Court Rejects Income-Only Trust Created by MassHealth Applicant

In a poorly-reasoned and somewhat murky decision, a Superior Court judge in Daley v. Sudders (Civil Action No. 15–CV–0188–D.Dec. 24, 2015) extends the Doherty decision to reject the MassHealth application of a man who, with his wife, placed his Worcester condominium into an irrevocable trust for long-term care planning purposes. To learn more about this case and its implications for life estate trusts, click HERE.

Estate of Purdue v. Commissioner

By, Caleb S. Sainsbury, Esq. of Morgan, Lewis & Bockius LLP

Citation: 145 T.C. Memo. 2015-249 (December 28, 2015)

Overview: This case addresses (1) whether the decedent retained an interest under §2036 of assets transferred to an FLP; (2) whether gifts of FLP interests qualify for the annual exclusion; and (3) whether interest on a loan to the estate to pay estate taxes may be deducted.

Summary of Facts: In 1995, the estate planning lawyer for Mr. and Mrs. Purdue advised them to establish an FLP and various trusts.  In 2000, the Purdues acted on this advice and contributed $22 million of marketable securities, an interest in a commercial building worth $900,000, a $375,000 promissory note from one of their children and an $865,523 certificate of deposit in exchange for all of the FLP membership interests.  The final agreement listed the following six reasons for establishing the FLP: to (1) consolidate the management and control of the property and improve efficiency in managing the property; (2) avoid fractured ownership; (3) keep ownership of the assets within the extended family; (4) protect assets from unknown creditors; (5) provide flexibility and management of assets not available through other business entities; and (6) promote the education and communication among extended family with respect to financial matters.

In addition, prior to the execution of the FLP, the estate planning attorney sent a memorandum to the Purdues summarizing five advantages of the structure. These advantages were (1) limited liability; (2) pass through income taxation; (3) minimum formalities; (4) appropriate entity for owning real estate; and (5) tax savings.

Prior to signing the documents, the Purdues had experienced some health issues. Mrs. Purdue had become semi-invalid due to a leg injury.  She had also experienced stroke-like symptoms in October 2000, but did not have residual neurological impairment.  Mr. Purdue was physically healthy at the time of the signing, but did experience symptoms of Alzheimer’s disease and was subsequently diagnosed with that disease.

Mr. Purdue died unexpectedly in August 2001 and his estate passed to a family trust and two QTIP trusts. From 2002 through 2007, Mrs. Purdue made gifts of the FLP membership interests to an irrevocable trust with beneficiary withdrawal rights.  The trust made approximately $1.95 million of distributions to the children from 2001 to 2007, with the majority of the cash coming from the FLP interests contributed to the trust.

Upon Mrs. Purdue’s death in 2007, a dispute arose among her children on whether the FLP should make a distribution to pay estate taxes. Because the FLP operating agreement required unanimous consent, this gridlock resulted in funds from the FLP not being available to pay the tax.  As such, some of the beneficiaries and the QTIP trusts loaned money to the estate to fund the estate tax payment.  The estate deducted the interest on the loan on the estate tax return.

Court Analysis:

  1. §2036 Issues

The IRS argued that Mrs. Purdue had a retained interest in all assets transferred to the FLP. However, the Court reasoned that §2036 did not apply with respect to the transfers to the FLP for the following reasons: (1) the record established legitimate and significant nontax reasons for creating the FLP, (2) the Purdues were not financially dependent on FLP distributions, (3) FLP funds and personal funds were not comingled, (4) the FLP maintained its own records and formalities were respected, (5) the assets were transferred to the FLP in a timely manner, and (6) the Purdues were in good enough health at the time of the transfers.

  1. Annual Exclusion

To qualify as a gift of a present interest in the context of FLP interests, the donees must have the use, possession or enjoyment of the FLP interests or the income from those interests. Although the donees could not transfer the FLP interests without the consent of all members, the Court reasoned that the donees did receive income from those interests and this satisfied the present interest requirement.  Therefore, the gifts did qualify for the annual exclusion.

  1. Deductibility of Interest

In order for the interest on a loan to the estate to be deductible on an estate tax return, the loan must be (i) bona fide, (ii) necessary and actually incurred in the estate administration and (iii) essential to the property settlement of the estate. See Treas. Reg. §20.2053-1(b)(2), §20.2053-3(a).  The Court reasoned that the loan was necessary because the FLP members could not agree on whether to make a distribution to pay the estate taxes.  Thus, the interest deduction was allowed.

Take Away Considerations:  This case provides a roadmap for highlighting factors resulting in a positive result for the client.  Particularly, advisors must take care to review the factors noted by the Court to avoid having the full value of assets transferred to an FLP included in the estate under §2036.

BBA Event Recap: Trusts & Estates Section Mid-Year Review

Program Title: Trusts & Estates Section Mid-Year Review

Program Date: Friday, January 22, 2016

Panelists: Melissa E. Sydney of Burns & Levinson LLP, Allison Whitmore of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., Christopher M. Falzone of Rockland Trust Company, and Valerie Sussman of Sullivan & Worcester LLP

Program Sponsor: Trusts & Estates Section

Materials:  To view the program materials, click HERE.

Summary of Program Topic: The Trusts and Estates Section Mid-Year Review covered recent federal and state case law, legislation and tax law matters. This year’s Mid-Year review included:

  • recent developments in Massachusetts case law, including a discussion of protecting trust assets from a divorcing spouse, income tax issues relating to trust situs and lessons on testamentary capacity
  • review status of pending legislation, including the pending Massachusetts estate tax bill
  • review final regulations on portability, proposed regulations under Code Section 2801, and discuss the Redstone and Obergefell cases.

BBA Event Recap: Maximizing Community Benefits

Program Title: Maximizing Community Benefits: Helping Clients Avoid Nursing Home Placement and Access Medicaid Coverage for Home Care and Assisted Living

Program Date: Tuesday, January 19, 2016

Panelists: Patricia C. D’Agostino of Margolis & Bloom

Program SponsorRebecca J. Benson of Margolis & Bloom and Gary Zalkin of Zalkin Law, co-Chairs of the Elder Law and Disability Planning Committee

Materials:  To view the program materials, click HERE.

Summary of Program Topic:  The state has rolled out several new programs to help keep elders and people with disabilities in the community, including the Home and Community Based Waiver (the “Frail Elder Waiver”), Adult Foster Care, Personal Care Attendant, Community Choices, Program for All Inclusive Care for the Elderly (“PACE”), and Senior Care Options (“SCO”). The clinical estate financial eligibility rules are complex and new programs are introduced often. A knowledgeable estate planner can help clients create eligibility, lengthen the life of their assets and remain at home for as long as possible.

Practice Fundamentals Series: Gift Planning Basics: Taxable Gifts – Definitions, Opportunities and Potential Pitfalls

Program Date: Wednesday, January 6, 2016

Panelist: Annette K. Eaton, Esq., Nixon Peabody LLP

Program Chairs: Anne L. Warren of Brown Brothers Harriman & Co.,   Tamara Lauterbach Sturges of Egleson & Sturges, LLC, and Heidi Seely of Rackemann, Sawyer & Brewster, P.C.

Materials: Click HERE for panelist’s handout.

Program Topic: The speaker provided an overview of common gifting strategies every estate planning practitioner should have in his or her toolkit.  Through case studies, the speaker reviewed: (i) annual exclusion gifting; (ii) gifting to minors; (iii) gifting fractional interests; (iv) GRATs; and (v) charitable gifting strategies.

BBA Event Recap: When A.R.T. is the Issue: The Impact of Assisted Reproductive Technologies on Estates and Probate

Program Title: When A.R.T. is the Issue: The Impact of Assisted Reproductive Technologies on Estates and Probate

Program Date: Tuesday, November 20, 2015

Panelists: Lisa M. Cukier, Esq. and David Raymon, Esq., both of Burns & Levinson LLP

Program SponsorsFamily Law Section, Health Law Section, Estate Planning Committee

Materials:  To view the program materials, click here.

Summary of Program Topic: The panelists discussed assisted reproductive technologies and its impact on estate planning, family law and probate.  During their presentation, the panelists reviewed statutes and case laws that control ownership of genetic material, what constitutes parentage and how to dispose of embryos in estate plans.

Practice Fundamentals Series: Basic Estate Planning Documents I: Will, Introduction to the Revocable Trust, Power of Attorney and Health Care Proxy

Program Date: Wednesday, December 2, 2015

Panelist: Melissa E. Sydney, Esq., of Burns & Levinson LLP

Program Chairs: Anne L. Warren of Brown Brothers Harriman & Co.,   Tamara Lauterbach Sturges of Egleson & Sturges, LLC, and Heidi Seely of Rackemann, Sawyer & Brewster, P.C.

Materials: Click HERE  for panelist’s handout.

Program Topic:  The speaker provided an introduction to basic estate planning documents.  She reviewed the key components of wills, health care proxies, durable powers of attorney, and touched on the basics of revocable trusts.  The speaker also provided drafting suggestions and advice on avoiding certain pitfalls when advising clients about their estate plan.

BBA Event Recap: Discretionary Distributions from an Irrevocable Trust

Program Title: Discretionary Distributions from an Irrevocable Trust: How much discretion does the trustee have? It depends….

Program Date: Wednesday, December 16, 2015

Panelists: Peter M. Shapland of Day Pitney LLP and Stacy K. Mullaney of Fiduciary Trust,

Program Sponsor: Peter M. Shapland of Day Pitney LLP and Stacy K. Mullaney of Fiduciary Trust, co-Chairs of the Trust Administration Committee

Materials:  To view the program materials, click on each of the following links: Handout 001, Handout 002, Handout 003, and Handout 004

Summary of Program Topic:  The panelists discussed discretionary distribution standards and factors that trustees must consider in responding to beneficiary requests for distributions.  The conversation included: (I) what analysis is required under certain distribution standards; (ii) the purpose and intent of the settlor; (iii) when should a beneficiary’s financial resources be considered; and (iv) what duty does the trustee have to consider the future needs of the current beneficiary and/or the needs of successor and remainder beneficiaries.

Estate of Redstone v. Commissioner

By, Caitlin Glynn

Overview: Transfer made as part of settlement of family litigation is not a taxable gift

Summary: The Tax Court case, Estate of Redstone v. Commissioner, 145 T.C. No. 11, focuses on a family dispute that led to a transfer of 33 ⅓ shares of a family business to a trust for the shareholder’s two children.  The issue the Tax Court reviews is whether the shareholder’s transfer of stock in trust for his two children was a gift subject to the gift tax or whether it constituted a bona fide, arm’s-length transaction that was free from donative intent and that was “made in the ordinary course of business.”

Summary of Facts:  Edward Redstone (“Edward”), along with his brother, Sumner, and father, Mickey, incorporated a closely-held family company National Amusements, Inc. (“NAI”).  Upon NAI’s incorporation, Mickey contributed a disproportionate amount of capital.  Nevertheless, Edward, Sumner and Mickey each were listed as the registered owners of an equal ⅓ of NAI’s shares, equal to 100 shares each.

Edward was eventually forced out of the business after numerous family disputes within the Redstone family, originally stemming from the institutionalization of Edward’s son, Michael, by Edward, for psychiatric problems.  Edward felt marginalized, not only with his family, but also within the family business.  Eventually, Edward quit the business.  Upon leaving, Edward demanded possession of the 100 shares of common stock registered in his name.

Mickey refused to give Edward the stock certificates.  Mickey argued that a portion of the shareholder’s stock, though registered in Edward’s name had actually been held since NAI’s inception in an “oral trust” for the benefit of Edward’s children, because of Mickey’s disproportionate contribution of capital.  Mickey contended that he had gratuitously accorded Edward more stock than he was entitled to, and the “extra” shares should be regarded as being held in trust for Edward’s children.

The parties negotiated for six months in search of a resolution.  Edward sued NAI to recover the 100 shares of stock that were registered in his name.  A settlement was ultimately reached.  The parties agreed in a Settlement Agreement that Edward was the owner of 66 ⅔ shares of the stock, and the remaining 33 ⅓ shares of stock would be transferred into irrevocable trusts for the benefit of Edward’s two children.  The Settlement Agreement further provided that Edward would transfer the 66 ⅔ shares to NAI for $5 million.

The IRS determined that Edward’s transfer of stock to the irrevocable trusts for the benefit of his children was a taxable gift.  The IRS further determined that in addition to gift tax owed, there were further penalties for fraud, negligence and failing to file a gift tax return.

Applicable Legal Principles and Analysis:  Where property is transferred for less than adequate and full consideration in money or money’s worth, the amount by which the value of the property exceeds the value of the consideration is deemed a gift.  A transfer of property within a family group normally receives close scrutiny as to whether it is a gift.  However, on numerous occasions, the Tax Court has held that a transfer of property between family members in settlement of bona fide unliquidated claims was made for “full and adequate consideration” because it was a transaction in the “ordinary course of business.”  A transfer of property will be regarded as made for “a full and adequate consideration” in the “ordinary course of business” only if it satisfies the three elements specified in Treas. Reg. Sect. 25.2512-8.  The three elements are that the transfer is bona fide, transacted at arm’s length and free of donative intent.

The Tax Court held that the transfer was not a gift as it satisfied all three elements.  The settlement was “bona fide” because the parties “were settling a genuine dispute as opposed to engaging in a collusive attempt to make the transaction appear to be something it was not.”  See 145 T.C. No. 11, at 21.  The transfer was at “arm’s length” as Edward acted “as one would act in the settlement of differences with a stranger.”  See id. at 22.  The Tax Court found that Edward was genuinely estranged from his father.  There were legitimate business grievances against one another that led to the parties being represented by counsel and engaged in adversarial negotiations for many months prior to settlement that was incorporated into a judicial decree.  The transfer was free of donative intent as Edward transferred stock to his children not because he wished to, but because his father demanded it.  See id. at 25.  At the time of the settlement, Edward had no desire to transfer stock to his children but was forced to accept this transfer in order to placate his father, settle the family dispute, and obtain a $5 million payment for his 66 2/3 shares.

Take Away Considerations:  In the settlement of litigation in a family related context, concerns are often raised by planners as to whether any parties are making taxable gifts as a result of the settlement.  Although transfers in compromise and settlement of genuine trust and estate disputes will typically be treated as transfers for full and adequate consideration in the ordinary course of business, this Tax Court case summarizes certain factors to consider in this context, which include: whether a genuine controversy existed between the parties; whether the parties were represented by and acted upon the advice of counsel; whether the parties engaged in adversarial negotiations; whether the value of the property involved was substantial; whether the settlement was motivated by the parties’ desire to avoid the uncertainty and expense of litigation; and whether the settlement was finalized under judicial supervision and incorporated in a judicial decree.  See 145 T.C. No. 11, at 20. These factors offer helpful guidelines for practitioners to consider when advising clients whether a transfer of property in the context of a family settlement should be reported as a taxable gift.

Volunteer T&E Attorneys Needed for Veterans Legal Services

Claire Carrabba and Nikki Marie Oliveira, co-chairs of the Public Service Committee, have been working with Lynn Girton, the Pro Bono Director of Veterans Legal Services (“VLS”), in order to establish a volunteer project to assist homeless and low-income veterans with basic estate planning needs.  In order to qualify for services, the veteran must generally have an income below 200% of the federal poverty level.  Many of the veterans require assistance in obtaining a Will and other estate planning documents, such as Durable Powers of Attorney and Health Care Proxies.  No specialized knowledge of veterans’ law or benefits is needed to help VLS clients.  VLS is able to offer malpractice insurance to those attorneys who provide pro bono assistance to VLS clients.

Lynn Girton is looking for 15 volunteers to get the pro bono project started and she anticipates having a few cases available in the next month.  If you have any questions or are interested in volunteering, please fill out the sign-up sheet (click here) and return it to Nikki Marie Oliveira at [email protected]