, the value of the trust fell
significantly. When the final principal distribution was made, the value of the
trust was 10% of the value when the uncle delegated investment responsibility to
Merrill Lynch.
­ The beneficiary brought suit against the uncle under the Prudent Investor Act for
breach of his fiduciary duty in delegating the management of trust assets. The
uncle brought and won a motion for summary judgment, which the nephew
appealed.
­ The Court noted that “[P]ursuant to the Ohio Uniform Prudent Investor Act, a
trustee ‘may delegate the following investment and management functions,
using reasonable care, skill and caution: 1) selecting an agent; 2) establishing the
scope and terms of the delegation consistent with the purpose and terms of the
trust; [and] 3) periodically reviewing the agent’s actions in order to monitor the
agent’s performance with the terms of the delegation.”
51
­ The Court of Appeals affirmed the lower court’s ruling, holding that a trustee
need not be heavily involved in the duties delegated in order to comply with the
Prudent Investor Act.
ƒ The uncle periodically met with Merrill Lynch, reviewed performance
reports, statement and confirmations of trades, and reviewed (but did not
scrutinize) the regular account statements. The uncle admitted he never
questioned the investment strategy. For the Court, it was sufficient that the
uncle did not “fall asleep at the wheel”.
ƒ The Court also took note that losses in high-tech stocks were very common
for the time period and that a common investment strategy was to stay the
course in that particular market.
­ Interestingly, the Court faulted the nephew for the losses. It was revealed that
he and the Merrill Lynch account officer collaborated in determining to make all
of the high-tech stock trades.
4. Exculpatory Clauses/Indemnification Provisions
„ New York Estates, Powers and Trusts Law §11–1.7(a) provides:
The attempted grant to an executor or testamentary trustee, or the successor of
either, of any of the following enumerated powers or immunities is contrary to
public policy
(1) The exoneration of such fiduciary from liability for failure to exercise
reasonable care, diligence and prudence.
See Estate of Allister, 545 N.Y.S.2d 483 (1989)
„ Connecticut Fiduciary Powers Act (Conn. Gen. Stat. §45a-234(38)) provides that
the following exculpatory clause may be incorporated by reference:
The fiduciary is hereby exonerated from any liability resulting from its retention,
sale or operation, whether due to losses, depreciation in value or actions taken or
omitted to be taken with respect to any business, farm or real estate interests held
in an estate or trust, nor shall the fiduciary be liable for any loss to or depreciation
of any other estate or trust property, so long as it is acting in good faith in the
management thereof and exercising reasonable care and diligence, but the
fiduciary is not exonerated from his own bad faith, willful misconduct or gross
negligence.
„ Fla. Stat. §736.1011 provides:
52
(1) A term of a trust relieving a trustee of liability to a beneficiary for breach of
trust is unenforceable to the extent that the term:
(a) Relieves the trustee of liability for breach of trust committed in bad faith
or with reckless indifference to the purposes of the trust or the interests of
interested persons; or
(b) Was inserted into the trust instrument as the result of an abuse by the
trustee of a fiduciary or confidential relationship with the settlor.
(2) An exculpatory term drafted or caused to be drafted by trustee is invalid as an
abuse of a fiduciary or confidential relationship unless:
(a) The trustee proves that the exculpatory term is fair under the
circumstances.
(b) The term’s existence and contents were adequately communicated
directly to the settlor or to the independent attorney of the settlor. This paragraph
applies to trusts created on or after July 1, 2007.
­ Fla. Stat. §733.620 applies this same language to personal representatives
„ DC Code § 19-1310.08; Va. Code Ann. § 55-550.08
­ Term of trust relieving a trustee for breach of trust is unenforceable to the extent
it relieves liability for acts of bad faith or reckless indifference
­ Such term is invalid as an abuse of the fiduciary relationship unless trustee
proves the existence and contents of the term were adequately communicated to
the settlor
„ Godette v. Estate of Mildred Cox, 592 A. 2d 1028 (D.C. 1991)
­ An exculpatory clause that excuses self-dealing or attempts to limit liability for
breaches of duty committed in bad faith, intentionally, or with reckless
indifference to the interest of the beneficiary, is generally considered to be
against public policy
„ Jacob v. Davis, 738 A. 2d 904 (Md. Ct. Spec. App. 1999)
­ Remanded to determine whether there was gross negligence, which was excused
under the exculpatory clause
„ If attorney includes an exoneration clause, is the attorney guilty of violating the
Code of Professional Responsibility?
­ Rule 3.1(a) prohibits an attorney from advancing a claim unless there is a basis
in law or fact for doing so that is not frivolous.
53
­ Rule 3.1(b) provides that a claim is frivolous if the lawyer knowingly advances a
claim or defense that is unwarranted under existing law.
ƒ This language is similar to the former Disciplinary Rules of the Code of
Professional Responsibility (“DR”) §7-102(a)(2), which was under
consideration in Estate of Edwin Lubin.
­ In Estate of Edwin Lubin, 539 N.Y.S.2d 695 (1989), the Surrogate said of the
testamentary exculpatory clause under consideration:
This provision purports to relieve the executor from liability “for any loss
or injury to the property…except…as may result from fraud, misconduct
or gross negligence.” This clause, which attempts to exonerate petitioner
from liability for his failure to use reasonable care, diligence and
prudence, is contrary to public policy and void (EPTL 11-1.7). Clearly,
counsel has an obligation to advise his client that such an exoneration
clause is a toothless tiger if the beneficiaries of the estate are aware of the
provisions of EPTL 11-1.7. If a client who has been so advised
nevertheless prevails upon counsel to include the exoneration clause,
either to lull the nominated fiduciary into a false sense of security so that
he will undertake the fiduciary responsibilities or to deceive the
beneficiaries into believing that they do not have a remedy against a
negligent fiduciary, is counsel guilty in violation of DR 7-102 of the Code
of Professional Responsibility of having become a coconspirator in an act
declared to be against public policy?
­ See also In re Kornrich, 2008 N.Y. Misc. LEXIS 2049 (noting an attorney’s
attempt to draft a trust agreement holding herself unaccountable “strongly
suggests a violation of professional ethics on her part”).
­ Greater protection from liability was previously available in the inter vivos
context. In New York, exculpatory clauses in inter vivos trusts have been
upheld [Carey v. Cunningham, 595 N.Y.S.2d 185 (1993); Bauer v.
Bauernschmidt, 589 N.Y.S.2d 582 (1992)] but that may be changing:
ƒ In re Kornrich, supra, the Surrogate held:
This public policy against exonerating testamentary fiduciaries from any
and all accountability is equally applicable with respect to inter vivos
trusts where…there is no one in a position to protect the beneficiaries’
interests during the existence of the trust. Although some decisions might
appear to hold that the references to testamentary fiduciaries in EPTL 111.7 signify that exoneration clauses in inter vivos trusts are not similarly
forbidden…such a conclusion is not supportable.
54
­ In any event, exculpatory provisions are strictly construed: Will a family trustee
appreciate that s/he will not necessarily be permitted to rely on an exculpation
clause?
­ Note that a lawyer who drafts a document limiting that lawyer’s own liability for
malpractice violates Rule 1.8(h)(1).
ƒ If the lawyer drafts a document with an exculpatory clause and the lawyer is
named as trustee, would this violate the Rule?
• The Rule provides that a lawyer may not limit his own liability for
“malpractice”. Does this Rule also extend to limiting his liability for
acting as a fiduciary?
• What if the drafting lawyer is not named in the document, but is later
appointed successor trustee? Must the lawyer decline the appointment to
avoid violating the Rule?
ƒ Note, the Model Rule allows the attorney to draft his own exculpatory clause
for professional malpractice if the client has his own independent
representation in connection with the agreement.
• Under the Model Rules, can a lawyer limit his liability for acting in a
fiduciary capacity under the terms of the document if the client has
independent representation?
„ Williams v. J.P. Morgan & Co., 248 F. Supp 2d 320 (S.D.N.Y. 2003), summary
judgment denied, 296 F. Supp. 2d 453, (S.D.N.Y. 2003), vacated by, opinion
withdrawn by, 2004 U.S. Dist. LEXIS 22721 (S.D.N.Y. 2004)
­ The Court reiterated the rule that indemnification clauses are subject to strict
scrutiny.
­ Maria Williams, a Brazilian citizen, was the income beneficiary of an inter vivos
trust and J.P. Morgan acted as trustee.
­ Williams became concerned that a proposed treaty between the U.S. and Brazil
(providing for an information exchange between the tax authorities) would lead
to severe consequences for Williams and her family for having failed to report
the trust assets to the Brazilian authorities.
55
­ To avoid the possible penalties, a plan was developed by Williams’ attorneys for
the trust assets to be reinvested solely in tax-exempt bonds so that the assets
would no longer be reported for tax purposes in the U.S.
­ Williams authorized J.P. Morgan to liquidate the trust’s tax-generating
investments in a letter which explained the nature of the proposed treaty,
including the fact that the treaty was only in the negotiation stage, although the
letter opined that ratification was likely.
­ The letter contained the following language:
I hereby release and discharge you from any liability to me for making
such sales and causing the trust to incur a net current decrease an account
of capital gain taxes. I hereby agree to indemnify you against any claims
made by other beneficiaries of the trust arising out of my requested action.
(emphasis added)
­ J.P. Morgan requested and received an opinion letter from Williams’ attorneys, a
prominent New York law firm, endorsing the strategy authorized by Williams.
­ U.S. and Brazil never entered the proposed treaty and Williams’s son Luiz filed
suit against J.P. Morgan for breach of fiduciary duty for failure to appropriately
reinvest the assets of the trust.
­ J.P. Morgan impleaded Maria Williams, asserting the right to contractual
indemnification based on the letter.
­ The Court held that, because of the strict scrutiny given to indemnification
clauses, the surrounding facts and circumstances must be considered in order to
find an “unmistakable and unequivocal intent” to indemnify the negligent party.
­ The Court found that the indemnification provision in the letter only
indemnified J.P. Morgan for the original reinvestment decision and not for J.P.
Morgan’s alleged failure to monitor the propriety of the trust investments in
subsequent years.
­ The Court held that J.P. Morgan could not “shirk its responsibilities to act as
trustee and fiduciary”.
56
„ In re Trusteeship of Williams, 591 N.W.2d 743 (Minn. Ct. App. 1999), affirmed
631 N.W.2d 398 (Minn. Ct. App. 2001)
­ A decedent created a testamentary trust, funded almost exclusively with stock
from his closely-held dairy farm. In 1980, Borden, Inc. acquired the dairy farm
and the trust’s stock was exchanged for Borden stock.
­ That same year, the two individual trustees (also beneficiaries) and one
corporate trustee began to diversify the trust assets. By the end of 1989, Borden
stock accounted for 40% of the trust assets. Over the next several years, the
value of Borden stock steadily declined and several attempts at further
diversification were attempted, but the corporate trustee voted to hold the stock
until the price recovered. When the stock was finally disposed of, the price of
Borden stock had fallen from $36.36 per share to $14.25 per share. One of the
individual trustees objected to the 1990-1995 accounting, and sought to
surcharge the corporate trustee for the losses.
­ The corporate trustee claimed that the trust agreement’s exculpatory clause
protected it from liability. It read:
No trustee shall be liable for the default or doing of any other Trustee,
whether the act be one of misfeasance or nonfeasance, nor shall he be held
liable for any loss by reason of any mistake or errors in judgment made by
him in good faith in the execution of the trust.
­ The Court of Appeals recognized the validity of an exculpatory clause, but held
that the clause could not protect the corporate trustee from an act of negligence.
ƒ The Court found that the first section of the clause protected trustees from the
acts of other trustees, not themselves; and the second section protected only
against “mistakes or errors of judgment”, not negligence.
ƒ The Court remanded the matter to the District Court to consider the surcharge
claim.
­ The District Court concluded that as part of its duty to diversify, the corporate
trustee also had a duty to educate or convince the individual trustees about the
need to diversify the assets. If unable to do so, the corporate trustee should have
sought instruction from the court or petitioned to withdraw.
­ The Court concluded that, by deferring the sale of Borden stock and attempting
to time the market, the corporate trustee breached its duty to diversify assets and
was surcharged $4 million.
57
Possible solution:
„ Investment Direction Agreement (“IDA”)
­ Estate of John P. Saxton, 686 N.Y.S.2d 573 (Sur. Ct. 1998), modified, 712
N.Y.S.2d 225 (App. Div. 2000)
ƒ The beneficiaries filed objections to a trustee’s final accounting based on the
trustee’s failure to diversify a high concentration of IBM stock over a 30-year
period.
ƒ An investment direction agreement had been signed by the life tenant and
two remainder persons in 1960. The IDA directed the trustees to hold the
IBM stock and released them from liability due to decreases in value.
ƒ Beginning in 1984, two of the three beneficiaries repudiated the IDA and
urged diversification, but the trust officer maintained that the IDA prevented
him from taking any action, despite the Bank’s own policy of diversification
and careful scrutinization of concentrated holdings.
ƒ The trustee also failed to communicate with the beneficiaries on tax
considerations, investment planning and market changes, never
comprehensively evaluated the IBM stock and never considered alternative
investment choices over the 30-year period.
ƒ By 1987, the trust had lost over $4 million.
ƒ The Surrogate held that “the bank breached its fiduciary duty…in such a
degree that no court of equity or law can permit it to shield itself behind an
IDA executed by two beneficiaries, then in their 20’s and 30’s, which they
subsequently repudiated time and time again.”
ƒ However, in dictum, the Court did say that a fiduciary should be entitled to
rely on an IDA in appropriate circumstances:
A fiduciary should be entitled to rely on an investment directive from the
beneficiaries in contravention of the normal policy of the bank for a
reasonable amount of time, or until such time that there is demonstrated
disagreement among the beneficiaries, provided however that the bank
does not completely abdicate its fiduciary responsibility to periodically
advise the beneficiaries of time-tested formulas for protecting their
investments from the inroads of a fluctuating market…What is a
reasonable time that a corporate fiduciary should be required to seek
reaffirmation of an IDA can only be set forth in this decision as dictum,
58
since there is no precedent for establishing such a benchmark, and it
would be unfair to hold a trustee to an ex post facto standard in this
proceeding. It seems to this court, however, that with the record-keeping
and computer systems available to the modern corporate fiduciary an IDA
should be reaffirmed at least every four years, or within 30 days upon any
indicated repudiation or disagreement among the beneficiaries.
Perfect solution?
„ Create a Directed Trust under Delaware Law
­ Under Delaware law, a settlor can name either an individual or institution to
direct the trustee on the investments.
­ This arrangement may be particularly attractive where the settlor owns a block
of stock, closely held family business or other asset which the settlor wants to
ensure remains in the family indefinitely.
­ Using a Delaware directed trust, the settlor can use his or her own outside
manager to make trust investment decisions, leaving the administrative duties in
the hands of the trustee.
­ Should the settlor want to retain investment control, he or she may serve as the
adviser without jeopardizing any potential estate planning benefits.
­ In Delaware, a settlor can authorize individual co-trustees, protectors or advisers
to direct the trustee to make distributions to beneficiaries.
­ Except in cases of willful misconduct, a trustee will not be held liable for any
loss resulting from complying with an investment direction or distribution
decision given or made by an authorized person. Del. Code Ann. tit 12, §3313.
Duemler v. Wilmington Trust Company, No. 2003 Del. Ch. filed Oct. 28, 2004
­ Ancillary benefits of using Delaware law:
ƒ Delaware allows trusts to continue indefinitely.
ƒ Delaware law provides that, as long as there are no Delaware beneficiaries,
there will be no Delaware income tax imposed on the trust income and
capital gains realized in the trust.
59
5. Derivative Strategies
„ Levy v. Bessemer Trust Co., 1997 U.S. Dist. LEXIS 11056 (S.D.N.Y.)
­ David Levy opened an investment management account with Bessemer Trust,
funded with a large concentration of Corning, Inc. stock which he acquired
shortly before the account was opened. The stock certificate prohibited trading
of the shares for a period of one year.
­ The investment management account constituted a large percentage of David’s
net worth, and he informed Bessemer trust that it was important to protect the
account from any possible downward movement in the price of Corning stock.
Bessemer Trust repeatedly informed him that, given the restrictions, it was not
possible to gain immediate protection.
­ At some later point, David consulted with an advisor outside of Bessemer Trust
who informed him that there were various hedging strategies he could employ to
protect against falling stock prices, including the purchase of a “European
options collar”.
­ David eventually purchased a European options collar through Merrill Lynch,
but not before the value of the stock dropped. He then brought suit against
Bessemer Trust for a variety of claims, including gross negligence and breach of
fiduciary duty for failing to inform him about the availability of collars.
­ The Court held that David’s suit survived summary judgment, but no ruling was
ever issued.
­ This case did not involve a trust or the application of the Prudent Investor Act
and David had specifically required Bessemer Trust to provide him with
diversification strategies. Nevertheless, it might be useful for a trustee to
consider a hedging strategy when dealing with a concentrated position if
diversification is not possible or is inappropriate.
F. Self-Dealing by Fiduciaries
„ Estate of Hester v. United States, 2007 U.S. Dist. LEXIS 14834 (W.D.Va.)
­ Testator established a trust naming her widower as income beneficiary and
trustee, with their two children as remainder persons. At the time of the
testator’s death, the trust was valued at $3.2 million.
60
­ In February 1998, the widower transferred all of the trust’s liquid assets into his
own brokerage account and co-mingled the funds. Over the next several
months, the widower lost $2 million from day-trading, withdrew over $450,000
in cash, and collected $280,000 on a promissory note held by the trust.
­ When the widower died in October 1998, the funds had become so co-mingled,
it was impossible to distinguish trust funds from the individual brokerage funds.
­ The estate tax return for the widower included the misappropriated funds in his
gross estate, and over $2.7 million was paid in estate taxes. The children did not
assert a claim against the father’s estate, nor did the executors claim a deduction
for possible claims, probably because the same individuals were beneficiaries of
both estates.
­ The estate later claimed an estate tax refund on two alternative grounds: (1) as
the widower had possessed no interest in the misappropriated assets, he was
merely holding the assets in a constructive trust for the benefit of the remainder
persons and the misappropriated funds were not includable in the decedent’s
gross estate, and alternatively (2) if the misappropriated assets were includable
in the estate, the estate should be awarded an offsetting deduction for claims
against the estate (under IRC §2053(a)(4)) or for indebtedness (with respect to
property includable in the estate under IRC §2053(a)(4)). When the IRS refused
the refund, the children brought suit.
­ District Court:
ƒ As to the first claim, the Court found that since the decedent “exercised
dominion and control over the assets as though they were his own without an
express or implied recognition of an obligation to repay”, the
misappropriated funds were properly includable in the gross estate.
ƒ The Court rejected the second argument, as the remainder persons had never
asserted a claim against the estate and the statute of limitations for asserting
such a claim had expired. The Court also held that misappropriation of trust
assets did not create an indebtedness.
­ Be mindful of Rule 1.15(a): A lawyer cannot commingle or misappropriate
client funds or property.
61
„ Estate of Robert Atkins (Settled)
­ In April 2003, diet guru Robert Atkins died leaving an estate valued at $400
million. 90% of the estate assets poured over to a martial trust. The remaining
assets passed to a foundation established to continue Dr. Atkins’ diet research.
Dr. Atkins’ widow, Veronica, and two individuals were named trustees under
the will. The income from the marital trust was reported to range between $14
million and $25 million per year.
­ Veronica reportedly suffered severe depression following the death of her
husband. Shortly after his death, Veronica received a phone call from a selfdescribed entrepreneur who offered to help her with her finances. He introduced
her to two of his acquaintances, an accountant and an attorney from Connecticut.
By the end of 2003, the three men succeeded the two original trustees and
became officers in the foundation.
­ The trustees were each paid $1.2 million a year in commissions. Two of the
trustees were paid by Veronica personally, as the combined payments exceeded
the statutory limitations on trustee commissions. Veronica also agreed to a tenyear employment agreement between the men and the foundation with automatic
time renewals, effectively employing the three men with the foundation for their
entire lives. The men also purchased and made themselves beneficiaries of $15
million in life insurance on Veronica.
­ The relationship began to break down in 2006 when Veronica met a man she
later married. Veronica eventually stopped paying the $1.2 million personally,
and sought to terminate the employment agreement. The men sued Veronica for
breach of contract and sought $8.7 million in damages, representing back pay
and fees to which they claimed they were entitled under the contract.
­ In April 2007, Veronica brought suit in New York Surrogate’s Court to remove
the three men as co-trustees of the marital trust, to surcharge them for
unreasonable compensation charged, and to appoint a corporate fiduciary.
„ Estate of Brooke Astor (Pending)
­ Socialite Brooke Astor died in August 2007 at the age of 105, leaving an estate
valued at approximately $130 million.
­ In 2002, Mrs. Astor executed a will under which her son, Anthony Marshall,
received significantly more assets outright than under her prior will, which was
executed in 1997. Mr. Marshall was appointed sole executor and trustee.
62
­ In July 2006, Phillip Marshall filed a petition in State Supreme Court accusing
his father Anthony Marshall of neglecting Mrs. Astor’s care while enriching
himself with her fortune.
­ JP Morgan Chase, one of the court-appointed guardians, challenged the 2003
transfer to Anthony Marshall of Mrs. Astor’s home in Maine and $5 million. In
fact, JP Morgan Chase filed amended tax returns for Mrs. Astor, characterizing
the items as taxable income rather than gifts. This could result in Mr. Marshall
owing millions of dollars of income tax payments.
­ In 2006, Mr. Marshall was removed as his mother’s guardian. He and his wife
Charlene also agreed to relinquish their appointment as co-executors of his
mother’s will. It was agreed that the Surrogate would name an administrator
following Mrs. Astor’s death.
­ After her death, the court-appointed guardians petitioned the Court for
appointment as temporary co-administrators. They also argued that the 2002
will was invalid, claiming Mrs. Astor was either not competent or was unduly
influenced when she signed it.
­ Mr. Marshall opposed the petition.
ƒ Mr. Marshall claimed that his mother was neither incompetent nor unduly
influenced when she signed the 2002 will. Mr. Marshall also opposed the
appointment of the administrators, claiming that the individual administrator
would use the appointment to further her own interests, contrary to his
mother’s wishes, and that the corporate administrator is biased against him.
­ On October 26, 2007, J.P. Morgan Chase and retired State Appeals Court Judge
Howard Levine were named temporary administrators.
­ In November 2007, Anthony Marshall was indicted on multiple criminal charges
stemming from his handling of Mrs. Astor’s finances while she was still living.
ƒ The charges include grand larceny, falsifying business records, offering a
false instrument for filing, and criminal possession of stolen property.
ƒ Mr. Marshall’s former attorney, Francis Morrissey, Jr. was also indicted.
­ The Westchester Surrogate’s Court has agreed to stay its proceedings until the
Manhattan District Attorney pursues its criminal charges against Mr. Marshall.
63
ƒ Mr. Marshall’s criminal trial date set for February 23, 2009, has been
postponed.
­ Be mindful of other Rules of Professional Conduct:
ƒ Rule 4.1: Truthfulness in Statements to Others
In the course of representing a client, a lawyer shall not knowingly make a
false statement of fact or law to a third party.
• Presumably, the falsification of business records would fall under this
Rule.
ƒ Rule 8.4: Misconduct
A lawyer or firm shall not:
…
(b) engage in illegal conduct that adversely reflects on the lawyer’s
honesty, trustworthiness or fitness as a lawyer;
(c) engage in conduct involving dishonesty, fraud, deceit or
misrepresentation;
(d) engage in conduct that is prejudicial to the administration of justice;
…
(h) engage in any other conduct that adversely reflects on the lawyer’s
fitness as a lawyer. [not in Model Rule]
• What is the proof necessary to find a violation of Rule 8.4?
○ In Connecticut, Delaware, Maryland, North Dakota and South
Carolina, the standard of proof in an attorney grievance proceeding is
clear and convincing evidence. Notopoulos v. Statewide Griev.
Comm., 890 A.2d 506, 515 (2006), In re Tenenbaum, 918 A.2d 1109,
1113 (2007), Atty. Griev. Comm’n v. Childress, 364 Md. 48, 55
(2001), Rule 3.5, N.D.R. Lawyer Discipl., In re Pennington, 380 S.C.
49, 60 (2001).
­ Note, pursuant to Rule 1.14(b), when a lawyer reasonably believes that his client
has diminished capacity, the lawyer may, but is not required to, take reasonably
necessary action to protect the client. Such action will not trigger a violation of
64
the attorney-client privilege, provided information is revealed only to the extent
reasonably necessary to protect the client’s interest.
„ Matter of Wallens, 816 N.Y.S.2d 793 (App. Div. 2006), reversed by, remitted by,
877 N.E.2d 960 (Ct. App. 2007)
­ A testator established a testamentary trust for the benefit of his granddaughter.
The trust authorized income and principal distributions for her support,
education, maintenance and general welfare until age 30, at which time the
balance of the funds would be distributed to the granddaughter outright.
­ The granddaughter’s divorced father was named trustee.
ƒ Under the terms of the divorce settlement, the father was obligated to pay his
daughter’s educational and medical expenses.
­ After the testator’s death in 1997, the father began to make payments from the
trust for his daughter’s private school expenses, medical expenses, and personal
allowance.
­ In August 2000, a court relieved the father from child support obligations and
ordered that his daughter’s further “normal and customary” college expenses be
paid from the trust.
­ In March 2003, the daughter objected to the trustee’s accounting, claiming that
the divorce decree required the father to personally pay her educational
expenses, rather than using trust funds.
­ Surrogate’s Court:
ƒ The Court found that the father’s personal obligation to support the
beneficiary could “not be avoided by him by the simple expedient of using
trust funds to pay for what he was otherwise lawfully required to expend for
her support” and ordered the father to reimburse the trust for expenditures
related to the daughter’s secondary education, medical expenses, and
personal allowance.
ƒ The Court did not require the father to reimburse the trust for expenditures
for her college education, finding that the August 2000 Supreme Court order
controlled.
­ Appellate Division:
65
ƒ The Appellate Division held that the father did not engage in self-dealing, as
he used the trust funds “precisely in the manner authorized by the testator in
the will provision establishing the trust”.
­ The Court also took note that the testator was aware of the father’s support
obligation.
­ Court of Appeals:
ƒ The Court agreed that the expenses in question were within the expenditures
authorized by the trust, but noted that the father did not seek court approval
for the use of trust funds to fulfill his personal obligation regarding the
secondary school expenses.
­ The Court remitted the matter to the Surrogate’s Court to determine if the father
made the expenditures of trust funds in good faith and if those expenditures
furthered his daughter’s interests.
G. Attorney-Client Privilege
„ Pursuant to Rule 1.6, a lawyer is prohibited from revealing confidential
information, absent informed consent of the client or in other limited circumstances.
„ Confidential information is defined as:
…information gained during or relating to the representation of a client,
whatever its source, that is (a) protected by the attorney-client privilege, (b)
likely to be embarrassing or detrimental to the client if disclosed, or (c)
information that the client has requested be kept confidential. “Confidential
information” does not ordinarily include (i) lawyer’s legal knowledge or legal
research or (ii) information that is generally known in the legal community or in
the trade, field or profession to which the information relates.
„ Model Rule 1.6 prohibits a lawyer from revealing information related to the
representation of a client, absent informed consent.
„ Under New York law, for example, the attorney-client privilege extends to
fiduciary relationships.
­ Civil Practice Law and Rules (“CPLR”) §4503(2) provides that a beneficiary is
not entitled to access privileged communications made between a personal
representative and the personal representative’s attorney, solely by virtue of
his/her position as a beneficiary.
66
„ However, a “fiduciary exception” to the privilege may apply.
­ The privilege is not absolute and a showing of “good cause” may trump the
privilege.
ƒ The controlling feature for the applicability of the fiduciary exception is
whether the advice sought was for the benefit of the beneficiary, as a result of
the fiduciary relationship. Stenovich v. Wachtell, Lipton, Rosen & Katz, 756
N.Y.S. 2d 367 (2003)
ƒ Factors to be considered are: (1) whether the beneficiaries may have been
directly affected by a decision the fiduciary made on the attorney’s advice,
(2) if the communications are the only evidence available regarding whether
the fiduciary’s actions furthered the interests of the beneficiaries, (3) whether
the communications relate to prospective actions and not advice on past
actions, and (4) whether the communications sought are highly relevant and
specific. Hoopes v. Carota, 531 N.Y.S.2d 407 (1988), affirmed by, 543
N.E.2d 73 (Ct. App. 1989)
„ Note, however, that inter vivos trusts are excluded from CPLR §4503(2) and
communications with counsel may be accessible by beneficiaries of inter vivos
trusts.
„ In Florida, for example, a lawyer retained by the trust generally represents the
trustee, not the beneficiary and the beneficiary would have to prove the existence of
some exception to overcome the privilege. Jacob v. Barton, 877 So. 2d 935 (2004)
­ However, the beneficiary may be considered the “real client” if the beneficiary
will ultimately benefit from the work the trustee has instructed the attorney to
perform, such as a legal memoranda regarding the trust’s tax issues.
ƒ See also Barnett Banks Trust Company v. Compson, 629 So. 2d 849 (Fla.
2nd DCA 1993)(finding that a trustee’s duty to provide beneficiaries with
relevant information regarding the assets and administration of a trust is not
sufficient to compel the production of documents when the litigantbeneficiary is not bringing suit to protect her interests as a beneficiary of the
trust).
­ Note, however, that that the law is clear regarding personal representatives and
estates: “In Florida, the personal representative is the client rather than the
estate or the beneficiaries.” Rules Regulating the Florida Bar, 4-1.7.
67
V. Minimizing Fiduciary Risk
Recent litigation offers fiduciaries some guidelines for minimizing risk:
Carefully examine the circumstances
„ The specific terms of a trust and the particular circumstances of the beneficiaries
will drive the choices a fiduciary must make; including whether to exercise the
power to adjust or opt-in to a unitrust regime and whether it might be permissible to
deviate from the duty to diversify assets.
Do not blindly rely on the language of the trust agreement
„ Trustees who blindly rely on the terms of a trust agreement leave themselves open
to liability. Retention and exculpatory clauses are strictly construed.
„ Boilerplate language is not sufficient to obviate the duty to diversify.
„ If the settlor’s intent is for a concentrated holding to be maintained, insure that is
documented in the trust instrument.
„ No matter what the language of an instrument provides, trustees must be vigilant
not to abdicate their fiduciary duties.
Maintain communications with the beneficiaries
„ Communication is key. A trustee should always maintain regular communication
with beneficiaries and keep them informed.
Maintain business records
„ A trustee should always document decisions made regarding the trust. Indeed, in
the Dumont case, the Surrogate found that the lack of documentation itself
constituted a breach of trust.
„ It is critical to establish and implement procedures to enable a trustee to comply
with his fiduciary responsibilities, and document having done so.
Consider an IDA or creating a trust in/moving a trust to Delaware
„ Courts are strongly disposed to find a duty to diversify. These are effective risk
reduction strategies.
68
Consider the use of derivative instruments
„ If diversification is not advisable for any reason, consider whether the use of
derivative instruments is appropriate.
Consider appointment of a corporate fiduciary
„ The appointment of a corporate fiduciary can alleviate the pressure on a family
member trustee, circumvent intra-family suspicion and prevent perceived or actual
impropriety.
„ Many individual trustees, particularly family members who may be acting as a
favor, do not appreciate the full extent of the responsibilities, and potential
liabilities, to which they are subject. A professional trustee can provide expertise
and guidance to insure compliance with the law.
69
GUIDE TO THE
Uniform Prudent Investor Act
A state-by-state analysis of investment legislation
governing trusts and foundations
A model Uniform Prudent Investor Act (UPIA) was promulgated by the National
Conference of Commissioners on Uniform State Laws in 1994 and recommended for
enactment by the states. The UPIA allows trustees and similar fiduciaries to employ
modern portfolio theory to guide investment decisions, and evaluates a fiduciary’s
conduct based on a strategy for the total portfolio, rather than on the selection of
individual assets. In addition, the UPIA makes the following alterations in the former
criteria for fiduciary investment: a) the tradeoff between risk and return is identified
as the fiduciary’s central investment consideration; b) categoric restrictions on types
of investments have been abrogated; c) the concept that fiduciaries should diversify
portfolio investments has been integrated into the definition of prudence; d) the
much criticized rule of trust law forbidding the trustee to delegate investment and
management functions has been reversed (some jurisdictions impose notice requirements not mandated by the UPIA); and e) the trustee may be relieved from liability
from acts of the agent, if certain requirements are met.
It should be noted that charitable foundations and private trusts are subject to
similar investment rules. The UPIA is applicable to foundations organized in trust
form. Charitable corporations, on the other hand, are governed in many jurisdictions
by the Uniform Prudent Management of Institutional Funds Act (UPMIFA).
The UPMIFA, promulgated in 2006 and modeled after the UPIA, replaces the former
Uniform Management of Institutional Funds Act of 1972.
A
State
Uniform Prudent Investor
Act (or most UPIA
provisions) Effective Date
Total Portfolio Statutes
(minimal UPIA provisions)
Effective Date
C
D
E
Authority
Risk /Return
Objectives
Emphasized
Unrestricted
Investment Types
Authorized
Diversification
of Portfolio as
Prudent
Delegation of
Investment Management
Authorized
Trustee/Agent
Liability
Severed
Notice of
Delegations
Required
Uniform Prudent
Management of Institutional
Funds Act (UPMIFA)
Yes
This chart shows the states that
Alabama
ALA. CODE §19-3B-901 to 19-3B-906
Yes
Yes
Yes
Yes [FN 1]
Yes
No
have adopted the UPIA, or substan-
Alaska
5/23/98
ALASKA STAT. §§13.36.225 to 13.36.290
Yes
Yes
Yes
Yes
Yes
No
No
Arizona
7/20/96
ARIZ. REV. STAT. §§14-7601 to 14-7611
Yes
Yes
Yes
Yes
Yes
No
Yes
tial portions thereof, as of this
publication. Additionally, other
states are identified that require
1/1/07
B
Arkansas
9/1/05
ARK. CODE ANN. §§28-73-901 to 28-73-908
Yes
Yes
Yes
Yes [FN 2]
Yes
No
No
California
1/1/96
CAL. PROB. CODE §§16045 to 16054
Yes
Yes
Yes
Yes
Yes
No
No
Colorado
7/1/95
COLO. REV. STAT. §§15-1.1-101 to 15-1.1-115
Yes
Yes
Yes
Yes
Yes
No
Yes
CONN. GEN. STAT. §§45a-541 to 45a-541l
Yes
Yes
Yes
Yes
Yes
No
Yes
a total portfolio approach to invest-
Connecticut
ment management, but which do
Delaware
not otherwise have provisions
District of Columbia
3/10/04
resembling the UPIA.
Florida
10/1/93
10/1/97
7/3/86
Georgia
If a state has no total portfolio
Hawaii
statute, the chart makes no
Idaho
representation regarding whether
that state’s laws contain any other
provision resembling the UPIA.
Iowa
Kansas
1/1/98; 7/1/02
4/14/97
DEL. CODE ANN. tit. 12, §§3302 and 3322
No
Yes
No
Yes
Yes
No
Yes
D.C. CODE ANN. §§19-1309.01 to 19-1309.06
Yes
Yes
Yes
Yes [FN 3]
Yes
No
Yes
FLA. STAT. ANN. §§518.11 to 518.112
Yes
Yes
Yes
Yes
Yes
Yes
No
GA. CODE ANN. §§53-12-287 and 53-12-290
No
Yes
No
Yes
Yes
No
Yes
HAW. REV. STAT. §§554C-1 to 554C-12
Yes
Yes
Yes
Yes
Yes
No
No
7/1/97
IDAHO CODE §§68-501 to 68-514
Yes
Yes
Yes
Yes
Yes
No
Yes
Illinois
1/1/92
760 ILL. COMP. STAT. §§5/5 and 5/5.1
Yes
Yes
Yes
Yes
Yes
Yes
No
Indiana
6/30/99
IND. CODE ANN. §§30-4-3.5-1 to 30-4-3.5-13
Yes
Yes
Yes
Yes
No
No
Yes
7/1/00
IOWA CODE §§633A.4301 to 633A.4309
Yes
Yes
Yes
Yes [FN 4]
Yes
No
Yes
7/1/00
KAN. STAT. ANN. §§58-24a01 to 58-24a19
Yes
Yes
Yes
Yes
Yes
Yes
Yes
The far right column of the chart
Kentucky
7/15/96
KY. REV. STAT. ANN. §286.3-277- applies only to corporate fiduciaries
Yes
No
Yes
Yes
No
No
No
indicates whether a state has
Louisiana
8/15/01
LA. REV. STAT. ANN. §§9:2087 and 9:2127
Yes
Yes
No
Yes
No
No
No
adopted the UPMIFA.
Maine
No
Maryland
FN 1 (Alabama) Delegation of Investment Management
Authorization located outside UPIA provisions. ALA.
CODE §19-3B-807
FN 2 (Arkansas) Delegation of Investment Management
Authorization located outside UPIA provisions. ARK. CODE
ANN. §28-73-807
FN 3 (District of Columbia) Delegation of Investment
Management Authorization located outside UPIA
provisions. D.C. CODE ANN. §19-1308.07
FN 4 (Iowa) Delegation of Investment Management
Authorization located outside UPIA provisions. IOWA
CODE §633.4206
FN 5 (Maine) Delegation of Investment Management
Authorization located outside UPIA provisions. 18-B ME.
REV. STAT. ANN. §807
FN 6 (Minnesota) Delegation of Investment Management
Authorization located outside UPIA provisions. MINN.
STAT. §501B:152
FN 7 (Montana) Delegation of Investment Management
Authority located outside UPIA provisions. MONT. CODE
ANN. §72-34-605
FN 8 (New Hampshire) Delegation of Investment
Management Authorization located outside UPIA
provisions. N.H. REV. STAT. ANN. §564-B:8-807
FN 9 (North Carolina) Delegation of Investment
Management Authorization located outside UPIA
provisions. N.C. GEN. STAT. §36C-8-807
FN 10 (North Dakota) Delegation of Investment
Management Authority located outside UPIA provisions.
N.D. CENT. CODE §59-16-07
FN 11 (Oregon) Delegation of Investment Management
Authorization located outside UPIA provisions. OR. REV.
STAT. §130.680
FN 12 (South Carolina) Delegation of Investment
Management Authorization located outside UPIA
provisions. S.C. CODE ANN. §62-7-807
FN 13 (Utah) Delegation of Investment Management
Authorization located outside UPIA provisions. UTAH
CODE ANN. §75-7-814
FN 14 (South Dakota) Trustee/Agent liability severed
with written approval by beneficiary or court.
FN 15 (Texas) Trustee/Agent liability severed, with
restrictions.
7/1/05
18-B ME. REV. STAT. ANN. §§901 to 908
Yes
Yes
Yes
Yes [FN 5]
Yes
No
10/1/94
MD. CODE ANN. EST. & TRUSTS §15-114
Yes
No
Yes
Yes
No
No
No
Massachusetts
3/4/99
MASS. GEN. LAW ch. 203C, §§1 to 11
No
Yes
Yes
Yes
Yes
No
No
Michigan
4/1/00
MICH. COMP. LAWS §§700.1501 to 700.1512
Yes
Yes
Yes
Yes
Yes
No
No
Minnesota
1/1/97
MINN. STAT. §§501B.151 to 501B.152
Yes
Yes
Yes
Yes [FN 6]
Yes
No
Yes
Mississippi
7/1/06
MISS. CODE ANN. §§91-9-601 to 91-9-627
Yes
Yes
Yes
Yes
Yes
No
No
Missouri
8/28/96
MO. REV. STAT. §§469.900 to 469.913
Yes
Yes
Yes
Yes
Yes
No
No
Montana
10/1/03
MONT. CODE ANN. §§72-34-601 to 72-34-610
Yes
Yes
Yes
Yes [FN 7]
Yes
No
Yes
Nebraska
1/1/05
NEB. REV. STAT. ANN. §§30-3883 to 30-3889
Yes
Yes
Yes
Yes
Yes
No
Yes
Nevada
10/1/03
NEV. REV. STAT. ANN. §§164.705 to 164.775
Yes
Yes
Yes
Yes
Yes
No
Yes
New Hampshire
10/1/04
N.H. REV. STAT. ANN. §§564-B:9-901 to 564-B:9-906
Yes
Yes
Yes
Yes [FN 8]
Yes
No
No
New Jersey
3/7/97
N.J. STAT. ANN. §§3B:20-11.1 to 3B:20-11.12
Yes
Yes
Yes
Yes
Yes
Yes
No
New Mexico
7/1/95
N.M. STAT. ANN. §§45-7-601 to 45-7-612
Yes
Yes
Yes
Yes
Yes
No
No
New York
1/1/95
N.Y. EST. POWERS & TRUSTS LAW §11-2.3
Yes
Yes
Yes
Yes
No
No
No
North Carolina
1/1/00
N.C. GEN. STAT. §§36C-9-901 to 36C-9-907
Yes
Yes
Yes
Yes [FN 9]
Yes
No
No
North Dakota
8/1/07
N.D. CENT. CODE §§59-17-01 to 59-17-06
Yes
Yes
Yes
Yes [FN 10]
Yes
No
No
1/1/07
OHIO REV. CODE ANN. §§5809.01 to 5809.08
Yes
Yes
Yes
Yes
Yes
No
No
OKLA. STAT. tit 60, §§175.60 to 175.72
Yes
Yes
Yes
Yes
Yes
No
Yes
OR. REV. STAT. §§130.750 to 130.775
Yes
Yes
Yes
Yes [FN 11]
Yes
No
Yes
20 PA. CONS. STAT. ANN. §§7201 to 7214
No
Yes
Yes
Yes
Yes
No
No
Ohio
Oklahoma
Oregon
11/1/95
1/1/06
Pennsylvania
12/25/99
Rhode Island
8/6/96
R.I. GEN. LAWS §§18-15-1 to 18-15-13
Yes
Yes
Yes
Yes
Yes
No
No
South Carolina
1/1/06
S.C. CODE ANN. §62-7-933
Yes
Yes
Yes
Yes [FN 12]
Yes
No
No
South Dakota
7/1/95
S.D. CODIFIED LAWS §§55-5-6 to 55-5-16
Yes
Yes
Yes
Yes
Yes [FN 14]
No
Yes
Tennessee
7/1/02
TENN. CODE ANN. §§35-14-101 to 35-14-114
Yes
Yes
Yes
Yes
Yes
No
Yes
Texas
1/1/04
TEX. PROP. CODE §§117.001 to 117.012
Yes
Yes
Yes
Yes
Yes [FN 15]
No
Yes
Utah
7/1/04
UTAH CODE ANN. §§75-7-901 to 75-7-907
Yes
Yes
Yes
Yes [FN 13]
Yes
No
Yes
Vermont
7/1/98
VT. STAT. ANN. tit. 9, §§4651 to 4662
Yes
Yes
Yes
Yes
Yes
No
Yes
Virginia
1/1/00
VA. CODE ANN. §§26-45.3 to 26-45.14
Yes
Yes
Yes
Yes
Yes
No
Yes
WASH. CODE REV. §§11.100.020, 11.100.047
No
Yes
Yes
Yes
No
No
No
W. VA. CODE §§44-6C-1 to 44-6C-15
Yes
Yes
Yes
Yes
Yes
No
Yes
WIS. STAT. §881.01
Yes
Yes
Yes
Yes
Yes
No
No
WYO. STAT. ANN. §§4-10-901 to 4-10-913
Yes
Yes
Yes
Yes
Yes
No
No
Washington
West Virginia
Wisconsin
Wyoming
1/1/85; 7/3/95
7/1/96
4/30/04
4/1/03
Fiduciary Trust Company International advises that this guide should be used for desk reference only and should not be relied upon for legal advice on specific matters. Further, Fiduciary Trust Company International is under no obligation to update the information contained herein.
F I D U C I A RY T R U S T C O M PA N Y I N T E R N AT I O N A L was founded
in 1931 to specialize in investment management and administration of assets for
individuals and families. A bank charter permits Fiduciary Trust to act as executor
and trustee, providing continuity of wealth management through multiple generations.
Fiduciary Trust’s investment management services extended to foundations and
endowments during the 1930s. In the early 1960s, Fiduciary Trust began investing
internationally, making it one of the first American firms to develop global
investment capabilities. Fiduciary Trust offers the following services to clients
throughout the world:
• Investment Management
• Master Custody
• Trust and Estate Administration
• Private Banking
• Strategic Wealth Planning
• Tax Reporting and Services
• Manager Selection and Oversight
Fiduciary Trust Company International
Fiduciary Trust International of Delaware
600 Fifth Avenue
New York, New York 10020
tel (877) 384-1111
1220 North Market Street
Wilmington, Delaware 19801
tel (866) 398-7414
Fiduciary Investment Management
International, Inc.
FTCI (Cayman) Ltd.
1133 Connecticut Avenue, N.W., Suite 330
Washington, DC 20036
tel (888) 621-3464
Fiduciary Trust International of the South
200 South Biscayne Boulevard, Suite 3050
Miami, Florida 33131
tel (800) 618-1260
11 Dr. Roy’s Drive
Grand Cayman
Cayman Islands
tel (345) 914-9483
Fiduciary Trust Company International
London Representative Office
Fiduciary Trust International of California
The Adelphi
1-11 John Adam Street
London WC2N 6HT United Kingdom
tel (44-20) 7073-8500
444 South Flower Street, 32nd Floor
Los Angeles, California 90071
tel (800) 421-9683
Fiduciary Trust Company International
Hong Kong Representative Office
Fiduciary Trust International of California
17th Floor, Chater House
8 Connaught Road Central
Hong Kong SAR, China
tel (852) 2877-1931
One Franklin Parkway
San Mateo, California 94403
tel (877) 284-2697
Fiduciary Trust Company International is a member of the Franklin Templeton Investments
family of companies.
This article and other information on wealth management can be found at www.fiduciarytrust.com.
This communication is intended to provide general information. It is not intended to provide
specific advice. Please consult your personal adviser to determine whether information in this
newsletter may be appropriate for you.
IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any
tax advice contained in this communication is not intended or written to be used, and cannot be
used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting,
marketing or recommending to another party any transaction or matter addressed herein.
About the Authors. Gail E. Cohen, Esq.,
Executive Vice President, General Trust Counsel
and Head of Global Wealth Management, is
responsible for all aspects of Fiduciary Trust’s
Wealth Management resources, including the
departments responsible for client relationships,
trust, estate, and tax in New York and across
our regional offices. She has over 28 years of
experience in the area of trusts and estates.
Ms. Cohen is a member of the Board of
Directors as well as member of the Management
and Executive Committees. Before joining
Fiduciary Trust in 1994, Ms. Cohen was a
trusts and estates associate at the law firm
of Debevoise & Plimpton. Previously, she was
an associate at the law offices of Edward S.
Schlesinger, P.C. She is a member of the
Executive Committee of the Trust Management
Association of the American Bankers
Association and the Trust and Investment
Executive Committee of the New York State
Bankers Association. Ms. Cohen is a member
of the New York City Ballet’s Advisory Board,
The Rockefeller University Committee on
Trust and Estate Gift Plans, the Planned Giving
Committee of the Anti-Defamation League,
and the Trust and Estates Steering Committee
of the UJA-Federation of New York. Ms. Cohen
received a B.A. from Mount Holyoke College
and a J.D. summa cum laude from Brooklyn
Law School. She is admitted to the bar in New
York and New Jersey.
Sharon L. Klein is Senior Vice President, Trust
Counsel and Director of Estate Advisement
at Fiduciary Trust, where she heads the Estate
Administration group. She has over 17 years’
experience in the area of trusts and estates
and is a frequent speaker and author on
estate and trust planning, administration and
management issues. Prior to joining Fiduciary
Trust, Ms. Klein was Special Counsel in the
trusts and estates department at Rosenman &
Colin LLP (now Katten Muchin Rosenman).
Previously, she served as law clerk to the Hon.
Chief Judge Fox of the Federal Court of
Australia. Ms. Klein received B.A. and LL.B.
degrees from the University of New South
Wales, Sydney, Australia, and an LL.M. from
Boalt Hall School of Law at the University of
California, Berkeley.
Erin Gilmore Smith, Estate Advisement
Officer, joined Fiduciary Trust in 2006.
Ms. Smith administers complex estates
and provides support on trust matters. She
earned a Bachelor of Arts from Texas A&M
University and a Juris Doctor cum laude from
Seton Hall University School of Law.
Fiduciary Trust Company International
600 Fifth Avenue
New York, New York 10020
tel (212) 632-3000
tel (877) 384-1111
www.fiduciarytrust.com
FIDUC UPIA 06/08
GUIDE TO THE
Uniform Principal and Income Act
A state-by-state analysis of legislation
to define trust income
The Uniform Principal and Income Act (“UPAIA”), issued by the National Conference
of Commissioners on Uniform State Laws, has the basic purpose of providing guidelines
for trustees in defining principal and income. The Act, which was originally promulgated
in 1931, was substantially revised in 1962 and 1997.
The UPAIA of 1997 is a companion to the Uniform Prudent Investor Act of 1994, and
provides the means to implement an investment regime embodied in the prudent investor
rule—investment for total return under modern portfolio theory. The shift to a total
return approach intensified the competing interests between the current and remainder
beneficiaries of a trust, placing the trustee in a dilemma between investing for growth of
capital and providing fair distributions to current beneficiaries who are entitled to trust
income. The UPAIA of 1997 revolutionized the administration of trusts by providing
potential solutions to the dilemma, permitting trustees discretionary power to adjust
allocations between income and principal to meet income needs of current beneficiaries
and preserve principal for future beneficiaries. This new approach is found in Section 104
of the UPAIA. Another widely-used approach is the unitrust option, permitting a trustee
to convert a conventional income trust to a total return trust, under which the payout to
the income beneficiary is a fixed percentage of the trust’s market value. The UPAIA does
not provide for a unitrust approach.
As of June 2008, 47 states and the District of Columbia have adopted the UPAIA, or
substantial portions thereof. Although North Dakota has adopted the UPAIA, it has not
yet drafted legislation. Illinois has not adopted the UPAIA, but it has enacted a form of
total return legislation. Mississippi and Vermont have adopted neither the UPAIA nor any
other form of total return legislation.
Included in this guide is information on the key aspects of total return legislation including:
a) a default rule of either the power to adjust approach, as found in UPAIA Section 104,
or traditional income allocation principles; b) the unitrust approach as an opt-in provision
with a statutory distribution percentage; c) mandatory court approval to opt into or opt
out of a unitrust approach, or both; d) safeguards to protect the trustee from liability for
the good faith exercise or non-exercise of these important new powers; and e) an abuse
of discretion standard that protects a trustee from liability for a good faith decision to
exercise or not exercise the power to adjust.
A
B
State
Effective Date
Authority
Default Rule
Opt-In Provision
This chart shows the states that
Alabama
1/1/01
ALA. CODE §§19-3A-101 to 19-3A-605
Power to Adjust
No
have adopted a method for defining
Alaska
9/1/03
ALASKA STAT. §§13.38.200 to 13.38.990
Power to Adjust
Unitrust (4%)
Arizona
1/1/02
ARIZ. REV. STAT. §§14-7401 to 14-7431
Power to Adjust
No
income under either or both the
C
Unitrust: Court
Approval Required
No
D
E
Trustee Safeguards
(see back page for details)
UPAIA §105 Abuse of
Discretion Standard
1
No
No
Yes
1
Yes
Arkansas
1/1/00
ARK. CODE ANN. §§28-70-101 to 28-70-605
Power to Adjust
No
No
No
power to adjust or unitrust
California
1/1/00
CAL. PROB. CODE §§16320 to 16375
Power to Adjust
Unitrust (4%) [FN 1]
No
2, 6, 10
No
approach, and describes the other
Colorado
7/1/01
COLO. REV. STAT. §§15-1-401 to 15-1-434
Power to Adjust
Unitrust (4%)*
No
1, 2, 6, 7
No
key aspects of each state’s law.
Connecticut
1/1/00
CONN. GEN. STAT. §§45a-542 to 45a-543
Power to Adjust
No
No
Yes
Delaware
6/21/01; 8/1/06
DEL. CODE. ANN. tit. 12, §3527, §3527A, §6113, §6114
Power to Adjust
Unitrust (3%–5%)
The chart makes no representation
District of Columbia
4/27/01
D.C. CODE §28-4801.01 to 28-4806.02
Power to Adjust
No
as to those states that have neither
Florida [FN 2]
1/1/03
FLA. STAT. ANN. §§738.101 to 738.804
Traditional, Power to Adjust
Unitrust (3%–5%)
Georgia
7/1/05
GA. CODE ANN. §§53-12-220 to 53-12-222
Power to Adjust
Unitrust (4%)
Hawaii
7/1/00
HAW. REV. STAT. §§557A-101 to 557A-506
Power to Adjust
No
1, 2, 6
No
Idaho
7/1/01
IDAHO CODE §§68-10-101 to 68-10-605
Power to Adjust
No
1, 2
No
adopted the UPAIA nor any other
form of total return legislation.
No
7
Yes
No
No
No
2, 7, 8
Yes
No
2
Yes
Illinois
8/23/04
760 ILL. COMP. STAT. 5/5.3
Traditional Income Allocation
Unitrust (3%–5%)
Opt-Out
7, 9
No
Indiana
1/1/03
IND. CODE ANN. §§30-2-14-1 to 30-2-15-26
Power to Adjust
Unitrust (4%)
No
1, 2, 7
Yes
Iowa
7/1/00; 4/5/02
IOWA CODE §§637.101 to 637.701
Traditional Income Allocation
Unitrust (4%)
No
7
No
Kansas
7/1/00
KAN. STAT. ANN. §§58-9-101 to 58-9-603
Power to Adjust
No
No
No
Kentucky
1/1/05
KY. REV. STAT. §§386.450 to 386.504
Traditional Income Allocation [FN 3]
Power to Adjust (3%–5%)
No
No
Louisiana
1/1/02 [FN 4]
LA. REV. STAT. §§9:2158 to 9:2163
Power to Adjust (5%)
No
No
Yes
1/1/03
ME. REV. STAT. ANN. tit. 18-A, §§7-701 to 7-773
Power to Adjust
Unitrust (4%)
Opt-Out
No
Yes
MD. CODE ANN. EST. & TRUSTS §§15-501 to 15-530
Unitrust (4%)
Power to Adjust [FN 5]
No
6, 7
No
Maine
Maryland
10/1/02
Massachusetts
1/1/06
MASS. GEN. LAW ch. 203D §§1 to 29
Power to Adjust
No
No
Yes
Michigan
9/1/04
MICH. COMP. LAWS §§555.501 to 555.1005
Power to Adjust
No
No
Yes
Minnesota
4/6/01
MINN. STAT. §§501B.59 to 501B.76
Power to Adjust
No
1, 2, 6
No
Mississippi
Missouri
8/28/01
MO. REV. STAT. §§469.401 to 469.467
Power to Adjust
Unitrust (3%–5%)
Montana
10/1/03
MONT. CODE ANN. §§72-34-421 to 72-34-453
Power to Adjust
No
9/1/01
NEB. REV. STAT. ANN. §§30-3116 to 30-3149
Power to Adjust
Unitrust (3%–5%)*
10/1/03
NEV. REV. STAT. ANN. §§164.780 to 164.925
Power to Adjust
No
Nebraska
Nevada
Opt-Out
No
No
No
1, 2
Yes
No
No
1, 2, 8
Yes
4
Yes
No
New Hampshire
1/1/03; 1/1/07
N.H. REV. STAT. ANN. §§564-C:1-101 to 564-C:6-602; 564-A:3-c
Power to Adjust
Unitrust (5%)
New Jersey
1/1/02
N.J. STAT. ANN. §§3B:19B-1 to 3B:19B-31
Power to Adjust
No
New Mexico
7/1/05
N.M. STAT. ANN. §§46-3A-101 to 46-3A-603
Power to Adjust
Unitrust (4%)*
No
7
New York
1/1/02
N.Y. EST. POWERS & TRUSTS LAW §§11-A-1.1 to 11-A-6.4; 11-2.3A to 11-2.4
Power to Adjust
Unitrust (4%)
Opt-In, Opt-Out [FN 6]
3
Yes
North Carolina
1/1/04
N.C. GEN. STAT. §37A-1-101 to 37A-6-602
Power to Adjust
Unitrust (3%–5%)
No
7
Yes
North Dakota
8/1/99
N.D. CENT. CODE §§59-04.2-01 to 59-04.2-30 [FN 7]
Traditional Income Allocation
No
No
No
1/1/03
OHIO REV. CODE ANN. §§5812.01 to 5812.52
Power to Adjust
No
2, 3, 5, 6
No
OKLA. STAT. tit. 60 §§175.101 to 175.602
Power to Adjust
No
No
No
Ohio
Oklahoma
Oregon
11/1/98
1/1/04
Opt-Out
9
1, 2, 6
OR. REV. STAT. §§129.200 to 129.450
Power to Adjust
Unitrust (4%)*
Opt-Out
No
Yes
Pennsylvania
7/15/02
20 PA. CONS. STAT. ANN. §§8101 to 8191
Power to Adjust
Unitrust (4%)
Opt-Out
No
Yes
Rhode Island
6/23/06
R.I. GEN. LAWS §§18-4-28 to 14-8-29
Power to Adjust
Unitrust (3%–5%)
No
No
No
South Carolina
7/18/01
S.C. CODE ANN. §§62-7-901 to 62-7-932
Power to Adjust
No
No
No
Yes
7, 10
No
1, 2, 6
No
No
Yes
1
Yes
South Dakota
7/1/07
S.D. CODIFIED LAWS §§55-13A-101 to 55-13A-602; 55-15-1 to 55-15-14
Power to Adjust
Unitrust (3% minimum, no maximum)
Tennessee
7/1/00
TENN. CODE ANN. §§35-6-101 to 35-6-602
Power to Adjust
No
Texas
1/1/04
TEX. PROP. CODE ANN. §§116.001 to 116.206
Power to Adjust
Unitrust (3%–5%)
Utah
5/3/04
UTAH CODE ANN. §§22-3-101 to 22-3-603
Power to Adjust
No
Virginia
1/1/00
VA. CODE ANN. §§55-277.1 to 55-277.33
Power to Adjust
Unitrust (3%–5%)
No
7
No
Washington
1/1/03
WASH. CODE REV. §§11.104A.001 to 11.104A.905
Power to Adjust
Unitrust (3%–5%)
Opt-Out
2, 3, 8
Yes
West Virginia
7/1/00; 6/8/07
W. VA. CODE §§44B-1-101 to 44B-6-604
Power to Adjust
Unitrust (3%–5%)
No
1, 2, 6, 7
No
WIS. STAT. §701.20
Power to Adjust
Unitrust (3%–5%)
No
1, 2, 9, 10
Yes
WYO. STAT. ANN. §§2-3-801 to 2-3-834; 2-3-901 to 2-3-917
Power to Adjust
Unitrust (3%–5%)
No
1, 2, 7
Yes
No
Vermont
Wisconsin
Wyoming
5/17/05
7/1/01; 7/1/07
Fiduciary Trust Company International advises that this guide should be used for desk reference only and should not be relied upon for legal advice on specific matters. Further, Fiduciary Trust Company International is under no obligation to update the information contained herein.
*The effective date for conversion may not be less than 60 days after the notice of conversion.
Trustee Safeguards:
1. Notice to beneficiaries of proposed adjustment is optional, but if trustee provides notice and no beneficiary objects, the trustee
may not be held liable for the adjustment.
2. No duty to adjust. A trustee is not liable for not considering whether to make an adjustment, or choosing not to make an
adjustment.
3. In an abuse of discretion proceeding regarding the trustee’s power to adjust, New York, Ohio and Washington added language
that the court may not require the trustee personally to pay damages unless the trustee acted in bad faith and dishonestly.
4. A decision to adjust the distribution to the income beneficiary to an amount not less than 3% nor more than 5% shall be
presumed fair and reasonable to all beneficiaries.
5. Trustee may make a safe harbor adjustment up to and including an amount equal to 4%.
6. In an abuse of discretion proceeding regarding the trustee’s power to adjust, the sole remedy shall be to seek an order from the
court to instruct the trustee to direct, deny, or revise the adjustment.
7. If a trustee reasonably and in good faith takes or omits to take any action under a unitrust section, and a person interested in
the trust opposes the act or omission, the person’s exclusive remedy shall be to seek an order from the court to direct the trustee
to convert, reconvert, or change the payout percentage.
8. Unless a court determines that a trustee abused its discretion regarding the adjustment power, a trustee shall be reimbursed
for all costs and attorney’s fees incurred in defending an abuse of discretion action.
9. Breach of fiduciary duty claims are barred two years from when the trustee sent notice of proposed action(s) to beneficiaries.
10. No duty to convert or reconvert to or from a unitrust.
FN 1 (California) 4% is the default. Percentage may be 3%–5% if all beneficiaries consent in writing.
FN 2 (Florida) Trusts that exist on 1/1/03: The default rule is traditional income allocation, and the trustee may opt into the power
to adjust or the unitrust. Trusts that are created after 12/31/02: The default rule is the power to adjust, and the trustee may opt
into the unitrust.
FN 3 (Kentucky) The default rule for an individual acting as trustee is the traditional income allocation rule, but a corporate
trustee’s default rule is the power to adjust. An individual trustee may opt into the power to adjust, but only with court approval.
Any trustee may opt out of the power to adjust with court approval.
FN 4 (Louisiana) Effective date for trusts created before 1/1/02 is 1/1/04, unless all current beneficiaries or the trust instrument
designates an earlier effective date. 1/1/02 effective date for trusts created on or after 1/1/02.
FN 5 (Maryland) Use of the power to adjust is contingent on a determination that a unitrust conversion is not appropriate.
A trustee may not make an adjustment without court approval if the adjustment results in a distribution other than 4%. Trustee
is required to give notice to all beneficiaries of a proposed decision regarding the exercise or non-exercise of the power to adjust.
FN 6 (New York) For trusts that existed as of 1/1/02, court approval was not required to adopt a unitrust approach if election was
made by 12/31/05. For trusts established after 1/1/02, court approval is not required if election is made before the last day of the
second full year of the trust.
FN 7 (North Dakota) Power to adjust section reserved but not yet drafted.
Fiduciary Trust Company International
Fiduciary Trust International of Delaware
600 Fifth Avenue
New York, New York 10020
tel (877) 384-1111
1220 North Market Street
Wilmington, Delaware 19801
tel (866) 398-7414
Fiduciary Investment Management
International, Inc.
FTCI (Cayman) Ltd.
1133 Connecticut Avenue, N.W., Suite 330
Washington, DC 20036
tel (888) 621-3464
Fiduciary Trust International of the South
200 South Biscayne Boulevard, Suite 3050
Miami, Florida 33131
tel (800) 618-1260
11 Dr. Roy’s Drive
Grand Cayman
Cayman Islands
tel (345) 914-9483
Fiduciary Trust Company International
London Representative Office
Fiduciary Trust International of California
The Adelphi
1-11 John Adam Street
London WC2N 6HT United Kingdom
tel (44-20) 7073-8500
444 South Flower Street, 32nd Floor
Los Angeles, California 90071
tel (800) 421-9683
Fiduciary Trust Company International
Hong Kong Representative Office
Fiduciary Trust International of California
17th Floor, Chater House
8 Connaught Road Central
Hong Kong SAR, China
tel (852) 2877-1931
One Franklin Parkway
San Mateo, California 94403
tel (877) 284-2697
About the Authors. Sharon L. Klein is
Senior Vice President, Trust Counsel
and Director of Estate Advisement at
Fiduciary Trust. She has over 16 years’
experience in the area of trusts and estates
and is a frequent speaker and author on
estate and trust planning, administration
and management issues. Prior to joining
Fiduciary Trust, Ms. Klein was Special
Counsel in the trusts and estates department
at Rosenman & Colin LLP (now Katten
Muchin Rosenman). Previously, she
served as law clerk to the Hon. Chief
Judge Fox of the Federal Court of
Australia. Ms. Klein received B.A. and
LL.B. degrees from the University of New
South Wales, Sydney, Australia, and an
LL.M. from Boalt Hall School of Law at
the University of California, Berkeley.
Erin Gilmore Smith, Estate Advisement
Officer, joined Fiduciary Trust in 2006.
Ms. Smith administers complex estates
and provides support on trust matters.
She earned a Bachelor of Arts from Texas
A&M University and a Juris Doctor cum
laude from Seton Hall University School
of Law.
This article and other information on
wealth management can be found at
www.fiduciarytrust.com.
This communication is intended to provide
general information. It is not intended to
provide specific advice. Please consult your
personal adviser to determine whether
information in this newsletter may be
appropriate for you.
IRS Circular 230 Notice: Pursuant to relevant
U.S. Treasury regulations, we inform you that
any tax advice contained in this communication
is not intended or written to be used, and
cannot be used, for the purpose of (i) avoiding
penalties under the Internal Revenue Code
or (ii) promoting, marketing or recommending
to another party any transaction or matter
addressed herein.
Fiduciary Trust Company International is a member of the Franklin Templeton Investments
family of companies.
Fiduciary Trust Company International
600 Fifth Avenue
New York, New York 10020
tel (212) 632-3000
tel (877) 384-1111
www.fiduciarytrust.com
FIDUC UPIAS 06/08
S T A T E
O F
N E W
Y O R K
____________________________________________________________________________
9038
2007-2008 Regular Sessions
I N
A S S E M B L Y
June 8, 2007
___________
Introduced by M. of A.
the Committee on Judiciary
WEINSTEIN
--
read once and referred to
AN ACT to amend the estates, powers and trusts law, in relation to
trust accounting income and the optional unitrust and to repeal
section 11-A-4.11 of the estates, powers and trusts law relating to
the allocation of trustee accounts for receipts from an interest in
minerals, water, and other natural resources
THE PEOPLE OF THE STATE OF NEW YORK, REPRESENTED IN SENATE AND ASSEMBLY, DO ENACT AS FOLLOWS:
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
Section 1. Clauses (A), (C) and (D) of subparagraph 5 of paragraph(b)
of section 11-2.3 of the estates, powers and trusts law, as added by
chapter 243 of the laws of 2001, are amended to read as follows:
(A) Where the rules in article 11-A apply to a trust and the terms of
the trust describe the amount that may or must be distributed to a beneficiary by referring to the trust`s income, the prudent investor standard also authorizes the trustee to adjust between principal and income
to the extent the trustee considers advisable to enable the trustee to
make appropriate present and future distributions in accordance with
clause (b)(3)(A) if the trustee determines, {after} IN LIGHT OF ITS
INVESTMENT DECISIONS, THE CONSIDERATION FACTORS INCORPORATED IN CLAUSE
(B)(5)(B), AND THE ACCOUNTING INCOME EXPECTED TO BE PRODUCED BY applying
the rules in article 11-A, that such an adjustment would be fair and
reasonable to all of the beneficiaries{, so that current beneficiaries
may be given such use of the trust property as is consistent with preservation of its value}.
(C) A trustee may not make an adjustment:
(i) {that diminishes the income interest in a trust that requires all
of the income to be paid at least annually to a spouse and for which an
estate tax or gift tax marital deduction is claimed} WITH RESPECT TO A
CHARITABLE REMAINDER UNITRUST DESCRIBED IN SECTION 664 OF THE UNITED
STATES INTERNAL REVENUE CODE OF 1986;
EXPLANATION--Matter in ITALICS (underscored) is new; matter in brackets
{ } is old law to be omitted.
LBD05971-02-7
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(ii) {that reduces the actuarial value of the income interest in a
trust to which a person transfers property with the intent to qualify
for a gift tax exclusion;
(iii)} that changes the amount payable to a beneficiary as a fixed
annuity or a fixed fraction of the value of the trust`s assets;
{(iv)} (III) from any amount that is permanently set aside for charitable purposes under a will or the terms of a trust unless the income
therefrom is also permanently devoted to charitable purposes;
{(v)} (IV) if possessing or exercising the power to make an adjustment
causes an individual to be treated as the owner of all or part of the
trust for income tax purposes, and the individual would not be treated
as the owner if the trustee did not possess the power to make an adjustment;
{(vi)} (V) if possessing or exercising the power to make an adjustment
causes all or part of the trust assets to be included for estate tax
purposes in the estate of an individual who has the power to remove a
trustee or appoint a trustee, or both, and the assets would not be
included in the estate of the individual if the trustee did not possess
the power to make an adjustment;
{(vii)} (VI) if the trustee is a current beneficiary or a presumptive
remainderman of the trust;
{(viii)} (VII) if the trustee is not a current beneficiary or a
presumptive remainderman, but the adjustment would benefit the trustee
directly or indirectly (WHICH, HOWEVER, SHALL NOT INCLUDE THE POSSIBLE
EFFECT ON A TRUSTEE`S COMMISSION); or
{(ix)} (VIII) if the trust is an irrevocable lifetime trust which
provides income to be paid for life to the grantor, and possessing or
exercising the power to make an adjustment would cause any public benefit program to consider the adjusted principal or income to be an available resource or available income and the principal or income or both
would in each case not be considered as an available resource or income
if the trustee did not possess the power to make an adjustment{.};
(D) AN ADJUSTMENT OTHERWISE PROHIBITED BY ITEMS (B)(5)(C)(I) THROUGH
(VIII) MAY BE MADE IF THE TERMS OF THE TRUST, BY EXPRESS REFERENCE TO
THIS SECTION, PROVIDE OTHERWISE. If item (b)(5)(C){(v), (vi), (vii), or
(viii)} (IV), (V), (VI) OR (VII) applies to a trustee and there is more
than one trustee, {a co-trustee} THE TRUSTEE OR TRUSTEES to whom the
provision does not apply may make the adjustment unless the exercise of
the power by the remaining trustee or trustees is {not permitted}
PROHIBITED by the terms of the trust. IF THERE IS NO TRUSTEE QUALIFIED
TO MAKE THE ADJUSTMENT, IT MAY BE MADE IF SO DIRECTED BY THE COURT UPON
APPLICATION OF THE TRUSTEE OR OF AN INTERESTED PARTY.
S 2. Paragraph (b) of section 11-2.4 of the estates, powers and trusts
law, as added by chapter 243 of the laws of 2001, is amended to read as
follows:
(b) Unitrust amount.
(1) For the first {three years} YEAR of the trust AS A UNITRUST,
INCLUDING A SHORT YEAR IF APPLICABLE, the "unitrust amount" for {a
current valuation} THE year {of the trust} shall mean an amount equal to
four percent of the net fair market values of the assets held in the
trust {on} AT THE BEGINNING OF the first business day of the current
valuation year.
(2) {Commencing with} FOR the {fourth} SECOND year of a trust AS A
UNITRUST, INCLUDING A FIRST SHORT YEAR IF APPLICABLE, the "unitrust
amount" for {a current valuation} THE year {of the trust} shall mean an
amount equal to four percent multiplied by a fraction, the numerator of
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which shall be the sum of (A) the net fair market values of the assets
held in the trust {on} AT THE BEGINNING OF the first business day of the
current valuation year and (B) the net fair market values of the assets
held in the trust {on} AT THE BEGINNING OF the first business day of
{each} THE prior valuation year, and the denominator of which shall be
{three} TWO.
(3) COMMENCING WITH THE THIRD YEAR OF A TRUST AS A UNITRUST, INCLUDING
A FIRST SHORT YEAR IF APPLICABLE, THE "UNITRUST AMOUNT" FOR A CURRENT
VALUATION YEAR OF THE TRUST SHALL MEAN AN AMOUNT EQUAL TO FOUR PERCENT
MULTIPLIED BY A FRACTION, THE NUMERATOR OF WHICH SHALL BE THE SUM OF (A)
THE NET FAIR MARKET VALUES OF THE ASSETS HELD IN THE TRUST AT THE BEGINNING OF THE FIRST BUSINESS DAY OF THE CURRENT VALUATION YEAR AND (B) THE
NET FAIR MARKET VALUES OF THE ASSETS HELD IN THE TRUST AT THE BEGINNING
OF THE FIRST BUSINESS DAY OF EACH PRIOR VALUATION YEAR, AND THE DENOMINATOR OF WHICH SHALL BE THREE.
(4) The unitrust amount for the current valuation year as computed in
accordance with subparagraph (b)(1) {or}, (2) OR (3), AS ADJUSTED IN
ACCORDANCE WITH THIS SUBPARAGRAPH, shall be proportionately reduced for
any CORPUS distributions to beneficiaries mandated by the terms of the
trust, in whole or in part (other than distributions of the unitrust
amount), and shall be proportionately increased for the receipt, other
than a receipt that represents a return on investment, of any additional
{property} CORPUS into the trust within a current valuation year.
{(4)} (5) For purposes of clause (b)(2)(B), the {combined} net fair
market values of the assets held in the trust {on} AT THE BEGINNING OF
the first business day of a prior valuation year shall be adjusted to
reflect any {reduction (in the case of a mandated distribution) or
increase (in the case of a receipt) in the unitrust amount for such
prior valuation year pursuant to subparagraph (b)(3)} DISTRIBUTIONS TO
BENEFICIARIES MANDATED BY THE TERMS OF THE TRUST, IN WHOLE OR IN PART
(OTHER THAN DISTRIBUTIONS OF THE UNITRUST AMOUNT), OR RECEIPTS (OTHER
THAN RECEIPTS THAT REPRESENT A RETURN ON INVESTMENT) OF ANY ADDITIONAL
PRINCIPAL INTO THE TRUST, WHICH HAVE OCCURRED AFTER THE FIRST DAY OF
SUCH PRIOR VALUATION YEAR AND BY THE CLOSE OF THE FIRST DAY OF THE
CURRENT VALUATION YEAR, as if the distribution or receipt had occurred
on the first day of such prior valuation year.
{(5)} (6) In the case of a short year, the trustee shall prorate the
unitrust amount on a daily basis. THE TRUSTEE SHALL PRORATE ANY ADJUSTMENT UNDER SUBPARAGRAPH (B)(4) ON A DAILY BASIS.
{(6) The assets "held in the trust" for purposes of computing the
unitrust amount shall not include assets while held in an estate. If
this section applies to a trust by reason of an election pursuant to
clause (e)(1)(B) and if such election is not expressly made effective
prospectively as permitted under clause (e)(4)(A),} (7) IN THE CASE
WHERE THE UNITRUST AMOUNT HAS BEEN INCORRECTLY DETERMINED EITHER IN A
CURRENT VALUATION YEAR OR IN A PRIOR VALUATION YEAR, then within a
reasonable time (NOT TO EXCEED EIGHTEEN MONTHS) after the {election}
ERROR WAS MADE, the trustee shall {determine the unitrust amount properly payable for any preceding and current valuation year of the trust.
The trustee shall} MAKE ANY NON-MATERIAL ADJUSTMENTS AND pay to the
{current} UNDERPAID beneficiary (in case of NON-MATERIAL underpayment)
or shall recover from the {current} OVERPAID beneficiary (in case of
NON-MATERIAL overpayment) an amount equal to the difference between the
unitrust amount properly payable and any amount actually paid for any
completed valuation year of the trust AND SHALL PROPERLY ADJUST THE
UNITRUST AMOUNT FOR THE CURRENT VALUATION YEAR IF AFFECTED NON-MATERIAL-
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LY BY PRIOR INCORRECT DETERMINATION OF A UNITRUST AMOUNT.
A MATERIAL
CORRECTION SHALL REQUIRE APPROVAL OF THE SURROGATE IF APPLIED FOR BY THE
TRUSTEE OR AN INTERESTED PARTY.
{(7) In the case where the net fair market value of an asset held in
the trust has been incorrectly determined either in a current valuation
year or in a prior valuation year, the unitrust amount shall be
increased (in the case of an undervaluation) or be decreased (in the
case of an overvaluation) by an amount equal to the difference between
the unitrust amount as determined based on the correct valuation of the
asset and the unitrust amount as originally determined.}
S 3. Subparagraphs 5, 6, 7 and 9 of paragraph (c) of section 11-2.4 of
the estates, powers and trusts law, as added by chapter 243 of the laws
of 2001, are amended to read as follows:
(5) "Net fair market value" shall mean the fair market value of each
asset comprising the trust reduced by THE FAIR MARKET VALUE OF any
outstanding interest-bearing obligations of the trust, whether allocable
to a specific asset or otherwise. FAIR MARKET VALUE OF AN ASSET MAY BE
DETERMINED BY ANY APPROPRIATE TECHNIQUE ADOPTED AND CONSISTENTLY APPLIED
BY THE TRUSTEE, AND SUCH TECHNIQUES MAY INCLUDE, BUT ARE NOT LIMITED TO,
USE OF THE ASSET`S VALUE AT THE CLOSE OF BUSINESS ON THE PREVIOUS BUSINESS DAY, AND NOTWITHSTANDING THAT SUCH DAY MAY BE IN A PRIOR YEAR OR BE
A DAY ON WHICH THE TRUST WAS NOT SUBJECT TO THIS SECTION.
(6) In determining the sum of the net fair market values of the assets
held in the trust for purposes of subparagraphs (b)(1) {and}, (2) AND
(3), AND IN DETERMINING WHETHER AN ADJUSTMENT IS REQUIRED IN ACCORDANCE
WITH SUBPARAGRAPH (B)(4) OR (5), there shall not be {included} TAKEN
INTO ACCOUNT the value:
(A) of any residential property or any tangible personal property
that, as of the BEGINNING OF THE first business day of the current valuation year, one or more current beneficiaries of the trust have or had
the right to occupy, or have or had the right to possess or control
(other than in his or her capacity as a trustee of the trust), and
instead the right of occupancy or the right to possession or control
shall be deemed to be the unitrust amount with respect to such residential property or such tangible personal property; provided, however,
that the unitrust amount shall be adjusted in accordance with {subparagraph} SUBPARAGRAPHS (b){(3)} (4) AND (5) for partial distributions from
or receipt into the trust of such residential property or tangible
personal property during the current valuation year.
(B) of any asset specifically given to a beneficiary and the return on
investment on such property, which return on investment shall be
distributable to such beneficiary.
(C) of any assets while held in a testator`s estate.
(D) OF (I) AMOUNTS PAID OR DISTRIBUTED TO THE TRUST BY A DECEDENT`S
ESTATE, ANOTHER TRUST OR ANOTHER PAYOR, AS INCOME PURSUANT TO ARTICLE
11-A ATTRIBUTABLE TO AN ASSET OR AMOUNT DUE TO THE TRUST FOR A PERIOD
PRIOR TO ITS PAYMENT OR DISTRIBUTION TO THE TRUST, UNLESS AND EXCEPT TO
THE EXTENT THAT THE UNITRUST TRUSTEE, HAVING THE POWER TO ACCUMULATE
INCOME, SHALL HAVE DETERMINED TO ACCUMULATE AND ADD SUCH INCOME TO PRINCIPAL, AND SUCH UNACCUMULATED NET INCOME SHALL BE DISTRIBUTABLE TO THE
BENEFICIARIES OF THE TRUST; OR (II) ANY AMOUNT PAID OR DISTRIBUTED BY
SUCH DECEDENT`S ESTATE, OTHER TRUST OR OTHER PAYOR, DIRECTLY TO BENEFICIARIES OF THE TRUST IN SATISFACTION OF THEIR ULTIMATE ENTITLEMENT TO
SUCH INCOME.
(7) In determining the net fair market value of each asset held in the
trust pursuant to subparagraphs (b)(1) {and}, (2) AND (3), the trustee
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shall, not less often than annually, determine the fair market value of
each asset of the trust that consists primarily of real property or
other property that is not traded on a regular basis in an active
market, and all such determinations shall, if made reasonably and in
good faith, be conclusive on all persons interested in the trust. Such
determination shall be conclusively presumed to have been made reasonably and in good faith unless proven otherwise in a proceeding commenced
by or on behalf of a person interested in the trust within three years
after the close of the year in which the determination is made.
(9) The term "trust" does not include an estate {or any trust pursuant
to the terms of which any amount is permanently set aside for charitable
purposes unless the income therefrom is also permanently devoted to
charitable purposes}.
S 4. The opening paragraph of subparagraph 1 of paragraph (d) of
section 11-2.4 of the estates, powers and trusts law, as added by chapter 243 of the laws of 2001, is amended to read as follows:
The interest of a current beneficiary or class of current beneficiaries in the unitrust amount begins on the date {specified in the
governing instrument, on the date specified in an election to have this
section apply pursuant to clause (e)(1)(B), on the date specified by the
court pursuant to clause (e)(2)(B) or, if no date is specified, on} ON
WHICH THIS SECTION BECOMES APPLICABLE TO THE TRUST PURSUANT TO CLAUSE
(E)(4)(A), OR IF LATER the date assets first become subject to the
trust. An asset becomes subject to a trust:
S 5. Subparagraph 2 of paragraph (d) of section 11-2.4 of the estates,
powers and trusts law, as added by chapter 243 of the laws of 2001, is
amended to read as follows:
(2) A trust which continues in existence for the benefit of one or
more new current beneficiaries or class of current beneficiaries upon
the termination of the interests of all prior current beneficiaries or
classes of prior current beneficiaries, shall be deemed to be a new
trust, and, for purposes of {clause} CLAUSES (e)(1)(B) AND (E)(4)(A) AND
SUBPARAGRAPH (D)(1), assets shall be deemed to first become subject to
the trust on {the first day of the first year that follows} the date of
the termination of such interests.
S 6. Clause (B) of subparagraph 1 of paragraph (e) of section 11-2.4
of the estates, powers and trusts law, as added by chapter 243 of the
laws of 2001, is amended to read as follows:
(B) {(I)} (I) with respect to a trust in existence prior to January
first, two thousand two, on or before December thirty-first, two thousand five, the trustee, with the consent by or on behalf of all persons
interested in the trust or in his, her or its discretion, elects to have
this section apply to such trust, or
{(II)} (II) with respect to a trust not in existence prior to January
first, two thousand two, on or before the last day of the second full
year of the trust beginning after assets first become subject to the
trust, the trustee, with the consent by or on behalf of all persons
interested in the trust or in his, her or its discretion, elects to have
this section apply to such trust.
{(III)} (III) An election in accordance with this subparagraph shall
be made by an instrument, executed and acknowledged, and delivered to
the creator of the trust, if he or she is then living, to all persons
interested in the trust or to their representatives and to the court, if
any, having jurisdiction over the trust.
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S 7. Clause (A) of subparagraph 4 of paragraph (e) of section 11-2.4
of the estates, powers and trusts law, as added by chapter 243 of the
laws of 2001, is amended to read as follows:
(A) This section shall apply to a trust with respect to which there
is:
(I) a direction in the governing instrument in accordance with clause
(e)(1)(A), AS OF THE DATE PROVIDED FOR IN SUCH GOVERNING INSTRUMENT, OR
IF THERE IS NO PROVISION THEN AS OF THE DAY ON WHICH ASSETS FIRST BECOME
SUBJECT TO THE TRUST;
(II) an election in accordance with clause (e)(1)(B), AS OF THE DATE
SPECIFIED IN THE ELECTION, WHICH MAY BE ANY DAY WITHIN THE YEAR IN WHICH
THE ELECTION IS MADE OR THE FIRST DAY OF THE YEAR COMMENCING AFTER THE
ELECTION IS MADE; or a
(III) court decision rendered in accordance with clause (e)(2)(B) as
of the {first year of the trust in which assets first become subject to
the trust, unless the governing instrument or} DATE SPECIFIED BY the
court in its decision {provides otherwise, or unless the election in
accordance with clause (e)(1)(B) is expressly made effective as of the
first day of the first year of the trust commencing after the election
is made.};
PROVIDED, HOWEVER, THAT IF LATER THAN ANY DATE SET BY THIS CLAUSE,
THIS SECTION SHALL NOT APPLY TO THE TRUST UNTIL JANUARY FIRST, TWO THOUSAND TWO.
S 8. Section 11-2.4 of the estates, powers and trusts law is amended
by adding a new paragraph (f) to read as follows:
(F) TRUSTS TO WHICH THIS SECTION SHALL NOT APPLY. THIS SECTION SHALL
NOT APPLY TO A TRUST IF:
(1) THE GOVERNING INSTRUMENT PROVIDES IN SUBSTANCE THAT THIS SECTION
SHALL NOT APPLY;
(2) THE TRUST IS A POOLED INCOME FUND DESCRIBED IN SECTION 642(C)(5)
OF THE UNITED STATES INTERNAL REVENUE CODE OF 1986;
(3) THE TRUST IS A CHARITABLE REMAINDER ANNUITY TRUST OR A CHARITABLE
REMAINDER UNITRUST DESCRIBED IN SECTION 664 OF THE UNITED STATES INTERNAL REVENUE CODE OF 1986; OR
(4) THE TRUST IS AN IRREVOCABLE LIFETIME TRUST WHICH PROVIDES FOR
INCOME TO BE PAID FOR THE LIFE OF A GRANTOR, AND POSSESSING OR EXERCISING THE POWER TO MAKE THIS SECTION APPLY WOULD CAUSE ANY PUBLIC BENEFIT
PROGRAM TO CONSIDER ADDITIONAL AMOUNTS OF PRINCIPAL OR INCOME TO BE AN
AVAILABLE RESOURCE OR AVAILABLE INCOME, AND THE PRINCIPAL OR INCOME OR
BOTH WOULD IN EACH CASE NOT BE CONSIDERED AN AVAILABLE RESOURCE OR
INCOME, IF THERE WAS NO POWER TO MAKE THIS SECTION APPLY, IF, BASED UPON
THE FACTS AND CIRCUMSTANCES SURROUNDING THE FORMATION OF SUCH TRUST, IT
CAN REASONABLY BE CONCLUDED THAT THE PRIMARY PURPOSE FOR THE ESTABLISHMENT OF THE TRUST WAS TO ENSURE THAT THE TRUST PRINCIPAL WOULD NOT BE
TREATED AS AN AVAILABLE RESOURCE FOR THE PURPOSES OF A GOVERNMENTAL
ASSISTANCE PROGRAM.
S 9. Subparagraph (B) of paragraph 2 of section 11-A-2.1 of the
estates, powers and trusts law, as added by chapter 243 of the laws of
2001, is amended to read as follows:
(B) paying from income or principal, in the fiduciary`s discretion,
fees of attorneys, accountants, and fiduciaries; court costs and other
expenses of administration; and interest on death taxes, but the fiduciary may pay those expenses from income {and} OF property passing to a
trust for which the fiduciary claims an estate tax marital or charitable
deduction only to the extent that the payment of those expenses from
income will not cause the reduction or loss of the deduction; and
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S 10. Section 11-A-2.2 of the estates, powers and trusts law is
amended by adding a new paragraph (e) to read as follows:
(E) THE PORTION OF A BENEFICIARY DETERMINED UNDER PARAGRAPH (A) IS
SUBJECT TO THE FIDUCIARY`S FURTHER POWER OF ADJUSTMENT UNDER SUBPARAGRAPH 11-2.3(B)(5), WHICH ADJUSTMENT IF MADE SHALL BE MADE TO OR FROM
THE PRINCIPAL OF SUCH BENEFICIARY`S SHARE. THE FIDUCIARY SHALL MAINTAIN
APPROPRIATE RECORDS SHOWING THE PRINCIPAL INTEREST OF EACH BENEFICIARY,
AS ADJUSTED.
S 11. Paragraph (a) of section 11-A-3.3 of the estates, powers and
trusts law, as added by chapter 243 of the laws of 2001, is amended to
read as follows:
(a) In this section, "undistributed income" means net income received
ON OR before the date on which an income interest ends. The term does
not include an item of income or expense that is due or accrued or net
income that has been added or is required to be added to principal under
the terms of the trust.
S 12. Section 11-A-4.11 of the estates, powers and trusts law is
REPEALED and a new section 11-A-4.11 is added to read as follows:
S 11-A-4.11 MINERALS, WATER, AND OTHER NATURAL RESOURCES
(A) TO THE EXTENT THAT A TRUSTEE ACCOUNTS FOR RECEIPTS FROM AN INTEREST IN MINERALS OR OTHER NATURAL RESOURCES PURSUANT TO THIS SECTION, THE
TRUSTEE SHALL ALLOCATE THEM AS FOLLOWS:
(1) IF RECEIVED AS A BONUS, DELAY RENTAL OR ANNUAL RENT ON A LEASE, A
RECEIPT OF LESS THAN ONE THOUSAND DOLLARS MUST BE ALLOCATED TO INCOME
AND A RECEIPT OF ONE THOUSAND DOLLARS OR MORE MUST BE ALLOCATED FIFTEEN
PERCENT TO PRINCIPAL AND EIGHTY-FIVE PERCENT TO INCOME;
(2) IF RECEIVED FROM A PRODUCTION PAYMENT, A RECEIPT MUST BE ALLOCATED
TO INCOME IF AND TO THE EXTENT THAT THE AGREEMENT CREATING THE
PRODUCTION PAYMENT PROVIDES A FACTOR FOR INTEREST OR ITS EQUIVALENT. THE
BALANCE MUST BE ALLOCATED TO PRINCIPAL;
(3) IF RECEIVED AS A ROYALTY, SHUT-IN-WELL PAYMENT, OR TAKE-OR-PAY
PAYMENT, A RECEIPT MUST BE ALLOCATED FIFTEEN PERCENT TO PRINCIPAL AND
EIGHTY-FIVE PERCENT TO INCOME;
(4) IF AN AMOUNT IS RECEIVED FROM A WORKING INTEREST OR ANY OTHER
INTEREST NOT PROVIDED FOR IN SUBPARAGRAPH (A)(1), (2), OR (3), A RECEIPT
MUST BE ALLOCATED FIFTEEN PERCENT TO PRINCIPAL AND EIGHTY-FIVE PERCENT
TO INCOME.
(B) AN AMOUNT RECEIVED ON ACCOUNT OF AN INTEREST IN WATER THAT IS
RENEWABLE MUST BE ALLOCATED TO INCOME. IF THE WATER IS NOT RENEWABLE,
NINETY PERCENT OF THE AMOUNT MUST BE ALLOCATED TO PRINCIPAL AND THE
BALANCE TO INCOME.
(C) THIS ARTICLE APPLIES WHETHER OR NOT A DECEDENT OR DONOR WAS
EXTRACTING MINERALS, WATER, OR OTHER NATURAL RESOURCES BEFORE THE INTEREST BECAME SUBJECT TO THE TRUST.
(D) IF A TRUST EXISTS ON THE EFFECTIVE DATE OF THIS SECTION, THE TRUSTEE MAY ALLOCATE RECEIPTS FROM AN INTEREST IN MINERALS, WATER, OR OTHER
NATURAL RESOURCES AS PROVIDED IN THIS SECTION OR IN THE MANNER USED BY
THE TRUSTEE BEFORE THE EFFECTIVE DATE OF THIS SECTION. FOR EVERY TRUST
CREATED AFTER THE EFFECTIVE DATE OF THIS SECTION, THE TRUSTEE SHALL
ALLOCATE RECEIPTS FROM AN INTEREST IN MINERALS, WATER, OR OTHER NATURAL
RESOURCES AS PROVIDED IN THIS SECTION. IF AND TO THE EXTENT THAT THE
TERMS OF A TRUST EXPRESSLY PROVIDE FOR A DIFFERENT ALLOCATION OF
RECEIPTS OR GRANTS THE TRUSTEE DISCRETIONARY AUTHORITY TO DETERMINE THE
AMOUNT OF THE ALLOCATION, THIS SECTION SHALL NOT APPLY TO THOSE
RECEIPTS.
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S 13. Section 11-A-6.4 of the estates, powers and trusts law, as added
by chapter 243 of the laws of 2001, is amended to read as follows:
S 11-A-6.4 Application of article
Except as specifically provided in the trust instrument, the will, or
in this article, this article shall apply to any receipt or expense
received or incurred on or after its effective date by any trust or
decedent`s estate established before, ON OR AFTER its effective date and
whether the asset involved was acquired by the trustee before, ON or
after its effective date, EXCEPT THAT THIS ARTICLE SHALL NOT APPLY TO A
TRUST WHILE ANY CURRENT BENEFICIARY IS INTERESTED IN A UNITRUST AMOUNT
PURSUANT TO SUBPARAGRAPH 11-2.4(B)(1); BUT IT DOES APPLY WITH RESPECT TO
ASSETS TO WHICH SUCH A UNITRUST MAY BECOME ENTITLED BUT PRIOR TO THEIR
ACTUAL RECEIPT INTO THE UNITRUST. {This article shall also apply to any
trust or decedent`s estate established on or after its effective date
except to the extent that the trust instrument or the will provides
otherwise, or unless an election or court decision is made pursuant to
11-2.4 to make this article not apply to such trust.}
S 14. This act shall take effect immediately.
RECENT CASES AFFECTING
FAMILY LIMITED PARTNERSHIPS AND LLCs
Louis A. Mezzullo
Luce, Forward, Hamilton & Scripps LLP
Rancho Santa Fe, CA
[email protected]
(May 29, 2009)
© Copyright 2009 by Louis A. Mezzullo. All rights reserved.
TABLE OF CONTENTS
Page
1.
Estate of Rector v. Commissioner, T.C. Memo 2007-367......................................1
a.
Facts of the Case ..........................................................................................1
b.
Court’s Opinion ...........................................................................................2
c.
Analysis of the Court’s Opinion ..................................................................4
2.
Estate of Mirowski v. Commissioner, T.C. Memo 2008-74 ...................................5
a.
Facts of the Case ..........................................................................................5
b.
Court’s Opinion ...........................................................................................6
c.
Analysis of the Court’s Opinion ................................................................10
3.
Estate of Christiansen v. Commissioner, 130 T.C. No. 1 ....................................11
a.
Summary of the Case .................................................................................11
4.
Holman v. Commissioner, 130 T.C. No. 12 (2008)..............................................12
a.
Facts of the Case ........................................................................................12
b.
Court’s Opinion .........................................................................................13
c.
Analysis of Court’s Opinion ......................................................................15
5.
Astleford v. Commissioner, T.C. Memo 2008-128 ...............................................17
a.
Facts of the Case ........................................................................................17
b.
Court’s Opinion .........................................................................................17
c.
Analysis of the Court’s Opinion ................................................................18
6.
Bianca Gross v. Commissioner, T.C. Memo 2008-221........................................19
a.
Facts of the Case ........................................................................................19
b.
Court’s Opinion .........................................................................................20
c.
Analysis of the Court’s Opinion ................................................................22
7.
Estate of Hurford v. Commissioner, T.C. Memo 2008-278.................................23
a.
Facts of the Case ........................................................................................23
b.
Court’s Opinion .........................................................................................24
c.
Analysis of the Court’s Opinion ................................................................25
8.
Estate of Jorgensen v. Commissioner, T.C. Memo 2009-66 ...............................25
a.
Facts of the Case ........................................................................................25
b.
Court’s Opinion .........................................................................................26
c.
Analysis of the Court’s Opinion ................................................................27
APPENDIX: FLPs AFTER MIROWSKI .........................................................................28
A. The Benefits of Using FLPs and FLLCs..........................................................28
B. IRS Response ...................................................................................................29
C. IRS Challenges to the Use of Entities to Depress Value..................................29
D. Courts Reject IRS Challenges..........................................................................30
i
E. IRS Finds New Arrows in its Quiver ...............................................................30
F. Where Do We Stand Today..............................................................................33
G. Proposed Legislation........................................................................................36
ii
RECENT CASES AFFECTING
FAMILY LIMITED PARTNERSHIPS AND LLCs
Louis A. Mezzullo
Luce, Forward, Hamilton & Scripps LLP
Rancho Santa Fe, CA
[email protected]
(May 29, 2009)
1.
Estate of Rector v. Commissioner, T.C. Memo 2007-367
a.
Facts of the Case
Mrs. Rector, a widow, died on January 11, 2001 at the age of 95, survived
by two sons, John and Frederick. John was a licensed investment broker
and had extensive financial experience. At the death of Mrs. Rector’s
husband in 1978, a bypass trust was created that provided for the income
to be paid to Mrs. Rector and principal to be paid for Mrs. Rector’s care
and support, but only if the assets in the marital deduction trust also
created when Mrs. Rector’s husband died could not be readily used for her
care and support. The marital deduction trust included one-half of the
husband’s estate, plus Mrs. Rector’s separate property and her one-half of
the community property. Mrs. Rector subsequently transferred the assets
in the marital trust to a new revocable trust in 1991, when she was 85. In
October 1998, at the age of 92, Mrs. Rector became a full-time resident of
a convalescent hospital.
In December of 1998, Mrs. Rector formed a limited partnership. Her son,
John, had learned of the idea from his estate planning attorney. There
were no negotiations over the terms of the partnership agreement.
According to Judge Laro, Mrs. Rector and her sons intended that Mrs.
Rector would make the only contributions to the partnership.
In March of 1999, Mrs. Rector transferred $8.8 million of cash and
marketable securities through her revocable trust to the limited partnership
in exchange for a 98% limited partnership interest held in the revocable
trust and a 2% general partnership interest held by her individually. At the
time the limited partnership was funded the bypass trust assets had a value
of approximately $2.5 million.
The partnership agreement provided that the general partners had the
absolute management and control of the business and affairs of the
partnership. It also provided the net cash flow, as defined in the
agreement, was to be distributed to the partners in proportion to their
partnership interests.
1
In the same month that Mrs. Rector funded the partnership, she made gifts
of an 11.1% limited partnership interest to each of her two sons. She later
assigned her 2 % general partnership to her revocable trust on January 2,
2001. She then gave an additional 2.754% interests to each of her sons on
January 4, 2001, leaving her revocable trust the owner of the 2% general
partnership interest and a 70.272% limited partnership interest. Mrs.
Rector died on January 11, 2001.
The partnership operated without a business plan or an investment
strategy, nor did it trade or acquire investments. There were no balance
sheets, income statements, or other financial statements and no formal
meetings. According to Judge Laro, the partnership functioned to own
investment accounts, make distributions, and pay Mrs. Rector’s personal
expenses. The partnership did maintain monthly statements of investment
account activity and a handwritten check register for payments, but did not
maintain statements of activity and capital accounts.
Distributions in its first three years to its partners exceeded the
partnership’s income by almost $500,000. During 1999 and 2000, 86 to
90% of the distributions were made to Mrs. Rector to pay her living
expenses. Mrs. Rector’s only income outside of distributions from the
partnership was from the bypass trust, which was about $45,000 a year
from 1998 until her death. During her life, checks were written from the
partnership to her revocable trust that were used to pay her gift tax
liabilities, and after her death checks were written from the partnership to
pay her federal and state estate tax liabilities.
At the time of her death in 2001 at the age of 95, the partnership assets had
a value of $8,126,579. The estate claimed a 19% discount for lack of
control and lack of marketability on the estate tax return. The IRS issued
a deficiency notice asserting a $1,633,049 federal estate tax deficiency,
based on the inclusion of the partnership assets in her estate under I.R.C.
§ 2036(a)(1).
b.
Court’s Opinion
Judge Laro held that, based on the record, the limited partnership was
formed to facilitate the transfer of Mrs. Rector’s property to her sons and
grandchildren primarily as a testamentary substitute, with the aim of
lowering the value of her gross estate by applying discounts for lack of
control and lack of marketability. In finding that Mrs. Rector and her sons
had an understanding that she would retain her interest in the transferred
assets, Judge Laro noted that she retained control of the distribution of the
partnership’s cash flow as the general partner. In addition, she transferred
practically all of her wealth to the partnership and derived economic
benefit from using the partnership’s assets to pay her living expenses, to
meet her tax obligations (including the payment of federal and state estate
2
taxes after her death), and to make gifts to her family members. Judge
Laro rejected the estate’s argument that her assets were sufficient to meet
her needs because of the $2.5 million in the bypass trust. He noted that
the bypass trust only permitted distributions of principal for her care and
comfortable support in her accustomed manner of living. According to
Judge Laro, the understanding among Mrs. Rector and her sons was that
the principal of the bypass trust would not be invaded.
In finding that the transfer did not satisfy the bona fide sale exception,
Judge Laro pointed out that, because the formation of the partnership
entailed no change in the underlying pool of assets or the likelihood of
profit, the receipt of the partnership interests did not constitute the receipt
of full and adequate consideration. In finding that the transfer of the assets
to the partnership were not made in good faith, Judge Laro noted that Mrs.
Rector’s sons did not negotiate the terms of the partnership agreement
(although other cases have not made this an absolute requirement), Mrs.
Rector made all the contributions, and her contributions constituted the
vast bulk of her wealth, the partnership was formed with Mrs. Rector and
her revocable trust as the only partners; the partnership was not funded
until nearly three months after it was formed (which, by itself, should not
matter); although the agreement contemplated more than one partner
would contribute to the partnership, it was intended that she would make
the only contributions; and there was no significant nontax business
purpose at its inception. Judge Laro adds the word “business” when he
describes the standard that should apply, although other cases have simply
required a legitimate and significant nontax purpose.
Judge Laro dismissed the estate’s reasons for forming the partnership,
which were to benefit from estate tax savings, to give away partnership
interests, to protect Mrs. Rector’s assets from creditors, and to diversify
her assets. According to Judge Laro, gift giving is testamentary, there was
no evidence that the assets transferred required any special kind of
management, there was no evidence to establish any legitimate concern
about the liabilities of Mrs. Rector (and as a general partner her assets
were not protected), and there was no investment strategy or business
plan. Based on his rejection of the estate’s reasons for forming the
partnership, and Mrs. Rector’s age and health, as well as the fact that only
cash and marketable securities were contributed, Judge Laro concluded
that the formation of the partnership was more consistent with an estate
plan than an investment in a legitimate business, and that the bona fide
sale exception did not apply.
In addition to the increase in the estate tax, the IRS imposed an accuracy
related penalty on the estate because of the failure to report the 1991 and
1999 gifts of $595,000 and $70,000, respectively, as adjusted taxable gifts
on the estate tax return. Judge Laro agreed with the IRS’ assessment of
the penalty based on the fact that John Rector, who signed the return as
3
co-executor of the estate, had extensive expertise in financial matters.
Judge Laro believed he should have known about the omission in his
capacity as co-executor and as the donee of half of the gifts. Furthermore,
the estate made no showing of reasonable cause or good faith with respect
to the omission.
c.
Analysis of the Court’s Opinion
The result in this case is not surprising, considering the facts.
Nonetheless, some of Judge Laro’s statements concerning the application
of the law to the facts are inconsistent with earlier cases. For example, his
mention of a “business” purpose is in contrast to the lack of any
“business” purpose in the Schutt case, in which the taxpayer was
successful because the business trusts were formed to carry out the
decedent’s investment objectives. In addition, his finding that there were
no negotiations as a factor indicating the transfer of assets was not made in
good faith has not been followed in many other cases, notably Kimball.
Finally, his opinion does not assist in determining which transfers are
subject to 2036(a). In every case involving I.R.C. § 2036(a), there is at
least one transfer, that is by the decedent, and perhaps others, to the entity
in exchange for interests in the entity. In addition, there may be additional
transfers during the decedent’s lifetime in the form of gifts (or purported
sales at fair market value that turn out to be part sale/part gift
transactions). It is unclear under the decisions dealing with I.R.C.
§ 2036(a), whether that section applies to the first or second transfer or to
both transfers. If I.R.C. § 2036(a) applies to the first transfer, because the
bona fide exception does not apply, and the decedent retained, even after
subsequent gifts of interests in the entity, either the enjoyment of the
income from all the transferred assets or the right to designate the persons
who would enjoy the income from all the transferred assets, then
subsequent gifts should not diminish the amount included in the
decedent’s estate under I.R.C. § 2036(a).
On the other hand, if the decedent’s enjoyment of the income or right to
designate the persons who would enjoy the income was effectively
reduced as a result of the gifts, which was probably not the likely scenario
in most of the decided cases in favor of the IRS, then the portion of the
assets attributable to the transferred interests would not be includable in
the decedent’s estate if the decedent lived for three years after the transfer
(thereby avoiding I.R.C. § 2035(a)). In most cases the courts have found
that the decedent continued to enjoy the income from all the assets until
the decedent’s death. Note that the subsequent gifts of the interests in the
entity would not qualify under the bona fide sale exception because they
are gifts.
4
In a footnote rejecting the estate’s argument that I.R.C. § 2036(a) only
applied to the transfers of the limited partnership interests to her sons and
not to her transfer of the assets to the partnership, Judge Laro treated the
transfer to the partnership and the subsequent gifts as part of a single plan
to minimize Mrs. Rector’s estate tax that lacked a significant nontax
business purpose, and accomplished no genuine pooling of assets. Judge
Laro could have simply stated that the original transfer was the
determinative transfer and, as long as Mrs. Rector continued to enjoy the
income form all the assets in the partnership under an implied agreement,
I.R.C. § 2036(a) applies to all the assets.
This case is another example that the criteria are similar in determining
whether the bona fide sale exception applies and whether there has been
an implied agreement that the decedent would continue to enjoy the
income from the assets. Many of the same factors are considered for both
issues. In fact, if an opinion starts out by discussing the bona fide sale
exception, the taxpayer has won. If the opinion starts out discussing the
implied right to enjoy the income issue, the taxpayer has lost. If the facts
warrant a finding of an implied right, the same facts would usually lead to
the conclusion that the bona fide sale exception does not apply.
2.
Estate of Mirowski v. Commissioner, T.C. Memo 2008-74
a.
Facts of the Case
Ms. Mirowski died at the age of 73 on September 11, 2001 (9/11). She
was a widow. Her husband died in 1990. He was the inventor of the
automatic implantable cardioverter defibrillator (ICD) (commonly referred
to as a pacemaker) and was entitled to 73% of the royalties from the ICD
patents, which he left to Ms. Mirowski. She created separate irrevocable
trusts in 1992 for each of her three daughters, and transferred
approximately 7% of the ICD patent royalties to each of the trusts. After
considering it for a year, Ms. Mirowski formed the Mirowski Family
Ventures L.L.C. (MFV) under Maryland law on August 27, 2001. She
then transferred her remaining interest in the ICD patent royalties to MFV
on September 1, 2001, and then transferred approximately $62 million of
marketable securities to MFV in three transfers on September 5, 6, and 7,
2001. On September 7, 2001, she made gifts of a 16% interest in MFV to
each of the irrevocable trusts she had earlier created for each of her three
daughters, leaving her with a 52% interest in MFV. Judge Chiechi noted
Ms. Mirowski never contemplated forming MFV without making the gifts
to her daughters’ trusts. Although Ms. Mirowski had diabetes and had
developed a foot ulcer, at no time before September 10, 2001, did she, her
doctors, or her daughters think her death was imminent. The IRS asserted
a deficiency of approximately $14.2 million, based on including all the
assets in MFV in her estate under I.R.C. §§ 2036(a), 2038(a)(1), and
2035(a).
5
b.
Court’s Opinion
Judge Chiechi, who also decided Estate of Stone v. Commissioner, T.C.
Memo 2003-309, another taxpayer victory in an FLP case, held that the
bona fide sale exception applied to the transfers to MFV by Ms. Mirowski
and that Ms. Mirowski did not retain the enjoyment of the income from
the transferred assets nor the right to designate who was to enjoy the
income from the transferred assets, and therefore, 2036(a), 2038(1), and
2035(a) did not apply. Her decision was based on the facts in the case, the
testimony of two of the daughters, the terms of the MFV operating
agreement, and Maryland law. At the outset, Judge Chiechi determined
that the resolution of the issues presented did not depend on who had the
burden of proof. It seems that none of the cases dealing with the
application of I.R.C. § 2036(a) have been decided on the basis of who had
the burden of proof.
The facts of the case indicated that Ms. Mirowski, from her childhood in
France, had always been concerned with keeping her family together. She
placed a great deal of emphasis on having the family make decisions
collectively. Nonetheless, she made her own investment decisions, even
up to her death.
Judge Chiechi found the testimony of the two daughters who served as
witnesses concerning the facts in the case, including the reasons for
forming and transferring assets to MFV, to be completely candid, sincere,
credible, and reasonable.
Judge Chiechi also pointed to the terms of the MFV operating agreement
that precluded Ms. Mirowski from having the right to enjoy the income
from the transferred assets or to designate who would enjoy the income
from those assets.
Finally, Judge Chiechi relied on Maryland law in determining that Ms.
Mirowski did not retain the right to enjoy the income or designate who
would enjoy the income from the transferred assets.
Judge Chiechi determined that for I.R.C. § 2036(a) to apply, there had to
be a transfer of property, the bona fide exception did not apply, and Ms.
Mirowski must have retained the right to the income or the right to
designate who would enjoy the income from the transferred property.
Judge Chiechi also treated the transactions as two separate transfers: the
transfers Ms. Mirowski made to MFV and the gifts she made to her three
daughters.
Bona fide sale exception.
Based on the testimony of two of Ms. Mirowski’s daughters, Judge
Chiechi found that Ms. Mirowski had the following legitimate and
6
significant nontax reasons for forming and transferring certain assets to the
partnership:
(1)
Joint management of the family’s assets by her daughters
and eventually her grandchildren;
(2)
Maintenance of the bulk of the family’s assets in a single
pool of assets in order to allow for investment opportunities
that would not be available if Ms. Mirowski were to make a
separate gift of a portion of her assets to each of her
daughters’ trusts; and
(3)
Providing for each of her daughters and eventually each of
her grandchildren on an equal basis.
Significantly, Judge Chiechi stated in a footnote that the first reason alone
would have been sufficient to satisfy the requirement under the bona fide
sale exception that there must be a legitimate and significant nontax
reason for creating the entity. In addition, she rejected the IRS’ contention
that the facilitation of lifetime giving may never qualify as a significant
nontax reason for forming and funding a family entity. While the Tax
Court in Bongard v. Commissioner, 124 T.C. 95 (2005) held that lifetime
giving was not a significant nontax reason for forming the partnership,
according to Judge Chiechi that holding was based on the facts in that case
and was not a holding that lifetime giving may never be a significant
nontax factor. Judge Chiechi also found that there was a fourth nontax
reason for forming and funding MFV; namely, for asset protection.
Although she noted Ms. Mirowski’s concern about creditors of her
daughters, Judge Chiechi concluded that the trusts Ms. Mirowski
established for them provided ample protection.
The government offered the following contentions in challenging the bona
fide sale exception, based on case law:
(1)
Ms. Mirowski failed to retain sufficient assets outside of
MFV for her anticipated financial obligations;
(2)
MFV lacked any valid functioning business operation;
(3)
Ms. Mirowski delayed forming and funding MFV until
shortly before her death and her health had begun to fail;
(4)
Ms. Mirowski sat on both sides of her transfers to MFV;
and
(5)
After Ms. Mirowski died, MFV made distributions totaling
over $36 million to pay her federal and state transfer taxes,
legal fees, and other estate obligations.
7
Judge Chiechi rejected each of these contentions, as follows:
(1)
The only anticipated significant financial obligation of Ms.
Mirowski when she formed and funded MFV was the
substantial gift tax for which she would be liable because of
the gifts she made. There was no express or implied
agreement that MFV would distribute assets to pay the gift
tax liability. In addition, there were three options available
for paying the gift taxes: (a) use of a portion of the $7.5
million (including $3.3 million in cash and cash
equivalents) she retained; (b)
use of the expected
substantial distributions (attributable in large part to the
royalties from the ICD patents) she would receive from
MFV as a 52% interest holder; and (c) loans using her
retained assets or her interest in MFV as collateral. In
addition, because until September 10, 2001, none of Ms.
Mirowski, her daughters, or her physicians expected her to
die, there were no discussions or expectations that transfer
taxes would be soon be due.
(2)
MFV at all relevant times was a valid functioning
investment operation and had been managing the business
matters relating to the ICD patents and the ICD patents
license
agreement,
including
related
litigation.
Specifically, Judge Chiechi rejected the government’s
contention that the level of activities must rise to a level of
a “business” for the bona fide sale exception to apply.
(3)
Based on the same facts discussed with regard to the
payment of estate taxes, because Ms. Mirowski’s death was
unexpected, Judge Chiechi rejected the government’s
contention that the bona fide sale exception should not
apply because the forming and funding of MFV was
delayed until shortly before her health had begun to fail.
(4)
The government’s contention that another reason to reject
the bona fide sale exception was the lack of negotiations
between Ms. Mirowski and her daughters about the
formation or funding of MFV would read out of the bona
fide sale exception the creation of any single member LLC.
In addition, Ms. Mirowski was the only contributor to
MFV; the trusts for the daughters were only recipients of
gifts of interests in MFV. In contrast, in Estate of Rector
v. Commissioner, T.C. Memo 2007-367, Judge Laro noted
the fact that Mrs. Rector was the only contributor as a
negative factor.
8
(5)
Because her death was unexpected the payment of transfer
taxes and other estate obligations were not discussed or
anticipated. Furthermore, Judge Chiechi rejected the
government’s suggestion that the payment of these
obligations was determinative in this case of whether the
bona fide sale exception applied.
Judge Chiechi also found that the cases relied on by the government were
factually distinguishable from the instant case and the government’s
reliance on them misplaced. She also rejected the government’s argument
that, because Ms. Mirowski only ended up with 52% of the membership
interests, she did not receive adequate and full consideration in the form of
a proportionate interest. According to Judge Chiechi, Ms. Mirowski made
two separate, albeit integrally related transfers of property: the transfers of
assets to MFV and the gifts to the trusts for the benefit of her daughters.
In return for her transfers to MFV, she received and held a 100% interest
and had the right to a distribution of property from MFV in accordance
with her capital account upon liquidation and dissolution of MFV.
Consequently, because Ms. Mirowski received an interest in MFV
proportionately equal to the fair market value of her contribution (which in
this case was 100%) and there were three legitimate and significant nontax
reasons for forming and funding MFV, the bona fide sale exception
applied.
Retained Right to Income
Because Ms. Mirowski’s transfers to MFV were bona fide sales for
adequate and full consideration in money or money’s worth, it was
unnecessary to deal with whether she retained the enjoyment of the
income or the right to designate who would enjoy the income form the
transferred property. However, because the gifts of the 16% interests to
the three trusts for the benefit of her daughters were not bona fide sales,
Judge Chiechi had to deal with those issues nonetheless.
The “linchpin” in the government’s argument was that under the operating
agreement Ms. Mirowski’s authority included the authority to decide the
timing and amounts of distributions from MFV. Based on the terms of the
operating agreement and Maryland law, Judge Chiechi found the Ms.
Mirowski’s discretion, power, and authority as MFV’s general manager
were subject to fiduciary duties to the other members of MFV. The
operating agreement provided for the distribution of cash flow, as defined
in the agreement, within 75 days after the end of the taxable year, as well
as the distribution of capital proceeds, as defined in the agreement.
Consequently, Ms. Mirowski did not retain the possession or the
enjoyment of, or the right to the income from, the respective 16% interests
in MFV that she gave to her daughters’ trusts.
9
As to whether there was an implied agreement, the government relied on
essentially the same contentions that it relied on in rejecting the bona fide
sale exception. These contentions had already been rejected. Judge
Chiechi again pointed to fact that Ms. Mirowski’s death was unexpected
by Ms. Mirowski, her daughters, and her physicians, as the primary reason
for rejecting the government’s arguments. She also found an additional
reason for rejecting the contention that the payment of estate taxes by
MFV was determinative of whether Ms. Mirowski retained the enjoyment
of the income from the transferred assets. The daughters decided not to
make pro rata distributions to the trusts when distributions were made to
the estate to pay taxes and other obligations, because, as equal
beneficiaries of the estate, the trusts were benefiting from the payment of
these estate liabilities equally. In effect, the distributions to pay estate
taxes and other liabilities were pro rata distributions to the three trusts.
Judge Chiechi then turned to I.R.C. § 2036(a)(2). Based on the same
analysis as she applied in rejecting the government’s argument that Ms.
Mirowski retained the right to the income, Judge Chiechi found she did
not retain the right to designate who would enjoy the income.
Judge Chiechi then dealt with the remaining issues. I.R.C. § 2038(a)(1)
did not apply for the same reasons that I.R.C. § 2036(a)(2) did not apply.
In addition, because neither I.R.C. § 2036(a) nor 2038(a)(1) applied, the
three year inclusion rule under I.R.C. § 2035(a) did not apply.
c.
Analysis of the Court’s Opinion
This case is in stark contrast to Rector, and to some extent, to some of the
other cases that were IRS victories. Judge Chiechi rejected many of the
positions advocated by Judge Laro in a number of cases he has decided
dealing with FLPs. A legitimate and significant nontax reason does not
have to include a business reason. Lifetime giving may be a significant
nontax reason for creating the entity. Negotiations between the transferor
and the donees of the interests in the entity are not a requirement in every
case. There is no requirement that someone other than the decedent
contribute assets to the entity. The payment of estate taxes and other post
mortem obligations does not necessarily mean there was an implied
agreement that the decedent would enjoy the income from the transferred
property. The fact that the decedent depended in part on expected
distributions from the entity, where it is clear the entity would have
substantial income, does not indicate there was an implied agreement.
Fortunately for many situations where FLPs and FLLCs were created for
both tax and legitimate and significant nontax reasons, but where the
transferor died unexpectedly shortly after the formation and funding,
Judge Chiechi’s holdings and the reasons for the holdings should provide
support for rejecting a challenge under I.R.C. § 2036(a) or 2038(a)(1).
10
However, because of Judge Chiechi’s emphasis on Ms. Mirowski’s family
history, the unexpected death of Ms. Mirowski, and the credible testimony
of two of Ms. Mirowski’s daughters, as well as the terms of the operating
agreement and Maryland law, this case should not provide solace in those
situations where the entity was clearly formed as a tax savings device, and
any nontax reason for creating the entity was a mere after thought and not
a motivating factor.
The key factors in favor of the taxpayer in this case were (1) the
unexpected death of Ms. Mirowski, (2) the family history, (3) the credible
testimony of the daughters, (4) the existence of the ICD patents and the
litigation associated with them, (5) the terms of the operating agreement
that provided for the way distributions of operating and capital proceeds
were to be made, (6) the substantial income MFV was expected to receive
because of the ICD patent royalties, and (7) Ms. Mirowski’s retention of
over $7 million of assets.
3.
Estate of Christiansen v. Commissioner, 130 T.C. No. 1
a.
Summary of the Case
This case upheld the effectiveness of a disclaimer of an interest in a
decedent’s estate over a specified dollar amount that passed to a charitable
foundation as a result of the disclaimer. There were two other issues:
whether the disclaimer was qualified with regard to an interest passing to a
charitable lead annuity trust where the disclaimant possessed a contingent
remainder interest and whether a savings clause with regard to the
disclaimer of the interest in the charitable lead annuity trust was effective
in rendering the disclaimer a qualified disclaimer. The Tax Court held
that the disclaimer of the interest that passed directly to a charitable
foundation was qualified and was not void as against public policy.
The Tax Court characterized the disclaimer in this case as involving a
fractional formula that increased the amount donated to charity should the
value of the estate be increased, and found it hard pressed to find any
fundamental public policy against making gifts to charity. If anything, the
opposite was true; public policy encourages gifts to charity and Congress
allows charitable deductions to encourage charitable giving. The Tax
Court rejected the government’s argument, based on Commissioner v.
Procter, 142 F.2d 824 (4th Cir, 1944), that voided a clause that reverted a
gift to the donor if it were subject to gift tax, because (1) the provision
would discourage collection of tax, (2) it would render the court’s own
decision moot by undoing the gift being analyzed, and (3) it would upset a
final judgment. The Tax Court found that, in the instant case, the formula
disclaimer would not undo a transfer, but only reallocate the value of the
property transferred among the charitable and noncharitable beneficiaries,
11
and, therefore, its decision would not be moot nor would the effect of its
decision upset the finality of its decision.
The Tax Court recognized that its decision could marginally affect the
incentive of the IRS to audit returns affected by such a disclaimer.
However, the Court pointed to other mechanisms that would prevent
abusive use of such formula disclaimers, including the fiduciary duty of
executors and trustees, as well as directors of foundations. In addition, the
IRS can go after fiduciaries who misappropriate charitable assets and, in
most states, the state attorney general has the authority to enforce these
fiduciary duties.
4.
Holman v. Commissioner, 130 T.C. No. 12 (2008)
a.
Facts of the Case
Tom and Kim Holman (Tom and Kim), husband and wife, formed a
limited partnership (the partnership) on November 2, 1999, and transferred
shares of Dell Computer Corp. (Dell) to the partnership the same day.
They each took back an .89% general partnership interest and a 49.04%
limited partnership interest. In addition, a trust for the benefit of their
children (the trust) transferred shares of Dell to the partnership for a .14%
limited partner interest. They had four reasons for forming the
partnership: very long-term growth, asset preservation, asset protection,
and the education of their four children. In addition, they wanted to
disincentivize their children from getting rid of the assets, spending them,
or feeling entitled to them. The partnership agreement gave the general
partners the exclusive right to manage and control the business and
prohibited an assignment of an interest by a limited partner without the
consent of all partners except to permitted assignees. The partnership
agreement also gave the partnership the right to acquire an assignee
interest acquired in violation of the agreement at fair market value based
on the assignee’s right to share in distributions. The partnership could
only be dissolved with the consent of all partners.
On November 8, 1999, Tom and Kim gave limited partner interests (LP
units) to the trust and to four uniform transfers to minors act
custodianships for the benefit of their children (custodian accounts) having
a reported value according to the gift tax returns roughly equal to their
$600,000 transfer tax exemptions at the time. On December 13, 1999 the
custodian accounts transferred additional shares of Dell to the partnership.
On January 4, 2000, Tom and Kim gave LP units to the custodian
accounts having a reported value equal to the annual exclusions available
to Tom and Kim ($80,000). On January 5, 2001 Tom and Kim transferred
additional shares of Dell to the partnership in exchange for additional LP
units. Finally, on February 2, 2001, Tom and Kim gave additional LP
12
units to the custodian accounts having a reported value equal to the annual
exclusions available to Tom and Kim ($80,000).
The Tax Court described the operation of the partnership as follows: there
was no business plan; there were no employees nor any telephone listing
in any directory; its assets consisted solely of Dell shares; there were no
annual statements; at the time Tom decided to create the partnership he
had plans to makes gifts of LP units in 1999, 2000, and 2001; and the
partnership had no income and filed no returns for 1999, 2000, and 2001.
The IRS increased the value of the gifts based on the following alternate
assertions: the transfer of assets to the partnership were indirect gifts of the
Dell shares; the interests were more analogous to interests in a trust than
an operating business; I.R.C. § 2703 applied to ignore the restrictions in
the partnership agreement; the restrictions on liquidations should be
ignored under I.R.C. § 2704(b); and the appropriate discount for lack of
control and lack of marketability should be 28%, rather than the taxpayer’s
49.25% discount.
At trial, the IRS abandoned the trust and
I.R.C.§ 2704(b) arguments.
b.
Court’s Opinion
The following will deal with the Court’s opinion with regard to the
indirect gifts theory, the application of I.R.C. § 2703(a), and the value of
the gifts for gift tax purposes. Note that, because this a gift tax
proceeding, I.R.C.§§ 3036(a) and 2038 were not issues.
Indirect Gifts Issue. The IRS had asserted that, based on Shepherd v.
Commissioner, 283 F.3d
1258 (11th Cir. 2002) and Senda v.
Commissioner, T.C. Memo 2004-160, aff’d 433 F.3d 1044 (8th Cir. 2006),
the gifts on November 8th were indirect gifts of the Dell shares, and
therefore no discounts were appropriate. Based on the facts, the Tax Court
distinguished the instant case because the shares were transferred six days
after the partnership was formed and there was a real economic risk of a
change in value between the date of formation and the transfer of the
shares. The government had argued that the step transaction doctrine
should have applied, because it was Tom’s intent in forming the
partnership to make the gifts. According to the Court, the fact that the
government had not asserted that the gifts in 2000 and 2001 should also be
treated as indirect gifts meant that government recognized that the passage
of time could defeat a step transaction argument. According to the Court,
because of the volatility of the Dell shares, six days was a sufficient period
in the instant case.
I.R.C. § 2703 Issue. The IRS asserted that the right of the partnership to
acquire an assignee’s interest at a value less its pro rata share of the
partnership’s net asset value (NAV) should be disregarded under I.R.C.
13
§ 2703(a) because it did not satisfy the three requirements under the
statutory safe harbor; namely, the right must be a bona fide business
arrangement, it must not be a device to transfer property to members of the
decedent’s family for less than full and adequate consideration in money
or money’s worth, and its terms must be comparable to similar
arrangements entered into by persons in an arm’s length transaction. The
Court agreed with the government, based on its opinion that the right did
not satisfy the bona fide business arrangement and device requirements.
The Court held that there was no closely held business and the reasons for
forming the partnership were educating the Holman’s children and
disincentivizing them from getting rid of Dell shares, spending the wealth
represented by the shares, or feeling entitled to the Dell shares. The Court
distinguished Estate of Amlie v. Commissioner, T.C. Memo 2006-76,
because in that case the conservator was seeking to exercise prudent
management of his ward’s minority interest in a bank consistent with his
fiduciary obligations to the ward and to provide for the expected liquidity
needs of her estate.
While the Court held that the gifts were not a device to transfer LP units
for less than adequate consideration, the right to acquire an assignee’s
interest was such a device. The Court reasoned that by purchasing a
transferred interest for a value less the a pro rata share of the NAV, the
value of the non assigning children’s LP units would be increased.
Although both parties’ experts agreed that the restrictions were common in
arm’s-length arrangements, the government’s expert believed that because
of the nature of the partnership, nobody at arm’s length would get into the
deal. Because the Court found that the right to acquire an assignee’s
interest was not a bona fide business arrangement and was a device, it did
not reach a conclusion as to whether the comparability requirement was
satisfied.
The Valuation Issue. Because the partnership’s only assets were the Dell
shares, the experts for each party agreed on the value of the Dell shares at
the date of the 1999 gift. The Court rejected the taxpayers’ expert’s
argument that the valuation method under the gift tax regulations did not
apply to the 2000 and 2001 gifts because the gifts were of partnership
interests and not of the shares themselves. The Court also rejected the
taxpayers’ expert’s contention that the lack of control discount should
reduce the NAV based on the value of shares of publicly held investment
companies that traded at a discount from NAV.
The Court essentially agreed with the government’s expert’s determination
of the lack of control discount and arrived at a discount of 11.32% for the
1999 gifts, 14.34% for the 2000 gifts, and 4.63% for the 2001 gifts. Both
experts relied on the prices of shares of publicly traded, closed-end
14
investment funds, but disagreed as to whether useful information could be
obtained by considering funds specializing in industries different from
Dell and as to the range, mean, and median of the subset and the sample.
The Court also rejected the taxpayer’s expert’s additional discounts for
lack of portfolio diversity and professional management.
As for the appropriate lack of marketability discount, the Court agreed
with the government’s expert that a 12.5% discount was appropriate. Both
experts agreed on the usefulness of restricted stock studies in determining
the appropriate marketability discount for the gifts, that no secondary
market existed for the LP units, that an LP unit could not be marketed to
the public or sold on a public exchange, and that an LP unit can be sold
only in a private transaction. They disagreed on the likelihood of a private
market among the partners for the LP units.
The taxpayers’ expert believed that there was no market for the LP units
and that the lack of marketability discount should have been at least 35%.
The government’s expert observed that the taxpayers’ expert’s conclusion
would lead to almost a zero value and the Court believed that the 35%
figure was a guess. In contrast, the government’s expert based his
conclusion that a 12.5% lack of marketability was appropriate on the
likelihood that a limited partner wishing to make an impermissible
assignment of LP units and the remaining partners would strike a deal at
some price between the discounted value of the units and the proportionate
share of the partnership’s NAV.
c.
Analysis of Court’s Opinion
The Court’s discussion of the application of the step transaction doctrine
will add additional confusion to an already confused area of transfer tax
law. It could be argued that the step transaction doctrine should not apply
at all to the transfer of assets to a partnership followed by gifts of interests
in the partnership if the intent of the donor was to give partnership
interests rather than the assets themselves for legitimate nontax reasons
and the partnership was a valid entity under state law. If the Court’s
analysis is correct, practitioners will have to determine in each case how
long the prospective donor must wait before making gifts of partnership
interests, presumably based on the nature of the asset.
The Court’s application of the statutory safe harbor under I.R.C. § 2703
greatly restricts its usefulness in family entities that do not engage in an
active trade or business. The Court implies the bona fide business
arrangement requirement can only be satisfied if there is a closely held
business involved or the reasons for the restrictions are business related.
Some commentators have argued that the Court ignores language in the
Finance Committee Report that “[b]uy-sell agreements are commonly
used to control the transfer of ownership in a closely held business…to
15
prevent the transfer to an unrelated party” [emphasis added]. If the
Court’s premise is that the bona fide business arrangement requirement
can only be met if there is a closely held business, which in its opinion
does not include an investment in one company’s stock, or the reasons for
the restrictions are business related, the reasons for having any restrictions
are irrelevant in meeting the requirement unless there is a closely held
business or the reasons are business related.
Although the Court did not treat the gifts of the LP units themselves as a
device, it held that the right to acquire an assignee interest at a value
below its proportionate NAV could result in value being transferred to
objects of the decedent’s bounty for less than adequate consideration.
However, the subsequent shift in value to the non-assigning children
would not involve a transfer from the parents to the children, but merely a
shifting of value among all the non-assigning partners. The result reached
by the Court can be avoided by including a true right of first refusal rather
than the provision giving the partnership the right to acquire an assignee’s
interest. Presumably the purchase price in a good faith offer by a third
party would be based on a value considerably less than a pro rata share of
the NAV.
Finally, as has been noted by other commentators, the willingness of the
Court to accept testimony concerning the comparability requirement other
than actual buy-sell agreements, which would be difficult to obtain for
closely held businesses, is a welcome approach to that issue.
As for determining the lack of marketability discount, the Court strays
from the hypothetical willing buyer and willing seller paradigm when it
agrees with the government’s expert’s conjecture of how a partner wishing
to dispose of his or her interest would strike a deal with the remaining
partners. In supporting its position that the remaining partners would
strike a deal, the provision in the partnership agreement permitting a
dissolution by the consent of all the partners convinced the Court that
preservation of family assets was not an unyielding purpose. The Court
ignores the fact that under any state’s partnership law a partnership can be
dissolved if all the partners consent.
In conclusion, this case raises many issues that practitioners and their
clients must consider when using business entities to carry out the clients’
nontax objectives. Because the case was a regular Tax Court decision, the
case has precedential authority.
16
5.
Astleford v. Commissioner, T.C. Memo 2008-128
a.
Facts of the Case
On August 1, 1996, Jane Astleford (Jane), whose husband had died in
1995 leaving a number of real estate properties to a marital trust for Jane’s
benefit, formed a limited partnership (the partnership) and funded the
partnership on the same day by transferring her interest in an elder-care
assisted living facility. On the same day she gave each of her three
children a 30% limited partnership interest. On December 2, 1997, Jane
transferred to the partnership her 50% interest in a general partnership
(Pine Bend) that was formed in 1970 by her husband and an unrelated
third party and that owned 1,187 acres of agricultural farmland (the
Rosemount Property) and 14 other properties, significantly increasing her
general partnership interest and decreasing her children’s limited
partnership interests. In addition, on December 1, 1997 (the same day as
the transfer of the properties described in the previous sentence), Jane
gave each of her children additional limited partnership interests reducing
her general partnership interests to 10% and increasing each of her
children’s limited partnership interest to 30%.
Although neither of these issues was raised by the government in this case,
the facts raise both a lapse under I.R.C. § 2704(a) and an indirect gift
under the step transaction doctrine. If the interests that Jane transferred
were converted from general partnership interests to limited partnership
interests, any diminution in value should have been treated as a gift.
Because the 1996 and 1997 gifts were made on the same day as Jane
transferred assets to the partnership, the IRS could have asserted that the
step transaction doctrine should have applied to treat the transfers to the
partnership as indirect gifts. In this case, because the assets were real
property, a fractionalization discount would still have been appropriate.
b.
Court’s Opinion
The issues in the case were the value of the Rosemount Property, whether
the 50% interest in Pine Bend should be valued as a general partnership
interest or as an assignee interest, and the lack of control and lack of
marketability discounts that should apply to the 50% Pine Bend interest
and the gifted partnership interests.
The issues in determining the value of the Rosemount Properties included
whether an “absorption” discount should apply and the appropriate
discount rate. While the Court accepted the government’s expert’s
starting value because he was particularly credible and highly experienced
and possessed a unique knowledge of property located in the area, the
Court agreed with the taxpayer’s expert that an absorption discount was
appropriate because of the size of the parcel and the likelihood that it
17
would take four years to dispose of the property without reducing the price
considerably. However, the Court used a 10% discount rate rather than
the 25% discount rate advocated by the taxpayer’s expert, which it
believed was more in line with the return on investments experienced by
farmers in the locality, thereby reducing the taxpayer’s absorption
discount from 41.3% to 20.396%.
The taxpayer treated the 50% Pine Bend interest as an assignee interest
based on Minnesota law and the fact that the other general partner did not
consent to the transfer. However, the Court agreed with the government
that the substance over form doctrine should apply based on Jane’s
position as the sole general partner of the partnership, and the
partnership’s resolution that treated the Pine Bend transfer as a transfer of
all of her rights and interests to the partnership. Because Jane was the sole
general partner of the partnership, she would continue to have and to
control the management rights associated with the 50% Pine Bend general
partnership interest whether she transferred only an assignee interest or a
general partnership interest.
The Court applied a combined 30% discount for lack of control and lack
of marketability to the 50% Pine Bend general partnership interest. The
Court rejected the government’s argument that applying discounts to both
the Pine Bend general partnership interest and the limited partnership
interests gifted in 1996 and 1997 was inappropriate because the Pine Bend
interest constituted less than 16% of the partnership’s NAV and was only
1 of 15 real estate investments held by the partnership.
The Court applied a 16.17% lack of control discount and a 21.23% lack of
marketability discount for the 1996 gifts and a 17.47% lack of control
discount and a 22% lack of marketability discount for the 1997 gifts. In
doing so, the Court relied on testimony from both experts. The taxpayer’s
expert relied on comparability data from sales of registered real estate
limited partnerships (RELPs), while the government’s expert relied on
comparability data from sales of publicly traded real estate investment
trusts (REITs). The Court used the RELP data to arrive at the discounts
for Pine Bend and the REIT data to arrive at the discounts for the gifts, but
made adjustments to the experts’ valuation in each case.
c.
Analysis of the Court’s Opinion
Presumably, the IRS did not raise the indirect gift issue either on audit or
at trial. After the Holman case, discussed above, it is likely that the IRS
will challenge gifts made simultaneously or shortly after the formation of
the partnership under the step transaction doctrine. Appraisers should find
solace in the Court’s acceptance of the taxpayer’s argument that an
absorption discount was appropriate, even though it cut the taxpayer’s
discount in half.
18
The second tier discount was warranted in this case for at least two
reasons. First, as the Court pointed out, the Pine Bend interest constituted
less than 16% of the partnership’s assets. Second, although not cited by
the Court, it was clear that Pine Bend was not formed to achieve another
level of discounts because Pine Bend was formed by Jane’s husband and a
third party 36 years before Jane formed the partnership and made gifts of
partnership interests to her children.
The determination of the appropriate discounts did not raise any unusual
issues, but demonstrated the importance of using credible statistics to
support an appraisal. The Court, as it often does, made adjustments to the
experts’ valuations in arriving at what it viewed as a more reasonable
result.
6.
Bianca Gross v. Commissioner, T.C. Memo 2008-221
a.
Facts of the Case
By 1998, Bianca Gross had acquired a sizable portfolio of publicly traded
securities. After her husband’s death in 1996, she had begun to consider
her own mortality and her desire to involve her two daughters in managing
what would someday become theirs, i.e., her securities portfolio. Because
she deemed one of her daughters extravagant, she considered a trust
arrangement, but rejected it because the other daughter declined to serve
as a trustee. She settled on a family limited partnership, which she
believed would encourage her daughters to work together and learn from
her experience while preserving in her (as the general partner) control over
the partnership’s assets.
On July 15, 1998, Bianca and her daughters agreed to form a limited
partnership in which each daughter would contribute $10 and she would
contribute $100, plus securities. Bianca would be the general partner,
would retain ultimate control over management of the partnership,
including the authority to make decisions about sales, purchases, and other
dispositions of the assets, and would have exclusive discretion concerning
the timing and the amounts of distributions to the partners. The daughters
would not be able to transfer their interests in the partnership without
Bianca’s approval, could not withdraw from the partnership or obtain a
return of their capital contribution, and could not force a dissolution of the
partnership.
On July 15, 1998, a certificate of limited partnership was filed with the
New York Department of State. Later, a notice of the formation of the
partnership was published in New York newspapers, as required by law,
and on October 14, 1998, an affidavit of publication was filed with the
New York Department of State. On July 31, the daughters wrote checks
for $10 each to the partnership, and on November 16, 1998, Bianca wrote
19
a check for $100 to the partnership. From the beginning of October until
December 4, 1998, Bianca transferred to the partnership securities worth
over $2.1 million, most of which were shares of well-known, publicly
traded companies.
On December 15, 1998, Bianca and her daughters signed a limited
partnership agreement that carried out the agreement they had entered into
on July 15, and also executed deeds of gifts whereby Bianca transferred a
22.25% limited partnership interest to each daughter. The gifts were
reported on gift tax returns taking into account a 35% discount for lack of
control and lack of marketability.
The IRS issued a notice of deficiency treating the transactions as indirect
gifts of the securities to the daughters rather than gifts of the limited
partnership interests, thereby eliminating any discounts. The IRS argued
that because the partnership was not formed until December 15, 1998, the
transfers of securities occurred at the same time as the gifts were made. In
the alternative, the IRS argued that the step transaction doctrine should
apply because the transfers of the securities to the partnership and the gifts
to the daughters were part of an integrated transaction.
b.
Court’s Opinion
The IRS argued that the limited partnership was formed on December 15,
followed by the gifts to the daughters, and then the securities were
contributed to the partnership, resulting in indirect gifts of the securities
rather than direct gifts of limited partnership interests. The IRS based this
on New York law that required the execution of a partnership agreement.
However, New York law also provided that a “limited partnership is
formed at the time of the filing of the initial certificate of limited
partnership with the department of state or at any later time not to exceed
sixty days from the date of filing specified in the certificate of limited
partnership. The filing of the certificate shall, in the absence of actual
fraud, be conclusive evidence of the formation of the limited partnership
as of the time of filing or effective date, if later….”
Based on New York law, the Court was unable to reach a conclusion as to
whether a limited partnership had been formed prior to December 15,
1998, when the limited partnership agreement was signed. Nonetheless,
the Court determined that, in any event, under New York law, at least a
general partnership had been formed on July 15, 1998 when Bianca and
her daughters entered into the agreement to form the limited partnership
and the certificate of limited partnership was filed. According to New
York case law, when parties seeking to form a limited partnership do not
satisfy the requirements necessary to form a limited partnership, they may
be deemed to have formed a general partnership if their conduct indicates
that they have agreed, whether orally and whether expressly or impliedly,
20
on all essential terms and conditions of their partnership arrangement. The
Court concluded that Bianca and her daughters had agreed upon the
essential terms and conditions of their partnership arrangement just before
the filing the certificate of limited partnership on July 15, 1998.
Consequently, the transfers of securities, beginning in October and
completed on December 4, had been to the partnership before
December 15, 1998, the date on which the gifts were made.
The Court then rejected the indirect gift argument based on the fact that
the transfers of the securities were reflected in Bianca’s capital account
before the gifts were made. In reaching this conclusion, the Court
compared the facts in the instant case with the facts in Estate of Jones v.
Commissioner, 116 T.C. 121 (2001) and Shepherd v. Commissioner, 115
T.C. 376 (2000), aff’d 283 F. 3d 1258 (11th Cir. 2002). Jones involved
gifts of limited partnership interests in two limited partnerships that were
made on the same day that the limited partnerships were formed and
funded. The Court rejected the IRS’ indirect gift argument because the
contributions to the partnership were credited to the capital account of the
decedent before the gifts were made and the value of the capital accounts
of the other partners were not enhanced by the contributions. In contrast,
in Shepherd, the partnership agreement provided that any contributions
would be allocated to the capital accounts of each partner according to
ownership. Consequently, when Mr. Shepherd contributed real property
and stock to the partnership in which his two sons held 25% interests, he
made indirect gifts of the property and the stock rather than direct gifts of
partnership interests.
Finally Judge Halpern rejected the step transaction argument advanced by
the IRS. The step transaction doctrine embodies substance over form
principles: it treats a series of formally separate steps as a single
transaction if the steps are in substance integrated, interdependent, and
focused toward a particular result. Where an interrelated series of steps
are taken pursuant to a plan to achieve an intended result, the tax
consequences are to be determined not by viewing each step in isolation,
but by considering all of them as an integrated whole.
Judge Halpern had previously decided the Holman case, where he rejected
the IRS’ contention that the step transaction doctrine should apply to
collapse transfers to the partnership and gifts made shortly thereafter so
that the transfers to the partnership were indirect gifts. His decision was
based on the fact that six days had elapsed from the date of the transfers of
Dell stock to the partnership and the date the gifts of partnership interests
were made. Because the Dell stock was publicly traded, Mr. Holman bore
the economic risk that the stock would decrease in value during that
period. In the instant case, Judge Halpern again concluded that, because
11 days had elapsed between the date of the last transfer of publicly traded
securities to the partnership and the date the gifts of partnership interests
21
were made, the step transaction doctrine did not apply under the facts in
the instant case.
The Court held that the 35% discount, which had been stipulated by the
parties if the transfers were of limited partnership interests, was still
appropriate even though the transfers may have been of general
partnership interests. This conclusion was based on the uncontradicted
testimony of the taxpayer’s expert that the daughters’ interests under the
agreement of July 15, 1998 were subject to the same restrictions that
would have applied under the limited partnership agreement.
c.
Analysis of the Court’s Opinion
This case again points out the importance of complying with the
formalities of state law. Had the limited partnership agreement been
signed at the same time or soon after July 15, 1998, the IRS’ position
would have been greatly weakened. In addition, the gift tax return
contained a schedule that stated that the shares had been transferred on
December 15, giving the IRS another leg to stand on in its indirect gift
argument. Fortunately for the taxpayer, the Court held that schedule was
intended to be a list of the securities that had been previously contributed.
Evidently, the IRS did not raise the possible application of I.R.C. § 2703
to disregard the restrictions that the Court found sufficient to justify the
35% discount.
Troubling is the Court’s willingness to consider the step transaction
doctrine in this case, which the IRS had also raised in Senda v.
Commissioner, 433 F. 3d 1044 (8th Cir. 2006), affg T.C. Memo 2004-160,
and Holman. Although, as in Holman, the Court did not find that the
doctrine applied under the facts in the instant case, it did note, as it did in
Holman, that its decision was based on the nature of the asset, and that a
different asset, such a preferred stock or a long-term Government bond,
might require a longer period between the contribution of the asset to the
entity and gifts of interests in the entity to avoid collapsing the two
transactions.
To avoid the indirect gift argument, it is imperative that contributions to
the family business entity increase the capital accounts of the contributing
owners, and that this is clearly documented in the entity’s records, before
the contributing owners make gifts of interests in the entity to others. To
avoid the step transaction doctrine, it may be necessary to wait some
period of time before the gifts are made. How long evidently depends
upon the nature of the asset. Publicly traded common stock may require a
period as short as six days, which Judge Halpern held was sufficient in
Holman. The length of time for other assets may depend upon the
volatility of the asset. However, the step transaction doctrine should not
apply when the intent is to transfer interests in the entity, rather than
22
interests in the underlying assets, for legitimate nontax reasons. It appears
that the step transaction doctrine is the IRS’ gift tax counterpart to its
2036(a) attack on family limited partnerships in the estate tax context. As
in the 2036(a) cases, a legitimate and significant nontax reason for
forming and funding the entity should go a long way to defeating a step
transaction challenge.
7.
Estate of Hurford v. Commissioner, T.C. Memo 2008-278
a.
Facts of the Case
Gary Hurford, who was a former president of Hunt Oil Company, died on
April 8, 1999. Gary was survived by his wife, Thelma, and his three
children: Michael, who was a psychiatrist practicing in Kentucky; David,
who had personal problems and worked on one of the family ranches; and
Michelle, who was the family’s bookkeeper. The total assets owned by
Gary and Thelma at Gary’s death had an estate tax value of $14,246,784
and consisted of real estate, stock, bonds, mortgages, notes, cash, life
insurance proceeds, miscellaneous property, and Hunt Oil Phantom Stock
having a $5,552,377 value. His estate plan provided for the typical
division into a bypass trust designed to pass estate-tax free at Thelma’s
death and a QTIP trust designed to qualify for the marital deduction.
Thelma was diagnosed with cancer in early 2000.
Soon after Gary’s death, the attorney who had done the family’s estate
planning was replaced by a more aggressive estate planning attorney.
Michelle and Thelma took notes on nearly every meeting involving the
estate planning after Gary’s death. Michelle turned these notes over to the
IRS. The Court noted that this was a strong indicator of her honesty. The
new attorney advised Thelma to set up three limited partnerships to which
she contributed substantially all her assets, including the assets that were
supposedly in the bypass and QTIP trusts. The new attorney then advised
Thelma to sell her interests in the three limited partnerships to her children
in exchange for a private annuity. Because Thelma did not want David to
have any signature authority with respect to the family’s assets, both to
protect him and the assets, the actual sale was to Michael and Michelle
only. However, Thelma made it clear to Michael and Michelle that when
she died, the assets remaining in the FLPs should be divided equally
among all three of her children.
There were a number of problems with the documentation and
implementation of the estate plan that the new attorney had recommended,
including the use of incorrect values for the assets transferred by Thelma
to the partnerships. In a number of places, Judge Holmes, who decided
the case, referred to the attorney’s work product as sloppy and poorly
drafted. Thelma died on February 19, 2001. The assets reported on
Thelma’s estate tax return amounted to $846,666. The IRS issued two
23
notices of deficiency in November 2004, one for the estate tax return for
$9,805,082 and plus $1,956,066 in penalties; and one for the 2000 gift tax
return for $8,314,283, plus $1,662857 in penalties. The notice of
deficiency prompted by the gift tax return characterized the $14,981,722
Thelma transferred under the guise of the private annuity as gifts to
Michael and Michelle because the annuity’s real fair market value was $O.
b.
Court’s Opinion
The Court first dealt with the private annuity and then the FLPs. The first
issue with regard to the private annuity was whether the transfer of
Thelma’s FLP interests in exchange for the private annuity was a bona
fide exchange for adequate and full consideration. The attorney used the
values reported on Gary’s estate tax return for valuing the FLP interests
Thelma transferred in exchange for the private annuity, which were lower
than the values at the time of the transfers. In addition, the attorney
determined the discounts for lack of control and lack of marketability on
his own. Consequently, because the value of the annuity was less than the
value of the FLP interests transferred in exchange, the exchange did not
satisfy the bona fide exchange exception.
The next issue with regard to the private annuity was whether Thelma
retained a prohibited interest in the property she transferred to her children
through the private annuity. Thelma’s annuity payments came from the
FLPs and she directed Michael and Michelle as to how the assets were to
be divided upon her death. Based on these facts, the Court found that
Thelma retained an impermissible interest in the assets she had tried to
transfer to her children through the private annuity.
The Court then turned to the FLPs. The first issue was whether the
creation of the FLPs was bona fide sale for adequate and full
consideration. Although the estate offered ten reasons for forming the
partnerships, the estate mainly relied on two of them: asset protection and
asset management. The Court found that placing the assets in the
partnerships provided no greater protection than they had while held by
the bypass and QTIP trusts and in Thelma’s own name. The Court also
did not find any advantage in consolidated management gained from the
transfer, particularly because the partner’s relationship to the assets did not
change after the formation.
In addition the Court pointed to a number of factors that indicated the
transfers to the partnerships were not motivated by a legitimate and
significant nontax reason. These included Thelma’s financial dependence
on distributions from the partnerships, the commingling of personal and
partnership funds, the delay or failure to transfer property to the
partnerships, the taxpayer’s old age or poor health, the lack of any
business enterprise or meaningful economic activity, and the lack of
24
adherence to partnership formalities. The Court concluded that the
purpose in forming the FLPs was nothing more than obtaining a discount,
and therefore, the transfers were not bona fide.
The next issue was whether Thelma retained the possession or enjoyment
of, or the right to the income from the property she transferred to the
FLPs. Because Thelma used the FLP assets to pay her personal expenses,
transferred nearly all of her assets to the FLPs, and her relationship to the
assets remained the same before and after the transfer, Thelma retained an
interest in the transferred assets. The Court then considered Thelma’s
transfer of the FLP interests in exchange for the private annuity, which
theoretically would have meant that she retained no FLP interests at her
death. Because the transfers occurred within three years of Thelma’s
death, the transferred FLP interests would have been included in her estate
under I.R.C. § 2035(a), even if the private annuity had been valid.
Unfortunately, the Court determined that, because the assets that were to
be held in the bypass trust were withdrawn by Thelma, those assets were
included in her estate, thereby causing a worse result than if no planning
had been done after Gary’s death. Finally, the Court determined that the
negligence penalty did not apply to Michael as the executor of Thelma’s
estate. The Court found that Michael’s reliance on the professionals he
chose, however unsuitable they turned out to be, was nevertheless under
the circumstances done reasonably and in good faith, and therefore it did
not impose a penalty for negligence or disregard of the Code.
c.
Analysis of the Court’s Opinion
Because of the many poor facts for the taxpayer in this case, it is
surprising that the Court spent so much time in rejecting the taxpayer’s
various contentions. However, the Court did provide a detailed analysis of
the tests that determine whether I.R.C. § 2036(a) applies to either a
transfer in exchange for a private annuity or a transfer to an FLP.
8.
Estate of Jorgensen v. Commissioner, T.C. Memo 2009-66
a.
Facts of the Case
The decedent died on April 25, 2002. She owned limited partnership
interests in two limited partnerships, one created while her husband was
alive and the other created after his death. Both partnerships held only
marketable securities, money market funds, and cash. At her death, her
two children were the general partners of both partnerships as well her
attorneys-in-fact. The decedent made gifts of limited partnership interests
to her children and grandchildren. The IRS determined a $796,954
deficiency against the estate. The issues were (1) whether the values of
the assets the decedent transferred to the two limited partnerships were
25
included in the value of her gross estate under I.R.C. § 2036(a); and (2)
whether the estate was entitled to equitable recoupment.
b.
Court’s Opinion
Because the Court decided the case based on the preponderance of the
evidence, it did not determine whether the burden of proof had shifted to
the government. The Court also determined that any voluntary inter vivos
act of transferring property is a transfer for purposes of I.R.C. § 2036(a).
In determining whether the transaction qualified as a bona fide sale, the
Court considered whether there were legitimate and significant nontax
reasons for transferring her property to the partnerships. Based on the
facts in the case, the Court rejected each of the estate’s reasons, which
included the following:
(1)
Management succession, because there was no active management
of investments;
(2)
Financial education of family members and promotion of family
unity, because there was no indication that there was any involvement of
the children and grandchildren in the management of the partnership or the
investment decisions and because the children had different spending
habits, there was likely to be more family disunity than unity;
(3)
Perpetuation of the family’s investment philosophy and motivating
participation in the partnerships, because there was no meaningful
participation by the limited partners in the partnerships;
(4)
Pooling of assets, because there was little evidence to support there
were any economies of scale achieved by the partnerships;
(5)
Spendthrift concerns, because there was no showing that the
partnerships provided any protection from creditors; and
(6)
Providing for children and grandchildren equally, because this
objective could have been accomplished by giving the assets contributed
to the partnerships to the children and grandchildren directly.
The Court also noted factors that indicated the transfers were not bona
fide, which included tax savings as the primary reason for forming and
funding the partnerships, the disregard of partnership formalities, and the
fact that either the decedent’s husband or the decedent stood on both sides
of the transactions. The IRS conceded that the transfers were made for
full and adequate consideration.
The Court then considered whether the decedent retained the possession or
enjoyment of the transferred property. Because of the actual use of a
26
substantial amount of partnership assets to pay the decedent’s predeath
and postdeath obligations, including making gifts of cash to her children
and grandchildren, the Court concluded that there was an implied
agreement at the time of the transfer of the decedent’s assets to the
partnerships that she would retain the economic benefits of the property
even if the retained rights were not legally enforceable. In the alternative,
the Court also found that, because the decedent’s children as cotrustees of
the decedent’s trust were under a fiduciary obligation to administer the
trust assets, including the partnership interests, solely for the decedent’s
benefit, and as general partners of the partnerships they had the express
authority to administer the partnership assets at their discretion, the
decedent retained the use, benefit, and enjoyment of the assets she
transferred to the partnerships. Although the estate did not press the issue,
the Court would not have found that the decedent terminated a portion of
her interest in the partnerships when she gifted partnership interests to her
children and grandchildren.
The final issue involved whether the estate tax deficiency could be offset
by the income tax paid by the children and grandchildren on sales of stock
by the partnerships after the decedent’s death. The children and
grandchildren used as the basis for the stock the fair market value of the
stock as reported on the decedent’s estate tax return. The basis would
have been higher had the estate reported the value as determined by the
IRS and subsequently by the Court. Although the children and
grandchildren filed protective refund claims, the claim for at least one of
the years was barred by the statute of limitations.
The doctrine of equitable recoupment allows a litigant to void the bar of
an expired statutory limitation period if the following elements are shown:
(1) the overpayment or deficiency for which recoupment is sought by way
of offset is barred by an expired period of limitation; (2) the time-barred
overpayment or deficiency arose out of the same transaction, item, or
taxable event as the overpayment or deficiency before the Court; (3) the
transaction, item, or taxable event has been inconsistently subjected to two
taxes; and (4) if the transaction, item, or taxable event involves two or
more taxpayers, there is sufficient identity of interest between the
taxpayers subject to the two taxes that the taxpayers should be treated as
one. The Court found that all four elements were met in this case.
c.
Analysis of the Court’s Opinion
This case confirms the analysis of other FLP cases in favor of the
government where the facts were similar; lack of conformity to
formalities, little support for any legitimate and significant nontax reason
for forming and transferring assets to the entity, and numerous factors
indicating that the primary purpose in creating the entity was to obtain
valuation discounts.
27
While some may argue that the taxpayer will never win when the only
assets in the limited partnership are marketable securities, if the family can
truly establish that there were one or more legitimate and significant
nontax reasons for forming and funding the limited partnership, and the
proper formalities are observed, under current law the transferred interests
should still be valued taking into account appropriate discounts for lack of
control and lack of marketability under the willing buyer/willing seller
standard. Had the family in this case substantiated the nontax reasons that
the Court considered and rejected, and had they abided by the formalities,
including making only pro rata distributions from the partnerships, the
result may have been different. In addition, the advisors in this case
emphasized in letters to the family the discounts that would be obtained if
they formed and funded the partnerships. While saving taxes is not a bad
motive for forming and funding a family limited partnership, it should not
be the only or even the primary reason.
APPENDIX: FLPs AFTER MIROWSKI
A.
The Benefits of Using FLPs and FLLCs
1.
Transfer Tax Benefits.
a.
b.
2.
Discounts.
(1)
Lack of Control.
(2)
Lack of marketability.
(3)
Others: portfolio mix, capital gain liability.
Example.
(1)
Client holds $1,000,000 of IBM stock, wishes to
give child $100,000 of the stock. If he gives the
stock to child or in trust for benefit of child, the
value of gift is $100,000.
(2)
If client transfers stock to an LLC and gives child a
10% interest, the value of the gift may be less than
$100,000 because of discounts.
Nontax benefits.
a.
Limited liability for owners – not a real concern if all the
assets are passive investments.
b.
Provides for the orderly management of the family’s
business and non-business assets.
28
B.
C.
c.
Assets in the entity protected from owner’s creditors.
d.
Greater diversification.
e.
Lower investment and management costs.
f.
Easier to transfer interests – simple deed of gift.
g.
Having a larger amount to invest may mean better
investment opportunities are available.
h.
Protect assets from spouses – either at divorce or at death.
i.
Educate younger family members concerning investments.
j.
Avoid ancillary
inheritance taxes.
k.
Could incorporate succession planning – one child named
as successor manager.
l.
Avoid or discourage disputes by requiring mediation or
arbitration and payment of legal fees by losing party.
m.
Positioning shares of stock in a company for a public or
private offering by having all of the shares held in one
entity.
n.
Maintain the
philosophy.
administration
older
family
and
possibly
members’
state
investment
IRS Response
1.
Initially, IRS’ position was that lack of control discounts were not
appropriate in a family controlled entity – see Rev. Rul. 81-253,
1981-2 C.B. 187.
2.
IRS’ position was rejected by the Courts. See, e.g., Propstra v.
United States, 680 F.2d 1248 (9th Cir. 1982); Estate of Bright v.
United States, 658 F.2d 999 (5th Cir. 1981); Estate of Andrews v.
Commissioner, 79 T.C. 938 (1982).
3.
In 1993, the IRS reversed its position; family control did not affect
lack of control discounts. Rev. Rul. 93-12, 1993-1 C.B. 202.
IRS Challenges to the Use of Entities to Depress Value
1.
Sham transaction.
29
D.
E.
2.
Step transaction.
3.
I.R.C. § 2703 – to disregard the entity.
4.
I.R.C. § 2703 – to disregard restrictions on transferability and
liquidation.
5.
I.R.C. § 2704(b) – to disregard applicable restrictions.
6.
Gift on formation.
7.
Challenge the amount of discount.
Courts Reject IRS Challenges
1.
Validly formed entity cannot be disregarded.
2.
I.R.C. § 2703 applies to restrictions on interests in an entity
imposed by agreements, not intended to disregard the entity itself.
3.
Restrictions that were commercially reasonable were not
disregarded under I.R.C. § 2703.
4.
Restrictions on the right to withdraw and receive some value for
the interest of the withdrawn owner were not applicable
restrictions under I.R.C. § 2704(b).
a.
Only a restriction on the right to cause a liquidation of the
entity itself was treated as an applicable restriction by the
Tax Court.
b.
If the restriction could not be removed without the consent
of an unrelated party, it was not an applicable restriction.
5.
There was no gift on formation if the capital accounts of the
contributors reflected the fair market value of the property
contributed.
6.
Courts sustained taxpayer’s discounts if experts were credible and
appraisals based on the facts in the case and rejected IRS’ experts
if not credible.
IRS Finds New Arrows in its Quiver
1.
I.R.C. § 2036(a) reads as follows:
The value of the gross estate shall include the value of all property
to the extent of any interest therein of which the decedent has at
any time made a transfer (except in the case of a bona fide sale for
30
an adequate and full consideration in money or money’s worth) by
trust or otherwise, under which he has retained for his life or for
any period not ascertainable without reference to his death or for
any period which does not in fact end before his death –
(1)
the possession or enjoyment of, or the right to the income
from, the property, or
(2)
the right, either alone or in conjunction with any person, to
designate the persons who shall possess or enjoy the
property or the income therefrom.
2.
Under Treas. Reg. § 20.2036-1(a), an interest or right is treated as
having been retained or reserved if at the time of the transfer there
was an understanding, express, or implied, that the interest or right
would be conferred [on the decedent].
3.
In contrast, in U. S. v. Byrum, 408 U.S. 125 (1972), the Supreme
Court held that, in order to fall under I.R.C. § 2036(a)(2), a right
had to be legally enforceable and ascertainable.
4.
Eighteen cases have held that the decedent, in connection with
transfers of property to an FLP, had retained the right to the
income from the transferred assets under an implied agreement,
based on the facts in the cases. Estate of Schauerhamer v.
Commissioner, T.C. Memo 1997-242; Estate of Reichardt v.
Commissioner, 114 T.C. 144 (2000); Estate of Harper v.
Commissioner, T.C. Memo 2002-121; Estate of Thompson v.
Commissioner, T.C. Memo 2002-246, aff’d, Turner v.
Commissioner, 3d Cir., No. 03-3173, September 1, 2004; Kimbell
v. United States, 2003-1 USTC ¶ 60,455 (N.D. Tex. 2002); Estate
of Strangi v. Commissioner, No. 03-60992 (5th Cir. July 15, 2005),
aff’g T.C. Memo 2003-145 (Strangi, II); Estate of Ida Abraham v.
Commissioner, 95 AFTR 2d 2005-2591 (lst Cir. May 25, 2005),
aff’g T.C. Memo 2004-39 (February 18, 2004); Estate of Lea K.
Hillgren, T.C. Memo, 2004-46; Estate of Bongard v.
Commissioner, 124 T.C. No. 8 (March 15, 2005); Estate of
Bigelow v. Commissioner, T.C. Memo 2005-65 (March 30, 2005),
aff’d, 100 AFTR 2d 2007-6016 (9th Cir. September 14, 2007);
Estate of Edna Korby v. Commissioner, T.C. Memo. 2005-102
(May 10, 2005); Estate of Austin Korby v. Commissioner, T.C.
Memo 2005-103 (May 10, 2005); Estate of Rosen v.
Commissioner, T.C. Memo 2006-115; Estate of Erickson v.
Commissioner, T.C. Memo, 2007-107; Estate of Sylvia Gore, et al.
v. Commissioner, T.C. Memo 2007-169; Estate of Rector, T.C.
Memo 2007-367; Estate of Hurford v. Commissioner, T.C. Memo
31
2008-278; and Estate of Jorgensen v. Commissioner, T.C. Memo
2009-66..
a.
5.
6.
However, the District Court’s decision in Kimbell was
reversed by the Fifth Circuit, which held that the transfer of
assets to the limited partnership was a bona fide sale for
adequate and full consideration in money or money’s
worth. Kimbell v. United States, 2003-1 USTC ¶ 60,455
(N.D. Tex. 2002).
Two of these cases also held that the decedent had retained the
right to designate the persons who would possess or enjoy the
transferred property or income from the transferred property.
Kimbell v. United States, 2003-1 USTC ¶ 60,455 (N.D. Tex. 2002)
and Estate of Strangi v. Commissioner, T.C. Memo 2003-145
(Strangi, II).
a.
The Fifth Circuit, in reversing the District Court’s decision
in Kimbell, held that the decedent did not retain control
over the limited liability company (“LLC”) that was the
general partner of the limited partnership because she did
not control the LLC; she only owned 50% of the
membership interest.
b.
The Fifth Circuit apparently ignored the following
language in I.R.C. § 2036(a)(2): “alone or in conjunction
with any person.”
c.
The Fifth Circuit, in affirming Strangi II, did not deal with
the I.R.C. § 2036(a)(2) issue because it found that I.R.C.
§ 2036(a)(1) applied.
Five cases, Estate of Schutt v. Commissioner, T.C. Memo. 2005126 (May 26, 2005); Estate of Bongard v. Commissioner, 124 T.C.
No. 8 (March 15, 2005); Kimbell v. United States, 371 F.3d 257
(5th Cir. 2004); Estate of Stone v. Commissioner, T.C. Memo 2003309, Estate of Mirowski, T.C. Memo 2008-74, have held that
I.R.C. § 2036(a) did not apply because of the bona fide sale
exception.
a.
Seventeen of the eighteen cases involving 2036(a) have
held that the exception did not apply, based on a two-prong
analysis:
(1)
the transfer had to be a bona fide sale, which meant
an arm’s-length transaction; and
32
(2)
7.
b.
In Stone, the Court found that there was a bona fide sale
because the contributors’ capital accounts reflected the fair
market value of the contributed assets, distributions were
based on the relative capital accounts of the partners, and
the donee/children actively managed the partnership
property after the formation.
c.
The Fifth Circuit reversed the Tax Court’s decision in
Kimbell v. U.S., 93 AFTR 2004-2400 (5th Cir. 2004),
holding that the bona fide sale exception applied because
the decedent received a pro rata partnership interest and the
transaction was not a sham or disguised gift.
d.
The Tax Court in Bongard and Schutt also found that the
bona fide sale exception applied because in Bongard there
were business reasons for forming the LLC and in Schutt
there was a legitimate and substantial nontax reason for
forming two business trusts treated as partnerships for tax
purposes.
e.
In Mirowski, Judge Chiechi concluded that, because Ms.
Mirowski received an interest in MFV proportionately
equal to the fair market value of her contribution (which in
this case was 100%) and there were three legitimate and
significant nontax reasons for forming and funding MFV,
the bona fide sale exception applied.
Strangi II confirmed the holdings in earlier cases concerning when
the bona fide sale exception applies and when there is an implied
agreement to retain the enjoyment of the income from the
transferred assets.
a.
F.
the transfer had to be for an adequate and full
consideration in money or money’s worth.
Unfortunately but not surprisingly, the Fifth Circuit did not
shed any additional light on when the decedent will be
treated as retaining the right to designate the persons who
will enjoy the income from the transferred property because
the Court found that there was an implied agreement to
retain the enjoyment of the income and therefore it did not
have to decide whether there was also a retained right to
designate the persons who would enjoy the income.
Where Do We Stand Today
1.
In light of Strangi II, Schutt, Bongard, Turner/Thompson, Kimbell,
and Mirowski, FLPs and FLLCs that are properly structured and
33
operated should continue to provide an efficient means of
transferring wealth to younger generations; however, it is
important to have either a business purpose or a legitimate and
substantial nontax purpose for creating the entity if the bona fide
sale exception is needed because either I.R.C. § 2036(a)(1) or
§ 2036(a)(2), or both, apply.
2.
a.
Note that in Estate of Kelly v. Commissioner, T.C. Memo
2005-235, the Tax Court applied a 32.24% combined
discount for lack of control and lack of marketability to a
94.83% interest in a family limited partnership and a onethird interest in the LLC general partner. The decedent
transferred $1,101,475 of cash and certificates of deposit to
the limited partnership between June 6 and September 13,
1999, and died on December 8, 1999. He was apparently in
good health at the time of the transfers and had railroad
retirement income to support him. The IRS dropped its
§ 2036(a) argument before trial. The IRS had argued for a
25.2% combined discount and the estate had argued for a
53.5% combined discount.
b.
See also the discussion of the Mirowski case, in which the
decedent transferred patent rights and marketable securities
worth well over $60 million to an LLC days before she
died, and yet the IRS was unsuccessful in applying either
I.R.C. § 2036(a)(1) or § 2036(a)(2).
The implied agreement argument under I.R.C. § 2036(a)(1) can be
avoided by:
a.
refraining from making non-pro rata distributions to the
owners, especially the transferor;
b.
refraining from commingling the entity’s funds with
personal funds;
c.
keeping accurate books reflecting the operative agreement
and the entity’s operations, beginning as soon as possible
after the entity is formed;
d.
encouraging the general partners or managing members to
actively manage the assets in the entity;
e.
complying with all of the formalities imposed by state law;
34
3.
f.
complying with the operative agreement in every respect or
amending the agreement to reflect changes in
circumstances;
g.
ensuring that assets transferred to the entity are retitled to
reflect the new owner;
h.
not transferring assets that the transferor will continue to
use personally, such as his or her residence; and
i.
not transferring so much of the older family member’s
assets that he or she cannot continue to live in his or her
accustomed manner without distributions from the entity in
excess of distributions that would be considered normal for
the type of assets held by the entity.
The transferor should not be treated as possessing a legally
enforceable and ascertainable right under I.R.C. § 2036(a)(2) if the
following facts exist:
a.
The transferor never had the right, either alone or in
conjunction with any other person, to designate the persons
who will receive the income from the transferred property;
or
b.
Other owners have more than a de minimis interest in the
entity and the fiduciary duty of the transferor as the general
partner or managing member has not been waived.
(1)
Note that the Fifth Circuit in Strangi II did not
object to the Tax Court’s finding that, because pro
rata distributions to the corporate general partner
(1% of the total) were de minimis, they did not
prevent Strangi from benefiting from the transferred
property.
(2)
In addition, the Fifth Circuit rejected the taxpayer’s
argument that a de minimis contribution should not
be ignored when considering whether there was a
substantial nontax purpose for creating the entity.
(a)
The taxpayer cited the Fifth Circuit’s
opinion in Kimbell for the proposition that
there was no requirement that a partner own
a minimum percentage for transfers to the
partnership to be bona fide.
35
(b)
4.
G.
However, according to the Fifth Circuit, the
existence of minimal minority contributions
when there is a lack of any actual
investments could lead the trier of fact to
find that a joint investment objective was
unlikely.
Based on Schutt, Bongard, Kimbell, Stone, and Mirowski, the bona
fide sale exception may apply if:
a.
Capital accounts reflect the fair market value of the
contributed property;
b.
Other owners have more than a de minimis interest;
c.
There is active management of the assets after the creation
and funding of the entity (but see Schutt, where the
decedent followed a buy and hold investment philosophy);
and
d.
There are legitimate and significant nontax reasons for the
creation and funding of the entity.
Proposed Legislation
1.
OPTIONS TO IMPROVE TAX COMPLIANCE AND REFORM
TAX EXPENDITURES, prepared by the Staff of the joint
Committee on Taxation, published January 27, 2005, in response
to a request by Senators Grassley and Baucus, the then Chairman
and the ranking Member of the Senate Finance Committee
(hereinafter the Report) (the Report can be accessed at
http://www.house.gov/jct/s-2-05.pdf), sets forth the following set
of rules for valuing property for federal transfer tax purposes that
would limit the availability of minority and lack of marketability
discounts and would apply to shares of stock of a corporation,
interests in a partnership or limited liability company, and other
similar interests in a business or investment entity or in an asset.
a.
The proposal has two parts, aggregation rules and a lookthrough rule.
b.
Step transaction principles are used to determine whether
two or more transfers are treated as a single transfer and an
interest owned by the spouse of a transferor or transferee is
considered as owned by the transferor or transferee.
c.
The rules generally apply to all gifts made during life
without consideration, transfers at death, generation36
skipping events, and any transfer of an asset by gift for an
amount of consideration less than the value determined
under those rules.
(1)
d.
e.
Under the basic aggregation rule, the value of an asset
transferred by a transferor (a donor or decedent) generally
is a pro rata share of the fair market value of the entire
interest in the asset owned by the transferor just before the
transfer.
(1)
For example, if mother, who owns 80% of the
interests in a limited liability company, transfers a
20% interest to a child, the value of the 20% interest
would be 25% of the value of the mother’s 80%
interest, with no minority discount.
(2)
If mother only owned a 40% interest, the 20%
interest transferred to the child would reflect the
minority discount applicable to mother’s 40%
interest.
Under the transferee aggregation rule, if a donor or a
decedent’s estate does not own a controlling interest in an
asset just before the transfer of all or a portion of the asset
to a donee or heir, but, in the hands of the donee or heir, the
asset is part of a controlling interest, the value of the asset
is a pro rata share of the fair market value of the entire
interest in the asset owned by the donee or heir after taking
into account the gift or bequest.
(1)
f.
The rules are not intended to change the principles
of present law concerning whether transfers made
in the ordinary course of business are, or are not,
treated as gifts.
In the second example above, if the child already
owned a 40% interest before mother’s gift of the
20% interest, the value of the gifted interest would
be one-third of a 60% interest, resulting in no
minority discount.
Under the look-through rule, after the application of the
aggregation rules, if a transferred interest in an entity is part
of controlling interest owned before the transfer by the
transferor, or after the transfer by the transferee, then, if at
least one-third of the value of the entity’s assets consists of
marketable assets, the value of the marketable assets is
37
determined without taking into account any marketability
discount.
(1)
2.
Marketable assets include cash, bank accounts,
certificates of deposit, money market accounts,
commercial paper, U.S. and foreign treasury
obligations and bonds, precious metals or
commodities, and publicly traded instruments, but
do not include assets that are part of an active
lending or financing business.
The following is part of H.R. 436, introduced by
Democratic Representative Earl Pomeroy on January 9,
2009.
Sec. 4. VALUATION RULES FOR CERTAIN TRANSFERS OF
NONBUSINESS ASSETS; LIMITATION ON MINORITY
DISCOUNTS.
(a) In General. Section 2031 of the Internal Revenue Code of 1986 (relating to
definition of gross estate) is amended by redesignating subsection (d) as
subsection (f) and by inserting after subsection (c) the following new
subsections:
“(d) Valuation Rules for Certain Transfers of Nonbusiness Assets- For
purposes of this chapter and chapter 12—
“(1) IN GENERAL- In the case of the transfer of any interest in an entity
other than an interest which is actively traded (within the meaning of section
1092)—
“(A) the value of any nonbusiness assets held by the entity shall be
determined as if the transferor had transferred such assets directly to the
transferee (and no valuation discount shall be allowed with respect to such
nonbusiness assets), and
“(B) the nonbusiness assets shall not be taken into account in determining the
value of the interest in the entity.
“(2) NONBUSINESS ASSETS- For purposes of this subsection—
“(A) IN GENERAL- The term ”nonbusiness asset“ means any asset which is
not used in the active conduct of 1 or more trades or businesses.
“(B) EXCEPTION FOR CERTAIN PASSIVE ASSETS- Except as provided
in subparagraph (C), a passive asset shall not be treated for purposes of
subparagraph (A) as used in the active conduct of a trade or business unless—
“(i) the asset is property described in paragraph (1) or (4) of section 1221(a) or
is a hedge with respect to such property, or
38
“(ii) the asset is real property used in the active conduct of 1 or more real
property trades or businesses (within the meaning of section 469(c)(7)(C)) in
which the transferor materially participates and with respect to which the
transferor meets the requirements of section 469(c)(7)(B)(ii).
For purposes of clause (ii), material participation shall be determined under
the rules of section 469(h), except that section 469(h)(3) shall be applied
without regard to the limitation to farming activity.
“(C) EXCEPTION FOR WORKING CAPITAL- Any asset (including a
passive asset) which is held as a part of the reasonably required working
capital needs of a trade or business shall be treated as used in the active
conduct of a trade or business.
“(3) PASSIVE ASSET- For purposes of this subsection, the term ”passive
asset“ means any—
“(A) cash or cash equivalents,
“(B) except to the extent provided by the Secretary, stock in a corporation or
any other equity, profits, or capital interest in any entity,
“(C) evidence of indebtedness, option, forward or futures contract, notional
principal contract, or derivative,
“(D) asset described in clause (iii), (iv), or (v) of section 351(e)(1)(B),
“(E) annuity,
“(F) real property used in 1 or more real property trades or businesses (as
defined in section 469(c)(7)(C)),
“(G) asset (other than a patent, trademark, or copyright) which produces
royalty income,
“(H) commodity,
“(I) collectible (within the meaning of section 401(m)), or
“(J) any other asset specified in regulations prescribed by the Secretary.
“(4) LOOK-THRU RULES—
“(A) IN GENERAL- If a nonbusiness asset of an entity consists of a 10percent interest in any other entity, this subsection shall be applied by
disregarding the 10-percent interest and by treating the entity as holding
directly its ratable share of the assets of the other entity. This subparagraph
shall be applied successively to any 10-percent interest of such other entity in
any other entity.
“(B) 10-percent INTEREST- The term ”10-percent interest“ means—
“(i) in the case of an interest in a corporation, ownership of at least 10 percent
(by vote or value) of the stock in such corporation,
“(ii) in the case of an interest in a partnership, ownership of at least 10 percent
of the capital or profits interest in the partnership, and
39
“(iii) in any other case, ownership of at least 10 percent of the beneficial
interests in the entity.
“(5) COORDINATION WITH SUBSECTION (b)- Subsection (b) shall apply
after the application of this subsection.
“(e) Limitation on Minority Discounts- For purposes of this chapter and
chapter 12, in the case of the transfer of any interest in an entity other than an
interest which is actively traded (within the meaning of section 1092), no
discount shall be allowed by reason of the fact that the transferee does not
have control of such entity if the transferee and members of the family (as
defined in section 2032A(e)(2)) of the transferee have control of such entity.”.
(b) Effective Date. The amendments made by this section shall apply to
transfers after the date of the enactment of this Act.
3.
The following is an excerpt from the Green Book describing
the Obama Administration’s Tax Proposals, issued by the
Treasury Department on May 11, 2009.
MODIFY RULES ON VALUATION DISCOUNTS
Current Law
The fair market value of property transferred, whether on the death or during the life of
the transferor, generally is subject to estate or gift tax at the time of the transfer. Sections
2701 through 2704 of the Internal Revenue Code were enacted to prevent the reduction of
taxes through the use of “estate freezes” and other techniques designed to reduce the
value of the transferor’s taxable estate and discount the value of the taxable transfer to the
beneficiaries of the transferor when the economic benefit to the beneficiaries is not
reduced by these techniques. Generally, section 2704(b) provides that certain “applicable
restrictions” (that would normally justify discounts in the value of the interests
transferred) are to be ignored in valuing interests in family-controlled entities if those
interests are transferred (either by gift or on death) to or for the benefit of other family
members. The application of these special rules results in an increase in the transfer tax
value of those interests above the price that a hypothetical willing buyer would pay a
willing seller, because section 2704(b) generally directs an appraiser to ignore the rights
and restrictions that would otherwise support significant discounts for lack of
marketability and control.
Reasons for Change
Judicial decisions and the enactment of new statutes in most states have, in effect, made
section 2704(b) inapplicable in many situations, specifically, by recharacterizing
restrictions such that they no longer fall within the definition of an “applicable
40
restriction”. In addition, the Internal Revenue Service has identified additional
arrangements designed to circumvent the application of section 2704.
Proposal
This proposal would create an additional category of restrictions (“disregarded
restrictions”) that would be ignored in valuing an interest in a family-controlled entity
transferred to a member of the family if, after the transfer, the restriction will lapse or
may be removed by the transferor and/or the transfer’s family. Specifically, the
transferred interest would be valued by substituting for the disregarded restrictions
certain assumptions to be specified in regulations. Disregarded restrictions would include
limitations on a holder’s right to liquidate that holder’s interest that are more restrictive
than a standard identified in regulations. A disregarded restriction also would include any
limitation on a transferee’s ability to be admitted as a full partner or holder of an equity
interest in the entity. For purposes of determining whether a restriction may be removed
by member(s) of the family after the transfer, certain interests (to be identified in
regulations) held by charities or others who are not family members of the transferor
would be deemed to be held by the family. Regulatory authority would be granted,
including the ability to create safe harbors to permit taxpayers to draft the governing
documents of a family-controlled entity so as to avoid the application of section 2704 if
certain standards are met. This proposal would make conforming clarifications with
regard to the interaction of this proposal with the transfer tax marital and charitable
deductions.
This proposal would apply to transfers after the date of enactment of property subject to
restrictions created after October 8, 1990 (the effective date of section 2704).
401007537.1
41
AMERICAN BAR ASSOCIATION
SECTION OF REAL PROPERTY,
TRUST & ESTATE LAW
20TH ANNUAL REAL PROPERTY &
ESTATE PLANNING SYMPOSIA
(WASHINGTON, D.C.,
APRIL 30 - MAY 1, 2009)
Program: Last Beneficiary Standing:
Identifying the Proper Parties in
Breach of Fiduciary Cases
(Thursday, April 30, 2009,
2:00 p.m. - 3:30 p.m.)
Program Chair/Moderator
Speakers/Authors
Robert N. Sacks
SACKS, GLAZIER, FRANKLIN &
LODISE LLP
350 South Grand Avenue
Suite 3500
Los Angeles, California 90071-3475
Phone:
(213) 617-7360
Fax:
(213) 617-9350
E-mail:
[email protected]
Daniel B. Herbert
MANNING & MARDER, KASS, ELLROD,
RAMIREZ LLP
801 South Figueroa Street, 15th Floor
Los Angeles, California 90017
Phone:
(213) 430-2673
Fax:
(213) 624-6999
E-mail: [email protected]
Anthony R. La Ratta
ARCHER & GREINER
One Centennial Square
P.O. Box 3000
Haddonfield, New Jersey 08033-0968
Phone:
(856) 354-3094
Fax:
(856) 673-7094
E-mail: [email protected]
Kevin J. Parker
SNELL & WILMER L.L.P.
One Arizona Center
Phoenix, Arizona 85004-2202
Phone:
(602) 382-6238
Fax:
(602) 382-6070
E-mail: [email protected]
STANDING
Daniel B. Herbert
MANNING & MARDER,
KASS, ELLROD, RAMIREZ LLP
801 South Figueroa Street, 15th Floor
Los Angeles, California 90017
Phone: (213) 430-2673
Fax: (213) 624-6999
E-mail: [email protected]
2
WHO GENERALLY HAS STANDING TO SUE A TRUSTEE
FOR BREACHES OF FIDUCIARY DUTY?
Successor-Trustees
If the trustee commits a breach of trust and is thereafter removed as trustee or
otherwise ceases to be trustee and a successor trustee is appointed, the successor trustee
can maintain a suit against the predecessor trustee to redress the breach of trust.
Restatement 2d of Trusts § 200, comment f. (1959). The successor trustee may,
moreover, also have a responsibility to take reasonable steps to uncover and redress any
breach of duty committed by a predecessor fiduciary, in certain circumstances discussed
below. Restatement 3d of Trusts § 76, comment d. (2003). See also, Cal. Probate Code
§ 16403(b).
Co-Trustees
If a trust has more than one trustee, any one of them may sue the others to enforce
their fiduciary duties. Restatement 2d of Trusts § 200, comment e, and § 224 (1959); see
also Unif. Trust Code § 1001, comment (2006). See Cal. Probate Code § 16420(a),
providing that if a trustee commits or threatens to commit a breach of trust, a co-trustee
may commence a proceeding against the offending trustee. When suing a predecessor
trustee, however, successor co-trustees usually must act by unanimous action, unless the
trust provides otherwise. Cal. Probate Code § 15620.
Beneficiaries
Normally any beneficiary whose rights are threatened has standing to sue a
current trustee. Restatement 2d of Trusts §§ 197, 198, 199, 200 (1959); Unif. Trust Code
§ 1001, comment (2006); Cal. Probate Code § 17200(a), (b)(12). The definition of
beneficiary, in this context, is surprisingly broad, and includes anyone with a vested or
contingent right to present or future distributions, including a reversionary interest.
Restatement 3d of Trusts § 82 (2007); Cal. Probate Code § 24; Edward C. Halbach, Jr.,
Standing to Enforce Trusts: Renewing and Expanding Professor Gubatz’s 1984
Discussion of Settlor Enforcement, 62 U. of Miami L. R. 713, 730 (2008). “Beneficiary”
includes one who is eligible to receive distributions only at the discretion of the trustee.
“Beneficiary” also includes a beneficiary’s successor in interest, such as one who has
succeeded the beneficiary by inheritance or assignment. A settlor holding a power of
revocation and, generally, the donee of a power of appointment are also beneficiaries.
Restatement 3d of Trusts §§ 48, 49, 74 (2007); Unif. Trust Code § 103(3)(B) (2006);
Halbach, supra, at 728-730. A suit may also be brought by others on behalf of a
beneficiary in appropriate circumstances. In the case of an incapacitated beneficiary, for
example, suit may be brought by a conservator or guardian, or an agent under a durable
3
power of attorney. See, e.g., Unif. Trust Code § 1001 (2006). A personal representative
of a deceased beneficiary can also maintain such a suit. Restatement 2d of Trusts § 200,
comment g. (1959).
“A more difficult question is whether a beneficiary has standing to sue a former
trustee, at least when a successor trustee is available to do so.” Andrew Zabronsky,
California Trust and Probate Litigation § 21.46A, CEB (2007). If a trustee in breach of
trust is removed or otherwise ceases to be trustee and a successor is appointed, the
successor may maintain a suit against the predecessor. “In such a case it would seem that
the beneficiaries cannot maintain a suit . . . unless the successor has refused or is
unavailable.” 4 Scott on Trusts (4th ed. 1989) § 294.4, pp. 104-105. Until recently, no
case, in California at least, had specifically addressed whether a beneficiary may have
standing in such situations. As a practical matter, California courts at the trial level have
generally tended to deny a beneficiary’s standing to sue predecessor trustees, while the
courts of appeal have been notably silent on this issue.
Estate of Bowles 169 Cal. App. 4th 684 (2d Dist., Div. 5) (Dec. 22, 2008),
however, now offers some guidance. In Estate of Bowles, a beneficiary sued the
predecessor (deceased) trustee for breach of trust and others for participating in the
breach. The defendants demurred on the grounds that the beneficiary lacked standing.
They argued that only the successor trustee was the real party in interest with standing,
relying in part on Scott on Trusts, supra, which had been cited in prior California cases,
and their interpretation of several pertinent probate statutes. The court, while
acknowledging the general rule that only trustees, and not beneficiaries, have standing to
sue on the trust’s behalf, disagreed.
The court, reasoning that beneficiaries
unquestionably have standing to sue current trustees, and that there is nothing in the code
or cases to limit that right to current trustees, expressly disagreed with the principles
espoused in Scott on Trusts, holding that the beneficiary could indeed proceed with his
claims against the former trustee for breach of fiduciary duty. The decision in Estate of
Bowles may not be in accord with the rationale of several prior decisions on beneficiary
standing, nor with a conjunctive reading of several controlling statutes, including Cal.
Probate Code §§ 15643, 16403, 16420, and 17200. The decision is not, moreover,
binding on the courts of appeal of the several other districts, nor even the seven other
divisions of the same district. The state supreme court has denied a petition for review,
possibly to allow the issues to be further developed at the appellate court level.
4
Settlors
It may seem surprising that the settlor, as settlor, generally can not maintain a suit
against the trustee to enforce a trust or to enjoin or obtain redress for a breach of trust.
Only where the settlor retains an interest in the trust property, can the settlor maintain a
suit against the trustee to protect that interest. Thus, if the settlor is also a beneficiary of
the trust, or if he has reserved power to revoke the trust, he can maintain a suit against the
trustee to protect his interest. Restatement 2d of Trusts § 200, comment b. (1959);
Halbach, Standing to Enforce Trusts, supra, at 730-731.
5
RIGHTS AND OBLIGATIONS OF SUCCESSOR FIDUCIARIES
AND
POTENTIAL LIABILITY FOR FAILURE TO PURSUE CLAIMS
Fiduciaries are often too consumed with discharging their own many duties, to
worry very much about whether their predecessors discharged their duties. Indeed, as a
general rule, a successor fiduciary is not liable for the malfeasance of his predecessor,
and has no particular duty seek an accounting of the predecessor’s actions. See
Restatement 2d of Trusts § 223(1), providing that a successor trustee is not liable to the
beneficiary for a breach of trust committed by a predecessor trustee, emulated by the
statutes of many states, e.g., Cal. Probate Code § 16403(a) (cf. Cal. Probate Code §
4203, which similarly says a successor attorney in fact is not liable for the acts of a
predecessor), Ill. Rev. Stat. ch. 17, para. 1684, La. Rev. Stat. Ann. § 9:2204, N.Y. Surr. Ct.
Proc. Act Law § 1506, Utah Code Ann.§ 75-7-306(6). See Matter of the Wm. M. Kline
Rev. Trust, 196 Misc. 2d 66, 763 N.Y.S.2d 721 (2003), citing Pfeffer v. Lehmann, 225
App Div 220, 7 N.Y.S.2d 275 (1938) and Matter of Ketchem, 124 N.Y.S.2d 895 (1953),
for the proposition that a successor trustee “has no particular duty to seek an accounting
from his predecessors.”
At the same time, while a successor trustee is not liable merely because his
predecessor committed a breach, the successor is liable for his own breach in failing to
redress the breaches of his predecessor, in three particular situations. The Restatement
states the rule as follows:
Liability of Successor Trustee
(1) A trustee is not liable to the beneficiary for a breach of trust committed by a
predecessor trustee.
(2) A trustee is liable to the beneficiary for breach of trust, if he
(a) knows or should know of a situation constituting a breach of trust
committed by his predecessor and he improperly permits it to continue; or
(b) neglects to take proper steps to compel the predecessor to deliver the
trust property to him; or
(c) neglects to take proper steps to redress a breach of trust committed by
the predecessor.
Restatement 2d of Trusts § 223 (1959). See also, e.g., Cal. Probate Code § 16403(b), Ill.
Rev. Stat. ch. 17, para. 1684, N.Y. Surr. Ct. Proc. Act Law § 1506.
6
In other words, while a successor trustee is not personally liable for the breach of
duty by his or her predecessor, the successor may be liable for his own breach in failing
to redress the breaches committed by the predecessor. If the successor trustee is aware,
or reasonably should have been aware, of a breach of trust by the predecessor trustee, the
successor must take steps to redress the breach. Restatement 2d of Trusts § 223,
comment a. (1959).
This specific duty to enforce claims against a predecessor trustee is consistent
with the general duty to take reasonable steps to enforce claims of the trust. See,
Restatement 2d of Trusts § 177, § 223, comment d. (1959), and Cal. Probate Code §
16010. “The trustee is under a duty to the beneficiary to take reasonable steps to enforce
any claim which he holds as trustee against predecessor trustees (see § 223), or in the
case of a testamentary trust, against the executors of the estate. . . .” Restatement 2d of
Trusts § 177, comment a. (1959).
Since a trustee is under a duty to the beneficiary to take reasonable steps to
enforce claims of the trust, a successor trustee is liable for breach of trust if he neglects to
take steps to compel his predecessor to redress a breach committed by the predecessor.
He is liable for damages to the extent a loss results from his failure to take such steps.
Id., comment d. If, for example, the successor fails to move timely against a predecessor,
and as a result a claim that was collectable becomes uncollectible, the successor may be
liable for the loss suffered by the trust. Purdy v Johnson, 174 Cal. 521, 528 (1917). A
trustee is also under a duty to take reasonable steps to take control of trust property, and
for this additional reason a successor trustee may be liable for breach of trust if he
neglects to take proper steps to compel his predecessor to deliver the trust property to
him. Restatement 2d of Trusts § 177, comment c. (1959)
Thus, a successor trustee who fails to take action against a predecessor for
breaches of trust may find himself liable for damages and other remedies, not to mention
his own costs of defense. Conversely, a successor trustee who does take action but fails
to recover from the predecessor, or fails to recover enough from the predecessor, relative
to risk and expense, may find himself funding the trust’s litigation out of his own pocket.
See Restatement 2d of Trusts §§ 205, 206 (1959).
When a Successor Trustee Need Not Bring an Action
It is not the duty of the trustee to bring an action to enforce a claim that is a part of
the trust property if it is reasonable not to bring such an action, owing to the probable
expense involved in the action or to the probability that the action would be unsuccessful
or that if successful the claim would be uncollectible owing to the insolvency of the
defendant or otherwise. Restatement 2d of Trusts § 177, comment c. (1959).
If it reasonably appears to the successor trustee that a claim against a predecessor
7
is uncollectible, he is not under a duty to incur the expense of bringing a suit to collect it.
Restatement 2d of Trusts § 177, comment a. (1959).
In exercising discretion about whether a claim against a predecessor should be
enforced, the standard is whether a prudent trustee would move to enforce the claim
under the circumstances. The successor must evaluate factors such as whether there is a
likelihood of success and whether a judgment would be collectible. Zabronsky,
California Trust and Probate Litigation, supra, §§ 21.22, 21.25.
The reasonableness of the trustee’s decision about whether to pursue a claim is
determined according to information known to the trustee at the time the decision is
made, under the circumstances then prevailing. Pillsbury v. Karmgard, 22 Cal.App.4th
743, 763 (1994). Provided the trustee exercises reasonable judgment, and that reasonable
steps are taken to evaluate the claim, the successor will not be liable for failing to seek
redress of the breach. See, In re Campbell’s Estate, 382 P.2d 920, 936 (1963) (Supreme
Court of Hawaii) in which the court held that the successor trustees were not liable for the
predecessors’ improper accounting, since while it is duty of successor trustees to pursue
all proper means of redress, they are not personally liable unless they have neglected to
take proper steps in the premises.
Practical Considerations
Occasionally the breach is apparent, such as when the predecessor’s final account
reveals missing or mishandled assets, in which case there may be little doubt about
whether to pursue the predecessor. As a starting point, therefore, the successor trustee
should carefully review the predecessor’s final account, to determine whether there has
been any obvious breach. If questions remain, the successor may conduct a further
examination. Zabronsky, California Trust and Probate Litigation, supra, §§ 21.24,
21.25.
Frequently the predecessor has resigned or has been removed because of conflict
with the beneficiaries. Often, in such cases, the predecessor’s departure is related to
some allegation of misconduct. On the other hand, the conflict could simply be the result
of personal animosity, or unsubstantiated suspicions of malfeasance. Either way, the
beneficiaries, or some of the beneficiaries, may be the first to allege wrongdoing, and to
ardently press the successor to take action against the predecessor. This can create great
difficulty for the successor, who has a duty to conserve trust assets, and must be
reasonably convinced of the wisdom of litigation, including the likelihood of recovery,
before devoting significant trust resources to the burdensome expense of litigation. Id., §
21.25.
The successor trustee therefore has a very legitimate concern, in that the successor
risks liability whether he proceeds against the predecessor or not. In some states, a
8
trustee in this situation may seek direction from the court, and pre-approval of a decision
of whether to proceed. In California, for example, a trustee may petition the court for
instructions. Cal. Probate Code § 17200(b)(6). In New York, in contrast, the court is
unlikely to offer guidance concerning possible claims that might lie against predecessors.
The decision of whether to pursue a predecessor is within the discretion of the successor
fiduciary, who is specifically empowered by statute to make the decision. The process
involves the exercise of discretion and judgment of the fiduciary; in such cases, the courts
frequently decline requests to give advice and direction, where to do so would merely
substitute the court’s judgment for that of the fiduciary. Matter of the Wm. M. Kline Rev.
Trust, supra, at 729, discussing SCPA 2107 and EPTL 1-1.1[b][13], citing Turano and
Radigan, New York Estate Administration § 12.06 (2003), and acknowledging the
successor’s “legitimate concern” and that the successor’s “dilemma is evident,” but
declining to offer any guidance to the successor about whether to proceed.
9
EXCULPATORY PROVISIONS
Kevin J. Parker
SNELL & WILMER L.L.P.
One Arizona Center
Phoenix, Arizona 85004-2202
Phone: (602) 382-6238
Fax: (602) 382-6070
E-mail: [email protected]
10
EXCULPATORY PROVISIONS
Many trusts include a provision that purports to immunize the trustee from
liability to the beneficiaries absent something beyond basic breach of fiduciary duty, for
example fraud or intentional misconduct.
In the “early days,” such clauses were held unenforceable as against public policy.
The modern rule (reflected in the Restatement and uniform statutes) provides for
enforceability of such clauses, with certain limitations.
A.
Overview.
Key points:
B.
•
Generally enforceable.
•
Strictly construed.
•
Substantive limitations:
indifference.
•
Procedural limitation: insertion of the clause itself into the trust
instrument was itself a breach of duty.
•
Damages limitation: distinction between Restatement and Uniform Trust
Code with regard to applicability to trustee profits.
Under the
Restatement, even if a trustee is excused from liability for a breach of trust
under the exculpatory clause, the trustee must still disgorge profits derived
from a breach of trust. The Uniform Trust Code version would not require
the trustee to disgorge profits if the activity is protected under the
exculpatory clause, even if there is a breach of trust.
bad faith, intentional misconduct, reckless
Practice Tips.
Drafting tips:
•
From the trustee’s perspective, there is no harm in having an exculpatory
clause in the trust. Any exculpatory clause is better than none at all.
•
Anticipate beneficiary arguments: the exculpatory clause was allegedly
inserted into the trust without the trustor’s knowledge (e.g., boilerplate) or
as a result of improper influence by the trustee.
11
Administration tips:
•
Anticipate beneficiary arguments: bad faith or reckless disregard.
Trustees should have a written record to support significant discretionary
decisions.
•
Email is discoverable. The beneficiary will be looking for some off-hand
remark in the email chatter to try to establish bad faith.
•
Know what is a privileged communication. Simply copying in-house
counsel on an email does not necessarily make the communication
privileged.
Litigation tips:
C.
•
The exculpatory clause does not solve all problems: even if the
exculpatory clause protects the trustee from liability, the beneficiary will
argue that he/she is still entitled to some equitable relief, including forcing
the trustee to reimburse/forfeit trustee fees, and/or removal of the trustee.
•
For controversial and significant discretionary decisions, the trustee may
want to petition the court for advance approval.
•
When sued by a beneficiary, raise the defense as both a ground for denial
of liability and as an affirmative defense. (There is some debate whether
the defense is an affirmative defense. See, e.g., Siegemund v. Shapland,
324 F. Supp. 2d 176, 183-185 (D. Me. 2004).)
Restatement (Second) of Trusts § 222.
§ 222 Exculpatory Provisions
(1) Except as stated in Subsections (2) and (3), the
trustee, by provisions in the terms of the trust, can be
relieved of liability for breach of trust.
(2) A provision in the trust instrument is not effective to
relieve the trustee of liability for breach of trust
committed in bad faith or intentionally or with reckless
indifference to the interest of the beneficiary, or of
liability for any profit which the trustee has derived
from a breach of trust.
12
(3) To the extent to which a provision relieving the
trustee of liability for breaches of trust is inserted in the
trust instrument as the result of an abuse by the trustee
of a fiduciary or confidential relationship to the settlor,
such provision is ineffective.
Comment on Subsection (1):
a. Exculpatory provisions strictly construed. The terms of
the trust may contain provisions relieving the trustee from
liability for breaches of trust. Such provisions are strictly
construed, and the trustee is relieved of liability only to the
extent to which it is clearly provided that he shall be
excused. Thus, if by the terms of the trust it is provided
that the trustee shall not be liable “except for his wilful
default or gross negligence,” although he is not liable for
mere negligence, he is liable if he intentionally does or
omits to do an act which he knows to be a breach of trust or
if he acts or omits to act with reckless indifference as to the
interest of the beneficiary.
Comment on Subsection (2):
b. Extent to which exculpatory provisions against public
policy. Notwithstanding any provision in the terms of the
trust relieving the trustee from liability for breach of trust,
he is liable for breaches of trust committed in bad faith, and
for intentional breaches of trust, and for breaches of trust
committed with reckless indifference to the interest of the
beneficiary. No provision in the terms of the trust is
effective to relieve the trustee who derives a profit from a
breach of trust from liability to the extent of the profit.
Such provisions as these are invalid on the ground that it
would be contrary to public policy to give effect to them.
c. Distinction between exculpatory provisions and those
limiting trustee’s duties. If by the terms of the trust it is
provided that the trustee shall not be under any duty to do
or to refrain from doing an act which but for such provision
it would be the duty of the trustee to do or refrain from
doing, the trustee does not commit a breach of trust in
doing or failing to do the act, unless such provision is
ineffective as contrary to public policy. If, however, the
trustee is not relieved of such a duty either because there is
no provision to that effect in the terms of the trust or
because such provision is ineffective as against public
13
policy, a provision in the terms of the trust that the trustee
shall not be liable for breach of trust is against public
policy to the extent stated in Comment b.
As to the effect of the terms of the trust upon the standard
of care and skill required of a trustee, see § 174, Comment
d.
As to the effect of the terms of the trust upon the extent of
discretion given to trustees in the exercise of powers
conferred upon them, see § 187.
Comment on Subsection (3):
d.
Exculpatory provision improperly inserted.
In
determining whether a provision relieving the trustee from
liability is ineffective on the ground that it was inserted in
the trust instrument as a result of an abuse of a fiduciary or
confidential relationship existing between the trustee and
the settlor at the time of the creation of the trust, the
following factors may be considered: (1) whether the
trustee prior to the creation of the trust had been in a
fiduciary relationship to the settlor, as where the trustee had
been guardian of the settlor; (2) whether the trust
instrument was drawn by the trustee or by a person acting
wholly or partially on his behalf; (3) whether the settlor has
taken independent advice as to the provisions of the trust
instrument; (4) whether the settlor is a person of experience
and judgment or is a person who is unfamiliar with
business affairs or is not a person of much judgment or
understanding; (5) whether the insertion of the provision
was due to undue influence or other improper conduct on
the part of the trustee; (6) the extent and reasonableness of
the provision.
The mere fact that the trustee draws the trust instrument
and suggests the insertion of a provision relieving the
trustee of liability does not necessarily make the provision
ineffective. Thus, if a father asks his son, an attorney, to
draw a will for the father under which the son is to act as
trustee for various relatives of the father and the son inserts
a provision relieving him of liability for negligent breaches
of trust and the father who is a person of business
experience and who appreciates the nature and effect of the
provision agrees, the provision is effective.
14
D.
Restatement (Second) of Trusts § 243.
§ 243 Effect of Breach of Trust on Compensation
If the trustee commits a breach of trust, the
court may in its discretion deny him all compensation
or allow him a reduced compensation or allow him full
compensation.
***
g.
Exculpatory provisions. A trustee may be
denied compensation, wholly or partially, on account of
a breach of trust committed by him, even though he
does not incur a liability for the breach of trust because
of an exculpatory provision in the trust instrument. See
§ 222.
E.
Restatement (Third) of Trusts § 96 [DRAFT].
Section 96 of the Restatement (Third) of Trusts will be the exculpatory clause
section. At this point, it is not even published in draft form. It will be included in
draft no. 5.
F.
Uniform Trust Code § 1008.
§ 1008. Exculpation of Trustee.
(a) A term of a trust relieving a trustee of liability for
breach of trust is unenforceable to the extent that it:
(1) relieves the trustee of liability for breach of
trust committed in bad faith or with reckless
indifference to the purposes of the trust or the
interests of the beneficiaries; or
(2) was inserted as the result of an abuse by the
trustee of a fiduciary or confidential relationship
to the settlor.
15
(b) An exculpatory term drafted or caused to be drafted
by the trustee is invalid as an abuse of a fiduciary or
confidential relationship unless the trustee proves that
the exculpatory term is fair under the circumstances
and that its existence and contents were adequately
communicated to the settlor.
COMMENT
2006 Main Volume
Even if the terms of the trust attempt to completely
exculpate a trustee for the trustee’s acts, the trustee must
always comply with a certain minimum standard. As
provided in subsection (a), a trustee must always act in
good faith with regard to the purposes of the trust and the
interests of the beneficiaries. Subsection (a) is consistent
with the standards expressed in Sections 105 and 814(a),
which, similar to this section, place limits on the power of a
settlor to negate trustee duties. This section is also similar
to Section 222 of the Restatement (Second) of Trusts
(1959), except that this Code, unlike the Restatement,
allows a settlor to exculpate a trustee for a profit that the
trustee made from the trust.
Subsection (b) disapproves of cases such as Marsman v.
Nasca, 573 N.E.2d 1025 (Mass. App. Ct. 1991), which held
that an exculpatory clause in a trust instrument drafted by
the trustee was valid because the beneficiary could not
prove that the clause was inserted as a result of an abuse of
a fiduciary relationship. For a later case where sufficient
proof of abuse was present, see Rutanan v. Ballard, 678
N.E.2d 133 (Mass. 1997). Subsection (b) responds to the
danger that the insertion of such a clause by the fiduciary or
its agent may have been undisclosed or inadequately
understood by the settlor. To overcome the presumption of
abuse in subsection (b), the trustee must establish that the
clause was fair and that its existence and contents were
adequately communicated to the settlor. In determining
whether the clause was fair, the court may wish to examine:
(1) the extent of the prior relationship between the settlor
and trustee; (2) whether the settlor received independent
advice; (3) the sophistication of the settlor with respect to
business and fiduciary matters; (4) the trustee’s reasons for
16
inserting the clause; and (5) the scope of the particular
provision inserted. See Restatement (Second) of Trusts §
222 cmt. d (1959).
The requirements of subsection (b) are satisfied if the
settlor was represented by independent counsel. If the
settlor was represented by independent counsel, the
settlor’s attorney is considered the drafter of the instrument
even if the attorney used the trustee’s form. Because the
settlor’s attorney is an agent of the settlor, disclosure of an
exculpatory term to the settlor’s attorney is disclosure to
the settlor.
G.
Other.
1.
Scott and Ascher on Trusts § 24.27 (2007).
2.
Annot., Provisions of Will or Other Trust Instrument Exempting Trustee
From or Limiting His Liability, 158 A.L.R. 276 (1945).
3.
Poor judgment in trust investments is not reckless indifference.
McDonald v. First National Bank of Boston, 968 F. Supp. 9 (D. Mass.
1997).
17
LIMITATION OF ACTION
AGAINST TRUSTEE
Kevin J. Parker
SNELL & WILMER L.L.P.
One Arizona Center
Phoenix, Arizona 85004-2202
Phone: (602) 382-6238
Fax
(602) 382-6070
E-mail: [email protected]
18
LIMITATION OF ACTION AGAINST TRUSTEE
The law with regard to time limits for a beneficiary to bring an action against a
trustee has evolved over time. In the early cases, the courts were pro-beneficiary,
rejecting time limit defenses on various grounds, including that the cause of action was
not time barred unless and until a certain period of time had elapsed after termination of
the trust or resignation of the trustee, or that statutes of limitation were tolled until full
disclosure had been made by the trustee. Some courts held that statutes of limitation did
not apply at all, on the theory that claims against trustees were equitable claims and
therefore only equitable timeliness defenses (e.g., laches) were available to the trustee.
The modern rules are more pro-trustee.
A.
Overview.
Key points:
B.
•
Restatement: laches.
•
Uniform Trust Code: statute of limitations.
•
Uniform Probate Code: statute of limitations or final accounting.
•
Binding minor, contingent, remainder beneficiaries.
•
Preclusion of claims by successor trustee (as distinguished from
beneficiaries).
Practice Tips.
Drafting tips:
•
For the trustee’s benefit, the trust instrument should include a selfexecuting accounting/release provision: a simple clause would state that
the trustee may send periodic accountings to the current beneficiaries, and
in that event, the trustee’s accounting is deemed approved and the trustee
is released from liability for the period of such accounting just as if the
court had approved the accounting, unless the receiving beneficiary
objects in writing within 90 days of receipt of such accounting.
19
Administration tips:
•
Send periodic accountings to the beneficiaries.
The broader the
distribution (e.g., current and remainder beneficiaries) and the fuller the
disclosure, the better argument later.
•
Anticipate beneficiary arguments: the accounting is incomplete; the
accounting deliberately withheld or misportrayed information; the
accounting did not alert the beneficiary to a potential claim; the
beneficiary never received the accounting; the beneficiary was a minor
and/or incapacitated.
Litigation tips:
C.
•
The trustee may want to initiate the litigation with a petition to the court
for approval of the accounting.
•
When sued by a beneficiary, raise the affirmative defenses.
Restatement (Second) of Trusts § 219.
§ 219. Laches of the Beneficiary
(1) The beneficiary cannot hold the trustee liable for a
breach of trust if he fails to sue the trustee for the
breach of trust for so long a time and under such
circumstances that it would be inequitable to permit
him to hold the trustee liable.
(2) The beneficiary is not barred merely by lapse of time
from enforcing the trust, but if the trustee repudiates
the trust to the knowledge of the beneficiary, the
beneficiary may be barred by laches from enforcing the
trust.
See Reporter’s Note.
Comment on Subsection (1):
a. What constitutes laches. In most States there is no
Statute of Limitations applicable to equitable claims, but
equitable claims may be barred by the laches of the
claimant.
20
In determining whether the beneficiary of a trust is
precluded by laches from holding the trustee liable for
breach of trust, the court will consider among others the
following factors: (1) the length of time which has elapsed
between the commission of the breach of trust and the
bringing of suit; (2) whether the beneficiary knew or had
reason to know of the breach of trust; (3) whether the
beneficiary was under an incapacity; (4) whether the
beneficiary’s interest was presently enjoyable or enjoyable
only in the future; (5) whether the beneficiary had
complained of the breach of trust; (6) the reasons for the
delay of the beneficiary in suing; (7) change of position by
the trustee, including loss of rights against third persons;
(8) the death of witnesses or parties; (9) hardship to the
beneficiary if relief is not given; (10) hardship to the trustee
if relief is given.
b. Length of time necessary to bar beneficiary. The length
of time necessary to bar the beneficiary from holding the
trustee liable for breach of trust depends upon the
circumstances. In the absence of special circumstances the
beneficiary is barred if the period of the Statute of
Limitations applicable to actions at law in analogous
situations has run.
c. Where beneficiary has no notice of breach of trust. The
beneficiary will not ordinarily be barred by laches from
holding the trustee liable for a breach of trust of which the
beneficiary did not know and had no reason to know.
d. Where beneficiary under incapacity. The beneficiary
will not be barred by laches as long as he is under an
incapacity. He will ordinarily be guilty of laches, however,
if knowing of the breach of trust he does not sue within a
reasonable time after the incapacity is removed.
e. Where beneficiary has future interest. A beneficiary
who has an interest enjoyable only in the future is guilty of
laches if knowing of the breach of trust he does not sue
within a reasonable time after his interest becomes
presently enjoyable. He may be guilty of laches, however,
by reason of his failure to sue before his interest becomes
presently enjoyable. Thus, if a trust is created to pay the
income to one beneficiary for life and on his death to pay
21
the principal to another beneficiary and during the lifetime
of the former beneficiary the trustee commits a breach of
trust of which the latter beneficiary has knowledge and he
delays suing for many years, he may be barred by laches
although he brings suit immediately after the death of the
life beneficiary.
If a trust is created for one beneficiary for life and another
in remainder, and the life beneficiary but not the
remainderman is barred by laches from holding the trustee
liable for a loss resulting from a breach of trust, the trustee
owes a duty to the remainderman to pay into the trust the
amount of the loss, but the trustee is entitled to take the
income during the life of the life beneficiary on the amount
so repaid. Compare § 216, Comment g.
f. Other factors. If the beneficiary knowing of the breach
of trust makes no complaint, he is ordinarily barred in a less
time than that in which he would be barred if he had
complained to the trustee of the breach of trust.
If the beneficiary has delayed bringing suit as a result of
promises of the trustee to redress the breach of trust, he will
not be barred as soon as he would be barred if he had not
been induced to delay suit by such promises.
The beneficiary may be barred from suing the trustee if the
trustee has changed his position, where he would not
otherwise be barred.
If witnesses or parties have died between the time when the
breach of trust was committed and the time of suit, the suit
may be barred by laches in a less time than it would
otherwise be barred, since under such circumstances it may
have become difficult as a result of the delay of the
beneficiary in suing to ascertain the facts and to do justice.
Comment on Subsection (2):
g. Effect of laches in terminating the trust. Although the
beneficiary may be barred by laches from holding the
trustee liable for breach of trust, he does not lose his
interest in the trust property merely because of the lapse of
time, however great; if, however, the trustee has repudiated
the trust to the knowledge of the beneficiary and the
22
beneficiary fails to bring suit, he may be barred by laches
from enforcing the trust. Such repudiation need not be in
specific words; it may consist of conduct on the part of the
trustee inconsistent with the existence of the trust.
D.
Uniform Trust Code § 1005.
§ 1005. Limitation of Action Against Trustee.
(a) A beneficiary may not commence a proceeding
against a trustee for breach of trust more than one year
after the date the beneficiary or a representative of the
beneficiary was sent a report that adequately disclosed
the existence of a potential claim for breach of trust and
informed the beneficiary of the time allowed for
commencing a proceeding.
(b) A report adequately discloses the existence of a
potential claim for breach of trust if it provides
sufficient information so that the beneficiary or
representative knows of the potential claim or should
have inquired into its existence.
(c) If subsection (a) does not apply, a judicial
proceeding by a beneficiary against a trustee for breach
of trust must be commenced within five years after the
first to occur of:
(1) the removal, resignation, or death of the
trustee;
(2) the termination of the beneficiary’s interest
in the trust; or
(3) the termination of the trust.
COMMENT
2006 Main Volume
The one-year and five-year limitations periods under this
section are not the only means for barring an action by a
beneficiary. A beneficiary may be foreclosed by consent,
release, or ratification as provided in Section 1009. Claims
23
may also be barred by principles such as estoppel and
laches arising in equity under the common law of trusts.
See Section 106.
The representative referred to in subsection (a) is the
person who may represent and bind a beneficiary as
provided in Article 3. During the time that a trust is
revocable and the settlor has capacity, the person holding
the power to revoke is the one who must receive the report.
See Section 603(a) (rights of settlor of revocable trust).
This section addresses only the issue of when the clock will
start to run for purposes of the statute of limitations. If the
trustee wishes to foreclose possible claims immediately, a
consent to the report or other information may be obtained
pursuant to Section 1009. For the provisions relating to the
duty to report to beneficiaries, see Section 813.
Subsection (a) applies only if the trustee has furnished a
report. The one-year statute of limitations does not begin
to run against a beneficiary who has waived the furnishing
of a report as provided in Section 813(d).
Subsection (c) is intended to provide some ultimate repose
for actions against a trustee. It applies to cases in which the
trustee has failed to report to the beneficiaries or the report
did not meet the disclosure requirements of subsection (b).
It also applies to beneficiaries who did not receive notice of
the report, whether personally or through representation.
While the five-year limitations period will normally begin
to run on termination of the trust, it can also begin earlier.
If a trustee leaves office prior to the termination of the trust,
the limitations period for actions against that particular
trustee begins to run on the date the trustee leaves office. If
a beneficiary receives a final distribution prior to the date
the trust terminates, the limitations period for actions by
that particular beneficiary begins to run on the date of final
distribution.
If a trusteeship terminates by reason of death, a claim
against the trustee’s estate for breach of fiduciary duty
would, like other claims against the trustee’s estate, be
barred by a probate creditor’s claim statute even though the
statutory period prescribed by this section has not yet
expired.
24
This section does not specifically provide that the statutes
of limitations under this section are tolled for fraud or other
misdeeds, the drafters preferring to leave the resolution of
this question to other law of the State.
E.
Uniform Probate Code § 7-307.
§ 7-307. Limitations on Proceedings Against Trustees After Final Account
Unless previously barred by adjudication,
consent or limitation, any claim against a trustee for
breach of trust is barred as to any beneficiary who has
received a final account or other statement fully
disclosing the matter and showing termination of the
trust relationship between the trustee and the
beneficiary unless a proceeding to assert the claim is
commenced within [6 months] after receipt of the final
account or statement.
In any event and
notwithstanding lack of full disclosure a trustee who has
issued a final account or statement received by the
beneficiary and has informed the beneficiary of the
location and availability of records for his examination
is protected after 3 years. A beneficiary is deemed to
have received a final account or statement if, being an
adult, it is received by him personally or if, being a
minor or disabled person, it is received by his
representative as described in Section 1-403(1) and (2).
F.
Other.
1.
It has been argued that the statute of limitations is tolled until the trust
terminates, the trustee repudiates the trust, or the trustee resigns. That
argument is generally rejected. See, e.g., Jones v. United States, 801 F.2d
1334, 1335-36 (Fed. Cir. 1986), cert. denied 481 U.S. 1013, 95 L.Ed.2d
495, 107 S.Ct. 1887 (1987); Harris Trust Bank of Arizona v. Superior
Court of the State of Arizona, 188 Ariz. 159, 163, 933 P.2d 1227, 1231
(App. 1996).
2.
Effect of self-executing accounting/release clause in the trust. Some trust
instruments include a provision that purports to release the trustee from
liability in increments under the circumstance where the trustee provides
interim accountings to certain beneficiaries. The provisions usually
provide that the trustee is automatically released from liability for that
accounting period unless the beneficiary takes certain action within a
25
specific time frame, e.g., 60 or 90 days. Such clauses are generally
assumed to be enforceable, with the issue being which beneficiaries are
bound.
3.
Virtual Representation.
a.
Uniform Probate Code § 1-403.
b.
Uniform Trust Code §§ 301-305.
26
ATTORNEY-CLIENT
PRIVILEGE
Anthony R. La Ratta
ARCHER & GREINER
One Centennial Square
P.O. Box 3000
Haddonfield, New Jersey 08033-0968
Phone: (856) 354-3094
Fax: (856) 673-7094
E-mail: [email protected]
27
ATTORNEY-CLIENT PRIVILEGE IN TRUST AND ESTATE DISPUTES -WHO HOLDS THE PRIVILEGE?
Lawyers often assume that the attorney-client privilege provides absolute
protection when it comes to inquiries into communications between lawyer and client.
However, in the context of trusts and estates, the privilege may not apply, or may even be
lost. Fiduciaries and attorneys representing them must be aware of these privilege issues,
as these concepts can be contrary to our general notion of being able to maintain in strict
confidence communications with clients.
For example, many states will not apply that privilege with respect to
communications between the lawyer and the client regarding estate planning when a will
or trust is being contested. Upon execution of a will, a testator may intend for the
contents of the will to be kept in confidence with the attorney only during the testator’s
lifetime. See, e.g., Balazinski v. Lebid, 168 A.2d 209 (N.J. Super. App. Div. 1961)
(finding conversations with attorney who prepared will admissible). But see Gould,
Larson, Bennett, Wells & McDonnell v. Panico, 869 A.2d 653 (Conn. 2005) (in will
contest, attorney who met with client and discussed estate plan could not be compelled to
disclose confidential communications since the attorney did not draft a will for the
client).
To generally establish the privilege, the following four factors must exist: the
communications must originate in the confidence that they will not be disclosed; the
element of confidentiality must be essential to the full and satisfactory maintenance of the
relationship between the parties; the relationship must be one which in the opinion of the
community ought to be fostered; and the injury that would inure to the relation by the
disclosure of the communications must be greater than the benefit thereby gained for the
correct disposal of litigation. Sherwin P. Simmons, Who Is the Client?: Ethical
Considerations, SC06 ALI-ABA 769, 772 (1997) (quoting 8 Wigmore on Evidence §
2285, at 527).
Identify the Client
When representing a fiduciary, the lawyer must initially determine to whom he
owes his loyalty. See, e.g., Peter Rice, Attorney-Client Privilege in the U.S. § 4:45 (2d
ed. Mar. 2003) (“the most common question that has arisen has been who is the client -the trust entity, the trustees or individuals who act for the entity, or the beneficiaries or
individuals for whom the entities were created?); Sherwin P. Simmons et al.,
Confidentiality Issues Between Fiduciaries and Their Legal Advisors, SH059 ALI-ABA
535 (2003) (discussing with respect to attorney-fiduciary privilege, “who is the client?”);
Jack A. Falk, Jr., The Fiduciary’s Lawyer-Client Privilege, Does it Protect
Communications from Discovery by a Beneficiary?, 77 Mar. FLA. B.J. 18 (March 2003)
(reviewing various jurisdictions’ approaches to parties subject to attorney-client
28
privilege); John T. Rogers, Jr., Who’s the Client? Ethics for Trust and Estate Counsel,
SJ036 ALI-ABA 255 (2003) (discussing ethical implications of representation of
fiduciary and purview of attorney client relationship); Steven M. Fast et al., The
Fiduciary Sticky Wicket -- Counseling Fiduciaries on Dealing with Receipts and
Releases; Requests for Resignation; Conflicts of Interest with Co-Fiduciaries; and
Discharge from Tax Liabilities, SC84 ALI-ABA 91 (1999) (asking “is it really the trustee
that you represent or is it the trust itself or possibly the trust’s beneficiaries?”); Peter R.
Brown, Clarifying the Role of the Attorney, Executor, and Trustee in Estate and Trust
Administration, SC85 ALI-ABA 149, 152 (1998) (“threshold issue is always to whom
does the lawyer owe his or her loyalty?”).
Define the Scope of Attorney-Client Relationship
Attorneys may be able to define the attorney-client relationship themselves with a
well-tailored retention letter. In Lerner v. Laufer, 819 A.2d 471 (N.J. Super. App. Div.),
certif. denied, 827 A.2d 290 (N.J. 2003), the Appellate Division held that an attorney is
ethically permitted under N.J.R.P.C. 1.2(c), with the consent of the client after
consultation, to limit the scope of his representation with a single, specifically tailored
form of a retainer agreement. See also Melvin Hirshman, Tips from Bar CounselAgreements with Your Client, 36-DEC MD. B.J. 58 (Nov./Dec. 2003) (citing Md. R.P.C.
2(c) and Lerner).
Lawyers who represent fiduciaries may want to consider a number of practical
considerations to further define issues of privilege and representation at the outset of the
relationship. First, the attorney can inform beneficiaries that he or she is representing the
fiduciary, that the fiduciary is the lawyer’s client, and that the lawyer does not represent
the beneficiaries.
The lawyer can also inform the beneficiaries upfront that
communications between the fiduciary and the attorney will be privileged, or even have
the beneficiaries sign an acknowledgment to this effect. The lawyer for the fiduciary can
also suggest that beneficiaries retain their own counsel. See Jack A. Falk, Jr., The
Fiduciary’s Lawyer-Client Privilege, Does it Protect Communications from Discovery by
a Beneficiary?, 77-MAR Fla. B.J. 18 (March 2003).
Breach of a trustee’s duty to the trust beneficiaries is probably not sufficient to
justify counsel’s breach of the duties of loyalty and confidentiality owed to the fiduciary
client in most jurisdictions. Robert F. Phelps, Jr., Representing Trusts and Trustees Who Is the Client and Do Notions of Privity Protect the Client Relationship, 66 Conn. B.
J. 211, 221-22 (1992). If counsel decides he can no longer represent a trustee because of
the trustee’s handling of the trust, counsel may prefer to resign rather than decide whether
the action justifies disclosure. Id. Moreover, when retained to render personal advice to
the trustee, counsel may wish to document the limited representation, noting that he was
retained for personal matters and not trust administration and that she was paid with the
trustee’s personal funds.
29
The Majority View: Fiduciary = Client
“[U]nless the lawyer elects to represent the estate or trust as an entity, and there is
a written agreement to this effect with the fiduciary,” the majority rule is that “the
lawyer’s only client is the fiduciary.” Brown, Clarifying the Role of the Attorney,
Executor, and Trustee in Estate and Trust Administration, supra, at 152.
Trusts
The majority rationale views trust counsel are agents hired by a trustee, so that
trust counsel owe their duty of loyalty to the fiduciary -- i.e., the trustee.
In Huie v. DeShazo, 922 S.W.2d 920, 925 (Tex. 1996), the Supreme Court of
Texas held that under Texas law, a trustee who hires an attorney to assist in administering
a trust is the actual client of the lawyer, and the trust beneficiaries are not the clients. The
court noted it “would strain reality to hold that a trust beneficiary, who has no direct
professional relationship with the trustee’s attorney, is the real client.” Id.
In Spinner v. Nutt, 631 N.E.2d 542 (Mass. 1994), the Supreme Judicial Court of
Massachusetts refused to impute an attorney-client relationship between the attorneys of
trustees, who also happened to be beneficiaries under the trust, and plaintiff-beneficiaries
of the testamentary trust. The Court reasoned that “[s]hould we decide that a trustee’s
attorney owes a duty not only to the trustee but also to the trust beneficiaries, conflicting
loyalties could impermissibly interfere with the attorney’s task of advising the trustee.”
Id. at 545-46. In so declining to recognize an attorney-client relationship between trust
beneficiaries and trustee’s counsel, the Court was careful to distinguish between thirdparty beneficiaries of the contract between the testator and the attorney drafting the will,
and the contract between the trustee and the trustee’s attorney. In the latter circumstance,
the trust beneficiaries are only incidental beneficiaries of the contract. The plaintiff trust
beneficiaries failed to cite authority for finding an attorney-client relationship between
the trust beneficiaries and the attorney for the trustee of the trust. Id.
Wills
In Goldberg v. Frye, 266 Cal. Rptr. 483, 488 (Cal. Ct. App. 1990), the California
Court of Appeals announced that “it is well established that the attorney for the
administrator of an estate represents the administrator, and not the estate.” Although the
attorney performs services that may benefit legatees, the attorney “has no contractual
privity with the beneficiaries of the estate.” Id.
In Grievance Committee, Wyoming State Bar v. Riner, 765 P.2d 925, 927 (Wyo.
1988), the Supreme Court of Wyoming disagreed with an attorney’s contention that he
represented the estate and not the personal representative. The court concluded that the
personal representative of the estate and the attorney “entered into an attorney-client
30
relationship when she engaged [him] to assist her in performing her duties as a personal
representative” of the estate.
In Simon v. Zipperstein, 512 N.E.2d 636, 638 (Ohio 1987), the court stated: “in
absence of fraud, collusion or malice, an attorney may [not] be held liable in a
malpractice action by a purported beneficiary of a will where privity is lacking.”
In In re Estate of Wagner, 386 N.W.2d 448, 450 (Neb. 1986), the court ruled
“[w]hen an attorney is employed to render services in securing the probate of a will or
settling an estate, he acts as attorney for the personal representative and not for the
estate.”
The Minority View: Beneficiary = Client
The minority view is that, although there is no direct attorney-client relationship,
the lawyer may still owe some duties to the beneficiaries. Brown, supra, at 152. Some
states even treat the beneficiaries of an estate as joint clients of the lawyer for the
fiduciary. For instance, the Court of Appeals of Michigan has held that even though the
personal representative retains the attorney, the attorney’s client is the estate, not the
personal representative, a conclusion supported by the fact that the probate court must
approve the attorney’s fees for services rendered on behalf of the estate and the fees are
paid from the estate. Steinway v. Bolden, 460 N.W.2d 306, 307 (Mich. Ct. App. 1990).
See Elam v. Hyatt Legal Servs., 541 N.E.2d 616, 618 (Ohio 1989).
Discovery has also been allowed even where the beneficiary was not
characterized as a client. In these minority-view states, the courts reasoned either that the
fiduciary was obligated to disclose all information relating to the administration of the
trust to the beneficiaries or that the fiduciary client could not reasonably have expected
that the lawyer represented him personally. John R. Price, Duties of Estate Planners to
Nonclients: Identifying, Anticipating and Avoiding the Problems, 37 S. Tex. L. Rev.
1063, 1087 (1996). See, e.g., Follansbee v. Gerlach, 56 Pa. D & C.4th 483 (2002)
(holding that as to beneficiaries, the attorney-client privilege never applies to
communications between trustee and attorney consulted in fiduciary capacity regarding
trust administration because trustee has duty to make such documents available to
beneficiaries).
As a lawyer-client relationship may be found to have existed based on the
reasonable subjective belief of a beneficiary, these states permit beneficiaries to discover
communications between the fiduciary and the fiduciary’s counsel. Price, supra, at 108687. See In re Estate of Torian, 564 S.W.2d 521, 526 (Ark. 1978), cert. denied, 439 U.S.
883 (1978) (applying joint client exception to attorney-client privilege in holding that
communication between executor and executor’s lawyer was discoverable by
beneficiary); Riggs Nat’l Bank of Wash., D.C. v. Zimmer, 355 A.2d 709, 714 (Del. Ch.
1976) (trustees “cannot subordinate the fiduciary obligations owed to the beneficiaries to
their own private interests under the guise of attorney-client privilege”); Hoopes v.
31
Carota, 531 N.Y.S.2d 407, 409 (App. Div. 1988), aff’d, 543 N.E.2d 73 (N.Y. 1989)
(attorney-client privilege did not protect president’s questions about exercise of his duties
as a trustee or corporate officer in connection with various proposals for sale or buyout of
corporation and transactions between management and corporation).
Where the issue is one of trust administration, “the trustee is not the real client in
the sense that he is personally being served.” Id. at 776. As the Delaware Chancery
Court noted in Riggs, the intention of the communication is to aid the beneficiaries. “The
policy of preserving the full disclosure necessary in the trustee-beneficiary relationship is
… more important than the protection of the trustees’ confidence in the attorney for the
trust.” Riggs, 355 A.2d at 714. However, if the trustee can demonstrate that he sought
advice for his personal benefit, he may invoke the attorney-client privilege. Factors
relevant in determining whether the trustee sought advice for his personal use rather than
for the administration of the trust include: whether the trustee used his personal funds or
those of the estate to pay for the attorney’s services and whether he sought advice relating
to a defense in pending litigation.
Regardless of whether a case arises in a majority or minority jurisdiction, an
attorney should approach communications with the beneficiaries with care. An attorney
should not allow the beneficiaries to believe that he represents their interests. Brown,
supra, at 154.
Recent Trends
The following cases epitomize how the recent trend appears to be leaning toward
the erosion of the privilege.
Moeller v. Superior Court, 947 P.2d 279 (Cal. 1997)
The Supreme Court of California ruled in this case that a successor trustee is the
holder of the attorney-client privilege over communications between a former trustee and
his trust administration counsel. This decision also addresses cases in this area around
the country.
A corporate fiduciary handled the trust at issue for a number of years, including
while litigation and related issues were addressed concerning toxic contamination to real
property owned by the trust. One of the beneficiaries, Mr. Moeller, became the successor
trustee in place of the corporate fiduciary, and sued his predecessor for various losses,
including alleged mishandling of the contaminated property and related litigation. Mr.
Moeller sought communications and other documents exchanged between the former
trustee and its counsel, but the former trustee refused to produce such documents,
claiming the attorney-client privilege.
32
The Supreme Court of California ruled that Mr. Moeller was entitled to all such
communications because the privilege belonged to the “office” of trustee, and not to a
particular trustee. The Court ruled that all attorney-client communications regarding any
trust administrative matter would not be privileged as against a successor trustee.
However, with respect to communications between a trustee and counsel on actual or
potential breaches of fiduciary duty, the Court ruled that such communications could be
protected from disclosure; the Court seemed to suggest that, to ensure the privilege, the
fiduciary should obtain its own counsel and pay for such legal services personally.
Wells Fargo Bank, N.A. v. Superior Court, 990 P.2d 591 (Cal. 2000)
In this sequel to Moeller, the California Supreme Court refused to recognize an
implied exception that would require trustees to share with trust beneficiary’s privileged
communications about trust administration. In Wells Fargo, William Couch established a
trust in 1991. He served as the sole trustee until his death in 1992. Then, his widow and
Wells Fargo became co-trustees. The beneficiaries accused the trustees of a variety of
misconduct. Wells Fargo filed a court action to settle its account and obtain approval for
its resignation as trustee. The beneficiaries filed objections.
The beneficiaries relied on Moeller to try to obtain in discovery documents
regarding communications between the trustees and their counsel. The California
Supreme Court did not allow this reliance, explaining that in Moeller “we did not suggest
that anyone other than the current holder of the privilege might be entitled to inspect
privileged communications. Nor did we create or recognize any exceptions to the
privilege. Instead, without questioning that the communications at issue were privileged,
we merely identified the current holder of the privilege.” Id. at 596. The California
Supreme Court refused to recognize an implied exception that would require trustees to
share privileged communications about trust administration with trust beneficiaries.
Even if the trust pays the fees charged by counsel retained by the trustee, the beneficiaries
cannot claim to be joint clients along with the trustee. The privilege, however, does not
shield non-privileged information that is forwarded to counsel. Id.
Thus, in Moeller, the California Supreme Court ruled that a successor trustee
could obtain otherwise privileged communications, because the privilege moves with the
office of the trustee. In Wells Fargo, that same court did not extend Moeller to rule that
beneficiaries are able to obtain such privileged information.
Estate of Fedor, 811 A.2d 970 (N.J. Super. Ch. Div. 2001)
The New Jersey court adopted Moeller.
The beneficiaries alleged
mismanagement and self-dealing by the fiduciaries (who were both executors and
trustees). In prior proceedings, the court had suspended the two individual fiduciaries of
the subject estate and trust, and appointed an attorney as the temporary fiduciary. The
substitute fiduciary and the beneficiaries then sought discovery of prior communications
33
between the former fiduciaries and the attorneys and accountants for the estate. The
former fiduciaries raised the attorney-client privilege.
The court ruled that the substitute fiduciary became the holder of the privilege and
therefore was entitled to have access to all records of the estate, including attorney-client
advice previously provided to the suspended fiduciaries by the attorneys and the
accountants. Likewise, she was entitled to decide whether to waive the privilege as to the
beneficiaries, based on the best interests of the estate. The court denied the beneficiaries’
motion without prejudice.
However, while the court did note that the beneficiaries did not seek discovery of
communications between the former fiduciaries and their “personal” attorney, the opinion
does not address those communications.
Bria v. United States, 89 A.F.T.R.2d 2002-2141 (D. Conn. 2002)
In this unreported but still noteworthy opinion, the co-executors of an estate
retained counsel. However, the attorneys were terminated while in the process of
preparing the United States Tax Form 706.
The IRS investigated whether the co-executors understated the value of the estate
on the Form 706 that was eventually filed with the IRS. The IRS issued a summons to
the former attorneys for the co-executors. An objection was raised based on the attorneyclient privilege, especially since some of the information was not listed on the Form 706
which was filed.
Although the court sustained the objection as to certain points, the court still
ordered the attorneys to answer questions and produce documents as to certain areas,
including joint bank accounts valued at over $407,000, held by the decedent but not listed
on the estate tax return which was filed.
Eddy v. Fields, 18 Cal. Rptr.3d 487 (Cal. Ct. App. 2004)
The court, following Moeller, held that a successor trustee was entitled to the files
of the lawyer of the predecessor trustees. In Eddy, the former trustees resigned and the
successor trustee requested that the attorney for the former trustees turn over his files.
The attorney petitioned the court for guidance on whether the files should be released.
The attorney argued that some of the documents had been prepared by him while
representing the former trustees and were protected by the work product privilege. The
trial court ordered the attorney to turn the files over to the successor trustee. Id. at 490.
The Court of Appeals affirmed, explaining that “a new trustee succeeds to all
rights, duties and responsibilities of his or her predecessors, including those related to
dealings with an attorney retained to assist the trustee in the management of the trust.”
Id. The court reasoned that the documents within the file, including all correspondence,
34
pleadings, expert reports, and other items reasonably necessary to the representation
belonged to the client. The court also found that the work product privilege had been
waived by disclosure. Id. at 491.
Borissoff v. Taylor & Faust, 93 P.3d 337 (Cal. 2004)
Again following Moeller, the California Supreme Court held that a successor
fiduciary of an estate may assert a professional negligence claim against the attorneys
retained by a predecessor fiduciary to provide tax assistance for the benefit of the estate.
Citing Moeller, the Court noted:
when a fiduciary hires an attorney for guidance in
administering a trust, the fiduciary alone, in his or her
capacity as fiduciary, is the attorney’s client. The trust is
not the client, because “a trust is not a person but rather ‘a
fiduciary relationship with respect to property.’” Neither is
the beneficiary the client, because fiduciaries and
beneficiaries are separate persons with distinct legal
interests.
Id. at 340 (citations omitted) (emphasis omitted).
The Borissoff court further clarified:
A successor fiduciary becomes the holder of the attorneyclient privilege “only as to those confidential
communications that occurred when the predecessor, in [his
or her] fiduciary capacity, sought the attorney’s advice for
guidance in administering the trust.” Conversely, a
successor fiduciary does not become the holder of the
privilege for confidential communications that occurred
when a predecessor fiduciary in his or her personal capacity
sought an attorney’s advice.
Id. at 343-44 (citations omitted) (emphasis omitted).
Jacob v. Barton, 877 So.2d 935 (Fla. Dist. Ct. App. 2004)
The Florida District Court of Appeals quashed the lower court’s order requiring
production of a trust attorney’s billing records to a beneficiary. The beneficiary had sued
to remove the trustee for mismanagement and for improper payments to the trustee’s
attorneys. According to the court, when confronted with the issue of privilege, a court
must consider whether the attorney represents the interests of the trustee or the
beneficiary. The court noted that usually a lawyer retained by a trust represents the
trustee, not the beneficiary, and therefore the trustee holds the lawyer-client privilege.
35
However, the court acknowledged that the beneficiary might hold the privilege if he is
the person who ultimately will benefit from the legal work the trustee has instructed the
attorney to perform, and in that sense may be the “real client.” Id. at 937. The court
ruled that, to the extent that the lawyer’s work concerned the dispute with the beneficiary,
the client is the trustee, not the beneficiary. The court remanded with directions to
conduct an in camera review to determine whether the billing entries would be protected
by either the lawyer-client privilege or the work product doctrine.
9411242.1
36
Planning for Qualified Plan and IRA Benefits – the
Final Minimum Required Distribution Rules
HARVEY B. WALLACE II
Berry Moorman PC
A.
B.
C.
D.
Overview of minimum distribution rules........................................................................ 1
1. Rules simplified. ..................................................................................................... 1
a. Lifetime distributions. ..................................................................................... 1
i.
Uniform lifetime table. .......................................................................... 1
ii.
Ten years younger spouse...................................................................... 1
b. Distributions following the participant's death. .............................................. 1
i.
Nonspouse designated beneficiary. ....................................................... 2
ii.
No designated beneficiary. .................................................................... 2
iii. Spouse is sole designated beneficiary. .................................................. 2
2. Plan and IRA agreement provisions........................................................................ 2
3. The 50% penalty. .................................................................................................... 2
4. Aggregation of multiple IRAs................................................................................. 2
a. Former planning strategy. ............................................................................... 3
b. New IRA aggregation rule. ............................................................................. 3
5. Final regulations and estate planning...................................................................... 3
a. Disclaimer planning available to all participants. ........................................... 3
b. Integration of benefits into estate plan. ........................................................... 3
History of the MRD rules – Code. .................................................................................. 4
Incidental death benefit rule............................................................................................ 4
Proposed and final Treasury regulations – scope and effective dates............................. 5
1. The 1987 regulations............................................................................................... 5
2. The 2001 proposed Treasury regulations................................................................ 5
3. The final regulations. .............................................................................................. 5
a. Scope – qualified plans, IRAs, tax sheltered annuities, and
section 457 plans. ............................................................................................ 5
b. Effective dates................................................................................................. 6
i.
Benefits with respect to pre-January 1, 2003 decedents........................ 6
ii.
Qualified plan amendments. .................................................................. 6
iii. IRA agreement amendments. ................................................................ 6
iv. Year 2002. ............................................................................................. 6
c. 2004 changes to final regulations.................................................................... 6
II. DISTRIBUTIONS DURING THE PARTICIPANT'S LIFETIME......................................... 7
A. Code section 401(a)(9)(A) reinterpreted......................................................................... 7
1. Application to defined contribution plans............................................................... 7
a. The final regulations adopt longest statutory distribution period. .................. 7
b. No elections to recalculate life expectancies need be made............................ 8
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2.
B.
C.
D.
Application to defined benefit plans and payments from annuity
contracts. ................................................................................................................. 8
Required beginning date (RBD). .................................................................................... 8
1. Non five percent owner participants. ...................................................................... 9
2. Plans may require RBD after age 70 1/2................................................................. 9
a. Plan's RBD applies to characterize postdeath distributions. ........................... 9
b. Character of amounts paid after plan RBD but before code
RBD................................................................................................................. 9
The uniform lifetime table. ........................................................................................... 10
1. Distribution calendar year. .................................................................................... 10
2. Payment of distribution for first distribution calendar year. ................................. 10
3. Prior yearend account balance. ............................................................................. 11
a. Plan postvaluation date adjustments. ............................................................ 11
b. Adjustment to second year account balance for pre-RBD
distributions eliminated by final regulations................................................. 11
c. Adjusting for rollovers. ................................................................................. 11
More than ten years younger spouse as sole beneficiary. ............................................. 12
1. The "at all times" requirement. ............................................................................. 12
2. Can a trust for the spouse's benefit be designated beneficiary? ............................ 12
a. Reasons to name a trust for the spouse as beneficiary. ................................. 13
b. Naming a "conduit" trust as beneficiary. ...................................................... 13
III. DISTRIBUTIONS FOLLOWING THE PARTICIPANT'S DEATH –SPOUSE
IS NOT SOLE BENEFICIARY ............................................................................................ 13
A. Overview....................................................................................................................... 13
B. The new rules. ............................................................................................................... 13
1. Participant has an individual designated beneficiary. ........................................... 13
a. Determination of annual distributions – beneficiary's fixed life
expectancy..................................................................................................... 14
b. Determination of annual distributions – participant's fixed life
expectancy..................................................................................................... 14
c. Plan provisions may limit payout on pre-RBD death. .................................. 14
i.
If no plan provision, deferred payment permitted. .............................. 14
ii.
If there is a plan provision, it controls. ................................................ 14
iii. Transition rule...................................................................................... 14
2. Participant does not have a designated beneficiary............................................... 15
a. Death after RBD............................................................................................ 15
b. Death before RBD......................................................................................... 15
C. Designated beneficiary.................................................................................................. 15
1. Designation under plan required. .......................................................................... 15
2. Impact of nonindividual beneficiaries................................................................... 16
3. Multiple beneficiaries. .......................................................................................... 16
a. Contingent beneficiaries generally taken into account. ................................ 16
b. Beneficiary entitled to benefit only due to death of prior
beneficiary disregarded. ................................................................................ 16
c. Death of designated beneficiary after designation date does not
affect distribution period. .............................................................................. 16
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4.
D.
Time at which designated beneficiary determined................................................ 17
a. Change from 2001 Regulations..................................................................... 17
b. The "window period". ................................................................................... 17
5. Designation of beneficiaries by beneficiaries. ...................................................... 17
Planning during the window period. ............................................................................. 18
1. Death of oldest beneficiary during window period............................................... 18
a. Substantial change to apparent rule of 2001 regulations. ............................. 18
b. Inclusion in deceased beneficiary's gross estate............................................ 18
c. Will a disclaimer by a deceased beneficiary's personal
representative be recognized? ....................................................................... 19
2. Creating separate shares following the participant's death. .................................. 19
a. Definition of separate accounts or shares...................................................... 19
b. Time at which separate accounts must be established. ................................. 19
c. Separate accounts for distributions in 2002 and earlier years....................... 20
d. Distribution in year after participant's death under 2002
regulations. .................................................................................................... 20
i.
Separate accounts established in year of participant's
death..................................................................................................... 20
ii.
Separate accounts established in year following the
participant's death. ............................................................................... 20
iii. Risk of having no designated beneficiary if separate
accounts do not exist on designation date. .......................................... 21
e. Accounts may be created for separate management at any time................... 21
i.
The wrong way. ................................................................................... 21
ii.
The right way....................................................................................... 22
iii. Custodian and trustee resistance to creating separate
IRAs..................................................................................................... 22
3. Using disclaimers during the window period to change the
designated beneficiary........................................................................................... 23
a. Recognition of disclaimers for transfer tax purposes.................................... 23
b. Qualified disclaimer defined. ........................................................................ 24
(1) Pre-disclaimer receipt of an MRD is not an
acceptance of an interest in benefits........................................... 24
(2) Distribution of income attributable to distributed
amount required.......................................................................... 24
(3) Partial disclaimers affirmed. ...................................................... 25
(4) Other indicia of acceptance. ....................................................... 25
(5) Spouse may retain certain interests in disclaimed
property. ..................................................................................... 25
(6) Spouse may not hold a nongeneral power of
appointment over a credit shelter trust. ...................................... 25
(7) Transfer type disclaimers. .......................................................... 25
(8) Takers in the event of a disclaimer must qualify as
individual beneficiaries. ............................................................. 26
c. Income tax impact of a disclaimer. ............................................................... 26
d. Plan anti-alienation provisions...................................................................... 26
e. Preapproved customized beneficiary designations or postdeath
persuasiveness needed to gain administrative acceptance. ........................... 26
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f.
Building a disclaimer into beneficiary designation....................................... 26
IV. DISTRIBUTIONS FOLLOWING THE PARTICIPANT'S DEATH – SPOUSE
IS SOLE BENEFICIARY...................................................................................................... 27
A. Overview....................................................................................................................... 27
B. Special MRD rules if spouse is sole designated beneficiary. ....................................... 27
1. Deferral of benefit commencement after participant's pre-RBD
death. ..................................................................................................................... 27
2. Spouse treated as participant if death occurs before benefits
commence after a participant's pre-RBD death..................................................... 27
a. If the spouse's death occurs before the designation date, what is
the applicable distribution period? ................................................................ 28
b. If the surviving spouse has no designated beneficiary under the
plan or IRA.................................................................................................... 28
c. If the surviving spouse has designated a beneficiary. ................................... 28
d. Balancing deferral and estate/GST tax exposure. ......................................... 29
3. Applicable distribution period if spouse is sole designated
beneficiary on participant's death.......................................................................... 29
a. Redetermined life expectancy during spouse's lifetime. ............................... 29
b. Fixed term distribution following surviving spouse's death. ........................ 29
c. Can a trust for the benefit of a spouse qualify for the special
minimum required distribution treatment?.................................................... 30
i.
Surviving spouse is not the sole beneficiary of a QTIP
trust. ..................................................................................................... 30
ii.
Conduit trust for surviving spouse satisfies the sole
beneficiary rule. ................................................................................... 30
C. Overriding rollover and "own IRA" elections. ............................................................. 30
1. Rollover by surviving spouse................................................................................ 31
a. Required minimum distributions may not be rolled over. ............................ 31
b. EGTRRA update – eligible retirement plans. ............................................... 32
c. Minimum required distributions from the spouse's rollover
IRA................................................................................................................ 32
d. Rescue rollovers if surviving spouse is "in control". .................................... 32
e. Direct rollovers - references to "rollover" made above are
generic in nature............................................................................................ 33
2. Election by surviving spouse to make a deceased participant's IRA
the spouse's IRA.................................................................................................... 33
a. Required distributions for year "own IRA" election is made........................ 34
b. How the "own IRA" election is made. .......................................................... 34
c. Own IRA election only available if spouse is the individual
beneficiary..................................................................................................... 35
D. Choosing between the alternatives available to a surviving spouse. ............................ 35
1. Rollover "reloads" the life expectancy deferral opportunity................................. 35
2. Planning for a young surviving spouse of a participant who dies
prior to the RBD.................................................................................................... 35
a. Private letter rulings require a choice............................................................ 35
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1-iv
b.
3.
Rollover to multiple IRAs to obtain penalty free distribution
and deferral.................................................................................................... 36
c. More recent ruling position permits deferred "own IRA"
election. ......................................................................................................... 36
Planning for an older spouse of a participant who dies before the
RBD. ..................................................................................................................... 36
V. IRA AND QUALIFIED PLAN PROVISIONS..................................................................... 37
A. Overview....................................................................................................................... 37
1. Agreements conforming to final regulations......................................................... 37
2. Oversight required to integrate estate planning. ................................................... 37
B. IRA agreement provisions. ........................................................................................... 38
1. Participant designates primary and contingent beneficiaries as of
participant's death.................................................................................................. 38
2. The surviving beneficiary usually names successor beneficiaries........................ 38
3. On beneficiary's death, the default beneficiary is beneficiary's estate.................. 38
a. Minimum required distributions not accelerated. ......................................... 38
b. Beneficiary's beneficiary designation desirable. ........................................... 38
4. Provisions for surviving spouses........................................................................... 39
a. Risk of five-year rule applying. .................................................................... 39
b. Payment over spouse's (or participant's) fixed life expectancy..................... 39
c. Durable powers of attorney........................................................................... 39
5. Planning and presumption provisions. .................................................................. 39
C. Qualified plan provisions. ............................................................................................. 40
1. Model amendment for defined contribution plans. ............................................... 40
2. Elimination of plan deferred payment options...................................................... 40
VI. RULES FOR NAMING TRUSTS AS BENEFICIARIES .................................................... 41
A. Qualifying a trust for the "look through" rules. ............................................................ 41
1. The four requirements. .......................................................................................... 41
2. Documentation requirements. ............................................................................... 41
a. After death requirements............................................................................... 41
b. One time opportunity to cure defective documentation –
October 31, 2003 deadline. ........................................................................... 42
c. Lifetime minimum required distributions – trust for ten years
younger spouse.............................................................................................. 42
B. Identifying the look through designated beneficiaries.................................................. 42
1. Applying the designated beneficiary definition to trust
beneficiaries – in general. ..................................................................................... 43
2. Disregarding contingent beneficiaries – death contingency nontrust
rules. ...................................................................................................................... 43
a. 2001 regulations. ........................................................................................... 43
b. Final regulations............................................................................................ 43
3. Disregarding contingent trust beneficiaries – death contingency in a
trust setting. ........................................................................................................... 44
a. The "normal" meaning of "contingent" does not apply. ............................... 44
b. Charities as remainder beneficiaries. ............................................................ 44
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Institute of Continuing Legal Education
4.
C.
D.
Identifying all trust beneficiaries. ......................................................................... 44
a. The erratic evolution of rules to permit certain contingent trust
beneficiaries to be disregarded...................................................................... 45
b. Disregarding identified younger beneficiaries – The Example 1
"flat earth" trust. ............................................................................................ 45
c. The actuarial approach - if a trust is to terminate within the life
expectancies of identifiable beneficiaries, may certain
successor beneficiaries be disregarded?........................................................ 46
d. It cannot be assumed that a beneficiary will survive to a stated
age. ................................................................................................................ 47
e. Disregarding contingent beneficiaries under the "snapshot"
approach. ....................................................................................................... 47
f. Trusts that defer termination for minor beneficiaries. .................................. 48
g. Can any trust beneficiary, however remote the interest, be
disregarded if trust termination is deferred? ................................................. 48
5. Are the potential beneficiaries of unexercised powers of
appointment taken into account?........................................................................... 49
a. Limiting permissible appointees. .................................................................. 49
b. Disclaiming a special power. ........................................................................ 50
c. GST nonexempt trusts................................................................................... 50
6. Use of benefits to pay estate expenses. ................................................................. 50
a. Payment of estate expense by a trust prior to the designation
date. ............................................................................................................... 51
b. State law creditor protection. ........................................................................ 51
c. State law creditor protection with actual expense payment. ......................... 51
7. Dynasty trusts and an expanding class of beneficiaries. ....................................... 51
8. Section 645 election. ............................................................................................. 52
9. Recognizing separate trusts created under a single trust agreement as
separate beneficiaries. ........................................................................................... 52
a. Private letter rulings refuse to recognize separate trusts created
on participant's death..................................................................................... 52
b. Naming ultimate trust or subaccount in beneficiary designation.................. 53
c. Formula allocations to resulting trusts. ......................................................... 53
10. Changing a trust's look through beneficiaries during the window
period. ................................................................................................................... 53
a. Payment by trust of estate taxes and estate expenses.................................... 54
b. Payment of charitable bequests. .................................................................... 54
c. Partial disclaimer or release of nongeneral powers of
appointment................................................................................................... 54
11. Estates do not qualify for the look through rules. ................................................. 55
QTIP trusts named as beneficiaries............................................................................... 55
1. Revenue Ruling 2000-2. ....................................................................................... 55
2. Productivity of plan/IRA assets. ........................................................................... 55
3. Identification of "trust accounting income" in IRAs and qualified
plans. ..................................................................................................................... 56
4. Disadvantages of QTIP trust as beneficiary.......................................................... 56
Drafting "safe harbor" trusts to receive plan and IRA benefits. ................................... 57
1. Conduit trusts. ....................................................................................................... 57
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a.
2.
3.
4.
Continuing conduit shelter trusts for descendants. ....................................... 58
i.
Conduit trust controls flow of plan/IRA distribution. ......................... 58
ii.
Conduit distributions cease on designated beneficiary's
death..................................................................................................... 58
iii. Example retirement benefit conduit subtrust....................................... 58
iv. Caveat re trustee authority................................................................... 58
v.
Provisions for taxes and expenses. ...................................................... 59
b. Conduit QTIP trusts. ..................................................................................... 59
i.
Disadvantages...................................................................................... 59
ii.
Advantage............................................................................................ 59
"Individuals only" (nonconduit) subtrusts. ........................................................... 59
a. Specified termination in favor of individual beneficiaries............................ 60
b. Oldest descendant as designated beneficiary. ............................................... 60
c. Limiting "older" spouse beneficiaries and appointees. ................................. 60
d. Subtrust administration. ................................................................................ 60
e. Example nonconduit subtrust........................................................................ 60
"Example 1" trust. ................................................................................................. 60
a. Possible use of example 1 trusts for marital-bypass primary
planning......................................................................................................... 61
b. Implications of example 1 trust as a model................................................... 61
Using trusts that do not qualify for the look through rules. .................................. 61
VII. ASSESSING DEATH BENEFIT PLANNING ALTERNATIVES...................................... 61
A. Balancing the planning objectives. ............................................................................... 61
1. The participant's dispositive goals. ....................................................................... 62
2. The participant's transfer tax goals........................................................................ 62
3. Income tax and investment goals. ......................................................................... 62
B. Integrating plan and IRA benefits into a trust based estate plan................................... 62
1. Revocable trust disclaimer method – disqualified trusts where
surviving spouse's welfare is chief concern. ......................................................... 62
a. Ignoring the look through rules..................................................................... 63
b. Revocable trust disclaimer method. .............................................................. 63
i.
The beneficiary designation................................................................. 63
ii.
Required governing trust instrument provisions. ................................ 64
c. Distribution from separate accounts for marital and nonmarital
trusts. ............................................................................................................. 66
2. Disclaimer plan where a portion of benefits are needed to fund a
bypass trust............................................................................................................ 66
a. Premium on immediate post-death planning................................................. 66
b. Two approaches to initial beneficiary named. .............................................. 66
c. Example beneficiary designation naming bypass trust first.......................... 67
d. Post-death evaluation of marital trust or spousal rollover. ........................... 67
e. Creation of separate accounts if one trust is qualified. ................................. 67
3. Conduit and nonconduit subtrusts of continuing shelter trusts. ............................ 67
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OVERVIEW AND BACKGROUND
A. Overview of minimum distribution rules.
The minimum required distribution ("MRD") rules of Internal Revenue Code ("Code")
section 401(a)(9) set the outer limits as to the deferral of the commencement and distribution of qualified plan and IRA benefits which a plan sponsor (or IRA custodian, trustee, or
issuer) may adopt in a plan or IRA agreement. The proposed Treasury regulations issued
in 2001 (referred to in this outline as the "2001 regulations") provided the first comprehensive reinterpretation of the MRD rules since the 1987 proposed Treasury regulations (the
"1987 regulations") were published shortly after the current wording of the minimum distribution rules became effective in 1985. The final (and temporary) regulations, published
on April 17, 2002 (the "final regulations"), further simplified the provisions of the 2001
regulations, sometimes to the participant's benefit and sometimes not. On June 15, 2004,
new regulations regarding payments in annuity form, replacing and improving upon
temporary and proposed regulations, were published together with a clarification to the
final regulation's rules for creating separate accounts after a participant's death. This outline principally focuses on how the final regulations affect estate planning for defined contribution plan participants and IRA accountowners (generally referred to in this outline as
plan or IRA "participants").
1. Rules simplified.
Under the final regulations, the measurement of the maximum "applicable distribution
period" over which plan and IRA benefits may be distributed depends upon the identity of
the participant's designated beneficiary, if any, and whether payments are being made
during the participant's lifetime or following the participant's death. Exhibit A to this outline gives a snapshot of the rules and sections II through IV below discuss these rules in
detail.
a. Lifetime distributions.
Beginning in a participant's first distribution calendar year and continuing through the distribution calendar year of the participant's death, distributions for each year are to be made
in one of two ways.
i.
Uniform lifetime table.
In most cases, distributions are determined using the distribution period shown on the uniform lifetime table for the age attained by the participant in the calendar year of distribution.
ii.
Ten years younger spouse.
In the case of a participant who has a spouse who is more than ten years younger than the
participant, distributions are determined in accordance with the joint life expectancy of the
participant and spouse based on the ages attained in the year of each distribution.
b. Distributions following the participant's death.
Following the participant's death, the amount of required distributions for the distribution
calendar year following the year of the participant's death and subsequent calendar years
depends upon the identity of the participant's designated beneficiary, if any, and whether
the participant dies prior to or after the required beginning date (the "RBD").
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i.
Nonspouse designated beneficiary.
If the participant has a designated beneficiary other than the participant's spouse or in addition to the participant's spouse, distributions are made over (i) the fixed life expectancy
of the participant's oldest designated beneficiary or (ii) over the fixed life expectancy of the
participant, if longer (if the participant dies on or after the RBD) or over the fixed life expectancy of the participant's oldest designated beneficiary (if the participant dies before the
RBD).
ii.
No designated beneficiary.
If the participant has no designated beneficiary, distributions are made over the remaining
fixed life expectancy of the participant (if the participant dies on or after the participant's
RBD) or distributions must be made before the end of the fifth calendar year following the
year of the participant's death (if the participant dies before the RBD).
iii.
Spouse is sole designated beneficiary.
If the participant's spouse is the sole designated beneficiary, distributions during the
spouse's survivorship period (including the year of the spouse's death) are to be made over
the spouse's redetermined life expectancy using the uniform lifetime table for the age attained (or which would have been attained) in the year of distribution, provided, if the participant dies after the RBD, the participant's remaining fixed life expectancy applies, if
longer. Upon the spouse's death, distributions beginning in the year after the spouse's
death are to be made over the remaining fixed life expectancy of the spouse. A spouse
may also (or alternatively) convert an IRA to the spouse's own account or roll over plan or
IRA benefits to the spouse's own IRA or plan account in which case the MRD rules apply
to the spouse as a participant.
2. Plan and IRA agreement provisions.
A plan or IRA agreement does not need to provide for the maximum deferral available under the MRD rules. Plans may accelerate the otherwise required commencement of benefits and may limit the period over which benefits may be distributed. A required lump sum
distribution on the RBD or shortly following the participant's death satisfies the MRD
rules. Similarly, many plan and IRA agreements provide that benefits will be distributed
upon a beneficiary's death. For these reasons and, in the case of qualified plans which are
subject to the spousal rights requirements of Code sections 401(a)(11) and 417, it is necessary to review the plan agreement (or a summary plan description) or the IRA agreement to
determine the deferral options available to a participant or beneficiary.
3. The 50% penalty.
Under Code section 4974(a), a 50% tax is imposed (on the payee of the benefits) on the
amount of any MRD to the extent the required amount is not actually distributed. The IRS
has the power to waive the imposition of the excise tax if the distribution shortfall was due
to reasonable error and reasonable steps are being taken to remedy the shortfall. Treas reg
54.4974-2, A-7(a).
4. Aggregation of multiple IRAs.
In Notice 88-38 (1988-1 CB 524), it was provided that, for purposes of determining the
minimum required distributions for an IRA accountowner, all IRAs which the individual
held as an accountowner as well as all IRAs created by another (deceased) accountowner
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of which the individual was beneficiary were to be aggregated and that the aggregate
minimum distribution required could be distributed from any one or more of the IRAs involved.
a. Former planning strategy.
Under the Notice 88-38 aggregation rules, it was possible for a surviving spouse who was
an accountowner of one or more IRAs and a beneficiary of one or more IRAs established
by a deceased spouse to satisfy the minimum required distribution for a distribution calendar year by receiving distributions from IRAs of which the spouse was a beneficiary.
Since the distribution period that applied to the IRA of which the spouse was beneficiary
was typically shorter than the distribution period for IRAs established by the spouse
(which might name children as designated beneficiaries), such a distribution choice preserved the balance of the IRA or IRAs which had the longer distribution period.
b. New IRA aggregation rule.
Under the final regulations, the aggregation rule is modified to state that only (i) IRAs of
which an individual is the accountowner or (ii) IRAs that an individual holds as a beneficiary of the same decedent and are being distributed over the same period may be aggregated. Treas reg 1.408-8, A-9. This aggregation rule may produce beneficial results in
cases where benefits are payable from separate accounts established by the deceased participant for a beneficiary that do not qualify for the separate share rule. See paragraph
VII.B.1.c below.
5. Final regulations and estate planning.
Under the 1987 regulations, the fact that a participant had to select and lock in the identity
of the participant's oldest designated beneficiary on the participant's RBD meant that many
participants made this decision without an awareness of the estate planning implications
involved. Moreover, even if advice was sought, there was no effective means of adjusting
for changes in the participant's family's circumstances which occurred between the RBD
and the participant's subsequent date of death.
a. Disclaimer planning available to all participants.
Under the 1987 regulations, the opportunity to change a participant's potential oldest designated beneficiary following the participant's death by means of having a named beneficiary or beneficiaries disclaim benefits in order to permit another named beneficiary to become the participant's oldest designated beneficiary only was effective in the case of a participant who died prior to the RBD. Under the final regulations, all participants, regardless
of whether or not minimum required distributions have commenced, can generally take advantage of the disclaimer technique so as to permit an optional distribution of plan and
IRA benefits to occur after the participant's death when all of the facts and circumstances
are known.
b. Integration of benefits into estate plan.
As discussed in detail in section VI below, the final regulations do not address many of the
numerous questions that have surfaced over the last several years regarding the naming of
trusts as beneficiaries of plan and IRA benefits and the application of the "look through"
rules to determine a participant's designated beneficiary. However, by providing that the
determination of the identity of the participant's designated beneficiary is not determined
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until September 30 of the calendar year following the calendar year of the participant's
death (referred to in this outline as the "designation date"), the final regulations permit
those estate planners who prefer to have plan and IRA benefits be distributed to trusts for
family members to provide for a method of changing or eliminating trusts as beneficiaries
during the 9 to 21 month window period between the participant's death and the designation date should the look through rules as finally determined prove unworkable.
B. History of the MRD rules – Code.
The precursor to the current wording of Code section 401(a)(9) was the original version of
that section which, under the 1954 Code, applied to employees under plans in which self
employed individuals described in Code section 401(c) were participants. Individual retirement accounts ("IRAs") as initially introduced contained similar MRD rules (but included special rules for a participant's surviving spouse). Code §408 adopted by section
2002(b) of the Employee Retirement Income Security Act of 1974 ("ERISA") PL 93-406.
(i)
The Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA", PL 97248) extended the MRD rules to all qualified plans.
(ii)
Effective for plan years after December 31, 1984, section 521(a)(1) of the
Deficit Reduction Act of 1984 ("DEFRA", PL 97-248) retroactively repealed section 401(a)(9) enacted by TEFRA and adopted the present
wording of section 401(a)(9) with the exception of the definition of "required beginning date" as it applies to employees other than five percent
owners (as discussed in II.B below).
(iii)
Section 521(b)(1) of DEFRA deleted the separate statement of MRD rules
for IRAs and adopted the present wording of Code section 408(a)(6) which
reads:
"Under regulations prescribed by the Secretary, rules similar to the rules of section
401(a)(9) and the incidental death benefit requirements of section 401(a) shall apply to
the distribution of the entire interest of an individual for whose benefit the trust is
maintained."
(iv)
The Tax Reform Act of 1986 (TRA 86, PL 99-514) extended (by cross
reference) the MRD rules to tax sheltered annuities and to certain plans of
state and local governments and tax exempt organizations, effective for
years beginning after December 31, 1988. §1852(a)(3)(A) and §1107(a)
adopting new Code §403(b)(10) and amending Code §457(d)(2).
C. Incidental death benefit rule.
Recognizing that the primary purpose of Code section 401 was to provide retirement benefits for participants, Treasury regulations 1.401-1(b)(1) provide that the benefits payable to
an employee must be incidental to the primary purpose of distributing the accumulated
funds to the employee. The "incidental death benefit" rule, the only pre section 401(a)(9)
rule which served as the means of assuring that tax deferred benefits served the intended
retirement benefit objective, was set forth in Revenue Ruling 72-241 (1972-1 CB 108):
"It is held that any settlement option under…a plan…will meet the requirement of
section 1.401-1(b)(1) of the regulations that benefits payable to the beneficiary of an
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employee must be incidental to the primary purpose of distributing accumulated funds to
the employee, if it contains certain provisions whereby the present value of the payments
to be made to the participant is more than 50 percent of the present value of the total
payments to be made to the participant and his beneficiaries."
The incidental death benefit rule is satisfied if payments from a qualified plan or IRA comply with the MRD rules. Treas reg 1.401(a)(9)-5, 1.40(a)(9)-6T. When TEFRA imposed
the initial version of the MRD rules, participants were entitled to make an election under
TEFRA section 242(b)(2) to specify a form of benefit payment permissible under the preTEFRA incidental death benefit rule, which, if unchanged, would be grandfathered (for
example, to distribute the entire account balance at the date the participant attained the age
that represented one half of the participant's life expectancy at the time of the election).
The final regulations contain provisions regarding the impact on section 242(b) elections
of plan to plan transfers, rollovers, and revocations. Treas reg 1.401(a)(9)-8, A-14, 15, and
16.
D. Proposed and final Treasury regulations – scope and effective dates.
1. The 1987 regulations.
Proposed Treasury regulations with respect to the MRD rules were published on July 27,
1987 under Code sections 401(a)(9), 403(b), 408, and 4974 (52 FR 28070) and were
amended on December 30, 1997 (62 FR 67780) to revise the requirements of the "look
through" rules applicable to trusts named as beneficiaries. These former proposed regulations are referred to in this outline as the "1987 regulations". These previously proposed
regulations were completely replaced by the proposed regulations issued in 2001.
2. The 2001 proposed Treasury regulations.
New proposed regulations (referred to in this outline as the "2001 regulations") were published in the Federal Register (REG-130477-00 and REG-130481-00) on January 17, 2001.
Prop Treas regs 1.401(a)(9)-0 through 8, 1.403(b)(2)-2, 1.408-8, and 54.4974-2. The 2001
regulations applied to all qualified plans, IRAs, tax sheltered annuities, and Code section
457(d) plans. The 2001 regulations are generally effective for plan and IRA distributions
that occur on or after January 1, 2002. Proposed regulations for eligible government and
tax exempt employer plans were published on May 8, 2002. Prop reg 1.457-6(d).
3. The final regulations.
The final regulations (and temporary regulations relating to defined benefit plans) were
published on April 17, 2002. 67 Fed Reg 18, 988.
a. Scope – qualified plans, IRAs, tax sheltered annuities, and section
457 plans.
The final regulations (as was the case for the 2001 regulations) apply to all qualified plans
(stock bonus, pension, and profit sharing plans), IRAs, tax sheltered annuities, and eligible
Code section 457(d) plans. Treas reg 1.401(a)(9)-1, A-1. Final regulations for section
457(d) plans were published on July 11, 2003. Treas reg 1.457-6(d). The portion of the
final regulations adopted in 2004 are generally effective for amounts distributed in 2003
and later years. However, a distribution from a defined benefit plan or annuity contract for
calendar years 2003, 2004, or 2005 may be made based on reasonable and good faith inter1-5
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pretation of section 401(a)(9) and need not conform to the final regulations promulgated in
2004.
b. Effective dates.
The final regulations are effective for plan and IRA distributions made in calendar years
beginning on or after January 1, 2003. Treas reg 1.401(a)(9)-1, A-2.
i.
Benefits with respect to pre-January 1, 2003 decedents.
If a participant died before January 1, 2003, the identity of the participant's oldest designated beneficiary, if any, and the applicable distribution period for 2003 and future years
must be reconstructed under the final regulations. The amount of required distributions
measured by a single designated beneficiary's life expectancy will be reduced. A beneficiary whose applicable distribution period was determined under the 1987 rules based on the
fixed joint life expectancy of a participant and beneficiary will be measured by a single
fixed life expectancy and, even under the new tables, the amount of distributions will
likely increase.
ii.
Qualified plan amendments.
Defined contribution plans must be amended to incorporate the final regulation's MRD rule
provisions on or before the last day of the plan year beginning on or after January 1, 2003
(that is, December 31 for a calendar year plan). Rev Proc 2002-29, 2002-24 IRB 1176.
Defined benefit plans need not be amended to comply with the final and temporary regulations until the end of the EGTRRA remedial amendment period (not sooner than the last
day of the 2005 plan year). Rev Proc 2003-10, 2003-2 IRB 1.
iii.
IRA agreement amendments.
Pre-EGTRRA and pre-final minimum required distribution regulation IRA agreements
may not be used to establish an IRA after October 1, 2002. Announcement 2002-49, 200219 IRB 919 (04/19/02) modifying Rev Proc 2002-10, 2002-4 IRB 401 (01/03/02).
iv.
Year 2002.
The preamble to the final regulations provides that taxpayers for 2002 distributions may
rely upon the final regulations, the 2001 regulations, or the 1987 regulations. Thus, IRA
accountowners were able to use the final regulations' distribution tables for 2002.
However, qualified plan participants could use the final regulations' tables only if the plan
was amended to adopt them effective for 2002 even if those provisions were adopted retroactively by the end of the 2003 plan year. Rev Proc 2002-29, 2002-24 IRB 1176.
c. 2004 changes to final regulations.
On June 15, 2004, final regulations regarding annuity payments from defined benefits
plans (and from annuity contracts purchased with the balances of defined contribution plan
accounts) were promulgated to replace and liberalize the temporary regulations published
in 2002. In addition, special rules were adopted clarifying the establishment of separate
accounts for purposes of the separate shares and the treatment of qualified domestic relations orders. Regs §1.401(a)(9)-8 and 1.409(a)(9)-6. 69 Fed Reg 33,288. These regulations are effective in the same manner as the 2002 final regulations described in paragraph
b above.
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II. DISTRIBUTIONS DURING THE PARTICIPANT'S LIFETIME
A. Code section 401(a)(9)(A) reinterpreted.
Code section 401(a)(9)(A) provides that, on or before participant's RBD, the entire interest
of the participant must:
(i)
Be distributed to the participant or
(ii)
Be distributed, beginning on or before the RBD over:
(a)
The life of the participant,
(b)
The lives of the participant and a designated beneficiary,
(c)
A period not extending beyond the life expectancy of the participant,
or
(d)
A period not extending beyond the joint life expectancy of the participant and a designated beneficiary.
1. Application to defined contribution plans.
In the case of defined contribution plans and IRAs, distributions were generally measured
under the 1987 regulations by one of the life expectancy periods [paragraph (ii)(c) or (d)
above], depending upon whether or not the participant, in fact, had a designated beneficiary on the RBD, unless the application of the qualified joint and survivor rules required the
purchase of an annuity contract (required in the case of a money purchase pension plan to
apply to at least one half of a participant's account unless the participant, with spousal consent, waives the requirement).
a. The final regulations adopt longest statutory distribution period.
With one exception, the uniform lifetime table described in paragraph C below applies to
all distributions during the participant's lifetime and treats each participant as if the participant had named a nonspouse beneficiary who was more than ten years younger than the
participant under the 1987 proposed regulations' minimum distribution incidental benefit
rule ("MDIB rule") regardless of the actual identity of the participant's beneficiary or
whether or not there is a beneficiary. The exception, which applies the joint life expectancy of a participant and a spouse sole designated beneficiary who is more than ten years
younger than the participant as described in paragraph D below, is also consistent with the
1987 proposed regulations in that the MDIB rules did not apply when a spouse was the
designated beneficiary.
(1)
The preamble to the 2001 regulations explains that allowing the use of the uniform lifetime table reflects the facts
that the participant may retain the ability to change beneficiaries until the participant's death occurs and ultimately
may select a beneficiary who is more than ten years
younger. While a participant's right to change beneficiaries was recognized under the 1987 regulations, a post RBD
change to a beneficiary who was younger than the beneficiary being replaced was not respected for MRD rule pur-
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poses, the younger beneficiary's life expectancy being disregarded. Prop Treas reg 1.401(a)(9)-1, A-5(c).
(2)
The 2001 regulations' interpretation literally meets the
wording of Code section 401(a)(9)(A)(ii)(D) in that a distribution may be made over "a period not extending beyond the life expectancy of such employee and a designated beneficiary" (emphasis added) rather than referring
to the participant's specifically named designated beneficiary.
b. No elections to recalculate life expectancies need be made.
Under the 2001 and the final regulations, minimum required distributions made during the
participant's lifetime over a period measured by the life expectancies of the participant and
a hypothetical ten years younger beneficiary (or the participant's more than ten years
younger spouse) are redetermined annually (that is, "recalculated" within the meaning of
the 1987 regulations). The life expectancy of the participant's spouse who is the participant's sole beneficiary is similarly redetermined during the spouse's survivorship period.
Thus, the previously elective life expectancy recalculations, where applicable, are built into
the 2001 and final regulations' applicable distribution periods and no elections to recalculate life expectancies are permitted or required. Under the 1987 regulations, the election to
recalculate life expectancy (which effectively assured that the participant's account balance
would not be depleted during the participant's lifetime) could also result in the unexpected
acceleration of benefit payments on the participant's death.
2. Application to defined benefit plans and payments from annuity
contracts.
Defined benefit plan benefits are typically paid in the form of nonincreasing annuity payments under paragraph (A) or (B) of Code section 401(a)(9)(A)(ii), either directly from the
plan or by the purchase and distribution of an annuity contract. Defined contribution plans
may also permit a participant's account balance to be used to purchase an annuity contract.
The 2001 and the temporary regulations essentially continue the 1987 regulations' requirements that an annuity form of payment must meet to satisfy the MRD rules. Prop
Treas reg 1.409-6; Temp reg 1.409-6T. Under the 2001 regulations, a defined benefit plan
that provides for a nonannuity form of benefit payment is governed by the rules applicable
to defined contribution plans. Prop Treas reg 1.401(a)(9)-6, A-1(e). The deletion of this
provision from the temporary regulations as a rule having little application drew numerous
protest letters. In response, final regulations containing more flexible provisions were
adopted in 2004. Treas Reg 1.401(a)(9)-6.These rules are not discussed in detail in this
outline which focuses on the application of the new rules of defined contributions plans
and IRAs.
B. Required beginning date (RBD).
The term "required beginning date" is defined in Code section 401(a)(9)(C)(i) to mean
April 1 of the calendar year following:
(i)
In the case of an IRA accountowner or a five percent owner plan participant, the calendar year in which the participant attains age 70 1/2 or
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(ii)
In the case of a non five percent owner plan participant, the calendar year in
which the participant retires from employment with the employer maintaining the plan.
A five percent owner is an employee who is a five percent owner within the meaning of
Code section 416 with respect to the plan year ending in the calendar year in which the
employee attains age 70 1/2. Treas reg 1.401(a)(9)-2, A-2(c).
1. Non five percent owner participants.
The application of the definition of the RBD to non five percent owner participants is the
only aspect of Code section 401(a)(9) which has changed since the present wording of the
section was enacted, effective for plan years beginning after December 31, 1984. The
postponement of the RBD for a non five percent owner participant until the year after a
post-age 70 1/2 retirement was deleted from the 1985 wording of the section by section
1121(b) of the Tax Reform Act of 1986 (PL 99-514), effective for plan years beginning
after December 31, 1988. Section 1404(a) of the Small Business Job Protection Act of
1996 (PL 104-188) effectively reinstated the pre-1989 definition of RBD for non five percent owners.
2. Plans may require RBD after age 70 1/2.
The 2001 and the final regulations, consistent with Notice 96-67 (1996-2 CB 235), permit
a plan to provide that the RBD for all employees will be April 1 of the calendar year following the calendar year in which the participant (whether or not a five percent owner) attains age 70 1/2. Treas reg 1.401(a)(9)-2, A-2(e).
a. Plan's RBD applies to characterize postdeath distributions.
If the plan so provides, an over age 70 1/2 non five percent owner participant who dies
prior to the end of the calendar year following the participant's retirement will nonetheless
be considered to have died after the participant's RBD for purposes of determining postdeath minimum required distributions. Treas reg 1.401(a)(9)-2, A-6(b).
b. Character of amounts paid after plan RBD but before code RBD.
If an over age 70 1/2 non five percent owner participant who has not retired and is a participant in a plan that has set the RBD for all participants as April 1 of the calendar year
following the calendar year in which a participant attains age 70 1/2 receives distributions
from the plan for the calendar year in which age 70 1/2 is attained (or any later calendar
year prior to the year following the year of retirement), may the participant roll these distributions over to an IRA? Under Code section 402(c)(4)(B), a plan distribution is not an
eligible rollover distribution to the extent it is a minimum required distribution under Code
section 401(a)(9)(C).
(1)
Since distributions are not required under Code section
401(a)(9)(C) in the case of working non five percent
owner participants, amounts distributed are generally eligible rollover distributions.
(2)
However, Code section 402(c)(4)(A) provides that an
eligible rollover distribution shall not include any distribution which is a series of substantially equal periodic pay1-9
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ments (not less frequently than annually) made over a life
expectancy or life expectancies or for a period of ten or
more years. Under section 1.402(c)-2 of the Treasury
regulations, if amounts are distributed in a series of payments equal to minimum required distributions, the payments will be considered equal periodic payments within
the meaning of Code section 402(c)(4)(A), thus foreclosing rollover.
(3)
If such distributions are eligible rollover distributions (because they are not periodic payments or to the extent that
the amount exceeds the minimum required distribution
amount), the 20% income tax withholding requirement of
Code section 405(c) will apply unless a direct rollover of
the amount involved is made. See Notice 97-75 (1997-51
IRB 1).
C. The uniform lifetime table.
Except in the case of a participant who has as his or her sole beneficiary a spouse who is
more than ten years younger, the 2001 and the final regulations provide that the distribution required to be made for any distribution calendar year through and including the distribution calendar year of the participant's death, is determined by dividing the participant's
account balance as of the preceding calendar yearend by the "applicable determination period" shown on the table (reproduced as exhibit B) for the age attained by the participant in
the distribution calendar year involved. Reg 1.401(a)(9)-5, A-1 and 4. The final regulations responded to the mandate of section 634 of EGTRRA by introducing new life expectancy tables that reflect year 2000 mortality factors. Treas reg 1.401(a)(9)-9.
1. Distribution calendar year.
A "distribution calendar year" is a calendar year for which a minimum distribution is required. The first distribution calendar year is the calendar year preceding the calendar year
in which the RBD occurs – that is, the calendar year in which the participant attains age
70 1/2 (or, in the case of a non five percent owner who participates in a qualified plan that
permits, the calendar year of the participant's retirement, if later). Treas reg 1.401(a)(9)-5,
A-1(b).
2. Payment of distribution for first distribution calendar year.
A distribution required to be made on or before a participant's RBD (whether made in the
first distribution calendar year or in the second distribution calendar year prior to the
April 1 RBD) is treated as a distribution required for the first distribution calendar year.
The distribution required to be made for the second and all later distribution calendar years
must be made before the end of the calendar year involved. Treas reg 1.401(a)(9)-5, A1(c).
In order to avoid the inclusion of two distributions, one for the first distribution calendar
year and one for the second distribution calendar year in the participant's second
distribution calendar year's taxable income, the initial required distribution should be
made before the end of the first distribution calendar year.
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3. Prior yearend account balance.
In the case of an IRA, the prior calendar yearend account balance is the amount by which
the applicable determination period for the participant's attained age is divided to determine the minimum distribution required.
a. Plan postvaluation date adjustments.
In the case of a qualified plan, the prior year divisible account balance is determined as of
the last plan valuation date to occur in the preceding distribution calendar year, increased
by any contributions or forfeitures allocated to the account (provided that contributions
allocated as of a date subsequent to the valuation date may be disregarded) and decreased
by distributions made after the valuation date and before the calendar yearend. Treas reg
1.401(a)9-5, A-3.
b. Adjustment to second year account balance for pre-RBD distributions eliminated by final regulations.
In the case of a distribution made in the participant's second distribution calendar year
from an IRA or from a plan under the 1987 and 2001 regulations, the prior yearend account balance was reduced by any portion of the minimum required distribution for the
participant's first distribution calendar year made in the second distribution calendar year
on or before the April 1 RBD. Prop Treas reg 1.401(a)(9)-5, A-3. Under the final regulations, in order to simplify the computation of the distribution for a participant's second distribution calendar year, a pre-RBD distribution made in the second distribution calendar
year is now disregarded and the second year distribution is based on the prior yearend account balance unreduced by any minimum required distribution made early in the second
year. Thus, deferring the initial minimum required distribution to the year of the RBD not
only results in two distributions being included in the participant's taxable income for the
second distribution calendar year but also increases the amount of the second distribution.
Compare prop Treas reg 1.401(a)(9)-5, A-3(c)(2) to Treas reg 1.401(a)(9)-5, A-3.
c. Adjusting for rollovers.
The rules regarding rollovers and plan to plan transfers are coordinated with the rules for
determining the account balance on which minimum distributions are computed.
(1)
In the case of a rollover or transfer which occurs in a
distribution calendar year of a participant, the transferring
plan or IRA is required to make a minimum required distribution for the year of transfer (based upon that plan's or
IRA's prior yearend account balance) and the receiving
plan's yearend account balance for purposes of any minimum required distribution for the year of rollover or transfer is not increased by the rollover amount.
(2)
The transferee plan's prior yearend account balance used to
determine its minimum required distribution for the distribution calendar year following the year of rollover or
transfer will include the rollover amount (in the case of a
transfer received by a plan after the last valuation date in
the year of receipt, by increasing the valuation date ac1-11
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count balance by the value at time of receipt of the transferred amount).
(3)
In the event of overlapping distribution calendar years
(that is, the distribution by a transferring plan in one year
and the receipt of the transfer by the receiving plan in the
following distribution calendar year), the transferred
amount is deemed to be received by the transferee in the
distribution calendar year in which the amount was distributed by the transferring plan. Treas reg 1.401(a)(9)-7,
A-1, 2, 3, and 4.
D. More than ten years younger spouse as sole beneficiary.
If the participant's spouse is the sole designated beneficiary of the participant's entire interest in the plan or IRA (or of a separate share of such interest) at all times during a distribution calendar year, the applicable distribution period is the longer of the applicable distribution period determined by the uniform lifetime table or the joint life expectancy period
determined by the attained ages of the participant and the spouse in such year. Treas reg
1.401(a)(9)-5, A-4(b). Joint life expectancy factors, found in the Joint and Last Survivor
Table in Treasury regulation 1.401(a)(9), A-3, will produce a longer distribution period if
the spouse is 11 or more years younger than the participant. Treas reg 1.401(a)(9)-5, A6(a).
1. The "at all times" requirement.
If the participant's spouse ceases to be married to the participant or ceases to be the participant's sole beneficiary during any distribution calendar year, the uniform lifetime table applies to determine that year's minimum required distribution. Relaxing the rule in the 2001
regulations that, in order for the Joint and Last Survivor Table to apply, the participant and
a more-than-ten-years-younger spouse who is the participant's sole designated beneficiary
must be married during the entire calendar year, the final regulations permit the joint life
table to apply for the year in which either the participant or spouse dies as long as the
couple is married on January 1. The joint life table also applies in the year of a couple's
divorce but apparently only if no successor beneficiary is designated during that calendar
year. Treas reg 1.401(a)(9)-5, A-4(b).
2. Can a trust for the spouse's benefit be designated beneficiary?
The preamble to the final regulations, in connection with the summary of the documentation rules which must be met to qualify a trust for the look through rules described in section VI.A.2 below, points out that the end of the calendar year following the calendar year
of the participant's death (referred to in this outline as the "designation date") is the deadline for complying with the trust documentation requirements for all purposes "unless the
lifetime distribution period for an employee is measured by the joint life expectancies of
the employee and the employee's spouse" (Trust as Beneficiary – second sentence).
However, the provisions of the final regulations that address the applicable distribution
period that applies when the participant's sole designated beneficiary is a spouse who is
more than ten years younger do not refer to trusts for the benefit of such a spouse.
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a. Reasons to name a trust for the spouse as beneficiary.
If a participant does not want the surviving spouse to have full access to plan or IRA benefits following the participant's death because:
(1)
The spouse is a spendthrift, suffers from an addiction
(such as compulsive gambling), or is incapacitated or
(2)
The participant wishes to preserve to the greatest extent
possible the benefits that remain upon the spouse's later
death for disposition remainder beneficiaries,
the trust intended to accomplish these objectives must be named as beneficiary prior to the
participant's death. The final regulations provide that "[F]or example, if a distribution is in
the form of a joint and survivor annuity over the life of the employee and another individual, the plan does not satisfy section 401(a)(9) unless such other individual is the designated individual under the plan". Treas reg 1.401(a)(9)-4, A-1.
b. Naming a "conduit" trust as beneficiary.
See the discussion of naming a conduit trust (probably qualifies), a QTIP trust (will not
qualify), or a conduit QTIP trust (probably qualifies) in paragraph IV.B.3.c below and the
rules for qualifying a trust for the look through rules in paragraph VI.A.2.c below.
III.
DISTRIBUTIONS FOLLOWING THE PARTICIPANT'S
DEATH –SPOUSE IS NOT SOLE BENEFICIARY
A. Overview.
As under the rules of the 1987 and the 2001 regulations, the applicable distribution period
that applies following a participant's death depends upon whether or not the participant has
an individual designated beneficiary. While the definition of designated beneficiary has
not changed, the time at which the designated beneficiary is determined and the distributions periods that result from having or failing to have a designated beneficiary are different under the final regulations.
B. The new rules.
As noted in section II above regarding distributions to a participant which commence on
the RBD, the uniform lifetime table applies in the year of the participant's death. In the
case of a participant who dies prior to the RBD, no distribution is required for the year of
death. In either case, the initial distribution governed by the postdeath MRD rules is required to be made in the distribution calendar year following the calendar year in which the
participant's death occurs. The key question is whether or not the participant has an individual designated beneficiary as of September 30 of the distribution calendar year following the distribution calendar year in which the participant dies (referred to in this outline as
the "designation date").
1. Participant has an individual designated beneficiary.
If the participant has an individual designated beneficiary, distributions may be made, beginning in the calendar year following the calendar year of the participant's death, over the
longer of (i) the "fixed" life expectancy of the designated beneficiary or (ii) in the case of a
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participant who dies after the RBD, the fixed life expectancy of the participant. Treas regs
1.401(a)(9)-3, A-3(a) and 1.401(a)(9)-5, A-5(a)(1) and (c)(1).
a. Determination of annual distributions – beneficiary's fixed life
expectancy.
The distribution for the distribution calendar year following the calendar year of the participant's death is determined by dividing the prior yearend balance of the account by the
years of life expectancy shown in the Single Life Table in Treasury regulation 1.401(a)(9)9, A-1 (see exhibit C attached) for the age attained by the beneficiary in that year and each
subsequent calendar year's distribution is determined by reducing that initially determined
life expectancy factor by one year for each distribution calendar year elapsed since the distribution calendar year following the calendar year of the participant's death (including the
year of distribution as an elapsed year for this purpose). Treas reg 1.401(a)(9)-5, A-5(c).
b. Determination of annual distributions – participant's fixed life
expectancy.
The distribution for the distribution calendar year following the calendar year of the participant's death is determined by the Single Life Table life expectancy shown for the age
which the participant attained (or would have attained) in the calendar year of death reduced by one year. Each subsequent calendar year's distribution is determined by the participant's year of death life expectancy reduced by one year for each distribution calendar
year elapsed since the year of death (counting the year of distribution as an elapsed year for
this purpose). Treas reg 1.401(a)(9)-5, A-5(c)(1).
c. Plan provisions may limit payout on pre-RBD death.
i.
If no plan provision, deferred payment permitted.
While Code sections 401(a)(9)(B)(ii) and (iii) state that, in the case of a participant who
dies before the RBD, the " five-year rule" applies unless the "exception to five-year rule
for certain amounts payable over life of beneficiary" applies, the 2001 and the final regulations provide that, if there is no plan provision directing that either the five-year rule or the
exception to the five-year rule applies, the exception to the five-year rule will apply if the
participant has a designated beneficiary on the designation date. Treas reg 1.401(a)(9)-3,
A- 4(a). This reverses the presumption made under the 1987 regulations which assumed
that the five-year rule applied unless the plan provided for distributions over the participant's lifetime.
ii.
If there is a plan provision, it controls.
A plan may specify that either the five-year rule or the exception to the five -year rule will
apply in all cases or with respect to certain identified participants or that the participant or
the beneficiaries may elect which rule to apply provided that, if no timely election is made,
the exception to the five-year rule applies. Treas reg 1.401(a)(9)-3, A-4(b) and (c).
iii.
Transition rule.
Under a transition rule, a designated beneficiary who was subject to the five-year rule under the 1987 regulations but did not begin to receive distributions before the end of the
year following the participant's death under the exception to the five-year rule may switch
to the life expectancy rule if a plan permits, provided that all amounts that would have
been required to be distributed under an application of the life expectancy rule were
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distributed by the earlier of December 31, 2003 or the end of the five-year rule period.
Treas reg 1.401(a)(9)-1, A-2(b)(2).
2. Participant does not have a designated beneficiary.
a. Death after RBD.
If the participant dies after the RBD and has no designated beneficiary on the designation
date, distributions will be made over the "fixed" life expectancy of the participant beginning with the distribution calendar year following the calendar year of the participant's
death. See paragraph 1.b above re computation of amounts. Treas reg 1.401(a)(9)-3, A3(a).
b. Death before RBD.
If the participant dies prior to the RBD and has no designated beneficiary on the designation date, the entire benefit will instead be distributed on or before the end of the fifth calendar year following the calendar year of the participant's death. Code §409(a)(B)(iii).
C. Designated beneficiary.
Code section 401(a)(9)(E) provides that the term "designated beneficiary" means any individual designated as a beneficiary by the participant.
1. Designation under plan required.
A beneficiary must be designated under the plan or IRA. An individual may be designated
as a beneficiary under a plan either by the terms of the plan or, if the plan so provides, by
an affirmative election by the participant (or the participant's surviving spouse if the spouse
is deemed to be a participant in the case of a participant's pre-RBD death) specifying the
beneficiary. A beneficiary designated as such under the plan is an individual who is entitled to a portion of a participant's benefit, contingent upon the participant's death or another
specified event. Treas reg 1.401(a)(9)-4, A-1. In addition –
(a)
A designated beneficiary need not be specified by name as long
as the individual who is to be the beneficiary is identifiable under the plan as of the designation date.
(b)
If a class of beneficiaries is capable of expansion or contraction,
the members of the class will be treated as identifiable if it is
possible to identify the class member with the shortest life expectancy on the designation date.
(c)
An individual to whom an interest in the plan passes under
applicable state law is not a designated beneficiary unless the
individual is a designated beneficiary under the plan. Treas reg
1.401(a)(9)-4, A- 1.
See section II.D.2 above regarding the application of the designated beneficiary definition
to distributions made during the participant's lifetime over the joint life expectancy of the
participant and a more than ten years younger spouse.
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2. Impact of nonindividual beneficiaries.
A person who is not an individual, such as the participant's estate or a charitable organization, may not be a designated beneficiary. Moreover, unless a nonindividual beneficiary is
the beneficiary of a separate share of the participant's benefit, the existence of the nonindividual beneficiary will cause the participant to be treated as having no designated beneficiary even if one or more of the beneficiaries named are individuals. While a trust is not an
individual, the naming of a trust as beneficiary will not cause there to be no designated
beneficiary if the trust qualifies for the "look through" rules described in section VI.A
below. Treas reg 1.401(a)(9)-4, A-3(a).
3. Multiple beneficiaries.
If two or more individuals are designated as beneficiaries on the designation date (one of
whom may be the participant's surviving spouse), the individual having the shortest life
expectancy (the oldest individual) will be the designated beneficiary for purposes of determining the distribution period unless separate shares in the participant's benefit have
been established. Treas reg 1.401(a)(9)-5, A-7(a).
a. Contingent beneficiaries generally taken into account.
If a beneficiary's entitlement to a participant's benefit is contingent on an event other than
the death of the participant or the death of another beneficiary (for example, if entitlement
were to occur upon a predecessor beneficiary's failing to graduate from college by a stated
age), the contingent beneficiary is considered to be a designated beneficiary for purposes
of determining the designated beneficiary having the shortest life expectancy and whether
or not there is a designated beneficiary. Treas reg 1.401(a)(9)-5, A-7(b).
b. Beneficiary entitled to benefit only due to death of prior beneficiary disregarded.
If a successor beneficiary is entitled to benefit only if another beneficiary dies after the
designation date and before the entire benefit to which that other beneficiary is entitled has
been distributed by the plan, the successor beneficiary may be disregarded in determining
the participant's designated beneficiary. Treas reg 1.401(a)(9)-5, A-7(c)(1). However, if a
successor beneficiary has any right (including a contingent right) to a participant's benefit
beyond being a mere potential successor to the interest of one of the participant's beneficiaries upon that beneficiary's death, the successor will be taken into account. In the language quoted in full in paragraph VI.B.2.b below, the regulations provide (in effect, treating a participant's account, itself, as if it were a trust) that, if one of the participant's beneficiaries has right to receive the income from the account during the beneficiary's lifetime
and a second beneficiary has the right to receive the principal of the account following the
first beneficiary's death, both beneficiaries would have to be taken into account in determining the beneficiary with the shortest life expectancy and whether only individuals are
beneficiaries.
c. Death of designated beneficiary after designation date does not
affect distribution period.
Under the 1987 regulations, rules were provided for changes in designated beneficiaries
made after the RBD but during the participant's lifetime under which, if a replacement
beneficiary having a shorter life expectancy was named in place of the initially named
designated beneficiary, the distribution period was accelerated. Former Prop Treas reg
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1.401(a)(9)-1, A-E-5. Due to the fact that the designated beneficiary is now determined on
the designation date, the rule that applied under the 1987 regulations to changes of designated beneficiaries after the participant's death (namely, that the distribution period continues to be determined by the deceased designated beneficiary's life expectancy regardless of
whether the life expectancy of the successor beneficiary is shorter or is longer than the
designated beneficiary's life expectancy) is the only rule. Prop Treas reg 1.401(a)(9)-5, A7(c)(2).
4. Time at which designated beneficiary determined.
The final regulations state that designated beneficiaries are determined based on the beneficiaries designated as of the date of the participant's death who remain beneficiaries as of
September 30 of the calendar year following the calendar year of the participant's death
(referred to in this outline as the "designation date"). Thus, to be a designated beneficiary,
an individual must be a beneficiary as of the participant's date of death as well as on the
designation date. Treas reg 1.401(a)(9)-4, A-4. However, see the final regulations' rule
described in paragraph D.1 below under which a (or the oldest) designated beneficiary who
dies during the window period is deemed to be living on the designation date.
a. Change from 2001 Regulations.
The designation date was moved up from December 31 of the year following the participant's death (as was provided in the 2001 regulations) so as to eliminate the administrative
catch-22 of having to make the initial post-death distribution on the same day that the designated beneficiary was to be identified.
b. The "window period".
By introducing the "window period", the 9 to 21 month period between the participant's
date of death and the designation date under the final regulations, the 2001 regulations
made uniform the post-death planning options that could affect the applicable distribution
period (the disclaimer by a beneficiary and the creation of separate accounts). These
options were previously available only if a participant died before the RBD. The opportunity to cash out a beneficiary's full benefits before the designation date was also added.
5. Designation of beneficiaries by beneficiaries.
If a plan allows (or gives the participant the power to specify that) any person shall have the
discretion to change the participant's beneficiaries after the designation date, the 1987 and
the 2001 regulations provided that the participant will be treated as having no designated
beneficiary. However, the 2001 regulations, consistent with Private Letter Ruling
199936052, stated that the prohibited discretion will not be found to exist merely because a
beneficiary may designate a subsequent beneficiary who would be entitled to benefits after
the designating beneficiary dies. Prop Treas reg 1.401(a)(9)-5, A-7(d). Although the final
regulations deleted the section of the 2001 regulations related to beneficiaries' designating
beneficiaries, it does not appear that the deletion was intended to change the 2001 regulations' rule because reference to the beneficiary of a deceased beneficiary is made in the final
regulations' provision regarding the death of a beneficiary during the window period, stating
that such a successor beneficiary will be disregarded in determining the participant's
designated beneficiary. See section D.1 below. Although the identity of the successor
beneficiary of a beneficiary who dies during the window period will not affect the
applicable distribution period, in many cases the beneficiary's probate estate (the default
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successor to a deceased beneficiary under most IRAs) may not be the optimal choice if
probate avoidance is a goal.
D. Planning during the window period.
Any person who is named as a participant's beneficiary as of the participant's date of death
but who has ceased to be a beneficiary as of the designation date, because the person disclaims entitlement to the benefits or because the person has received the entire benefit to
which the person is entitled, is disregarded in identifying the participant's oldest designated
beneficiary (or whether or not the participant has a designated beneficiary) for purposes of
determining the applicable distribution period for the calendar year following the participant's death and subsequent years. Treas reg 1.401(a)(9)-4, A-4(a). If a participant has
designated multiple beneficiaries to share the benefit, separate shares or accounts may be
created by the end of the calendar year following the calendar year of the participant's
death in order to have each share or account obtain the applicable distribution period that
would apply if the designated beneficiary of that share were the participant's sole designated beneficiary for the purposes of the Code section 401(a)(9)(B) postdeath distribution
rules. Treas reg 1.401(a)(9)-8, A-2 and 3.
1. Death of oldest beneficiary during window period.
If a named oldest beneficiary survives the participant but dies prior to the designation date,
the postdeath applicable distribution period will be determined by the fixed life expectancy
of the deceased beneficiary and the identity of the successor (or remaining) beneficiary or
beneficiaries who are living on the designation date are disregarded for purposes of determining the post-death applicable distribution period. Treas reg 1.409(a)(9)-4(c), A-4.
a. Substantial change to apparent rule of 2001 regulations.
It had appeared under the 2001 regulations that, because designated beneficiaries were
defined as individuals living on the designation date, the successor to a deceased beneficiary would be taken into account in determining the applicable distribution period for plan
and IRA benefits or a separate account. This rule would have caused there to be no designated beneficiary if the beneficiary's estate were the successor or caused a longer payout
period if younger generation beneficiaries succeeded.
b. Inclusion in deceased beneficiary's gross estate.
In the case of an IRA and in the case of most plans, a surviving beneficiary's interest in the
plan or IRA becomes fully withdrawable immediately upon the participant's death and is
thus includable in the beneficiary's gross estate under Code section 2033 (property includable to the extent of the interest of the decedent at the time of death). If the method of
benefit payment is required to be in the form of noncommutable installment or annuity
payments, the amount includable in the deceased beneficiary's gross estate will be determined under the actuarial tables in the Treasury regulations. Therefore, if a customized
beneficiary designation identifying successor beneficiaries in the event of a surviving
beneficiary's death is employed, consideration must be given to whether or not estate tax
will be payable upon the beneficiary's death and how that obligation will be satisfied.
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c. Will a disclaimer by a deceased beneficiary's personal representative be recognized?
Will the disclaimer made by a deceased individual beneficiary's personal representative
that is valid under state law be recognized so that the deceased beneficiary will be disregarded if the disclaimer occurs before the designation date? The final regulations require
the life expectancy of a deceased beneficiary to be taken into account if the beneficiary
dies prior to the designation date "without disclaiming". Treas reg 1.401(a)(9)-4, A-4(c).
It is possible that the regulation may be interpreted as requiring that a pre-death disclaimer
be made in order for the deceased beneficiary's life expectancy to be disregarded.
However, it would seem that a timely qualified disclaimer under Code §2518 by an
executor should be honored but the timing of the beneficiary’s death would have to be
soon after that of the participant to be able to accomplish the disclaimer within the nine
month period following the participant’s death.
2. Creating separate shares following the participant's death.
If a participant has named multiple beneficiaries for plan death benefits, the ability to
obtain the otherwise available maximum applicable distribution period may be curtailed
due to:
(a)
The existence of a nonindividual beneficiary,
(b)
The fact that the spouse is not the sole beneficiary, or
(c)
The requirement that the oldest beneficiary's life expectancy
governs payments to all beneficiaries.
If separate accounts are established, the MRD rules are applied separately to each account
based upon its beneficiaries alone. Treas reg 1.401(a)(9)-8, A-2.
a. Definition of separate accounts or shares.
Consistent with the 1987 and the 2001 regulations, the final regulations provide that a participant's benefit may be divided into separate accounts under the plan or IRA if each separate beneficiary's portion of a participant's benefit is determined by an acceptable separate
accounting including the allocation of investment gains and losses, contributions, and forfeitures on a pro rata basis in a reasonable and consistent manner among the separate
accounts. Treas reg 1.401(a)(9)-8, A-3(a). A benefit in a defined benefit plan is separated
into segregated shares if it consists of separate identifiable components that may be separately distributed. Treas reg 1.401(a)(9)-8, A-3(b).
b. Time at which separate accounts must be established.
Under the final regulations, separate accounts will be recognized if the beneficiaries with
respect to a separate account differ from those of another separate account as of the end of
the year following the year containing the participant's (or spouse's, if applicable) date of
death. For MRDs payable after January 1, 2003, the regulations adopted in 2004 provide
that the timely establishment of separate accounts relates back to the participant's date of
death and, therefore, applies to distributions made in the year following the participant's
death based upon the participant's beneficiaries as of the designation date even though the
separate accounts are not established until after the designation date has occurred (that is,
during the final three months of the year following the participant's death). Treas reg
1.401(a)(9)-8, A-2.
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c. Separate accounts for distributions in 2002 and earlier years.
Under the 2002 regulations, it appeared that the separate applicable distribution period
would be available with respect to separate accounts for any year only if the separate accounts were actually established on a date no later than the last day of the preceding calendar year 2002. Treas reg 1.401(a)(9)-8, A-2(a)(2). Particularly, in the case of participants
who died late in the calendar year, it was virtually impossible to establish separate
accounts in the participant's year of death. As a result, if separate accounts were established in the year following the participant's death, the participant's account will potentially
have differing sets of beneficiaries for the year following the participant's death and the
second year after the year of the participant's death.
d. Distribution in year after participant's death under 2002 regulations.
The interaction between the rule that the identity of the designated beneficiary for purposes
of determining the applicable distribution period is made based on the participant's beneficiaries as of the designation date (September 30 of the year following the year of the participant's death) and the deadline for the establishment of separate accounts (which may
occur in the final three months of the year following the year of the participant's death) was
not spelled out in the 2002 final regulations. Fortunately, the following questions raised by
the 2002 regulations provisions are not a concern for MRDs made for 2003 and future
years.
i.
Separate accounts established in year of participant's
death.
If separate accounts were established in the year of the participant's death in 2001 or earlier
years (and are thus taken into account in determining the designated beneficiaries for the
purposes of determining the applicable distribution periods for the year following the participant's death), it is clear that each separate account would have a separate designated
beneficiary and applicable distribution period for the year after the participant's death.
ii.
Separate accounts established in year following the
participant's death.
Since separate accounts are not recognized until the calendar year after the accounts have
been established under the 2002 final regulations, the separate accounts are aggregated
(and all beneficiaries are taken into account) in determining distributions for the year following the participant's death (for example, 2002) if the establishment of separate accounts
occurs in that year.
1. Accordingly, if a participant named as
beneficiaries a surviving spouse, a charity, and a
child in specified percentages, the participant
would be deemed to have no designated
beneficiary for the calendar year following the
year of death (because the charity is not an individual). If the participant died after the RBD,
the minimum distribution required would be
measured by the participant's fixed life expectancy. If the participant died before the RBD,
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tion would be required for the year following the
year of the participant's death.
2. The examples in the final regulations imply that,
for the year after the year following the participant's death, differing applicable distribution
periods would apply to the three separate
accounts established for each beneficiary in the
year following the participant's death. Thus, in
the subsequent year, the charity would receive a
distribution determined based on the participant's fixed life expectancy (or under the fiveyear rule), the surviving spouse's separate
account would determine distribution based on
the spouse's recalculated single life expectancy,
and the child's separate account would determine
distributions based on the child's fixed life expectancy.
iii.
Risk of having no designated beneficiary if separate
accounts do not exist on designation date.
Because the separate account provisions of the 2002 final regulations do not cross-reference the rules for determining the participant's designated beneficiary, there may be a risk
that the failure to establish separate accounts in the year of the participant's death in 2001
or earlier years (which may be impossible to accomplish if the participant dies late in the
year) would cause the participant to have no designated beneficiary when a nonindividual,
such as a charity, is one of multiple beneficiaries as of the designation date. One way to
avoid the risk would be to distribute the interest of the nonindividual beneficiary before the
designation date.
e. Accounts may be created for separate management at any time.
After the designation date has occurred without separate accounts having been established
with respect to a deceased participant's IRA and, for example, benefits distributable to
multiple beneficiaries are required to be paid over the life expectancy of the oldest beneficiary, the beneficiaries may wish to create separate accounts in order to separately direct
investments or to have different IRA custodians or trustees. In the case of any nonspouse
beneficiary, the decedent's IRA account is deemed to be an "inherited" IRA and no rollover
is permitted. An IRA for multiple nonspouse beneficiaries can nonetheless be transferred
to a new trustee or custodian (or divided into separate accounts by the existing trustee or
custodian). Care must be taken that the transfer or division is not treated as a transfer of
the inherited IRA to a beneficiary's IRA because such a transfer is not excluded from the
beneficiary's gross income.
i.
The wrong way.
In Private Letter Ruling 9014071, the transfer of a decedent's IRA account balance to an
IRA established in the name of his daughter (the designated beneficiary of the decedent's
account) resulted in the inclusion of the transferred account balance in the daughter's taxable income for the year of transfer.
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ii.
The right way.
In Private Letter Ruling 8716058, the son of a deceased IRA accountowner who was the
designated beneficiary of an IRA arranged to have a new IRA account established in his
deceased mother's name with an eligible IRA trustee and proposed to have a trustee-totrustee transfer of the account balance made.
1. After citing Revenue Ruling 78-406 (1978-2 CB
157) which held trustee to trustee transfers
between IRAs not to be a distribution or a prohibited rollover, the ruling noted that, even
though the designated beneficiary (rather than
either the IRA participant or the bank trustee)
wished to initiate the transfer, the transfer was
not a prohibited rollover because the IRA would
be maintained in the name of the deceased IRA
participant.
2. In Private Letter Rulings 9623037 through
9623040, four daughters of a deceased accountowner, as designated beneficiaries, proposed to have the existing IRA trustee divide the
IRA into four equal shares. Each share was then
to be transferred to a new IRA trustee (in a trustee-to-trustee transfer), each recipient IRA remaining in the name of the deceased accountowner, as owner. Each ruling approves the
transfer to an account to be maintained in the
name of the deceased accountowner with the
particular daughter requesting the ruling as the
sole designated beneficiary of the IRA.
The separate account should be established in the deceased participant’s name for the
benefit of the beneficiary and, contrary to early private letter rulings, should use the beneficiary’s (not the participant’s) social security or taxpayer identification number (as provided in form 1099-R instructions).
iii.
Custodian and trustee resistance to creating separate
IRAs.
Many private letter rulings have followed the foregoing position.
1. PLR 200343030 approved the transfer of a
beneficiary's one third interest in an IRA payable
to an estate to an account in the post RBD
deceased participant's name which could be paid
out over the participant's remaining life expectancy without regard to the distribution pattern
adopted by the beneficiaries of the remaining
two thirds of the IRA.
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2. In PLR 200349009, an IRA participant died before the RBD and designated a trust as beneficiary. The Service ruled that the account could be
subdivided with one half being paid outright to
one of the two beneficiaries and the remaining
one half being continued in an account in the decedent's name for the second beneficiary with
MRDs to be made over the life expectancy of
the oldest of the two beneficiaries. See also
PLRs 200234019, and 200329048, and
200410020.
3. In PLRs 200432027-29, an IRA was payable to
a trust that was to terminate on the participant's
death and distribute outright to three children.
The Service approved the division of the IRA
into three IRAs, each payable over the eldest
beneficiary's life expectancy.
While practitioners view a quantity of private letter rulings that are consistent in their
holdings as a critical mass indicative of IRS policy, many custodians and trustees refuse to
adopt a flexible policy on account divisions by trustee to trustee transfer because no formal
IRS pronouncements exist (although the final regulations do refer to trustee to trustee IRA
transfers). Regs §1.408-8, A-8. As the number of continuing private letter ruling requests
for approval of trustee to trustee transfers indicate, not all trustees and custodians will
follow the private letter ruling results. If a trustee or custodian refuses to establish separate
accounts, the beneficiary's only recourse is to arrange a trustee to trustee transfer of the
IRA to a new custodian or trustee (such as Vanguard or Fidelity) that will permit separate
accounts to be established.
3. Using disclaimers during the window period to change the designated beneficiary.
The 1987 regulations did not refer to disclaimers but the 2001 and the final regulations
expressly recognize that a qualified disclaimer of entitlement to benefits under Code §2518
may eliminate a disclaiming beneficiary prior to the designation date. Treas reg
1.401(a)(9)-4, A-4(a); see also PLR 200013041. In order for a beneficiary who becomes
entitled to benefits as a result of a prior beneficiary's disclaimer to be recognized as a designated beneficiary, the successor beneficiary must be designated under the plan or under a
beneficiary designation pursuant to the plan. Treas reg 1.401(a)(9)-2, A-1. Accordingly,
in order to take advantage of the ability to change beneficiaries during the window period,
a ladder of primary and contingent beneficiaries must be included in the participant's (or
spouse's) beneficiary designation.
a. Recognition of disclaimers for transfer tax purposes.
For federal transfer (gift and estate) tax purposes, the effect of a qualified disclaimer under
Code section 2518(a) is that the disclaimed interest in property is treated as if it has never
been transferred to the person making the qualified disclaimer and, instead, had passed, ab
initio, directly from the transferor of the property (that is, the deceased testator, trust
settlor, or participant) to the person entitled to receive the property as a result of the dis1-23
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claimer. Treas reg 25.2518-1(b). Code section 2654(c) specifically provides that Code
section 2518 controls the effect of a qualified disclaimer for purposes of the generationskipping transfer tax. PLR 9203028.
b. Qualified disclaimer defined.
A "qualified disclaimer" means an irrevocable and unqualified refusal by a person to
accept an interest in property but only if:
(1)
Such refusal is in writing,
(2)
Such writing is received by the transferor of the interest or
the holder of the legal title to the property to which the
interest relates not later than nine months after the later of
the day on which the transfer creating the interest in such
person is made or the day on which such person attains age
21,
(3)
Such person has not accepted the interest or any of its
benefits, and
(4)
As a result of such refusal, the interest passes without any
direction on the part of the person making such disclaimer
and passes either:
(i)
To the spouse of the decedent or
(ii)
To a person other than the person making the disclaimer. Code §2518(b).
Note that the entitlement to disclaimed benefits may, in turn, be disclaimed by the successor beneficiary in the same manner (that is, within nine months of the original disclaimer
creating the successor beneficiary's interest in the benefits).
(1) Pre-disclaimer receipt of an MRD is not an
acceptance of an interest in benefits.
Revenue Ruling 2005-36, 2005-26 IRB 1368 (June 27, 2005), applying the Treasury
Regulations for qualified disclaimers, concludes that a designated primary beneficiary who
has received an MRD payment following a participant's death may nonetheless disclaim
the balance of the benefit. If the disclaimer occurs on or before the designation date
(September 30 of the calendar year following the calendar year of the participant's death),
the disclaiming beneficiary will not be considered to be a designated beneficiary.
(2) Distribution of income attributable to distributed amount required.
Under the Revenue Ruling 2005-36 analysis, the amount of the received MRD is treated as
a distribution from corpus of a pecuniary amount. To qualify as a disclaimer, no income or
other benefit of the disclaimed amount may inure to the disclaimant. Regs §25.2518-3(e).
Accordingly, the receipt of an MRD is considered to be the acceptance of a proportionate
amount of the account's income, determined by formula under the qualified disclaimer
regulations and, because this income amount cannot be disclaimed, it must be distributed
to the recipient on or before the designation date.
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(3) Partial disclaimers affirmed.
Revenue Ruling 2005-36 also illustrates fact situations in which the MRD recipient disclaims a pecuniary amount (less than the total benefit) and a fractional (percentage) share
of the total benefit, provided in either case, that the income attributable to the disclaimed
portion is also disclaimed.
(4) Other indicia of acceptance.
Actions that a beneficiary might take prior to an attempted disclaimer that may indicate
acceptance of the benefits include exercising investment control, naming a successor beneficiary, a spouse rolling the benefits over to the beneficiary’s own account, or a spouse
electing to treat the participant’s IRA as the spouse's own account.
(5) Spouse may retain certain interests in disclaimed property.
If a surviving spouse disclaims an interest in property, that interest can pass to a trust with
respect to which the spouse is a trust income beneficiary, is a permissible distributee of
principal in the discretion of a third party, has a withdrawal right limited by an ascertainable standard, or has a 5 & 5 power without invalidating a qualified disclaimer in favor of
that trust. Treas regs 25.2518-2(e)(2) and (5), examples (4), (5), (6), and (7). However,
the spouse must have no power with respect to the trust principal (i) which is not subject to
the spouse's federal estate or gift tax or (ii) which could determine the ultimate recipient of
that trust principal (unless such power is limited by an ascertainable standard).
(6) Spouse may not hold a nongeneral power of
appointment over a credit shelter trust.
A disclaimer by a surviving spouse in favor of a nonmarital credit shelter (or bypass) trust
will not be a qualified disclaimer if the disclaiming spouse has a nongeneral power of
appointment over the trust property – as is often the case where the trust's creator wishes to
provide flexibility in his estate plan. Treas reg 25.2518-2(e)(2). However, a spousal disclaimer under those circumstances can still be achieved if the spouse releases all nongeneral powers the spouse has over the trust prior to disclaimer, concurrently disclaims all
nongeneral powers, or the decedent's estate plan provides for a "disclaimer trust" (not containing a nongeneral power exercisable by the spouse) to receive the disclaimed interest.
(7) Transfer type disclaimers.
Code section 2518(c)(3) permits a transfer type disclaimer which is intended not to be
dependent on complying with any local law disclaimer requirements. A written transfer
that otherwise meets the requirements of a qualified disclaimer and that conveys ownership
of the disclaimed interest to the person(s) who would have received the property had the
disclaimant making the transfer made an effective state law disclaimer will be a qualified
disclaimer. The wording of the original transfer document (typically the will, trust instrument, or death benefit beneficiary designation) may thus specifically authorize a beneficiary (whether an individual or the trustees of a trust) to accomplish a disclaimer by a written
transfer of the right to receive the property interest intended to be disclaimed to the party
designated in the transfer document to take in the event of a disclaimer (typically the next
designated contingent beneficiary).
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(8) Takers in the event of a disclaimer must qualify as individual beneficiaries.
In PLR 200327059, a surviving spouse of a participant who died before the RBD rolled
over a portion of an IRA to the spouse's own IRA. The spouse successfully disclaimed the
balance of the IRA. However, the disclaimer was in favor of the participant's residuary
estate which was to pass to a trust for the spouse's benefit. Because the participant's estate
was the beneficiary, the life expectancy of the surviving spouse could not be used as a
measure of MRDs and the five year rule instead applied to the benefits that were not rolled
over.
c. Income tax impact of a disclaimer.
Private letter rulings have recognized that the recipient of the disclaimed interest becomes
the income taxpayer of a disclaimed interest. PLR 9319020 re Code §691, PLR 9037048
re Code §408(d)(1), and PLR 9303027 re Code §402(a).
d. Plan anti-alienation provisions.
General Counsels Memorandum 39858 (published in 1991) held that a disclaimer that satisfies the requirements of state law and Code section 2518(b) is not an assignment of
income or an alienation of plan benefits contrary to Code section 401(a)(13) and is not a
forfeiture or transfer contrary to Code section 408 in the case of an IRA. The memorandum further states that a plan or IRA distribution is includable in the recipient's taxable
income when distributed (rather than in the disclaimant's income when disclaimed).
e. Preapproved customized beneficiary designations or postdeath
persuasiveness needed to gain administrative acceptance.
Few, if any, plan or IRA agreements contemplate the disclaimer of benefits by a beneficiary. While many plan administrators, trustees, and custodians are unwilling to accept
customized beneficiary designations, some, such as the Vanguard Group, are willing to do
so if the designation (or a separate letter or form) holds the custodian or trustee harmless
from all liability and responsibility in making distributions based upon the direction of an
identified representative of participant or the participant's revocable trust. See the sample
clause in the beneficiary designation attached as exhibit G. In order to facilitate postdeath
disclaimers, the beneficiary designation should:
f.
(1)
Expressly state in the case of each named beneficiary that
the plan interest will pass to the next named beneficiary if
the trust named beneficiary dies (or is no longer in existence) or if the beneficiary disclaims the benefit and
(2)
State the methods by which a disclaimer is made by a
beneficiary.
Building a disclaimer into beneficiary designation.
While disclaimers of qualified plan benefits have been frequently recognized in letter rulings (for example, PLRs 9016026, 9247026, and 200105058), it is possible that a plan administrator might refuse to recognize a disclaimer by claiming that a disclaimer based on
state law that changes a beneficiary is preempted by ERISA. In Egelhoff v. Egelhoff, 121
S.G. 1322, 532 U.S. 141 (2001), the court held that a state law that would have voided a
beneficiary designation in favor of an ex-spouse was preempted. If a beneficiary designaInstitute of Continuing Legal Education
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tion accepted by the plan provides that plan benefits pass to contingent beneficiaries if the
initial beneficiary dies or disclaims the benefits, a strong argument can be made that the
plan's terms recognize the disclaimer.
IV.
DISTRIBUTIONS FOLLOWING THE PARTICIPANT'S
DEATH –
SPOUSE IS SOLE BENEFICIARY
A. Overview.
If a participant's surviving spouse is the sole designated beneficiary of the participant (or
the sole beneficiary of a separate account of the participant's benefits), special MRD rules
may apply to determine at what time benefits must commence following the participant's
death, the applicable distribution period (both during the surviving spouse's lifetime and
following the spouse's death), and how the identity of the successor beneficiaries who will
receive benefits on the spouse's death will be determined. Moreover, a surviving spouse
beneficiary has the ability to elect to treat the participant's account as the spouse's own account or to roll the participant's account over to the spouse's own IRA (or plan).
B. Special MRD rules if spouse is sole designated beneficiary.
Special MRD rules apply to a participant's surviving spouse who is the sole designated
beneficiary of the benefits (or a separate account) of a participant unless the surviving
spouse, alternatively, takes action under the rules which cut across the MRD rules by:
(i)
In the case of an IRA, electing either to treat the participant's account as the
spouse's own account under Treasury regulation 1.408-8, A-5 or electing to
roll the account over to an IRA in the spouse's name under Code section
408(d)(3)(c)(ii)(II) or
(ii)
In the case of a plan, electing to roll a distribution from the account over to
the spouse's own IRA under Code section 401(c)(9) or to a plan in which
the spouse is a participant under the new EGTRRA rules.
1. Deferral of benefit commencement after participant's pre-RBD
death.
Under Code section 401(a)(9)(B)(iv)(II), if the sole designated beneficiary of a participant
who dies prior to the participant's RBD is the participant's surviving spouse, the commencement of minimum required distributions which, under the general rule of Code section 401(a)(9)(B)(iii) is to occur in the distribution calendar year following the calendar
year of the participant's death, is deferred until the end of the calendar year in which the
participant would have attained age 70 1/2 if the participant had survived. Since the usual
rule of Code section 401(a)(9)(B)(iii) requires distribution in the year following the year of
death, no actual deferral occurs if the participant attained (or would have attained) age
69 1/2 or older in the year of death.
2. Spouse treated as participant if death occurs before benefits commence after a participant's pre-RBD death.
If a surviving spouse beneficiary who survives the participant's pre-RBD death is the sole
designated beneficiary of the participant's benefits (or a separate account) as of the desig1-27
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nation date and then dies before the end of the distribution calendar year in which minimum distributions are required to begin (the end of the distribution calendar year in which
the participant would have attained age 70 1/2), the postdeath distribution rules (the fiveyear rule or the payment over a designated beneficiary's life expectancy) apply as if the
surviving spouse were the participant. Code §401(a)(9)(B)(iv)(II) and Treas reg
1.401(a)(9)-4, A-4(b). The special rule that applies to a surviving spouse of the participant
may not, however, be reapplied to defer the commencement of benefits to a remarried surviving spouse's surviving spouse. Treas reg 1.401(a)(9)-3, A-5. If the surviving spouse is
living at the end of the year following the year in which the participant would have attained
age 70 1/2 (that is, after benefits are required to commence), the surviving spouse is no
longer deemed to be the participant for the purposes of the MRD rules under Code section
401(a)(9)(B)(iv)(II) and, on the spouse's subsequent death, the distributions of any remaining benefits are made over the spouse's fixed life expectancy under paragraph 3.b
below rather than in accordance with the five-year rule or its exception.
a. If the spouse's death occurs before the designation date, what is
the applicable distribution period?
Notwithstanding the fact that Treasury regulation 1.401(a)(9)-3, A-5(b) stipulates that a
surviving spouse of a participant who dies before the RBD will be treated as the participant
"if the employee's spouse is the sole designated beneficiary as of September 30 of the calendar year following the calendar year of the employee's death", the special rules of Code
section 401(a)(9)(B)(iv)(II) are probably intended to apply to a surviving spouse sole beneficiary who survives the participant but dies prior to the designation date. Though not free
from doubt, the rule that the life expectancy of a beneficiary who is a beneficiary as of the
participant's death but dies prior to the designation date without disclaiming is taken into
account for purposes of determining the oldest beneficiary for MRD rule purposes [contained in the paragraph that follows A-4(b) cited above] probably is intended to apply to a
surviving spouse who survives the participant but dies before the designation date because
that rule is prefaced by the words "For purposes of this A-4". Treas reg 1.401(a)(9)-4, A4(c). If this conclusion is not correct, distributions in the event that the spouse sole beneficiary died before the designation date would have to be made in accordance with the fiveyear rule or over the fixed life expectancy of the spouse rather than over the redetermined
single life expectancy of the spouse.
b. If the surviving spouse has no designated beneficiary under the
plan or IRA.
If the surviving spouse beneficiary of a participant who died before the RBD has not designated a beneficiary and dies before the benefit commencement date (that is, the end of
the year in which the participant would have attained 70 1/2), the five-year rule applies and
most IRA agreements name the spouse's estate as designated beneficiary (and any contingent beneficiary named by the participant to succeed to the balance of the benefit upon the
spouse's death is ignored).
c. If the surviving spouse has designated a beneficiary.
Since the surviving spouse is deemed to be the participant for purposes of the MRD rules,
distributions to the beneficiary designated by the surviving spouse must commence on or
before the end of the distribution calendar year following the calendar year of the spouse's
death (if deferred payments are to be made over the fixed life expectancy of the beneficiInstitute of Continuing Legal Education
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ary) or in full by the end of the fifth distribution calendar year following the calendar year
of the spouse's death (under the five-year rule).
d. Balancing deferral and estate/GST tax exposure.
If the objective of the participant and spouse is to defer the distribution of plan benefits for
as long as possible, the proactive approach would be to file beneficiary designations for
both the pre-RBD participant and for the spouse at the same time when the plan or IRA
benefit is established. In the case of an IRA account and in the case of a plan that permits
the surviving spouse to withdraw benefits, the plan benefits will be includable in the surviving spouse's gross estate. If estate tax is expected to be payable and other assets of the
spouse are insufficient, the spouse's beneficiary designation might provide that a separate
share of the spouse's benefit pass to the spouse's estate or a revocable trust.
3. Applicable distribution period if spouse is sole designated beneficiary on participant's death.
The special applicable distribution periods described in paragraphs a and b below that apply to the surviving spouse of a participant who is the sole designated beneficiary of the
participant's benefits (or a separate account) will not apply in the case of a participant who
dies after the RBD if the use of an applicable distribution period equal to the participant's
fixed life expectancy (see paragraph III.B.1.a above) would produce a lower minimum
required distribution for any year. Treas reg 1.401(a)(9), A-5(a).
a. Redetermined life expectancy during spouse's lifetime.
Beginning with the distribution calendar year following the participant's death or, if the
commencement date is deferred under Code section 401(a)(9)(B)(vi)(II), beginning with
the distribution calendar year in which the participant would have attained age 70 1/2 had
the participant survived, benefits are to be distributed to a sole surviving spouse designated
beneficiary over the spouse's remaining life expectancy, redetermined annually for each
distribution calendar year through the calendar year of the spouse's death. Each year's distribution equals the amount of the preceding yearend account balance divided by the years
of life expectancy shown on the Single Life Table for the age attained by the spouse in
such year (see exhibit C). Treas reg 1.401(a)(9)-5, A-5(c)(2).
b. Fixed term distribution following surviving spouse's death.
Beginning with the distribution calendar year following the calendar year of surviving
spouse's death, distributions are to be made to the contingent beneficiaries designated by
the participant (or, if the spouse's death occurs before the deferred commencement date for
a spouse who has survived the participant's pre-RBD death as described above, those designated by the spouse) over a fixed term "using the age of the spouse as of the spouse's
birthday in the calendar year of the spouse's death" (the number of years of life expectancy
shown on the Single Life Table) and reducing the years of life expectancy by one year for
each calendar year that has elapsed since the calendar year of the spouse's death (treating
the year of distribution as having elapsed for this purpose). Treas reg 1.401(a)(9)-5, A6(c)(2).
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c. Can a trust for the benefit of a spouse qualify for the special minimum required distribution treatment?
Treasury regulation 1.401(a)(9)-5, A-7(c) states that a beneficiary may be disregarded (as
merely a "successor beneficiary") in determining the identity of a participant's designated
beneficiaries if the successor beneficiary would only receive benefits if another (predecessor) beneficiary dies before the entire plan benefit has been distributed to the predecessor
beneficiary by the plan.
i.
Surviving spouse is not the sole beneficiary of a QTIP
trust.
Example 1(iii) of the above regulation comments on the QTIP trust described in the example that qualifies for the look through rules (see section VI below). The example states
that, because some amounts distributed from the plan to the QTIP trust (the amounts in
excess of the income earned on the plan benefits which income is required to be distributed
to the surviving spouse beneficiary of the trust) may be accumulated in the QTIP trust
during the spouse's lifetime for the benefit of the QTIP trust's remainder beneficiaries, the
remainder beneficiaries are considered to be designated beneficiaries (even though access
to the accumulated amounts is delayed until after the spouse's death).
ii.
Conduit trust for surviving spouse satisfies the sole
beneficiary rule.
Example 2(ii) of the foregoing regulation describes a conduit trust for the surviving
spouse's benefit under the terms of which all amounts distributed to the trust by the plan
are paid to the spouse (that is, no plan benefits are accumulated in the trust during the
spouse's lifetime for the benefit of any other beneficiary). In this case, because the surviving spouse is the sole beneficiary of the trust's interest in the participant's plan benefits,
the commencement of minimum required distributions may be postponed until the end of
the calendar year in which the participant would have attained age 70 1/2 if the participant
died before the RBD under Code section 401(a)(9)(B)(iv)(I). Treas reg 1.401(a)(9)-5, A7(c)(3), example 2(ii). A conduit trust may result in minimizing the plan benefit received
by the surviving spouse under certain circumstances because minimum required distribution commencement is postponed and, when begun, is made over the spouse's redetermined life expectancy (unless plan distributions are accelerated in the trustee's discretion).
If the surviving spouse dies prior to the postponed commencement date, minimum required
distributions may be made over the fixed life expectancy of the beneficiaries who survive
the spouse [assuming that the Code section 401(a)(9)(B)(iv)(II) provision also will apply to
a conduit trust].
C. Overriding rollover and "own IRA" elections.
In lieu of taking advantage (or continuing to take advantage) of the special MRD rules
described in paragraph B above, a surviving spouse who is a participant's sole beneficiary
may, in the case of a plan benefit, and can, in the case of an IRA benefit, instead elect to
roll the benefit over to an IRA in the spouse's name or, beginning in 2002, to a plan in
which the spouse participates. A spouse may achieve the same result in the case of an IRA
by electing (indirectly or, under the 2001 and the final regulations, directly) to treat a participant's IRA as the spouse's own IRA. While not entirely clear from the final regulations,
it appears that the position previously advanced in private letter rulings that a pre-age
59 1/2 surviving spouse was required to choose between taking advantage of the special
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MRD rules of Code section 401(a)(9)(B)(iv) and, alternatively, rolling over the benefits (or
making an "own IRA" election) has been withdrawn. A rollover or own IRA election by
the surviving spouse typically will obtain the longest available applicable distribution
period because –
(i)
If the spouse's RBD has not yet occurred, the commencement of distributions may be deferred until the spouse's RBD.
(ii)
Minimum required distributions made during the spouse's lifetime (including the year of the spouse's death) will be measured by the uniform lifetime
table.
(iii)
If the spouse names younger generation family members (or trusts for their
benefit) as beneficiaries of the IRA, the distributions beginning in the year
following the spouse's death will be measured by the fixed life expectancy
of the younger beneficiaries, effectively "reloading" the life expectancy
deferral opportunity.
1. Rollover by surviving spouse.
Under Code section 402(c)(9), a surviving spouse of a plan participant may generally roll
over any distribution from the plan which is attributable to the participant to an IRA in the
same manner as the plan participant can roll over an eligible rollover distribution under
Code section 402(a)(2). Under Code section 408(d)(3)(c)(ii)(II), a surviving spouse beneficiary (and only a surviving spouse beneficiary) may roll over any amount distributed
from the IRA to another IRA. A surviving spouse who wishes to roll over to a new IRA in
the name of the deceased participant, and thereby preserve the MRD rules that apply to the
deceased participant's account under Code section 401(a)(9)(B), may do so (PLR
94180334). In the case of distributions received after December 31, 2001, a surviving
spouse may roll over distributions to any "eligible retirement plan" for the spouse's benefit
(as defined in paragraph b below).
a. Required minimum distributions may not be rolled over.
In the case of a distribution from a qualified plan, only a "qualified rollover distribution"
may be rolled over. Code section 402(c)(4) defines a qualified rollover distribution as any
distribution of all or a portion of the balance to the credit of a participant except:
(1)
Any distribution which is a series of substantially equal
periodic payments (not less frequently than annually)
made (i) for the life (or life expectancy) of the employee or
the joint lives (or joint life expectancies) of the employee
or the employee's designated beneficiary, or (ii) for a
specified period of ten years or more,
(2)
Any distribution to the extent such distribution is required
under Code section 401(a)(9), or
(3)
After December 31, 2001, any distribution which is made
upon hardship.
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In the case of a distribution from an IRA, Code section 408(d)(3)(E) provides that no
amount that is a minimum required distribution under Code sections 408(a)(6) or 408(b)(3)
may be rolled over.
b. EGTRRA update – eligible retirement plans.
Section 641(d) of EGTRRA permits a surviving spouse to roll over all otherwise taxable
distributions made from a deceased participant's IRA to an eligible retirement plan (a
qualified plan, tax sheltered annuity, or an eligible government section 457 plan that benefits the spouse as well as to the spouse's own IRA). Code §402(c)(9), as amended.
c. Minimum required distributions from the spouse's rollover IRA.
If the surviving spouse rolls the deceased participant's account over to a new or an existing
IRA in the spouse's name, the spouse will be deemed to have elected to treat the interest in
the IRA as the spouse's own and minimum required distributions will then be determined
by applying the rules to the spouse as participant. Treas reg 1.408-8, A-7; PLRs 9450042
and 9534027. If the spouse's RBD has not yet occurred, no distributions from the spouse's
IRA are required until that time. If the spouse's RBD has occurred, distributions with
respect to the rolled over amount must begin from the spouse's IRA in the calendar year
following the year in which the rollover occurred (consistent with the rollover rules
described in section II.C.3.c above).
(1)
Even if required minimum distributions have commenced
prior to the time of rollover from the deceased participant's
IRA or plan, the spouse's age, life expectancy, and designated beneficiaries determine the required payout. See
PLRs 9005071, 9311037, 9426049, 9450042, and
9534027.
(2)
A surviving spouse may roll over a deceased participant's
IRA even though the spouse has attained age 70 1/2 and
passed the RBD. PLRs 9005071, 9311037, 9450042, and
9534027.
d. Rescue rollovers if surviving spouse is "in control".
The rollover opportunity may enable a spouse to rescue an unplanned situation where there
is no designated beneficiary of a deceased participant's IRA or plan and the deferred payment is otherwise foreclosed. For example, where the participant's estate is named (or by
default becomes) the beneficiary of IRA or plan benefits, a spouse may roll over the benefits if the spouse is both executor and sole beneficiary of the estate. PLRs 200433026,
8746055, 9351041, 9402023, 9450041, 9533042, 9545010, and 9537030.
(1)
Similarly, if a spouse is the trustee of a trust or a subtrust
named as beneficiary and has the power to distribute benefits to him/herself, a rollover may be obtained as if the
spouse were designated beneficiary. PLRs 200440024,
200245055, 9016067, 9047060,9235058, 9302022,
9401038, 9426049, 9510049, 9533042, and 9608036.
(2)
In general, rollovers have been permitted if the spouse can be
considered to have received the benefit from the decedent
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(rather than from a trust where the spouse's receipt of benefits
is subject to a trustee's exercise of distribution discretion).
PLRs 9321032 and 9608036. Thus, a spouse's ability to
revoke a trust allowed the distribution to be rolled over in
Private Letter Rulings 9401039, 9427035, 9423039, and
9515042. Proceeds received as an elective share were rolled
over in Private Letter Rulings 200438045 and 9524020. In
Private Letter Ruling 200505030, the members of a surviving
spouse's family disclaimed all interest in the participant's
estate causing plan benefits to pass directly to the spouse and
be eligible for rollover.
(3)
Treasury regulation 1.408-8, A-5, relating to the "own
IRA" election described in paragraph 2 below, requires
that, in order for a spouse to make the election to treat an
IRA as the spouse's own IRA, the spouse must be the sole
beneficiary of the IRA and have an unlimited withdrawal
right (a circumstance which the regulations state cannot be
satisfied if a trust for the spouse is named beneficiary). It
appears, however, that the final regulations were not
intended to restrict rollovers by a spouse trustee and sole
beneficiary. See PLR 200304037.
e. Direct rollovers - references to "rollover" made above are generic
in nature.
Since the enactment of the Unemployment Compensation Amendments Act ("UCA" PL
102-318) in 1992, a traditional rollover from a qualified plan (the receipt by the participant
or spouse of qualified plan funds followed by the deposit of those funds to an IRA) results
in the reduction of plan distributions by 20% (for income tax withholding) so that it is
preferable to instead transfer the plan funds being rolled over by a plan to plan transfer
under Code section 401(a)(31) or "direct rollover" (where no withholding applies). Note
also that Code section 408(d)(3)(B) allows only one tax free withdrawal to be made from
an IRA during a 12 month period, while the frequency of plan to plan transfers is unlimited.
2. Election by surviving spouse to make a deceased participant's IRA
the spouse's IRA.
The surviving spouse of a deceased IRA participant who is the sole beneficiary and has an
unlimited withdrawal right over the participant's IRA may elect (sometimes referred to in
this outline as making an "own IRA" election) to treat the IRA as the spouse's own IRA,
regardless whether or not distributions have commenced to the spouse prior to the election.
The election may be made at any time after the distribution of the required minimum distribution amount for the calendar year of the participant's death, if any, has been made. As
is the case with a spousal rollover, the spouse becomes the IRA participant for purposes of
determining minimum required distributions following the election so that the "lifetime"
distribution rules of Code section 401(a)(9)(A) apply rather than the Code section
401(a)(9)(B) postdeath rules that apply with respect to the deceased participant. Treas reg
1.401(a)(9)-5, A-5(a).
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a. Required distributions for year "own IRA" election is made.
Treasury regulation 1.401(a)(9)-5, A-5(a) states that the required minimum distribution for
the year of the election and each subsequent year will be determined by Code section
401(a)(9)(A) with the spouse as the IRA owner. As noted above, the spouse's election can
only be made after any required distribution for the calendar year of the participant's death
has been made. This rule (which first appeared in the 2001 regulations) would appear to
require that a second minimum distribution is required to be made from the deceased participant's IRA for the deceased participant's year of death if a surviving spouse whose RBD
has already occurred makes the election in the year of the participant's death. However,
the final regulations provide that if the own IRA election is made in the calendar year containing the IRA owner's death, the spouse is not required to take a required minimum distribution for that year as the IRA owner. Instead, the spouse is required to take a minimum
distribution determined with respect to the IRA owner to the extent such a distribution was
not made before the IRA owner's death.
b. How the "own IRA" election is made.
The final regulations provide for a direct "own IRA" election in addition to the two transactional methods of election contained in the 1987 regulations. The election is made by:
(1)
The surviving spouse's redesignation of the account as an
account in the name of the spouse as IRA owner,
(2)
The failure to distribute from the IRA (or from any IRA to
which the account is rolled over) any minimum distribution which would be required to be distributed to the
spouse under Code section 401(a)(9)(B) if the account had
continued as the deceased participant's account, or
(3)
The contribution to the account (or from any IRA to which
the account is rolled over) of any amounts by the spouse
that would be subject to the "lifetime" Code section
401(a)(9)(A) MRD rules. Treas reg 1.408-8, A-5(b).
As described in paragraph B.2 above, the surviving spouse beneficiary of a participant who
dies before the RBD is considered to be the participant for purposes of MRD rule payments of the spouse dies before benefits are required to commence from the participant's
account at the end of the year in which the deceased participant would have attained age 70
1/2. If no minimum required distribution has been made by the required commencement
date, the surviving spouse will be considered to have made an "own IRA" election and will
continue to be the participant with respect to the account. If a minimum required distribution based on the spouse's single life expectancy is made for the year in which the participant would have attained age 70 1/2, the plan or IRA account will be considered to be the
participant's account unless an affirmative own IRA election is made (and, absent such an
election, distributions following the spouse's death will be made over the spouse's fixed life
expectancy rather than over the fixed life expectancies of the beneficiaries named by the
spouse).
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c. Own IRA election only available if spouse is the individual
beneficiary.
The final regulations expressly state that the requirement that the surviving spouse must be
the sole beneficiary of the IRA and have an unlimited right of withdrawal from the IRA in
order to make an "own IRA" election is not met if a trust is named as beneficiary of the
IRA even if the spouse is the sole beneficiary of the trust. Treas reg 1.401(a)(9), A-5(a).
D. Choosing between the alternatives available to a surviving spouse.
Unless the earlier position taken in certain private letter rulings that a sole surviving spouse
beneficiary of a participant who dies prior to the RBD must, in certain circumstances, irrevocably choose between receiving minimum required distributions under Code section
401(a)(9)(B)(iv) on the one hand or a rollover or "own IRA" election on the other is
revived, the question becomes when (rather than whether) a spousal rollover or own IRA
election should be made.
1. Rollover "reloads" the life expectancy deferral opportunity.
As compared to the Code section 401(a)(9)(B) minimum required distribution provisions
under which distributions are made over spouse's redetermined life expectancy during the
spouse's lifetime and, upon the spouse's death, over the fixed life expectancy of the spouse,
a rollover or an own IRA election permits the use of the more generous uniform lifetime
table to determine distributions during the spouse's lifetime and, upon the spouse's death,
allows distributions to be made over the fixed life expectancy of the spouse's designated
beneficiary. The rollover or own IRA election gives the surviving spouse the fresh start
ability to name a new designated beneficiary.
2. Planning for a young surviving spouse of a participant who dies
prior to the RBD.
If a surviving spouse who has not attained age 59 1/2 is the sole beneficiary of a participant
who dies prior to the RBD, the 10% penalty tax that is assessed on premature distributions
does not apply due to the exception for beneficiaries of a deceased accountowner. Code
§72(t)(2)(A)(ii). In the event of an "own IRA" election or a rollover, the spouse, as the
accountowner, would be subject to the 10% premature distributions tax on pre-age 59 1/2
distributions. If the surviving spouse expects to receive distributions prior to attaining age
59 1/2, the surviving spouse would likely defer a spousal rollover or own IRA election
until age 59 1/2 is attained.
a. Private letter rulings require a choice.
In Private Letter Rulings 9418034 and 9608042, it was stated that an irrevocable election
of the Code section 401(a)(9)(B)(iv) provision would occur at the time a pre-age 59 1/2
surviving spouse first received IRA distributions from a decedent's IRA and failed to pay
the 10% early distribution tax that is imposed under Code section 72(t)(1), a tax that would
be payable if an own IRA election had been made and a pre-age 59 1/2 distribution had
been received by the spouse. In these rulings, the IRS adopted the view that the exception
to the early distribution tax for distributions made to a beneficiary on or after the death of
the accountowner [Code §72(t)(2)(A)(i)] which clearly applies to distributions received
from an account in the deceased accountowner's name under the Code section 401(a)(9)(B)
rules does not apply if the surviving spouse has elected to treat the account as the spouse's
own IRA (effectively transforming the spouse from a death benefit beneficiary to an ac1-35
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countowner). The failure to pay tax was construed to be an election out of the "own IRA"
election option.
b. Rollover to multiple IRAs to obtain penalty free distribution and
deferral.
Private Letter Ruling 9842058 approved a rollover of a deceased accountowner's IRA into
two IRAs in the spouse's name. One IRA was funded with an amount that was intended to
provide periodic distributions to the surviving spouse that were projected to cover the
spouse's needs through age 59 1/2. Payments were arranged to satisfy the exception to the
10% tax for a series of substantially equal periodic payments over the life expectancy of
the designated beneficiary. Code §72(t)(2)(A)(i) and Notice 89-29 (1981-1 CB 662). In
general, once initiated, if periodic payments are terminated or modified before the fifth
anniversary of the initial payment or the beneficiary's attainment of age 59 1/2, if later, the
10% tax for all pre-age 59 1/2 payments is assessed with interest. Note, however, that a
one time change in the amount of periodic distributions may now be made without incurring the recapture tax. Rev Rul 2002-42 IRB 1. See Revenue Ruling 2002-42 and recent
Private Letter Rulings 200432021, 200432023, and 200437038 regarding methods by
which periodic payments may be determined. The second rollover IRA would be expected
to defer any distributions until the spouse attained age 59 1/2. Periodic distributions from
(and measured by the balance of) just one of several IRAs are permitted since the rule that
requires all IRAs to be aggregated for MRD rule purposes does not apply for the 10%
excise tax purposes.
c. More recent ruling position permits deferred "own IRA" election.
Private Letter Ruling 200110033 expressly reverses this "irrevocable choice" position and
affirms that a younger surviving spouse who has received pre-age 59 1/2 distributions as a
beneficiary of a deceased accountowner's IRA may subsequently elect to treat the IRA as
the spouse's own or roll over the remaining account balance to the spouse's own IRA without having to remit the 10% penalty tax with respect to prior pre-age 59 1/2 distributions.
While this ruling predates the final regulations, note that the new regulations are substantially similar to the previously proposed regulations in this respect but now state that the
election to treat a deceased individual's entire interest as a beneficiary in an individual's
IRA (or the remaining part of such interest if distribution thereof has commenced for the
spouse) as the spouse's own account "is permitted to be made at any time after the individual's date of death". Treas reg 1.408-8, A-5(a).
3. Planning for an older spouse of a participant who dies before the
RBD.
In the event that the sole surviving spouse beneficiary of a participant who dies prior to the
RBD is at least one year older than the participant, a rollover or own IRA election would
accelerate the commencement of MRD rule payments because the spouse has an earlier
RBD. If the surviving spouse defers a rollover or own IRA election until the end of the
calendar year in which the deceased participant would have attained age 70 1/2, no distribution will be required until the calendar year of election or rollover. In the meantime, the
surviving spouse may designate a beneficiary to receive the IRA balance over the beneficiary's life expectancy under Code section 401(a)(9)(B)(vi)(II) should the spouse die prior to
the election or rollover being made (thus producing the same deferral, upon the spouse's
death, that would be obtained if the account had been rolled over).
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V. IRA AND QUALIFIED PLAN PROVISIONS
A. Overview.
If qualified plan or IRA benefits are not made payable to a trust, the plan or IRA agreement
and beneficiary designation will control the disposition of these benefits not only upon the
participant's death but also upon the death of any designated individual beneficiary who
survives the participant. Most existing plan and IRA agreements (sometimes referred to as
"inside trusts") do not include provisions that effectively deal with the dispositive contingencies (such as a beneficiary's untimely death, an unexpected order of deaths, or a beneficiary's incapacity) that a client's "outside trust" routinely covers.
1. Agreements conforming to final regulations.
As noted in paragraphs ID3b(3) and (4), the deadline for revising existing IRA agreements
has now passed (10/01/02) and the deadline for qualified plan amendments was the last
day of the plan year that begins in 2003. It was expected (or hoped) that amendments
made to conform plan and IRA agreements to the provisions of the final regulations would
include specific administrative guidance regarding window period planning options such
as establishing separate accounts for differing designated beneficiaries and the disclaimer
of benefits as well as guidance for establishing separate accounts for non MRD rule purposes such as separate investment management. For the most part, updated IRA agreements do not include such guidance.
2. Oversight required to integrate estate planning.
In the case of clients who have substantial assets, most estate planners seek to integrate all
of the client's (or married couple's) assets into a comprehensive estate plan that will provide for the disposition of those assets through a central vehicle (a revocable trust or will)
which, by formula, will allocate the client's assets among trusts for the client's surviving
spouse and descendants in a manner intended to minimize estate and GST taxes. Often the
client's assets are ultimately to be transferred to continuing trusts for descendants which,
by providing for independent trustees with the power to make discretionary trust distributions or by providing ascertainable standards for trust distributions:
(a)
Protect the assets from a descendant's creditors (including divorcing spouses),
(b)
Shelter the assets from estate tax on a descendant's death,
(c)
Provide asset management guidance and the budgeting of
distributions to assure lifetime support, and
(d)
Provide a coherent plan for transmitting those assets to lower
generation beneficiaries.
To the extent that the estate plan provides for the separate disposition of specific assets
(such as IRA and plan benefits), the estate planner must monitor the value of each asset
and know the rules that apply to its disposition to assure that the overall estate plan is not
jeopardized.
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B. IRA agreement provisions.
All IRA agreements either incorporate the final regulations by reference or state that the
IRA will be administered, in all respects, in accordance with the final regulations. The
absence of an express provision in an IRA agreement does not necessarily mean that the
administrative option is foreclosed. However, discussions with the IRA provider and the
submission of a customized beneficiary designation will likely be indicated.
1. Participant designates primary and contingent beneficiaries as of
participant's death.
Beneficiary designation forms for IRA agreements typically provide entry lines for one or
more "primary beneficiaries" and one or more "contingent beneficiaries". The named contingent beneficiaries are entitled to receive benefits only if none of the primary beneficiaries survive. If a primary beneficiary predeceases the participant, the remaining primary
beneficiaries (or, if none, the contingent beneficiaries) share the benefits. Unless a customized beneficiary designation is filed and accepted by the plan sponsor that characterizes
the contingent beneficiaries as "successor beneficiaries", any interest of the contingent
beneficiaries named by the participant in the IRA benefits ceases upon the participant's
death if one or more primary beneficiaries survive the participant (regardless whether the
surviving primary beneficiary dies prior to or following the MRD rule designation date).
2. The surviving beneficiary usually names successor beneficiaries.
Under many IRA agreements, a beneficiary who survives the participant has the right to
designate the primary and contingent beneficiaries who will receive the IRA benefits upon
the beneficiary's death. Under a few IRA agreements, the participant has the express
power to name successor beneficiaries and, if the participant stipulates a beneficiary to
receive the IRA benefits upon a beneficiary's death, the participant's designation takes
precedence over the deceased beneficiary's designation.
3. On beneficiary's death, the default beneficiary is beneficiary's
estate.
If no beneficiary designation has been filed by a deceased beneficiary who has survived the
participant (and no designation of successor beneficiaries, if applicable, has been made by
the participant), most IRA agreements provide that the plan benefits are payable to the
beneficiary's estate.
a. Minimum required distributions not accelerated.
Under the MRD rules, if the deceased beneficiary is the only beneficiary (and is not the
surviving spouse of a participant who died prior to the RBD) or the deceased beneficiary is
the oldest named beneficiary, distributions, beginning in the calendar year following the
participant's death, would be made over the single life expectancy of the deceased beneficiary. See paragraph III.D.1 above.
b. Beneficiary's beneficiary designation desirable.
Although minimum required distributions are not accelerated if the beneficiary's estate is
the default beneficiary of a deceased beneficiary designated by the participant and the IRA
account can be divided and assigned to the estate beneficiaries, probate avoidance and the
risk of an unintended intestate succession can be avoided if the surviving beneficiary files a
beneficiary designation.
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4. Provisions for surviving spouses.
Most IRA agreements include the special provisions that apply to a participant's surviving
spouse described in section IV above and permit the surviving spouse to designate successor beneficiaries on the surviving spouse's death. Because the maximum stretch out of
benefit payments can typically be obtained by a surviving spouse's rollover to the spouse's
own IRA or an own IRA election (for the reasons outlined in paragraph IV.C above), a
decision will often be made to name the participant's spouse (directly or via post-death disclaimers) as the sole designated beneficiary of all or a portion of the participant's plan or
IRA benefits. The spouse's failure to file a beneficiary designation with respect to the
inherited IRA will likely sabotage the hoped for extended applicable distribution period.
a. Risk of five-year rule applying.
Under most IRA agreements, the default beneficiary of a surviving spouse who survives
the participant and then dies is the spouse's estate. If a surviving spouse of a participant
who has died before the participant's RBD subsequently dies without having named a
beneficiary, the five-year rule will apply. If the surviving spouse has made an own account
election or rolled the benefits over to the spouse's own IRA and the surviving spouse's
RBD has not occurred, the five-year rule will similarly apply if no beneficiary designation
has been made by the spouse.
b. Payment over spouse's (or participant's) fixed life expectancy.
If the surviving spouse of a participant who has died after the participant's RBD survives
the participant and dies without having made a beneficiary designation, distributions
beginning in the year following the spouse's death, will be made to the spouse's estate over
the longer of the spouse's or the deceased participant's life expectancy. If the surviving
spouse has rolled over the benefits or made an own account election, distributions will be
made to the spouse's estate over the fixed life expectancy of the spouse. In either case, the
opportunity to take advantage of a younger beneficiary's fixed life expectancy is lost.
c. Durable powers of attorney.
Most IRA agreements provide, directly or indirectly, for the recognition of an authorized
agent acting under a durable power of attorney. The submission of a power that authorizes
the agent to make an own account election, to initiate rollover transfers, and to designate
beneficiaries (either in all events or only in the event of the surviving spouse's incapacity)
may increase the potential that the deferral objectives will be accomplished.
5. Planning and presumption provisions.
An "inside" trust is not an "outside" trust but may or may not include some of the definitional and presumptive provisions commonly included in a revocable or irrevocable trust
that is part of an estate plan. Some IRA agreements define the meaning of "per stirpes" as
either traditional descent by right of representation or as being by right of representation if
at least one senior generation member survives but per capita among the next generation
members if no senior generation members survive. Some IRA agreements include a presumption of survivorship in the event of a common disaster or refer to the law of the participant's domicile. Few IRA agreements include specific provisions regarding disclaimers
by beneficiaries (notwithstanding the endorsement of window period disclaimers in the
final regulations). Accordingly, facilitating or presumptive provisions often must be
incorporated in the participant's or beneficiary's beneficiary designation.
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C. Qualified plan provisions.
Because qualified plans are not generally available to the public, it is difficult to anticipate
what changes (other than the mandated changes described below) may be made in response
to the final regulations. Plan administrators and participants are usually best served if plan
benefits can be rolled over to an IRA during the participant's lifetime or by a surviving
spouse after the participant's death. CAVEAT: qualified plans that include securities of
the employer sponsor distributed as part of a lump sum receive special benefits and
employees born before 1936 may be eligible for special income tax averaging.
1. Model amendment for defined contribution plans.
The IRS has published a model amendment that, if timely adopted, will satisfy the
requirement that qualified plans be amended for the MRD rules. Rev Proc 2002-29, 200224 IRB 1176 (05/28/02). The model amendment presents a detailed description of the pre
and post-death MRD rules for the distribution of benefits and includes a statement that "All
distributions required under this article will be determined and made in accordance with
Treasury regulations under section 401(a)(9) of the Internal Revenue Code". While the
September 30 designation date is thus specified, no reference to beneficiary disclaimers or
the creation of subaccounts is made.
2. Elimination of plan deferred payment options.
Under the anti-cutback rules of Code section 411(d)(6), any change made to a defined
contribution plan's benefit payment options, even changes made to eliminate little used or
administratively burdensome options (such as providing for payments in the form of an
annuity as a payment option when the plan is not required by the joint and survivor annuity
rules to do so) was until recently viewed as a prohibited reduction of participants' benefits.
Final Treasury regulations, promulgated on August 31, 2000, increased the ability of
employers to make such amendments if participants, upon notice, consented. Treas reg
1.411(d)-4, A-2(e)(1). EGTRRA, except to the extent provided in future regulations permits a plan sponsor to eliminate benefit options previously available as long as an equivalent single sum distribution option is available to participants at the same time and with
respect to the same (or a greater portion) of the benefits to which the benefit distribution
option eliminated related. Code §411(d)(6)(D), as amended. Final regulations regarding
permitted changes in plan benefit options were published on August 11, 2005. Treas Reg
1.411(d)-3.
(a)
A participant or surviving spouse may obtain installment distributions under the MRD rules by rolling a single sum distribution over to an IRA. However, non spouse beneficiaries (who
have no rollover option) would be able to obtain deferred distributions only if the participant or a surviving spouse has
received a pre-death single sum distribution and established an
IRA before death.
(b)
Of course, the elimination of deferred payment options will not
eliminate a surviving spouse's right to death benefits if the plan
is a money purchase pension plan. Only a rollover by a participant, if available, made pursuant to a waiver of spousal benefits
with spousal consent can eliminate the survivor benefit rules'
application in that type of plan.
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VI.
RULES FOR NAMING TRUSTS AS BENEFICIARIES
A. Qualifying a trust for the "look through" rules.
As an exception to the rule that the naming of a nonindividual as the (or one of the) beneficiaries of a deceased participant results in the participant being treated as having no designated beneficiary for purposes of the MRD rules, the beneficiaries of a trust will be treated
as the designated beneficiaries of the participant if the trust meets four regulatory requirements. Treas regs 1.401(a)(9)-4, A-5 and A-6. The final regulations confirm the position
taken in Revenue Ruling 2000-2 (2000-1 CB 305) that a testamentary trust may qualify for
look through treatment. Treas reg 1.401(a)(9)-5, A-7(c)(3), Example 1. Except for the
change in the time at which the requirements must be met, the four requirements are substantially the same as those of the 1987 regulations as amended on December 30, 1997 (62
FR 67780).
1. The four requirements.
In order to treat a trust beneficiary as the participant's designated beneficiary for purposes
of the look through rules:
(a)
The trust must be a valid trust or would be a valid trust under
state law if it had a corpus,
(b)
The beneficiaries of the trust entitled to the plan or IRA benefits
must be identifiable,
(c)
The trust must be either irrevocable or, by its terms, will
become irrevocable at the participant's death, and
(d)
The documentation requirements described in paragraph 2
below must be satisfied. Treas reg 1.401(a)(9)-4, A-5.
If the beneficiary of a trust is another trust, the beneficiaries of the other trust will be
treated as the participant's designated beneficiaries if the four requirements are satisfied
with respect to that trust as well. Treas reg 1.401(a))9)-4, A-5(d).
2. Documentation requirements.
The documentation requirements remain the same as those under the 1987 regulations (as
amended in late 1997). However, the fact that the RBD is no longer the date as of which
the designated beneficiary is determined changes the time at which the requirements must
be satisfied.
a. After death requirements.
By October 31 of the calendar year immediately following the calendar year in which the
participant died (one month after the designation date), the trustee of the trust must either
provide the plan administrator (or IRA trustee or custodian) with:
(1)
A copy of the trust agreement of the trust named as
beneficiary or
(2)
A list of all beneficiaries of the trust (including contingent
and remaindermen beneficiaries with a description of the
conditions of their entitlement) and
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(i)
Certify that, to the best of such trustee's knowledge,
the list is correct and complete,
(ii)
Certify that the three nondocumentation requirements listed in paragraph 1 above (paragraphs a, b,
and c) are satisfied, and
(iii)
Agree to provide a copy of the trust agreement to the
plan administrator upon demand. Treas regs
1.401(a)(9)-1, A-4(c) and 1.408-8, A-11.
b. One time opportunity to cure defective documentation –
October 31, 2003 deadline.
If a trust has failed to provide a copy of the trust document (or a list of beneficiaries) under
the proposed regulations' deadlines, the beneficiaries of the trust will nonetheless be treated
as designated beneficiaries if such documentation was provided to the plan administrator
by October 31, 2003.
c. Lifetime minimum required distributions – trust for ten years
younger spouse.
In the case of a conduit trust for a spouse more than ten years younger than the participant
that is named as beneficiary for a year in which the participant is living, in order to obtain a
joint life expectancy distribution period, the trustee of the trust must provide all of the
information described in paragraph a above and must additionally agree that, if the trust
agreement is amended during the participant's lifetime, a copy of the amendment or corrected certification, if the amendment changes the information certified, must be furnished
to the plan administrator within a reasonable time. Under the 1987 regulations, documentation was required to be furnished by the later of the participant's RBD or the date as of
which the trust was named beneficiary. The final regulations do not specify a deadline but
presumably the documentation would be required to be delivered prior to the calendar year
in which a joint life expectancy distribution is to be made (or, perhaps, prior to the RBD in
the case of the first and second distribution calendar years).
B. Identifying the look through designated beneficiaries.
Except in the case of a conduit trust for the benefit of a surviving spouse of a participant
who dies before the participant's RBD discussed in sections II.D.2 above and IV.B.3.c
above, minimum required distributions must be made, beginning with the calendar year
following the calendar year of the participant's death, over the life expectancy of the oldest
trust beneficiary determined as of the designation date. If the primary trust beneficiary (for
example, the participant's spouse) is not the oldest beneficiary (for example, because a parent of the participant becomes a trust beneficiary if living on the spouse's death), the applicable distribution period will be shorter. If there is no designated beneficiary on the designation date because one or more of the trust beneficiaries required to be taken into account
is a nonindividual (or trust funds may be paid after September 30 of the calendar year following the participant's death to or for the benefit of the participant's estate to cover taxes
and expenses), minimum required distributions to the trust will be made by the end of the
fifth calendar year following the year of the participant's death (if the participant dies
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before the participant's RBD) or over the participant's remaining fixed life expectancy (if
the participant dies after the participant's RBD).
1. Applying the designated beneficiary definition to trust beneficiaries – in general.
The final regulations, in the provision that authorizes the look through rules for trusts, state
that the beneficiaries of a trust that is named as the beneficiary of plan benefits will be
treated as having been designated as beneficiaries of the participant under the plan for purposes of the MRD rules. Treas reg 1.401(a)(9)-4, A-5. Question A-5 speaks of "the beneficiaries of the trust with respect to the trust's interest in the participant's benefit" as being
the look through beneficiaries so that a trust agreement may presumably provide that less
than all of the trust's beneficiaries have an interest in the trust's interest in the benefits and
exclude from consideration those beneficiaries who do not have such an interest.
However, see paragraph 9 below re applying the separate share rules to trusts.
2. Disregarding contingent beneficiaries – death contingency nontrust
rules.
The 1987 regulations provided that, in the case of a series of successive individual beneficiaries:
"If a beneficiary's entitlement to an employee's benefit is contingent on the death of a prior
beneficiary, such contingent beneficiary will not be considered a beneficiary for purposes of
determining who is the designated beneficiary with the shortest life expectancy under
paragraph (a) or whether a beneficiary who is not an individual is a beneficiary." Former
prop Treas reg 1.401(a)(9)-1, A-5(e)(1).
a. 2001 regulations.
The 2001 regulations modified the definition of a disregardable contingent beneficiary to
clarify that a contingent beneficiary may be disregarded "only if another beneficiary dies
before the entire benefit to which that other beneficiary is entitled has been distributed by
the plan". Treas reg 1.401(a)(9)-5, A-7(c)(1). The premise in a nontrust setting is that if
plan benefits are to be distributed over the life expectancy of a beneficiary, the beneficiary
will receive all of the benefits from the plan if the beneficiary lives out the life expectancy
period. The contingent beneficiary may be disregarded under this rule only if the premature death of the predecessor beneficiary is the sole circumstance under which the contingent beneficiary will receive benefits. See Treas reg 1.401(a)(9)-5, A-7(c)(3), example 1.
b. Final regulations.
The final regulations generally state that, if a beneficiary's entitlement to a participant's
benefit after the participant's death is a contingent right, such contingent beneficiary shall
nonetheless be considered a designated beneficiary in determining the identity of the oldest
designated beneficiary or whether there is a nonindividual beneficiary. A person will not
be considered a beneficiary for purposes of identifying the oldest (or a nonindividual)
beneficiary merely because the person could become a successor to the interest of one of
the participant's beneficiaries after that beneficiary's death. However, the preceding sentence does not apply to a person who has any right (including a contingent right) to a participant's benefit beyond being a mere potential successor to the interest of one of the participant's beneficiaries upon that beneficiary's death. Treas reg 1.401(a)(9)-5, A-7(c).
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3. Disregarding contingent trust beneficiaries – death contingency in a
trust setting.
The final regulations state:
"Thus, for example, if the first beneficiary has a right to all income with respect to an
employee's individual account during that beneficiary's life and a second beneficiary has a
right to the principal but only after the death of the first income beneficiary (any portion of
the principal distributed during the life of the first income beneficiary to be held in trust until
that first beneficiary's death), both beneficiaries must be taken into account in determining
the beneficiary with the shortest life expectancy and whether only individuals are
beneficiaries." Treas reg 1.401(a)(9)-5, A-7(c)(1).
By analogy to the foregoing broadly worded rule applicable to participant's account, if a
trust named as beneficiary allows plan or IRA benefits that are received from a participant's account to be accumulated in the trust for payment in the future to beneficiaries
other than the trust's current primary beneficiary, all such future beneficiaries must presumably be taken into account.
a. The "normal" meaning of "contingent" does not apply.
The future trust beneficiaries are taken into account under this view even though the successor beneficiaries will not benefit in the future unless and until they, in fact, survive the
initial designated beneficiary. Note that the possibility that the benefits will be completely
distributed to a predecessor beneficiary (for example, by exercise of trustee discretion) is
not considered to be relevant.
b. Charities as remainder beneficiaries.
In Private Letter Ruling 9820021, the plan benefits of a participant who died prior to the
RBD were payable to a marital trust that was to pay all income to the spouse together with
principal invasions under an ascertainable standard. Charitable organizations were named
as remainder beneficiaries. The five-year rule applied to the marital trust to determine the
payment of benefits upon the participant's death due to the fact that there was no designated beneficiary because the charities were deemed to be "entitled" to trust benefits and
were thus taken into account in the designated beneficiary determination. In effect, the
primary beneficiary's death affected only the timing of the receipt by (rather than the actual
entitlement of the charities to) the benefits.
4. Identifying all trust beneficiaries.
As illustrated by the final regulations' examples concerning the circumstances under which
a surviving spouse of a participant can be considered to be the sole beneficiary of a trust
(discussed in paragraph IV.B.3.c above), the fact that a trust does not require the distribution of the plan benefits it receives to the spouse as the oldest beneficiary and may instead
hold the benefits for distribution to other trust beneficiaries after the spouse's death prevents the remaining trust beneficiaries from being disregarded under the death contingency
provision even if the trust were to require that no distributions of plan benefits could occur
to a successor trust beneficiary until the primary beneficiary died. In the terminology of
the 2001 regulations, the predecessor (or primary) beneficiary of a trust is not entitled to
the benefits distributed by the plan and successor trust beneficiaries can therefore not be
disregarded as contingent beneficiaries.
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a. The erratic evolution of rules to permit certain contingent trust
beneficiaries to be disregarded.
The elliptical provisions of the final regulations have done little to advance the search for a
bright line test under which contingent trust beneficiaries can be eliminated from the pool
of beneficiaries that must be considered in order to determine the measuring life for
MRDs. As had been the case under previous regulations, practitioners are forced to
attempt to discern guidelines from private letter rulings – a difficult task due to the brevity
of the factual descriptions often provided, the focus of the discussion on the particular
issues identified by the requesting taxpayer, and the fact that the negotiated resolution of
other issues not described in the ruling may have influenced the outcome.
(1)
The emerging rule appears to be that if there are younger
contingent beneficiaries who have an unrestricted right to
receive the trust assets (including IRA and plan benefits)
upon the trust's termination at the time of the initial beneficiary's death, further contingent beneficiaries may be disregarded. In other words, the possibility that the younger
beneficiaries may not survive until the trust's termination
may be ignored and the actuarial likelihood of the younger
beneficiaries' survival will serve to cut off successor beneficiaries to them.
(2)
Until such time as the rules for disregarding contingent
beneficiaries are promulgated in a revenue ruling or
amended regulations, conservative practitioners will recommend the use of conduit trusts (the only vehicle that
clear circumscribes the pool of potential designated beneficiaries).
(3)
If the developing bright line test described in the private
letter rulings below is employed, it is advisable to nonetheless limit the successor beneficiaries which the test
appears to exclude (i) to individual beneficiaries younger
than the initial beneficiaries intended to be the measuring
lives for MRD purposes and (ii) to permit the disinterested
trustees of the trust to disclaim plan and IRA benefits in
favor of the initial current trust beneficiaries as a safety
valve in the event that the bright line test has changed at
the time of the participant's death.
b. Disregarding identified younger beneficiaries – The Example 1
"flat earth" trust.
In example 1 of Treas reg 1.401(a)(9)-5, A-7, the surviving spouse is considered to be the
oldest designated beneficiary because the trust remaindermen (the children) who will succeed her when the trust terminates upon her death are all younger than the spouse. The
example stipulates that no other person has a beneficial interest in the trust. The lack of
alternative trust provisions that would apply if the remaindermen should fail to survive the
surviving spouse has caused the example 1 trust to be dubbed the "flat earth" trust by commentator Virginia Coleman of Boston. In the absence of additional trust dispositive provi1-45
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sions, were the children to predecease the surviving spouse, the trust assets (including the
plan benefits) would become payable to the spouse's estate or the children's estates
depending on state law. The fact that an estate might potentially be a successor to the trust
beneficiaries' interests in example 1 (and cause the participant to have no designated beneficiary if that ultimate disposition were taken into account) was not discussed implies that
the ultimate disposition of trust property upon an exhaustion of trust beneficiaries will be
disregarded in determining the oldest designated beneficiary.
c. The actuarial approach - if a trust is to terminate within the life
expectancies of identifiable beneficiaries, may certain successor beneficiaries be disregarded?
But for the fact posited in example 1 that there are no cleanup beneficiaries, example 1 is
consistent with earlier private letter rulings based on an "actuarial" approach. In Private
Letter Ruling 9846034, the exception to the five-year rule applied to allow distributions
payable to a trust named as beneficiary to be made over the spouse's (oldest current beneficiary's) fixed life expectancy following the participant's death. The trust, a QTIP trust, was
to continue for the spouse's lifetime and, on the spouse's death, was to terminate and make
outright distributions to the spouse's descendants.
(1)
The "cleanup" beneficiaries who would have benefited
only if the children successor beneficiaries failed to survive their mother (which, if the children lived out their life
expectancies, the children would clearly do) were ignored
as "contingent" beneficiaries within the meaning of former
proposed Treasury regulation 1.401(a)(9)-1, E-5(e)(1).
The cleanup beneficiaries in this instance were the participant's heirs at law (and thus might have included the participant's siblings who, if not disregarded, might have been
older than the participant's surviving spouse).
(2)
As a result, in what appeared to be an actuarial analysis,
this ruling seems to say that if a look through beneficiary
who lived out his or her life expectancy would receive
from the trust all of the plan or IRA benefits if such beneficiary would survive an older predecessor beneficiary
based on normal life expectancy assumptions, any successor beneficiaries who are older than the predecessor
younger successor beneficiary could be disregarded.
While the existence of the trust means that the life beneficiary will not receive all of the plan or IRA benefits, the
fact that the remainder beneficiaries need only survive to
receive them effectively makes all subsequent beneficiaries mere successors.
(3)
It is not clear whether the fact that the flat earth trust of
Example 1 had no named clean up beneficiaries is material
to the result. Thus, the result in Private Letter Ruling
9846034 may (or may not) continue to apply.
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(4)
If a primary beneficiary has a withdrawal right, the beneficial interests of future, contingent beneficiaries would also
presumably be disregarded. PLR 199903050.
d. It cannot be assumed that a beneficiary will survive to a stated
age.
In Private Letter Ruling 200228025 (issued under the proposed 2001 regulations), a discretionary trust was established for the participant's two minor grandsons with each grandson having the right to withdraw his entire share at age 30. If either grandson should die
before attaining age 30, the surviving grandchild beneficiary would receive all of the trust's
distributions and, if both the beneficiaries should die before attaining age 30, contingent
beneficiaries (including an aunt who was age 67 at the time of the participant's death)
would receive the trust benefits. In holding that the 67 year old beneficiary must be taken
into account, the ruling states that:
"In this case, the discretion the trustee of Trust X has with respect to the payment of
trust amounts to the Grandchildren, who are the primary beneficiaries, is a
contingency over and above the death of a prior beneficiary."
(1)
While this ruling appeared to be inconsistent with an
actuarial analysis in Private Letter Ruling 9846034, the
grandson beneficiaries must do more than merely survive
to obtain the full amount of the IRA benefits (that is, attain
age 30).
(2)
Contrast this result with the snapshot approach discussed
below.
e. Disregarding contingent beneficiaries under the "snapshot"
approach.
In Private Letter Ruling 200438044, the number of potential contingent see through beneficiaries required to be taken into account was limited in the case of a QTIP and a credit
shelter trust created upon the participant's death for the benefit of the surviving spouse.
During the spouse's lifetime, each trust was to pay income to the spouse with discretionary
principal invasions for the spouse's welfare. Upon the spouse's death, the trust assets were
to be held in separate trusts for the participant's descendants, per stirpes, with each descendant's trust to terminate when the descendant attained age 30, distributing the trust assets
(including the trust's interest in IRA benefits) outright. At the time of the participant's
death, he was survived by three children each of whom had attained age 30.
(1)
The idea of the snapshot approach is to analyze the
beneficiaries' status as look through beneficiaries by
assuming that the primary beneficiary (or the current
income beneficiaries or permissible distributees) died at
the time the snapshot is taken (here, at the time the trust
was established upon the participant's death).
(2)
In PLR 200438044, the Service concluded that each of the
three age 30 children had an "unrestricted right to a portion
of the remainder interest" because, if the spouse's interest
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were terminated on the snapshot date, the descendants'
trust would immediately terminate and distribute outright.
Thus, any lower generation descendants who might
receive an interest in the trust assets should any of the age
30 children in fact predecease the spouse are ignored.
(3)
f.
The snapshot approach is consistent with the private letter
rulings described in paragraphs c and d above in that, if
successor beneficiaries need only survive in order to
receive the IRA benefits outright, further successor beneficiaries may be disregarded.
Trusts that defer termination for minor beneficiaries.
If the foregoing test is to be relied upon to disregard beneficiaries who might succeed a
participant's children upon a trust termination, take care that the trust agreement's normal
trusts for minors provision (which allows the trustee to extend the trust beyond its otherwise scheduled termination date at the time of the initial beneficiary's death – for example
the surviving spouse's death) do not apply if plan or IRA benefits are paid to the trust.
g. Can any trust beneficiary, however remote the interest, be disregarded if trust termination is deferred?
In the case of trusts intended to continue for the rule against perpetuities period (or indefinitely), may remote contingent beneficiaries (charities or the participant's heirs at law determined under the state of domicile) that might benefit under a clean up clause or failure
of issue situation be disregarded under any circumstances? This question as of yet has not
been answered by any published ruling.
(1)
The principal purpose of the quest under the look through
rules to identify the oldest beneficiary and foreclose nonindividual recipients is to prevent any individual beneficiary or any entity from receiving the benefits over an
applicable distribution period that is longer than the
applicable distribution period that would be available to
that individual or entity were there no trust involved.
(2)
If the trust agreement's terms limit the pool of beneficiaries that may ultimately receive trust distributions to the
oldest individual beneficiary and individuals who are
younger than that oldest individual whose measuring life is
intended to determine the applicable distribution period,
the purpose of the look through rules would appear to be
served regardless how long the trust remains in existence
before ultimately making distributions to beneficiaries
upon termination. Trusts designed to limit beneficiaries in
this matter have been variously referred to as "last man
standing trusts", "circle trusts", or "individuals only
trusts". See the discussion in paragraph VII D 2 below.
(3)
On May 27, 2003, the Employee Benefits Committee of
the American College of Trusts and Estate Counsel
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(ACTEC) submitted a request for further published guidance to the IRS regarding the distinction between a "contingent beneficiary" and a "successor beneficiary" under
Treasury regulations 1.401(a)(9)-5, A-7(b) and (c). The
submission poses six fact settings involving plan and IRA
benefits payable to a trust, discusses the existing regulatory and private letter ruling guidance, presents suggested
(and alternative) results, and requests that the IRS publish
guidance. Due to existing IRS guidance projects and the
need to issue guidance regarding the extensive legislation
recently enacted, it is not expected that a response to this
request for guidance will be on a fast track.
5. Are the potential beneficiaries of unexercised powers of appointment taken into account?
If a beneficiary holds a broad nongeneral power of appointment (which could be exercised
in favor of older or nonindividual beneficiaries), the IRS will likely take the position that
such hypothetical appointees must be counted as beneficiaries. While the meaning and
scope of Treasury regulation 1.401(a)(9)-5, A-7(c) is far from certain, private letter rulings
involving trusts containing powers of appointment (for example, in Private Letter Rulings
19993050 and 199918065) have not often involved a discussion of the issue.
a. Limiting permissible appointees.
In Private Letter Rulings 200235038-041, the existence of special powers of appointment
held by children that limited permissible appointees to individuals no older than the oldest
child was stipulated as a fact in a ruling that permitted the oldest child's measuring life to
determine the maximum payout period. In Private Letter Ruling 200235088, a special
power's permissible distributees were limited to all individuals of the same age or younger
than the powerholder. The ruling effectively concluded that this group represented a class
of identifiable beneficiaries.
(1)
If beneficiaries at different generational levels hold (or
will potentially hold) powers of appointment, the permissible appointees of which are to be limited to individuals
no older than the oldest beneficiary intended to be the
measuring life for MRD purposes, reference should be
made to the oldest current beneficiary of the trust or any
predecessor trust (income beneficiary or permissible distributee) who is living at the time of the participant's death
and who has not disclaimed benefits under the trust as of
the participant's designation date nor received a full distribution (cash out) of trust benefits by that time.
(2)
Typically, the limiting of permissible appointees will
involve excluding nonindividual beneficiaries and spouses
of descendants who may be older than the current oldest
beneficiary who holds the power of appointment. If eliminating older spouses may distort the dispositive plan, the
permissible appointees could be limited to individuals a
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certain number of years older than the oldest descendant
(say, five years) without sacrificing much of the stretch out
in distributions if the oldest beneficiary is a child of the
participant.
b. Disclaiming a special power.
In Private Letter Ruling 200438044 discussed in paragraph 4.e above, the surviving spouse
disclaimed a special power of appointment exercisable in favor of the participant's lineal
descendants and their spouses. The ruling does not discuss the disclaimer but the fact that
a descendant's spouse could, in theory, be older than the surviving spouse probably made
the disclaimer a relevant fact in the holding.
c. GST nonexempt trusts.
In the case of generation skipping transfer (GST) tax nonexempt trusts, practitioners often
include provisions intended to cause the inclusion of trust assets in a beneficiary's taxable
estate. These inclusionary provisions are motivated by the goal of reducing the transfer tax
rate applicable to the nonexempt property (applying the lower estate tax rate instead of the
maximum GST tax rate) and of permitting the deceased beneficiary's executors (if the
beneficiary's taxable estate is less than the beneficiary's unused GST exemption amount for
the year of the beneficiary's death) to allocate GST exemption to the included GST nonexempt trust assets. These provisions may grant the beneficiary a power of appointment
exercisable in favor of the beneficiary's probate estate (only exercisable with the consent of
a disinterested trustee) or give a disinterested trustee the power to grant such a power to the
beneficiary.
(1)
If the power of appointment is intended solely for GST tax
purposes, an alternative would be to grant the beneficiary a
withdrawal right, exercisable only with the consent of a
disinterested trustee. Such a withdrawal power would
cause inclusion under IRC §2041 but would eliminate
potential older and nonindividual beneficiaries.
(2)
Now that the estate tax and GST tax rates are converging,
the existence of the nonexempt trust general powers may
be less important as a planning strategy in many cases.
6. Use of benefits to pay estate expenses.
The IRS has implied that a participant may have no designated beneficiary if the participant's estate may receive (or indirectly benefit from) the use of plan or IRA benefits payable to a deceased participant's revocable trust if trust assets may be used to pay estate
expenses of the deceased participant. Private letter rulings point out that the absence of a
provision permitting such a use of trust funds is a favorable factor when allowing look
through treatment for trusts named as beneficiary. See PLRs 9809059, 9820021,
199912041, and 200010055. Payments made from plan or IRA benefits for estate taxes or
estate expenses are arguably not payments to a beneficiary at all but rather payments to
creditors to which the benefits may be legally (and are equitably) subject. Even in the case
of a nontrust beneficiary, benefits may be required to be paid for estate expenses. If a trust
agreement provides that plan and IRA benefits payable to the trust may not be utilized to
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pay estate expenses on or after September 30 of the calendar year following the
participant's death, the fact that benefits may be so applied prior to the designation date
should arguably not cause the participant's estate to be a beneficiary on the designation
date. Recent private letter rulings may indicate that the IRS is taking a flexible position on
such clauses.
a. Payment of estate expense by a trust prior to the designation date.
In PLRs 200432027-029, the trustee of a trust named as an IRA beneficiary withdrew IRA
funds to pay estate, last illness, funeral, burial, administrative expenses, and estate taxes
prior to the designation date. The trust did not contain a clause restricting post-designation
date withdrawals to pay expenses. The taxpayer's representative apparently asserted that
all expenses were covered by the withdrawals. The ruling holds that, because the withdrawals to pay expenses were made prior to the designation date, the participant's estate
was not a beneficiary of the trust. The Service also noted that the remote possibility that
the trust assets may be required to pay further estate taxes did not change the conclusion.
The representative stated that any additional estate taxes would be paid first from other
estate assets and the IRA would be tapped only if there were no other estate assets in which
case, "your authorized representative asserts that such payment is required by Code
§6324(a)(2).”
b. State law creditor protection.
In PLR 200433019, two IRAs named a trust for the benefit of an only child as beneficiary.
The trust authorized the trustee to pay the decedent's debts, expenses, estate and inheritance taxes, and administration expenses but provided that no such expenses were to be
paid from assets that were exempt from creditors' claims under applicable state or federal
law. No IRA assets were used to pay any of the expenses. The Service agreed that state
courts would rule that the IRAs were exempt from creditor's claims and concluded that the
participant's estate was not a trust beneficiary.
c. State law creditor protection with actual expense payment.
PLR 200440031 produces a puzzling but taxpayer favorable result. A trust named as beneficiary of two retirement plans expressly permitted the use of plan funds to pay taxes,
administrative expenses, and funeral expenses. State law protected that plan assets from
creditors' claim but a state court ruled that the plan assets should be used to pay estate
expenses in the absence of other assets. However, the Service ruled that the use of plan
assets to pay estate expenses did not make the estate a beneficiary of the trust for MRD
purposes, and recognized the oldest trust beneficiary as the measuring life for MRD distributions.
7. Dynasty trusts and an expanding class of beneficiaries.
A beneficiary need not be specified by name in the plan or by the participant in order to be
a designated beneficiary as long as the individual who is to be the beneficiary is identifiable under the plan as of the date the beneficiary is to be determined. Treas reg
1.401(a)(9)-4, A-1. The members of a class of beneficiaries capable of expansion or contraction will be treated as being identifiable if it is possible, as of the date the beneficiary is
determined, to identify the class member with the shortest life expectancy. Does a class of
trust beneficiaries defined as "all of my descendants now living or hereafter born" set forth
in a trust that will continue for a period equal to rule against perpetuities (or indefinitely in
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jurisdictions that permit) constitute a group of identifiable beneficiaries? Under the death
contingency beneficiary rules as they appear to be presently interpreted by the IRS, no descendant could be disregarded because no predecessor beneficiary will necessarily receive
the benefits involved. Accordingly, it appears that the exercise of discretionary trustee
distribution authority and beneficiary held powers of appointment would need to be limited
to the beneficiaries (or classes of beneficiaries) that are taken into account for purposes of
determining the trust beneficiary who is treated as the designated beneficiary for payout
period determination purposes.
8. Section 645 election.
Under Code section 645, the executor of a participant's estate (if any) and/or the trustee of
a participant's qualified revocable trust can elect for the trust to be treated as and be subject
to income tax as a part of the participant's estate (rather than as a separate trust). The election, if made, applies for purposes of the Subtitle A income tax of the Code, which include
the minimum required distribution rules. While the impact of a section 645 election was
not addressed in the final regulations, the preamble to the regulation (under the heading
"Trust as Beneficiary") states that a revocable trust will not fail to be a trust for minimum
required distribution purposes merely because the trust elects to be treated as an estate
under section 645, as long as the trust continues to be a trust under state law.
9. Recognizing separate trusts created under a single trust agreement
as separate beneficiaries.
The final regulations state that "[T]he separate account rules under A-2 of Section
1.401(a)(9)-8 are not available to beneficiaries of a trust with respect to the trust's interest
in the employee's benefit". Treas reg 1.401(a)(9)-4, A-5(c). This language confirms the
rule that applied under the proposed regulations as well, that separate account rules apply
at the level of the plan or IRA. Thus, a single trust having multiple beneficiaries could not
establish separate accounts or IRAs in the separate trust beneficiaries' names with respect
to the trust's interest in the benefits payable to the trust as beneficiary (even if the separate
percentage interests or shares of the beneficiaries in the single trust are identifiable). If the
dispositive plan is to have two or more separate trusts each receive a portion of the participant's plan or IRA benefits (and to have the look through rules apply separately to each
trust), separate accounts or separate IRAs must be created by the end of the year following
the participant's death.
a. Private letter rulings refuse to recognize separate trusts created on
participant's death.
In three private letter rulings dated December 19, 2002, a participant's beneficiary designation named a single trust that, by its terms was to divide into three separate equal subaccounts for the trust's three surviving beneficiaries effective as of the participant's date of
death. Although decided under the pre final regulation rules, the IRS, citing the final
regulation provision quoted above, held that the benefit amounts "passed through" the single trust and that, even though the IRA had been divided into three separate IRAs, the life
expectancy of the oldest child who was a beneficiary of the single individual trust must be
used to determine the MRD rule payout period from all three IRAs. PLRs 200317041,
200317043, and 200317044. These rulings reverse a prior ruling that recognized separate
subtrusts created under a single trust agreement effective on the participant's death. See
PLR 200234074.
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b. Naming ultimate trust or subaccount in beneficiary designation.
It is clearly arguable that separate subaccounts or separate trusts that are required to be created (without any trustee discretion) effective upon the participant's death (and thus, from a
trust law perspective are separate legal entities) should be recognized as separate
beneficiaries and that the separate share rules in the regulations are irrelevant in making
this determination. The recognition of separate trusts or subtrusts created from a
preexisting single trust effective as of the participant's death can be likely obtained by
naming the separate trusts or subtrusts (rather than the single trust, itself) as separate
beneficiaries in the beneficiary designation. Until the IRS position is clarified, some
practitioners may decide to create separate trusts under separate trust agreements to be
designated as beneficiaries to provide protection against the possibility that the cloudy
analysis in the private letter rulings will be further extended.
c. Formula allocations to resulting trusts.
Based on the concept of the foregoing private letter rulings, a trust agreement formula allocation of plan benefits (for example, an allocation between marital and bypass trusts) will
not be considered to create separate marital trust and bypass look through trusts for the
MRD rule purposes (even if the formula's application is mandatory and involves no trustee
discretion) because the plan benefits are viewed as passing through the original trust
named as the participant's beneficiary.
(1)
As a result, if the planning objective is to establish two
separate look through trusts (for example, in the case of a
marital trust, bypass trust division where the participant's
surviving spouse is not a beneficiary of the bypass trust), a
specific marital deduction allocation formula must be included in the participant's beneficiary designation.
(2)
For example, if the provisions of the beneficiary designation provides that if the participant's spouse survives, income in respect of a decedent is to be transferred in kind to
the QTIP marital trust created under the trust agreement
except that such transfer will abate in favor of the credit
shelter trust created under the trust agreement to the extent
that the transfer would cause the "reduce to zero" marital
deduction formula of the trust agreement to be reduced below zero, the formula (if it names the trustees of the
resulting trusts directly as beneficiaries) should identify
the trusts that are the beneficiaries on the designation date
(since the amount receivable by each trust is determinable
as of the participant's date of death or as of the sixth month
alternate valuation date).
10. Changing a trust's look through beneficiaries during the window
period.
The "window period", the period of time between the participant's date of death and the
designation date, may present an opportunity to cash out certain look through beneficiaries
or to modify powers of appointment that might, depending on how the look through rules
develop, otherwise cause the participant to be treated as having no designated beneficiary.
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a. Payment by trust of estate taxes and estate expenses.
If payment of estate taxes and expenses (or the payment of estate taxes other than any
attributable to the inclusion of the plan or IRA benefits in the participant's gross estate, if
that turns out to be the rule) are considered to make the participant's estate one of a trust's
multiple beneficiaries, the full payment of such expenses prior to the designation date
should avoid having the trust be treated as having no designated beneficiary due to the
inclusion of the nonindividual estate in the beneficiary pool.
(1)
Limiting payment obligation as of designation date - since
the window period may extend from just over nine months
to just under 21 months, a final determination of the participant's death tax obligations may or may not occur during the window period and a potential estate tax obligation
may exist on the designation date. If it is possible to
anticipate that the maximum amount of taxes and expenses
potentially payable on the designation date can be paid
from trust assets other than plan or IRA benefits, the trust
agreement might provide that the trustee has the discretion
to require that plan or IRA benefits become payable to a
subaccount of the trust which prohibits the use of benefits
for the payment of such expenses from and after the designation date (perhaps, drawing down a portion of the
benefits to cover post designation date expenses prior to
the allocation of the balance of the benefits to such a
subaccount).
(2)
Surviving spouse's estate tax payable by QTIP trust - the
fact that a QTIP trust to which plan or IRA benefits are
payable may, upon the surviving spouse's death, be used
(or required to be used) to pay an estate tax obligation of
the surviving spouse's estate could, if the look through
rules are applied so as to take into account every future
beneficiary, prevent the QTIP trust from having a designated beneficiary. However, the approval of QTIP trusts
as look through trusts described in paragraph C below
implies that the Service will not press this potential issue.
b. Payment of charitable bequests.
If a participant's revocable trust is required to pay benefits from the trust or to satisfy
charitable bequests made in the participant's will, if need be, the payment of a bequest
before the designation date should eliminate the charity as a nonindividual look through
beneficiary of the trust. Nonindividual cleanup beneficiaries, if taken into account, under
the look through rules as ultimately developed, remain a problem.
c. Partial disclaimer or release of nongeneral powers of appointment.
If the potential appointees of a broad nongeneral power of appointment held by a trust
beneficiary are considered to be look through trust beneficiaries under the look through
rules as ultimately developed, the adult donee of the power may partially disclaim or
release the power in order to eliminate nonindividual or older permissible appointees.
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11. Estates do not qualify for the look through rules.
The final regulations expressly provide that a person who is not an individual, such as an
employee's estate, may not be a designated beneficiary. Treas reg 1.401(a) (9)-4, A-3(a).
While the ostensible reason for providing that nonindividual beneficiaries cannot qualify as
designated beneficiaries is based on the Code section 401(a)(9)(E) definition of a designated beneficiary as "any individual designated by the employee", it is not clear why look
through rules are permitted to apply to trusts named as beneficiaries and are not permitted
to apply to a participant's estate (particularly if the participant dies testate). From the viewpoint of administering the income tax purpose of the MRD rules, the key requirement is
that there be an individual identified for purposes of determining the applicable distribution period. The final regulations' provision that states that the fact that an employee's interest in a plan which passes to a certain individual under applicable state law does not
make that individual a designated beneficiary unless the individual is designated as a beneficiary under the plan, would seem to apply (or not apply) equally to a trust arrangement
(created under state law) or to an estate (created under the participant's will). Treas reg
1.409(a)-4, A-1.
C. QTIP trusts named as beneficiaries.
An example included in the final regulations confirms the holding of Revenue Ruling
2000-2 (2000-1 CB 305) that the income received by a qualified terminable interest property trust (QTIP trust) does not have to be immediately distributed by the trust to the
spouse beneficiary as was required by obsolete Revenue Ruling 89-89 (1999-2 CB 231) if
the requirements of a marital deduction savings clause are met. Treas reg 1.401(a)(9)-5,
A-7(c)(3), Example 1.
1. Revenue Ruling 2000-2.
Revenue Ruling 2000-2 holds that:
"An executor may elect under section 2056(b)(7) to treat an IRA and a trust as QTIP when
the trustee of the trust is the named beneficiary of the decedent's IRA, the surviving spouse
can compel the trustee to withdraw from the IRA an amount equal to all the income earned
on the IRA assets at least annually and to distribute that amount to the spouse and no person
has a power to appoint any part of the trust property to any person other than the spouse."
Such a holding was clearly required by the final QTIP regulations published on
February 28, 1994 [Treas reg 20.2056(b)-7(d)(2)] which confirmed that the principles of
Treasury regulations 20.2056(b)-5(f)(4) and (5) which set forth savings clauses that establish a surviving spouse's right to income under a "life estate with power of appointment"
marital trust apply equally to the determination of whether a surviving spouse beneficiary
of a QTIP trust has a "qualifying income interest for life". Note that a QTIP election
apparently must be made for both the QTIP trust and for the IRA arrangement.
2. Productivity of plan/IRA assets.
Revenue Ruling 2000-2 stipulates that "[t]he IRA is invested only in productive assets".
(a)
It is unlikely that the IRS intended to abandon the requirement
that a surviving spouse have the power to make the plan or IRA
investments productive if they become unproductive and it
would be desirable for the QTIP trust document (or beneficiary
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designation or both) to give the spouse the power to require the
plan or account property to be reasonably productive of income.
(b)
Alternatively, an "(f)(4)/(5) savings clause" may be used to give
the surviving spouse the power (under the beneficiary designation form, the QTIP agreement, or both) to require the QTIP
trustee to make distributions to the surviving spouse from the
assets of the QTIP trust (including amounts withdrawn from the
IRA or plan account). The additional amount subject to such a
spousal direction would be equal to the excess of the income the
IRA or plan account assets would have earned if such assets
were reasonably productive of income [perhaps as measured by
an identified rate of return index representative of the rate of
return earned by funds that are reasonably productive (such as
the current dividend yield index for the S&P 500)] over the
income actually earned.
3. Identification of "trust accounting income" in IRAs and qualified
plans.
Because income and principal are not typically pertinent to accounting for IRAs or retirement trusts, difficulty may be encountered in ascertaining the "income" of the IRA account
or plan fund attributable to the benefits. This difficulty may be overcome, at least in the
case of an IRA or individual account plan, if:
(a)
The IRA or plan governing document requires the trustee or
custodian to maintain records in sufficient detail to permit the
amount of trust accounting income earned by the account to be
determined annually or
(b)
There is a written undertaking by the trustee or custodian to furnish such information (see PLR 9232036).
4. Disadvantages of QTIP trust as beneficiary.
If a QTIP trust is named beneficiary for plan or IRA benefits, alternatives available to a
spouse, individually or as the beneficiary of a conduit trust, are lost.
(a)
The "own IRA" election or spousal rollover to defer the
commencement of minimum distributions until the spouse
reaches his or her RBD, to have distributions made over the
spouse's lifetime using the uniform lifetime table, and to have
distributions after the spouse's death made over the fixed life
expectancy of the spouse's designated beneficiary is not available in the case of a spouse designated beneficiary of a marital
trust (see paragraph IV above).
(b)
The ability of the spouse to defer benefit commencement until
the end of the calendar year in which the deceased participant
would have attained age 70 1/2 is foreclosed (see paragraph IV
above) except in the case of a conduit QTIP trust.
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(c)
The IRA and plan distributions are subject to the high trust
income tax brackets if accumulated by the marital trust.
Notwithstanding the disadvantages, where a QTIP trust is desirable for reasons other than
preserving trust assets for specific remainder beneficiaries such as participant's children
from another marriage (such as to preserve flexibility in determining the marital deduction
amount, to allow reverse QTIP elections for GST purposes, or to provide for a spouse for
whom asset management is necessary), the use of the savings clause approach of Revenue
Ruling 2000-2 (instead of the pure conduit approach of Revenue Ruling 89-89) to secure
QTIP treatment allows the full amount of the plan benefits to be retained by the QTIP trust
if the surviving spouse has no need for the benefits.
D. Drafting "safe harbor" trusts to receive plan and IRA benefits.
In light of final minimum required distribution regulations and private letter rulings discussed in paragraph C.4 above, many trusts as they are now drafted may not qualify for the
maximum payout period that is available to individual designated beneficiaries after a participant's death. Beneficiary designations naming trusts as beneficiaries and trust provisions drafted to qualify for the maximum distribution period for income tax purposes may
require that estate and GST tax planning objectives be partially compromised and/or that
normal dispositive objectives be altered. The limited guidance now available describes
only two kinds of trusts (the conduit and the "example 1" trusts) that have clear minimum
required distribution consequences, suggests a third kind of trust (the "individuals only" or
"nonconduit" trust described below) that may produce clear MRD rule consequences, and
provides only a limited conceptual framework from which to analyze many common flexible estate planning trust provisions. Due to the fact that the look through rules have in the
past been subject to IRS interpretations beyond the ken of estate planners, it is recommended that the trustees of trusts named as beneficiaries be given the safety valve power to
disclaim benefits in favor of individual trust beneficiaries if such a power is not contrary to
the dispositive plan.
1. Conduit trusts.
All amounts received by the trustees during the lifetime of the oldest individual look
through beneficiary of a conduit trust are, upon receipt, required to be distributed by the
trustees to that individual (or to other individual trust beneficiaries). Treas reg 1.401(a)(9)5, A-7(c)(3), Example 2. As in the case of an individual designated beneficiary, the designated beneficiary of a conduit trust will receive all of the plan or IRA benefits if the beneficiary lives out his or her life expectancy. As a consequence, any successor beneficiary of
the trust is treated as a "mere potential successor" and may be disregarded. Compared to a
continuing trust that provides for distributions in the discretion of an independent trustee
(or pursuant to an ascertainable standard), a continuing conduit trust erodes the shelter
(creditor, beneficiary's estate tax, management, and spendthrift protections) and places an
increasing portion of the assets under the dispositive control of the beneficiary. The benefit of a conduit trust is that the look through designated beneficiary is clearly identifiable,
affording an applicable distribution period that equals the period that would apply were the
trust beneficiary directly designated. The conduit trust also preserves some of the benefits
of a shelter trust.
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a. Continuing conduit shelter trusts for descendants.
In the case of a single participant or a participant whose surviving spouse is not named as a
bypass trust beneficiary, trusts that follow the example 1 model (continuing for the lifetime
of the child who is the primary beneficiary and oldest look through designated beneficiary
and then distributing outright to the child's children) may be an option. However, in most
cases, the participant's dispositive plan would provide for a child's siblings to be successor
beneficiaries if a child has no descendants at the time of the child's death. Moreover,
depending upon the age of the children, the number of children, and how prolific the children are, the participant may be unwilling to risk having the benefits pass under a deceased
beneficiary's estate rather than expressly providing for a "clean up" disposition that may
involve collateral family lines that have family members older than the children or charitable organizations. Subject to the comments below regarding continuing trusts that are
intended to benefit individuals only, a conduit trust may be an appropriate vehicle.
i.
Conduit trust controls flow of plan/IRA distribution.
While it is true that the benefits for which a continuing shelter trust for a child is formed
are diminished over time as plan and IRA distributions to the trust are passed through to
the trust's primary beneficiary, the rate of that diminishment will correspond to the beneficiary's increasing maturity. Even a beneficiary who attains age 60 in the calendar year
following the participant's death will receive an initial minimum required distribution equal
to only 4% of the previous yearend benefit fund value unless the conduit trust trustees
accelerate distributions from the plan or IRA. A beneficiary age 40 would receive only
2.29% of the fund value.
ii.
Conduit distributions cease on designated beneficiary's
death.
Compared to naming a child, individually, as the beneficiary of an IRA or plan account,
naming a conduit trust gives the conduit trust trustees spendthrift control over the plan and
IRA benefits not yet required to be distributed under the MRD rules. Moreover, plan or
IRA benefits distributed after the death of the conduit beneficiary are no longer subject to
passthrough and may be retained in trust for successor beneficiaries.
iii.
Example retirement benefit conduit subtrust.
Exhibit D titled "Retirement Benefit Conduit Subtrust" is intended as a starting point for
drafting a provision to take advantage of the conduit trust rules. In order to be effective,
the subtrust (rather than the separate trust for the oldest current beneficiary and that beneficiary's family of which it is a part) must be named as beneficiary in the participant's
beneficiary designation (see exhibit H, involving an individuals only trust for a format of
such a designation).
iv.
Caveat re trustee authority.
Note that exhibit D contemplates that the retirement benefit plan subtrust has an independent (or disinterested) trustee. In the event that the subtrust does not have an independent
trustee, the clause regarding the trustee's authority to withdraw amounts in excess of minimum required distribution amounts (which amounts must, in turn, be distributed to the
beneficiary or beneficiaries) may need to be restricted by an ascertainable standard in order
to avoid having the trustee beneficiary hold a general power of appointment.
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v.
Provisions for taxes and expenses.
Steven E. Trytten, a practitioner from Pasadena, California, has suggested that specific
provision be made in a conduit trust authorizing the trustee to divert amounts from the
conduit pass through in order to pay the subtrust’s share of trust administrative expenses as
well as income, estate, and GST taxes to the extent such expenses and taxes are chargeable
to or otherwise payable by the subtrust with respect to the plan benefits received or receivable. The exhibit D draft does not refer to the payment of such amounts in order to literally meet the requirement for conduit trusts that all IRA and plan amounts received by the
trustee be distributed. In the case of a subtrust that is part of a separate trust that will contain non plan and IRA assets, it is assumed that administrative expenses will be born by the
trust as a whole and will not be charged back to the subtrust. If the conduit trust is a separate trust, a provision permitting the payment of expenses would seem to be unavoidable.
b. Conduit QTIP trusts.
A conduit QTIP trust for the participant's surviving spouse [described in paragraph
IV.B.3.c.ii above] activates the special rules that apply to a surviving spouse sole beneficiary of a participant's account (the deferred commencement of minimum required distributions if the participant had died before the RBD, distributions based on the recalculated
single life expectancy of the spouse, and, if the spouse dies before minimum required distributions are required to commence, distributions based on the fixed life expectancies of
the remainder beneficiaries).
i.
Disadvantages.
Since the surviving spouse may receive all (or virtually all) of the benefit distributions, a
conduit trust is inappropriate if the QTIP trust is intended to preserve the trust principal for
the remainder beneficiaries. As compared to naming the surviving spouse as the direct
beneficiary of the IRA with the opportunity to roll the amount over or make an own IRA
election, the conduit trust (using the recalculated single life table) will distribute much
more rapidly than the uniform lifetime table available on a rollover.
ii.
Advantage.
By permitting the QTIP trustees to limit distributions to the greater of trust income (computed taking the income from benefits into account) or the MRD amount for each year, the
conduit trust provides a limited spendthrift benefit while slowing the rate of minimum
required distributions when compared to the distribution over the fixed life expectancy of
the surviving spouse (or of the participant, if longer, in the case of a post RBD death)
required by a nonconduit QTIP trust.
2. "Individuals only" (nonconduit) subtrusts.
Under the final regulations, the members of a class of beneficiaries capable of expansion of
contraction will be treated as being identifiable if it is possible to identify the class member
with the shortest life expectancy. Treas reg 1.401(a)(9)-4, A-1. If a subtrust for a class of
beneficiaries, such as the participant's descendants, must by its terms terminate and distribute all assets including accumulated plan and IRA benefits to living members of the class
prior to the death of the last living member of the class, distributions should be measured
under the MRD rules by the fixed life expectancy of the oldest living class member. An
individual's only trust places the distribution decisions in the hands of the trustees and preserves the trust's shelter benefits.
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a. Specified termination in favor of individual beneficiaries.
For example, the trust provisions might require that the subtrust terminate at the end of the
rule against perpetuities period or when only one descendant of the participant is living, if
earlier (or perhaps, when there are two or three descendants living to avoid a common disaster possibility). While this kind of tontine disposition may not reflect the typical plan
that a participant would provide for other assets, the plan/IRA subtrust would not limit the
ability of the trustees to make discretionary distributions from the subtrust prior to the
subtrust's termination date.
b. Oldest descendant as designated beneficiary.
Unless the participant's descending family lines are all well populated, it is likely that,
upon the failure of a family line, the trust's provisions would allocate the remaining trust
assets to trusts for a child's siblings and their descendants. Unlike a conduit trust, both current and contingent trust beneficiary's must be taken into account in determining the oldest
look through beneficiary over whose fixed life expectancy MRD rules payments will be
measured. If all of the oldest members of each family line are of the same generation, the
increase in the rate of distribution for the younger siblings (compared to a conduit trust)
will generally not be significant.
c. Limiting "older" spouse beneficiaries and appointees.
Further subtrust limitations for an individuals only trust must be provided if the class of
beneficiaries is expanded to include spouses of descendants [so as to limit the spouses
taken into account to those who are younger than the oldest descendant (whether a current
or contingent beneficiary) who is the oldest look through designated beneficiary] and/or if
trust beneficiaries have the power to exercise nongeneral powers of appointment (so as to
limit appointees to the participant's descendants and younger spouses and, if exercisable in
further trust, to require that all subtrust dispositive restrictions continue to apply).
d. Subtrust administration.
Unlike a conduit subtrust, the individuals only subtrust requires the maintenance of an
accounting separate from the trust of which it is a part in order to track the fund created by
accumulated plan or IRA distributions received.
e. Example nonconduit subtrust.
Without further guidance from the IRS, it is not clear whether an individuals only trust will
allow minimum required distributions to be made over the oldest class member's life
expectancy. The example subtrust wording attached (exhibit E) is presented as a drafting
starting point and is not recommended for use until the IRS has provided more guidance
unless the participant's beneficiary designation provides for safety valve disclaimers by the
trust's trustees in favor of the trust beneficiaries individually. As in the case of a conduit
subtrust, the beneficiary designation must specifically name the subtrust as beneficiary.
3. "Example 1" trust.
An "example 1" trust – a trust which requires that all of the income of the trust (including
the income of an IRA or qualified plan account of which the trust is beneficiary and which
the trustees are entitled to withdraw) be distributed to the oldest look through designated
beneficiary and which has identifiable remainder beneficiaries all of whom are younger
than the oldest look through designated beneficiary. Treas reg 1.401(a)(9)-5, A-7(c)(3),
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Example 1. This minimalist example appears to assume that the younger remainder beneficiaries will receive the trust principal outright upon the oldest look through beneficiary's
death. Since the example describes a QTIP trust, the requirement that trust income be
distributed is probably not material to the look through treatment. However, the fact that
no remote contingent beneficiary is named to receive benefits if the younger identified
contingent beneficiaries fail to survive is likely material (at least until the application of the
snap shot approach is further confirmed).
a. Possible use of example 1 trusts for marital-bypass primary planning.
If a participant's plan calls for the creation of marital and bypass trusts that are to terminate
and distribute outright to descendants upon the surviving spouse's death, the participant,
depending on the family's size, may be willing to accept the risk that the example 1 trust
has no cleanup provision in the event that all descendants predecease the surviving spouse.
b. Implications of example 1 trust as a model.
Except as the example 1 trust serves as an indication that an individuals only trust will be
respected or that the ultimate potential distribution to a deceased beneficiary's estate will
not cause there to be no designated beneficiary, it is difficult to imagine an estate planner
recommending a plan of disposition that does not specifically contain a specific (rather
than statutory) disposition upon a beneficiary's death.
4. Using trusts that do not qualify for the look through rules.
In considering the alternatives, it is important to keep in mind that, while the MRD rules
that apply to a trust that has a look through designated beneficiary produce essentially the
same MRD rule payout period regardless of whether the participant's death occurs before
or after the participant's RBD, the failure to have a look through designated beneficiary
will require the distribution to the trust of all benefits before the end of the calendar year in
which the fifth anniversary of the participant's death occurs if the participant dies before
the RBD. In contrast, the lack of a designated beneficiary in the case of the participant's
post-RBD death will result in distributions over the remaining fixed single life expectancy
of the participant (which is a period of five or fewer years only if the participant dies after
attaining age 88). If the participant's spouse is intended to be the oldest beneficiary of both
the marital trust and the bypass trust, the spouse is one or more years older than the participant, and the participant dies after the RBD, the post death MRD rule payout period
will not be increased by assuring that the trust qualifies for the look through rules. Thus, if
the participant and spouse are close in age, the participant may well decide that the preservation of the estate plan's dispositive pattern is more important than qualifying for the look
through rules. In that case, the participant may plan, after reaching the RBD, to utilize the
default payout rule rather than to name a subtrust designed to meet the look through rule
requirements.
VII. ASSESSING DEATH BENEFIT PLANNING ALTERNATIVES
A. Balancing the planning objectives.
Depending upon the value and asset make up of a participant's estate, the following three
planning goals may compete for priority in planning for the disposition of qualified plan
and IRA death benefits. The proper disposition of plan and IRA death benefits requires an
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exploration of these three priorities with the client and the formulation of an explanation of
how these priorities are balanced in the planning alternatives available under the provisions
of the final regulations as they are presently understood.
1. The participant's dispositive goals.
Each participant has a preferred plan for providing for his or her immediate family members for the balance of their lifetimes and for the ultimate disposition of his assets upon a
family member's death. Depending on the age, health, and character of these family members, the protection and management of the assets during the lifetime of one or more family
members may be indicated.
2. The participant's transfer tax goals.
If the value of a married couple's assets exceed the current applicable exclusion amount,
the participant will wish to dispose of his or her assets in a manner so as to minimize or
avoid potential estate and GST taxes. To the extent that plan and IRA benefits constitute a
substantial portion of the participant's assets, the funding of a nonmarital share (whether in
trust or not) so as to avoid tax on the surviving spouse's death may be a significant goal.
3. Income tax and investment goals.
Under the post-death MRD rules, the income tax exempt investment of the plan or IRA
benefits (and the ultimate after income tax amounts received by the plan or IRD beneficiaries) will be maximized if plan and IRA benefits are paid to a surviving spouse individually or in a conduit trust or to children (or grandchildren) as individual beneficiaries.
B. Integrating plan and IRA benefits into a trust based estate plan.
As noted in paragraph V.A.2 above, in the case of clients who have substantial assets, most
estate planners seek to integrate all of the client's (or married couple's) assets into a comprehensive estate plan that will provide for the disposition of those assets through a central
vehicle (a revocable trust or will) which, by formula, will allocate the client's assets among
trusts for the client's surviving spouse and descendants in a manner intended to minimize
estate and GST taxes. Often the client's assets are ultimately to be transferred to continuing trusts for descendants in order to protect the assets from a descendant's creditors
(including divorcing spouses), shelter the assets from estate tax on a descendant's death,
and provide a coherent plan for transmitting those assets to lower generation beneficiaries.
Assuming the dispositive and transfer tax goals are important priorities, what options
available to preserve the tax exempt benefits to the maximum extent possible?
1. Revocable trust disclaimer method – disqualified trusts where
surviving spouse's welfare is chief concern.
If, and only if, the participant and spouse are close in age and the participant has passed the
RBD (the five-year rule will apply if the participant dies before the RBD), the revocable
trust and beneficiary designation provisions that were used prior to the final regulations (as
part of a plan that permits trustee disclaimers to change the outcome) may still be viable.
In this situation, it is assumed that the surviving spouse will be the primary beneficiary of
both a QTIP marital trust and a residuary (bypass) trust and that minimum required distributions beginning in the year following the participant's death will be made under the
default rule (the longer of the participant's or the surviving spouse's fixed life expectancy).
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a. Ignoring the look through rules.
Because the default MRD rules are being applied, there is no need to restrict potential trust
beneficiaries. The formula allocation of benefits (together with all other income in respect
of a decedent) to the marital trust except to the extent that such an allocation will "overqualify" the marital deduction and under fund the bypass (residuary) trust can be contained
in the trust agreement since it does not matter if the plan and IRA benefits are considered
to "pass through" the terminating original trust.
b. Revocable trust disclaimer method.
An example beneficiary designation (exhibit H) is one component of a revocable trust disclaimer method that may be used to integrate plan and IRA benefits into a typical marital/nonmarital type estate plan which is intended to preserve the flexibility to select the
optimal income and estate tax treatment form the alternatives available after the participant's death when the alternatives can be best evaluated. The other necessary component is
the inclusion in the revocable trust of provisions (i) intended to accomplish, before any
disclaimers, what is presumed to be the most advantageous allocation of the benefits
involved and (ii) to facilitate disclaimers by the trustees of the original trust, the trustees of
the marital trust, and the spouse to permit changes to that initially provided allocation of
benefits.
i.
The beneficiary designation.
Under such a standardized approach, all of the participant's qualified plan and IRA death
benefits would be made payable (in separate but virtually identical beneficiary designation
forms for each IRA or plan) as follows if the participant's spouse survives:
First beneficiary
–
The participant's revocable trust (which by its
terms provides for a specific allocation of benefits to a subtrust of the marital trust except that, if
and to the extent such an allocation would cause
the marital deduction to be overqualified, benefits
are instead allocated to the residuary or nonmarital trust),
Second beneficiary
–
The marital trust (or, if the participant's spouse
does not survive, the residuary trust) under the
revocable trust document,
Third beneficiary
–
The participant's spouse, and
Fourth beneficiary
–
The participant's descendants, per stirpes.
The beneficiary designations should provide that –
(a)
Each successive beneficiary would be entitled to receive such
death benefits only in the event of either:
(1)
The nonexistence (or prior death) of the preceding
beneficiary (or beneficiaries) or
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(2)
A timely and proper section 2518 disclaimer by the
preceding beneficiary (or beneficiaries) of part or all of
such benefit.
(b)
The wording of the beneficiary designation would specifically
permit a disclaimer of part or all of the death benefits to be
made by a written transfer of the right to receive the disclaimed
benefits – provided that such "transfer" type disclaimer meets
the requirements of section 2518(c)(3) (thereby avoiding the
need for such disclaimer to comply with any local law requirements).
(c)
The plan administrator would be held harmless from liability in
making distributions based on written representations and opinions furnished by counsel for any designated beneficiary (for
example, as to whether a trust has been revoked or cannot come
into existence, whether a disclaimer is effective, and so on).
(d)
In the event that a marital trust is named as beneficiary the installment or annuity payments will all be received only by the
marital trust (even if it means continuing the trust in existence
to receive the last payments after the spouse's death).
ii.
Required governing trust instrument provisions.
Under such a standardized approach, the trust document that establishes and governs (i) the
revocable trust (after death referred to as the "terminating original trust"), (ii) the marital
trust, and (iii) the nonmarital bypass (or residuary) trust (that are referred to in the beneficiary designation) must contain provisions that accomplish the following two objectives.
(a)
Specific allocation of all other IRD to marital trust.
The governing trust document would specifically allocate to the marital trust all "income in
respect of a decedent" (IRD) property [as defined in Code section 691(a)] – except that any
such IRD property which, if so allocated:
(1)
Would not qualify for the marital deduction or
(2)
Would cause overfunding of the marital deduction formula
amount,
will instead be allocated to the nonmarital trust. This specific allocation of all other IRD
property has the effect of:
(i)
Institute of Continuing Legal Education
Eliminating the risk that might otherwise exist that
the allocation of these other items of IRD to the
marital (or residuary) trust pursuant to any pecuniary marital deduction (or credit shelter) formula (or
perhaps even a nonpro rata fractional share formula)
would be treated as requiring the accelerated reporting of the taxable income involved in such IRD
properties and
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(b)
(ii)
Assuring that (insofar as a marital deduction is
called for) such remaining IRD properties (i) will
qualify for the marital deduction and (ii) insofar as
possible, will be burdened with the income tax
liability that each inherently carries with it (so as to
thereby reduce the surviving spouse's gross estate),
(iii)
But, at the same time, allocating to a "benefit subtrust" of the marital trust all qualified plan, tax
sheltered annuity, and IRA death benefits included
among such IRD properties otherwise allocable to
the marital trust so as to facilitate their separate disclaimer by the surviving spouse from the marital
trust into the credit shelter trust under separate
marital trust disclaimer provisions.
Fiduciary disclaimer authorization.
In order to permit:
(1)
The terminating original trust trustees to disclaim to the
marital trust:
(i)
Benefits allocable to the marital trust that they believe should be rolled over to a spousal IRA (which
might not be possible absent such a disclaimer by
both the original trust and marital trust trustees)
and/or
(ii)
Benefits that would otherwise be allocated to the residuary trust which, because no estate tax appears
likely on the surviving spouse's death, should similarly be made eligible for a spousal rollover IRA,
and
(2)
The marital trust trustees to disclaim to the surviving
spouse any benefits otherwise receivable by the marital
trust which it would be preferable to have rolled over into
a spousal IRA,
the governing trust instrument should specifically authorize the trustees of each trust thereunder to make tax elections (such as disclaimers) in such manner as the trustees (other than
any who are beneficiaries), in their sole (but reasonably exercised) judgment, determine
will achieve the overall minimum of present and future tax and expense burden to the
settlor's family as a whole (without adjustments or liability on account of such trustee
actions if taken in good faith). See exhibit F for an example of a provision authorizing
trustee disclaimers.
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c. Distribution from separate accounts for marital and nonmarital
trusts.
As described in paragraph I.A.4.b above, IRAs that an individual holds as a beneficiary of
the same decedent and are being distributed over the same period are aggregated Treas reg
1.408-8, A-9. The 2004 Treasury Regulations provide that, except to the extent separate
shares are established, all separate accounts "will be aggregated for the purposes of section
401(a)(9)" Treas reg 1.401(a)(9)-8, A-2 (a)(1). In the case of benefits payable “through" a
participant's revocable trust, no separate share treatment is permitted and separate IRA
accounts established in the deceased participant's name for the marital trust and the nonmarital trust must be aggregated. The annual MRD for the entire inherited IRA (both
shares) is thus determined by reference to the oldest beneficiary, the surviving spouse, of
each separate IRA based on the entire account balance of both IRAs. Can the MRD for the
aggregate IRA be paid from the marital trust IRA, permitting the nonmarital IRA account
grow? It would appear to be the case.
2. Disclaimer plan where a portion of benefits are needed to fund a bypass trust.
In the case of the revocable trust disclaimer method described in paragraph 1 above, the
preferred allocation of benefits is accomplished by the initial beneficiary designated (the
revocable trust which contains the anticipated optimal tax allocation) and the disclaimer
ladder serves as an opportunity to second guess that preferred disposition. If a look
through trust is to be a beneficiary (or one of the beneficiaries), the marital deduction bypass formula would have to be contained in the beneficiary designation, itself – a level of
complexity even the most cooperative IRA provider may refuse to accept.
a. Premium on immediate post-death planning.
As a result of the foregoing, the initial beneficiary named on the disclaimer ladder will
typically be the bypass (residuary) trust or the surviving spouse. Since it is intended that a
portion of the benefits become payable to the bypass trust and a portion to a marital trust
(or the surviving spouse), timely post-death action must be taken to identify disclaimer
amounts.
b. Two approaches to initial beneficiary named.
The two basic approaches are –
(1)
To designate the participant's spouse or the marital trust as
the primary beneficiary of the plan and IRA benefits and
provide that, if the spouse fails to survive the participant or
to the extent that the spouse (or marital trust trustees) disclaims (or disclaim) the benefits, the benefits will pass to the
bypass trust (or separate resulting trusts) as the contingent
beneficiary. See Private Letter Ruling 200522012 for an
example of multiple post death disclaimers by a surviving
spouse beneficiary pursuant to a laddered beneficiary
designation.
(2)
To designate the bypass trust (or separate resulting trusts)
as primary beneficiary and provide that, to the extent that
the bypass trust trustees disclaim the benefits, the benefits
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will pass to the spouse (or to the marital trust which the
marital trust trustees may in turn disclaim in favor of the
spouse, individually) as a contingent beneficiary.
The choice of designation may depend upon a predeath projection of the expected division
of the participant's assets between the marital and bypass trusts. Naming the bypass trust
as primary beneficiary has the advantage of relying on the bypass trust's trustees (rather
than the participant's surviving spouse) to carry out the disclaimer and of permitting the
surviving spouse to retain a nongeneral power of appointment over the bypass trust. This
power of appointment would have to be also disclaimed if the plan/IRA benefits pass to the
bypass trust pursuant to the spouse's disclaimer.
c. Example beneficiary designation naming bypass trust first.
Exhibit H is an IRA beneficiary designation that, if the participant's spouse survives,
names a retirement benefit nonconduit subtrust of the bypass trust as initial beneficiary. It
is expected that, to the extent the benefits would otherwise cause the bypass trust assets to
exceed the participant's available applicable exclusion amount (or other target amount that
takes into account state death taxes), the subtrust's trustees will disclaim the benefits
(causing them to pass to the retirement benefit nonconduit subtrust of the martial trust).
d. Post-death evaluation of marital trust or spousal rollover.
If there is no perceived need to retain the disclaimed benefits in the marital trust, the marital trusts subtrust trustees may also disclaim the benefits, in whole or in part, causing the
spouse, individually, to become the beneficiary. The spouse may receive a distribution of
the benefits and roll them over to a separate IRA (or, if a separate IRA has been timely
established with respect to the benefits for the spouse, make an own IRA election) so as to
maximize the minimum required distribution applicable distribution period.
e. Creation of separate accounts if one trust is qualified.
If the participant and the spouse are close in age and the participant has passed the RBD,
the initial beneficiary named might instead be the bypass trust, itself, rather than a more
restrictive subtrust. If the balance of the benefits are disclaimed by the bypass trust trustees and the marital trust retirement benefit nonconduit subtrust retains the benefits that are
intended to qualify for the look though rules, the marital trust will not be able to qualify for
the look through rules unless separate IRA accounts are created during the window period
because the participant's IRA will otherwise have multiple (trust) beneficiaries one of
whom is a nonindividual on the designation date.
3. Conduit and nonconduit subtrusts of continuing shelter trusts.
The provisions of the exhibit H beneficiary designation that apply if the participant
survives the spouse provide for a division of the benefits into equal shares, one for each
surviving child and one for each deceased child who has a "qualified surviving spouse" or
descendants who survive the participant. Each share is then allocated between retirement
benefit conduit subtrusts of GST exempt and nonexempt continuing shelter trusts.
Nonconduit subtrusts could alternatively be named but, in either case, the subtrust trustees
have a safety valve power to disclaim benefits in which case the child or descendants who
would be subtrust beneficiaries become individual beneficiaries of the IRA benefits.
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0263A(1)
HBW8295a*
OU/2/es
-/8295
EXHIBIT A
Minimum Required Distribution Rules
Applicable Distribution Periods
Under 2002 Final Regulations
DB
During P's Lifetime
After P's Pre-RBD Death
After P's Post-RBD Death
DB as of September 30 of
year after P's death (the
"Designation Date") except
as stated in box 9
Annual amounts required
for year prior to RBD
through year of P's death
Annual amounts for each year
after the year of P's pre-RBD
death (initial years' payments may
be deferred per box 3 or box 11a)
Annual amounts required for each
year after the year of P's postRBD death
No DB
1
Uniform Lifetime
Table (for age attained each year)
2
Pay by end the year in which
the 5th anniversary of P's
death occurs
3
Pay over P's fixed life expectancy (P's single life expectancy per Single Life
Table for age P attained (or
would have attained) in year
of P's death reduced by 1 for
each year thereafter)
4
DB (but S is not sole
DB)
5
Uniform Lifetime
Table (for age attained each year)
6
Pay over oldest DB's fixed
single life expectancy (DB's
life expectancy per Single
Life Table for age attained in
year after P's death,
reduced by 1 for each year
thereafter)
7
Pay over the longer of (i)
oldest DB's fixed single life
expectancy (per box 7) or (ii)
P's fixed life expectancy (per
box 4)
8
S is sole DB (determined on January 1 of
each year during P's
lifetime including year
of P's and/or S's death
and as of the
Designation Date for
payments after the
year of P's death)
9
Uniform Lifetime
Table or, if S is over
10 years younger
than P, per Joint and
Last Survivor Table
(for age or ages
attained each year)
10
Payments begin in year P
would have attained age
70 1/2; if a SS sole DB dies
before the end of that year,
SS is treated as P (and box
3 or 7 applies); a DB of SS
who is remarried SS's SS is
not treated as sole DB
11a
Payments begin in year after 11b
year of P's death
In year payments begin under 11a or 11b, pay over SS's redetermined
single life expectancy per Single Life Table for age attained each year
through year of spouse's death
DB – Designated beneficiary
P – Plan participant or IRA accountowner
S – P's spouse
SS – P's surviving spouse
RBD – Required beginning date
Beginning with year after SS's
death, pay over SS's fixed single
life expectancy per Single Life
Table for age SS attained (or
would have attained) in year of
SS's death reduced by 1 for each
year thereafter
Beginning with year after SS's
death, pay over the longer of
(i) SS's fixed single life expectancy per Single Life Table for age
SS attained (or would have
attained) in year of SS's death reduced by 1 for each year thereafter or (ii) over P's single life
expectancy per box 4, if longer
Year – Calendar year (or distribution calendar year)
OR
Spousal rollover or "own IRA" election
If SS rolls P's account (or any portion of it) over to SS's own IRA or plan
or if SS has a full right of withdrawal and elects to treat P's IRA as SS's
own IRA, the above rules apply to SS as the P of such new plan or IRA
account (and box 11 no longer applies). SS may designate a younger
DB and "reload" the life expectancy period that applies on SS's death. If
a SS who had passed the SS's RBD makes an "own IRA" election, a
distribution must be made from the IRA account for the year of the
election unless the election is made in the year of P's death (for which a
distribution is already required).
0263A(1)
HBW8295b-X
MI/2/es
-/8295
EXHIBIT B
UNIFORM LIFETIME DISTRIBUTION PERIOD TABLE
UNDER 2002 FINAL REGULATIONS
Age of the
Participant
Distribution
Period
Applicable
Percentage
Age of the
Participant
Distribution
Period
Applicable
Percentage
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
27.4
26.5
25.6
24.7
23.8
22.9
22.0
21.2
20.3
19.5
18.7
17.9
17.1
16.3
15.5
14.8
14.1
13.4
12.7
12.0
11.4
10.8
10.2
3.6496%
3.7736%
3.9063%
4.0486%
4.2017%
4.3668%
4.5455%
4.7170%
4.9261%
5.1282%
5.3476%
5.5866%
5.8480%
6.1350%
6.4516%
6.7568%
7.0922%
7.4627%
7.8740%
8.3333%
8.7719%
9.2593%
9.8039%
93
94
95
96
97
98
99
100
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115 & older
9.6
9.1
8.6
8.1
7.6
7.1
6.7
6.3
5.9
5.5
5.2
4.9
4.5
4.2
3.9
3.7
3.4
3.1
2.9
2.6
2.4
2.1
1.9
10.4167%
10.9890%
11.6279%
12.3457%
13.1579%
14.0845%
14.9254%
15.8730%
16.9492%
18.1818%
19.2308%
20.4082%
22.2222%
23.8095%
25.6410%
27.0270%
29.4118%
32.2581%
34.4828%
38.4615%
41.6667%
47.6190%
52.6316%
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EXHIBIT C
SINGLE LIFE EXPECTANCY TABLE
UNDER 2002 FINAL REGULATIONS
Age
Multiple
Applicable
Percentage
Age
Multiple
Applicable
Percentage
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
82.4
81.6
80.6
79.7
78.7
77.7
76.7
75.8
74.8
73.8
72.8
71.8
70.8
69.9
68.9
67.9
66.9
66.0
65.0
64.0
63.0
62.1
61.1
60.1
59.1
58.2
57.2
56.2
55.3
54.3
53.3
52.4
51.4
50.4
49.4
48.5
47.5
1.2136%
1.2255%
1.2407%
1.2547%
1.2706%
1.2870%
1.3038%
1.3193%
1.3369%
1.3550%
1.3736%
1.3928%
1.4124%
1.4306%
1.4514%
1.4728%
1.4948%
1.5152%
1.5385%
1.5625%
1.5873%
1.6103%
1.6367%
1.6639%
1.6920%
1.7182%
1.7483%
1.7794%
1.8083%
1.8416%
1.8762%
1.9084%
1.9455%
1.9841%
2.0243%
2.0619%
2.1053%
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
46.5
45.6
44.6
43.6
42.7
41.7
40.7
39.8
38.8
37.9
37.0
36.0
35.1
34.2
33.3
32.3
31.4
30.5
29.6
28.7
27.9
27.0
26.1
25.2
24.4
23.5
22.7
21.8
21.0
20.2
19.4
18.6
17.8
17.0
16.3
15.5
14.8
2.1505%
2.1930%
2.2422%
2.2936%
2.3419%
2.3981%
2.4570%
2.5126%
2.5773%
2.6385%
2.7027%
2.7778%
2.8490%
2.9240%
3.0030%
3.0960%
3.1847%
3.2787%
3.3784%
3.4843%
3.5842%
3.7037%
3.8314%
3.9683%
4.0984%
4.2553%
4.4053%
4.5872%
4.7619%
4.9505%
5.1546%
5.3763%
5.6180%
5.8824%
6.1350%
6.4516%
6.7568%
Age
Multiple
Applicable
Percentage
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
105
106
107
108
109
110
111+
14.1
13.4
12.7
12.1
11.4
10.8
10.2
9.7
9.1
8.6
8.1
7.6
7.1
6.7
6.3
5.9
5.5
5.2
4.9
4.6
4.3
4.1
3.8
3.6
3.4
3.1
2.9
2.7
2.5
2.3
2.1
1.9
1.7
1.5
1.4
1.2
1.1
1.0
7.0922%
7.4627%
7.8740%
8.2645%
8.7719%
9.2593%
9.8039%
10.3093%
10.9890%
11.6279%
12.3457%
13.1579%
14.0845%
14.9254%
15.8730%
16.9492%
18.1818%
19.2308%
20.4082%
21.7391%
23.2558%
24.3902%
26.3158%
27.7778%
29.4118%
32.2581%
34.4828%
37.0370%
40.0000%
43.4783%
47.6190%
52.6316%
58.8235%
66.6667%
71.4286%
83.3333%
90.9091%
100.0000%
0263A(1)
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EXHIBIT D
Page 1
SAMPLE TRUST AGREEMENT PROVISION
FOR
CONDUIT SUBTRUST
Retirement Benefit Conduit Subtrust.
If:
(i)
Plan benefit distributions subject to the minimum distribution rules of
section 401(a)(9) of the Code in any retirement account qualified under
section 401(a), individual retirement account ("IRA") or annuity qualified
under section 408, a Roth IRA under Code section 408A, "deemed"
IRA or Roth IRA under Code section 408(q), annuity or custodial
account qualified under section 403(b), eligible government or tax
exempt organization plan qualified under section 457(b), or any other
retirement plan or arrangement that is subject to the minimum distribution rules are payable to a retirement benefit conduit subtrust of any
separate trust under this article 5 pursuant to any beneficiary designation filed by settlor (or any other person) as a participant,
accountowner, or surviving spouse beneficiary [under section
401(a)(9)(b)(iv)] of that plan and
(ii)
The trustees of that separate trust have not disclaimed such benefit
distributions on or before September 30 of the calendar year following
settlor's (or other designating person's) death,
the trustees of the separate trust shall segregate those plan distributions in that retirement benefit
conduit subtrust. The conduit subtrust shall be governed by all of the provisions of the separate trust
of which the subtrust is a part except as follows –
(a)
During the remaining lifetime of the oldest current beneficiary [as defined in section 11.3(b) below] of that separate trust who is living on the
date of settlor's death (or, in the case of a subtrust designated as
beneficiary by another person, on the date of such person's death), the
trustees shall distribute all plan distributions (including all minimum
required distribution amounts) directly to the oldest beneficiary [and/or
directly to and among one or more of the individual beneficiaries of the
trust, as the independent trustee (or trustees) shall, in that trustee's (or
those trustees') sole discretion, determine], as soon as is reasonably
convenient following the trustee's receipt of those distributions.
(b)
Any power of appointment with respect to plan distributions otherwise
exercisable by any subtrust beneficiary or any other person during the
oldest beneficiary's lifetime shall only be exercisable effective upon the
death of the oldest beneficiary of the separate trust which includes the
subtrust.
(c)
The independent trustee (or trustees) shall have the discretion to
withdraw plan benefit distributions in excess of the minimum required
distributions for each calendar year to the extent permitted by the plan
or IRA involved, provided such excess distributions shall be subject to
paragraph (a) above.
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EXHIBIT D
Page 2
(d)
Unless the subtrust is earlier terminated by the distribution of all of the
plan assets in the discretion of the independent trustees or under the
provisions of section 8.1 below, the subtrust shall terminate upon the
death of the oldest beneficiary of the subtrust who was living on the
date of settlor's death. Any plan distributions payable after that oldest
beneficiary's death shall become the assets of the separate trust which
included that subtrust. The trustees may assign the subtrust's interest
in retirement plan benefits and need not liquidate plan benefits in
connection with the subtrust's termination.
The sole purpose of this retirement benefit conduit subtrust (and the restrictions upon the otherwise
applicable provisions that govern the separate trust which includes this subtrust) is to qualify all benefits
from the plans and individual retirement arrangements paid to the subtrust under the so-called section
401(a)(9) look through rules. In that way, the minimum required distributions from any plan or individual
retirement arrangement may be calculated and paid to the subtrust over the single life expectancy of
the oldest current trust beneficiary at the time of the death of settlor (or other person who designates
the retirement benefit conduit subtrust as beneficiary). The provisions of section 401(a)(9), section 408,
or the Treasury regulations issued with respect to those sections that apply to any plan assets payable
to the subtrust may be modified or other official guidance, such as a revenue ruling, may be issued by
the Internal Revenue Service. If those modifications, such guidance, or any specific determination by
the Internal Revenue Service with respect to the trust or subtrust involved has the effect that,
notwithstanding the foregoing subtrust limitations, any plan or individual retirement arrangement
distributions payable to the retirement benefit conduit subtrust of any separate trust must be paid at a
rate more rapid than over the single life expectancy of the oldest current trust beneficiary on the date of
settlor's (or other designating person's) death, the subtrust may, in the discretion of the independent
trustee(s), be terminated in advance of the above specified terminating events.
----------------------------------------------------------------------------------------------------------------------------------------11.3(b)
(b)
Current Beneficiary.
The term "current beneficiary" (collectively, "current beneficiaries"), as
that term applies to any particular trust as of any specified time (referred to for such purposes as "at that
time"), shall mean each person (or those persons) who, at that time, either:
(1)
Is (or are) currently entitled to receive regular distributions (for
example, income, annuity, unitrust, or other similar periodic
distributions) or
(2)
May currently receive distributions in the discretion of any then
trustee (or trustees) of such trust (with or without reference to
any standard as guidance in the exercise of such discretion),
whether such distribution is (or such distributions are) from the income or principal (or both the income
and principal) of that trust (or any part thereof). However, in either case, no person shall be
considered to be a current beneficiary of any trust solely by reason of:
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EXHIBIT D
Page 3
(A)
That person's entitlement to any trust distributions made or to be
made (either at one time or in two or more installments) in partial
or complete satisfaction of what would otherwise amount to a
specific bequest that came (or is coming) into effect upon an
individual's death or
(B)
A possible future exercise of a power of appointment held in an
individual (as contrasted with a fiduciary) capacity.
----------------------------------------------------------------------------------------------------------------------------------------Possible addition to paragraph (b) if conduit trust is not a subtrust:
"Notwithstanding the foregoing, such distributions shall be
reduced by trust administrative expenses as well as income,
estate, generation skipping transfer, or other tax to the extent
that such expense and taxes are chargeable to or otherwise
payable by the subtrust with respect to the plan benefits received
or receivable."
0263A(1)
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EXHIBIT E
Page 1
SAMPLE TRUST AGREEMENT PROVISION
FOR
SUBTRUST BENEFITTING DESCENDANTS
YOUNGER THAN THE TRUST'S OLDEST
LOOK THROUGH DESIGNATED BENEFICIARY
Retirement Benefit Nonconduit Subtrust.
If:
(i)
Plan benefit distributions subject to the minimum distribution rules of
section 401(a)(9) of the Code in any retirement account qualified under
section 401(a), individual retirement account ("IRA") or annuity qualified
under section 408, a Roth IRA under Code section 408A, "deemed" IRA
or Roth IRA under Code section 408(q), annuity or custodial account
qualified under section 403(b), eligible government or tax exempt
organization plan qualified under section 457(b), or any other retirement
plan or arrangement that is subject to the minimum distribution rules are
payable to a retirement benefit conduit subtrust of any separate trust
under this article 5 pursuant to any beneficiary designation filed by settlor
(or any other person) as a participant, accountowner, or surviving spouse
beneficiary [under section 401(a)(9)(b)(iv)] of that plan and
(ii)
The trustees of that separate trust have not disclaimed such benefit distributions on or before September 30 of the calendar year following settlor's (or other designating person's) death,
the trustees of the separate trust shall segregate those plan distributions together with all other
subtrust assets and proceeds from their reinvestment ("plan assets") in a retirement benefit nonconduit subtrust. The nonconduit subtrust shall be governed by all of the provisions of the separate
trust of which the subtrust is a part except as follows –
(a)
Any individual beneficiary of the separate trust which includes the
subtrust (including any individual who may, at a future date, become a
beneficiary of the separate trust following the death of one or more
current trust beneficiaries) who is older than the oldest descendant (or
spouse of a descendant) of settlor living on the date of settlor's death
(or, if another person has designated a subtrust as beneficiary, on such
other person's date of death) who is a trust beneficiary (the "oldest
beneficiary") shall, for the purposes of the subtrust, be deemed to have
predeceased settlor and shall not be a beneficiary of the subtrust.
(b)
From and after September 30 of the year following the calendar year of
settlor's death:
(I)
No charitable organization that is a current or potential future
beneficiary of the separate trust which includes the subtrust shall
be a beneficiary of that subtrust and
(II)
No plan assets shall be applied, directly or indirectly, for the
payment of settlor's debts, estate or other death taxes, or postdeath administration.
0263A(1)
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EXHIBIT E
Page 2
(c)
Any power of appointment held by a trust beneficiary or any other person
with respect to the separate trust which includes the subtrust shall be exercisable with respect to subtrust assets exclusively in favor of one or
more individual descendants (or spouses of descendants) of settlor who
are (or could in the future become) permissible distributees of such subtrust or in favor of a trust benefitting such individuals which has the same
restrictions that apply to the subtrust.
(d)
Unless the subtrust is earlier terminated by the distribution of all of the
subtrust assets to the subtrust beneficiaries, outright and free of trust
(in the discretion of the independent trustees or otherwise under the
provisions of the separate trust which includes the subtrust) or under
the provisions of section 8.1 below, the subtrust shall terminate when
there are no more than two subtrust beneficiaries to whom the subtrust
assets may be distributed.
The sole purpose of this retirement benefit nonconduit subtrust (and the restrictions upon the otherwise applicable provisions that govern the separate trust which includes this subtrust) is to qualify all
benefits from the plans and individual retirement arrangement paid to the subtrust under the so-called
section 401(a)(9) look through rules. In that way, the minimum required distributions from such plans
and individual retirement arrangements may be calculated and paid to the subtrust over the single life
expectancy of the oldest trust beneficiary. The provisions of section 401(a)(9), section 408, or the
Treasury regulations issued with respect to these sections that apply to any amounts payable to a
subtrust may be modified or other official guidance, such as a revenue ruling, may be issued by the
Internal Revenue Service. If those modifications, such guidance, or any specific determination by the
Internal Revenue Service with respect to the trust or subtrust involved has the effect that, notwithstanding the foregoing subtrust limitations, any plan or individual retirement account distributions
payable to the retirement benefit nonconduit subtrust of any separate trust must be paid at a rate more
rapid than over the single life expectancy of the oldest trust beneficiary on the date of settlor's (or such
other designating person's) death, the subtrust may, in the discretion of the independent trustee(s), be
terminated in advance of the above specified terminating events.
0263A(1)
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EXHIBIT F
TRUST PROVISION RE DISCLAIMER AUTHORITY
Direction to Minimize Taxes.
In the administration of each trust under this trust agreement, the
trustees of such trust shall exercise all tax related elections, options, discretions, and choices
which they have in such manner as they, in their sole but reasonable judgment (where
appropriate, receiving advice of tax counsel), believe will achieve the overall minimum in total
combined present and reasonably (but appropriately discounted) future administrative
expenses and tax burdens of all kinds, for such trust, its beneficiaries, and any other trusts
involved (and their beneficiaries). Among other discretions, the "disinterested trustees" may
disclaim any benefits receivable by any trust under this agreement in any manner permitted
by law or by a "transfer" meeting the requirements of section 2518(c)(3) of the Internal
Revenue Code. Such trustees shall not be accountable to any person interested in any trust
hereunder for the manner in which, in good faith, they shall carry out this direction to minimize
overall taxes and expenses (including any decision they may make to not incur the expense
of a detailed analysis of alternative choices). Even though the trustees' decisions in regard to
tax minimization may result in increased tax or decreased distributions to a trust or to one or
more beneficiaries, there shall in no event be any equitable adjustments seeking to compensate for any such seeming inequities in tax effect or actual distributions unless the disinterested trustee(s) of such trust, in their sole and uncontrolled discretion determine that the
fundamental and normally overriding objective of minimizing the overall expenses and taxes
to be borne by such trust's(s') beneficiaries generally would be better served by making an
equitable adjustment.
Note: "Disinterested trustees" are trustees other than those who are
donors to or current or contingent beneficiaries of the trust.
0263A(1)
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EXHIBIT G
Page 1
BENEFICIARY DESIGNATION FOR REVOCABLE TRUST –
DISCLAIMER METHOD –
DOES NOT QUALIFY TRUST BENEFICIARIES FOR LOOK THROUGH RULES
BENEFICIARY DESIGNATION
RE
(IRA) INDIVIDUAL RETIREMENT ACCOUNT (ACCOUNT NUMBER)
1.
In accordance with the right granted to me under this IRA to designate and redesignate the beneficiary or beneficiaries to
receive all benefits which are payable after my death from this IRA –
a.
I hereby designate as my beneficiaries the individuals and trusts, as listed in subparagraph d below, in the order of
priority indicated, who survive me (or, in the case of any trust, which is then in or, as a result of my death, is coming
into existence), as the beneficiary or beneficiaries to whom or to which (or, in the case of a trust, to the assignees of
which) all such benefits shall be distributed. However, if an individual beneficiary who becomes entitled to benefit
distributions dies without having received (or by notice to this IRA's sponsor, elected to withdraw) all of such distributions, all subsequent benefit distributions shall be made to the beneficiaries named below, determined in the
same manner as if I had died immediately following the time of such individual beneficiary's death.
b.
If, under the circumstances existing at the time of my death (including trustee and beneficiary disclaimers, if any),
two or more designated beneficiaries are to share said benefits, such benefits shall be distributed in the "ultimate
shares" indicated for each beneficiary (that is, in the percentage portions of my account indicated for each –
meaning, in the case of a formula amount, the percentage portion of my account which such formula amount represents as of the date of my death).
c.
When such ultimate shares are thus identified, the assets of this IRA shall be segregated on the basis of said ultimate share percentages, effective as of my death, into separate subaccounts of this IRA, one for the share representing each beneficiary (or such beneficiary's assignee), so that all postdeath IRA investment net earnings, gains,
and losses are determined separately for each such subaccount.
d.
My beneficiaries are –
FIRST
– The trustee or trustees of the original John J. Doe, Jr. Trust, a revocable and amendable trust UTA dtd
02/12/03 made by me as settlor with me and Mary A. Doe as the initial trustees or, if such trust is revoked
before my death or to the extent its trustees disclaim such benefits,
[Note that the revocable trust provides that, if settlor's spouse survives, all income in
respect of a decedent, is to be transferred, in kind, as though specific bequests under
settlor's will, to the marital trust except that such specific transfer shall abate to the extent
that such transfer would cause the marital deduction formula amount to be reduced
below zero.]
[Note also that under the trust agreement, IRD allocable to the marital trust is held in a
separate subaccount which the spouse may disclaim into a disclaimer trust (having no
spousal power of appointment and having a 5-5 power) or, if the interest in the
disclaimer trust is also disclaimed by the spouse, to the nonmarital trusts.]
SECOND – The trustee or trustees of the John J. Doe, Jr. Marital Trust (or, if my wife, Mary A. Doe, does not survive
me, of the John J. Doe, Jr. Residuary Trust) under said 02/12/03 TA, or, if such trust for any reason
cannot come into existence following my death or to the extent its trustees disclaim such benefits,
THIRD
– Mary A. Doe, my wife, or, if she is not then living or to the extent she disclaims such benefits,
FOURTH – Those of my lineal descendants who survive me (other than any who disclaim such benefits), per stirpes or,
if there are none,
FIFTH
e.
– My "heirs" [that is, the person or persons who, under the then applicable laws of descent and distribution,
would be entitled to my property (if more than one, sharing in the same proportions as they would under
such laws) had I died (i) intestate, (ii) without either creditors or other assets, and (iii) a resident of the state
of Michigan].
If the above Marital Trust is to receive benefits that are payable after my death from this IRA, for each calendar year
(or part of such a year) after my death –
0263A(1)
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EXHIBIT G
Page 2
(1)
f.
2.
From time to time, my spouse shall have the right to require the trustee or trustees of the Marital Trust to
cause this IRA's sponsor to distribute to such Marital Trust trustee(s) (to the extent not otherwise being distributed) an amount (the "income portion") equal to the excess, if any, of:
(a)
The trust accounting income such account earned for such period over
(b)
The minimum distribution, if any, required pursuant to IRC section 401(a)(9) for the same period.
(2)
The Marital Trust trustee(s) shall treat the full amount of each IRA distribution (or, if less, the aforesaid income
portion thereof) as income for trust accounting purposes.
(3)
If any substantial amount of the assets of such account shall be or become unproductive of a reasonable
amount of income, the trust accounting income for such period shall be the income such account would have
earned had such account's assets been invested in a manner reasonably productive of income [which, for this
purpose, shall be deemed to be the amount of income that such account would have produced had all of the
assets of such account produced income during such period at a rate of return equal to the percentage
dividend yield of the Standard & Poor's 500 Common Stocks for such period based on the average for such
period of the account's fair market value (as computed by averaging the beginning and ending fair market
values for each whole or partial calendar month within such period)].
Disclaimer may be (i) by any method which is effective under the laws of the state of my domicile at the time of my
death and which meets the requirements of IRC section 2518 or (ii) by a written transfer of the right to receive part or
all of such benefits, provided that such transfer meets the requirements of IRC section 2518(c)(3) (references to IRC
sections are to those sections as from time to time amended). To the extent that any one or more of my designated
individual or trust beneficiaries disclaim such benefits, such disclaimant(s) shall be treated for this purpose as not
having survived me.
I expressly hold this IRA's sponsor harmless from all liability and responsibility in making distributions based on written
representations and opinions furnished by the trustees of my revocable trust (or by counsel for such trustees) or by
counsel for any above designated beneficiary (such as whether a trust has been revoked or cannot come into existence,
whether a disclaimer is effective, the effectiveness of my instructions given herein to the trustees of any trust, and so on).
Terms used in this document that are used in my revocable trust shall have the same meaning here that those terms have
in the administration of trusts under that trust's governing document.
Accepted and approved:
(
(IRA Sponsor), Trustee
By
Its
(
/
/
)
John J. Doe, Jr.,
Grantor/Accountowner
Social Security No.
Date of birth
Spouse's date of birth
/
/
)
0263A(1)
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EXHIBIT H
Page 1
BENEFICIARY DESIGNATION INTENDED TO QUALIFY TRUSTS
RECEIVING BENEFITS FOR LOOK THROUGH RULES
BENEFICIARY DESIGNATION
RE
(IRA) INDIVIDUAL RETIREMENT ACCOUNT (ACCOUNT NUMBER)
1.
In accordance with the right granted to me under this IRA to designate and redesignate the beneficiary or beneficiaries to receive all benefits which are payable after my death from this IRA –
a.
I hereby designate as my beneficiaries the individuals and trusts, as listed in subparagraph d below, in the order of priority
indicated, who survive me (or, in the case of any trust, which is then in or, as a result of my death, comes into existence),
as the beneficiary or beneficiaries to whom or to which all such benefits shall be distributed.
b.
If, under the circumstances existing at the time of my death (including trustee and beneficiary disclaimers, if any), two or
more designated beneficiaries are to share said benefits, such benefits shall be distributed in the "ultimate shares"
indicated for each beneficiary (that is, in the percentage portions of my account indicated for each – meaning, in the
case of a formula amount, the percentage portion of my account which such formula amount represents as of the date of
my death).
c.
When such ultimate shares are thus identified, the assets of this IRA shall be segregated on the basis of said ultimate
share percentages, effective as of my death, into separate IRAs (or subaccounts of this IRA), one for the share representing each beneficiary, so that all postdeath IRA investment net earnings, gains, and losses are determined separately
for each such IRA or such subaccount.
d.
My beneficiaries shall be –
(1)
If my wife, Mary A. Doe, survives me (in the event that my spouse and I die simultaneously or under circumstances such that the order of our deaths cannot be clearly established by proof I shall be presumed to have survived her) –
FIRST
– The trustee or trustees of the retirement benefit nonconduit subtrust of the John J. Doe, Jr.
Exempt Residuary Trust under the John J. Doe, Jr. Trust, a revocable and amendable trust UTA
dtd 02/12/03 made by me as settlor with me and Mary A. Doe as the initial trustees or, if that trust
does not come into existence upon my death or to the extent its trustees disclaim those benefits,
SECOND – The trustee or trustees of the retirement benefit nonconduit subtrust of the John J. Doe, Jr.
Nonexempt Marital Trust under that 02/12/03 TA or, if that trust does not come into existence upon
my death or to the extent its trustees disclaim those benefits,
THIRD
– Mary A. Doe, my wife, or, if she is not living or to the extent she disclaims those benefits,
FOURTH – Those of my lineal descendants who survive me (other than any who disclaim those benefits), per
stirpes or, if there are none,
FIFTH
(2)
– My "heirs" [that is, the person or persons who, under the then applicable laws of descent and distribution, would be entitled to my property (if more than one, sharing in the same proportions as
they would under such laws) had I died (i) intestate, (ii) without either creditors or other assets,
and (iii) a resident of the state of Michigan].
If my wife, Mary A. Doe, predeceases me, my IRA benefits shall be divided into equal shares, one in the name of
each of my children who is living and one in the name of each who is deceased but who has any descendant or
unremarried qualified surviving spouse (that is, such deceased child and spouse were married at least 15 years or
there is at least one child of that marriage living) and the respective beneficiary of each such share shall be –
FIRST
– The trustee or trustees of the retirement benefit conduit subtrust of:
(i)
The Exempt Family Trust under my 02/12/03 TA in the name of the child of mine for whom or
for whose family such trust exists with respect to the portion of such share as is equal to my
unused generation-skipping transfer (GST) tax exemption as of the date of my death divided
by the number of shares being created and
(ii)
The Nonexempt Family Trust under my 02/12/03 TA in the name of the child of mine for whom
of for whose family such trust exists with respect to the balance of such share
or, if either of such trusts does not come into existence upon my death or to the extent the trustees
of either such trust disclaim those benefits,
0263A(1)
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EXHIBIT H
Page 2
SECOND – The child of mine in whose name such share stands (or, if such child predeceases me, such child's
then living lineal descendants, per stirpes), or if there are none or to the extent any such beneficiary
disclaims such benefits,
THIRD
– Those of my lineal descendants who survive me (other than any who disclaim those benefits), per
stirpes or, if there are none,
FOURTH – My "heirs" [that is, the person or persons who, under the then applicable laws of descent and distribution, would be entitled to my property (if more than one, sharing in the same proportions as
they would under such laws) had I died (i) intestate, (ii) without either creditors or other assets,
and (iii) a resident of the state of Michigan].
e.
If the above Marital Trust is to receive benefits that are payable after my death from this IRA, for each calendar year (or
part of such a year) after my death –
(1)
f.
2.
From time to time, my spouse shall have the right to require the trustee or trustees of the Marital Trust to cause
this IRA's sponsor to distribute to such Marital Trust trustee(s) (to the extent not otherwise being distributed) an
amount (the "income portion") equal to the excess, if any, of:
(a)
The trust accounting income such account earned for such period over
(b)
The minimum distribution, if any, required pursuant to IRC section 401(a)(9) for the same period.
(2)
The Marital Trust trustee(s) shall treat the full amount of each IRA distribution (or, if less, the aforesaid income
portion thereof) as income for trust accounting purposes.
(3)
If any substantial amount of the assets of such account shall be or become unproductive of a reasonable amount
of income, the trust accounting income for such period shall be the income such account would have earned had
such account's assets been invested in a manner reasonably productive of income [which, for this purpose, shall
be deemed to be the amount of income that such account would have produced had all of the assets of such
account produced income during such period at a rate of return equal to the percentage dividend yield of the
Standard & Poor's 500 Common Stocks for such period based on the average for such period of the account's fair
market value (as computed by averaging the beginning and ending fair market values for each whole or partial
calendar month within such period)].
Disclaimer may be (i) by any method which is effective under the laws of the state of my domicile at the time of my death
and which meets the requirements of IRC section 2518 or (ii) by a written transfer of the right to receive part or all of
such benefits, provided that such transfer meets the requirements of IRC section 2518(c)(3) (references to IRC sections
are to those sections as from time to time amended). To the extent that any one or more of my designated individual or
trust beneficiaries disclaim such benefits, such disclaimant(s) shall be treated for this purpose as not having survived
me.
I expressly hold this IRA's sponsor harmless from all liability and responsibility in making distributions based on written representations and opinions furnished by the trustees of my revocable trust (or by counsel for such trustees) or by counsel for any
above designated beneficiary (such as whether a trust has been revoked or cannot come into existence, whether a disclaimer
is effective, the effectiveness of my instructions given herein to the trustees of any trust, and so on). Terms used in this
document that are used in my revocable trust shall have the same meaning here that those terms have in the administration of
trusts under that trust's governing document.
Accepted and approved:
(
(IRA Sponsor), Trustee
By
Its
(
/
/
)
John J. Doe, Jr.,
Accountowner
Social Security No.
Date of birth
Spouse's date of birth
/
/
)