Florida Estate Planning Lawyer & Attorney : Stokes McMillan Maracini & Antúnez : Litigation, Probate, Trust Administration

As the population growth rate (both in North America and world-wide) continues to rise, so to does the number of individuals diagnosed every year with mental and/or physical disabilities. This makes it increasingly likely that, at some point in your estate planning practice, you will encounter a family in need of an estate plan addressing, and providing for, a family member with special needs. There are a multitude of tools available to these families which, when utilized, can serve not only to provide for the long-term care of the individual after the death of his or her caretaker, but also to provide tax benefits for expenses incurred in connection with the care of the special needs individual.

Special Needs Trusts

A. Purpose

Special Needs Trusts (also called “Supplemental Needs Trusts”) enable the caretaker of an individual with special needs to provide for the individual long after the caretaker’s death. The typical plan provides for a testamentary trust whereby, upon the death of the caretaker, a trustee is appointed to hold the assets of the trust for the benefit of the special needs individual, paying special attention not to make available to the beneficiary any assets which could be deemed to disqualify the beneficiary from being eligible to receive certain benefits under governmental programs such as Social Security and Medicaid.

B.  Critical Provisions

The terms of the Special Needs Trust should provide the trustee with discretion to make distributions from income or principal that are deemed necessary or advisable for the satisfaction of the beneficiary’s “special non-support needs.” Special non-support needs should be specifically defined as those necessary to sustain the beneficiary’s good health, safety, and welfare when, in the discretion of the trustee, those requisites are not being provided by any public agency, office, or department, or are not otherwise being provided by other sources of income available to the beneficiary. It is advisable to include a non-exclusive list of what special non-support needs may consist of, such as: sophisticated medical or dental or diagnostic work or treatment for which funds are otherwise unavailable, including plastic surgery or other non-necessary medical procedures; private rehabilitative training; dental care; and recreation and transportation. It is imperative, however, to specify that payment for such special non-support needs can only supplement governmental or private assistance or benefits programs and cannot replace them. This is key to ensuring the assets of the Special Needs Trust never serve to disqualify the beneficiary’s eligibility for the governmental assistance he or she may be receiving.

Other crucial language in a Special Needs Trust includes empowering the trustee to take whatever administrative or judicial steps may be necessary to continue the public assistance program eligibility of the beneficiary (including terminating the trust), as well as specifying that the beneficiary may not appoint or assign the trust’s assets away, and that the assets are not available to the beneficiary except in the trustee’s discretion.

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In Estate of Zlotowski v. Commissioner, the U.S. Tax Court held the estate's two executors liable for the untimely filing of the estate's 706 return.  While an individual may escape liability if it is shown he or she reasonably relied on the legal advice of counsel, the Tax Court found no such reasonable reliance in Zlotowski.  While the estate argued its attorney had failed to advise the executors of the return's due date, the IRS responded by arguing that, first, a taxpayer's reliance on the advice of its attorney with respect to matters such as meeting filing deadlines generally does not constitute reasonable reliance, and, secondly, the executors' reliance on the attorney to file the estate tax return was an impermissible delegation of their responsibility as executors.  The IRS further pointed out that, in this case, there was no evidence the executors even discussed with their attorney whether, as a matter of law, it was not necessary to timely file a return.  Therefore, the IRS concluded, there was no actual legal advice given that the executors could even argue they reasonably relied upon. 

The Tax Court sided with the IRS, holding that there was no way the estate could possibly stand upon its argument of reasonable reliance on the advice of counsel: there was no evidence the executors had even asked their attorney for advice as to whether the return was due on time, let alone that they had received such advice.  In its analysis, the court also pointed to testimony given by one of the executors that further demonstrated the executors' complete disengagement from the estate administration process, including the preparation of the estate tax return.  In the end, the estate was held liable for the additional tax generated as a result of the late filing. 

The moral of the story: An executor's complete disengagement from the estate administration process will not suffice as support for the argument of reasonable reliance on the legal advice of counsel.  The executor of an estate, in accepting the position, takes on certain obligations and responsibilities that cannot be ignored or placed solely upon an attorney.  For this reason, the position of executor is not one to be accepted without giving consideration to the duties involved. 

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In this recent Wall Street Journal article, the pros and cons of the increasing trend toward employing multiple trust advisors to manage a single trust are explored.  The article points out that in the past, when it came time to appoint a trustee, most families opted to appoint a single trustee (such as a family member, trust company, or trusted advisor) to perform trustee duties such as investing and monitoring trust funds, ensuring tax returns and related paperwork get filed, and making distributions to beneficiaries.  When families did choose to appoint multiple trustees, it was typically under a scheme where all the trustees shared the same responsibilities.  Nowadays, however, more and more individuals are invoking a more complicated regime when it comes to who manages their trusts:

"...families are 'slicing and dicing' trust duties, says Dennis Belcher, a trust lawyer with McGuire Woods LLP in Richmond, Va.  Families are specifying that one trustee, typically an institutional trust company, hold custody of the assets and handle the administrative trustee duties. Meanwhile, another fiduciary -- often a family investment committee -- has the authority to direct investments. Trust creators are also naming separate trustees to handle distributions to beneficiaries. "

In order to manage the increasing number of trustees per trust,  some individuals are even opting to designate "trust protectors," who are given the power to hire and fire trustees.  Additionally, a growing number of states have enacted laws that specifically allow trust documents to name separate trustees for administration and for trust investments; trusts that utilize this approach are termed "directed trusts" and can be especially useful for families who may be uncomfortable handing family businesses or real estate over to trust companies for management.

Despite the benefits these "directed trusts" can provide, there are several cons to keep in mind, namely: cost and complexity.  Dividing trustee duties between multiple institutions or individuals can clearly lead to an increase in trustees' fees.  Additionally, appointing multiple trustees can make it difficult to determine which trustee is responsible for what, and hence which trustees bear fiduciary responsibility if things go wrong. 

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In Revenue Procedures 2007-45 and 2007-46, the IRS released sample language to be utilized in drafting both inter vivos (Rev. Proc. 2007-45) and testamentary (Rev. Proc. 2007-46) charitable lead annuity trusts (CLATs).

A CLAT is an irrevocable split-interest trust which provides that during the term of the trust, a specified amount be paid to one or more charitable beneficiaries, and that at the end of the term of the trust, the principal remaining be paid over to (or held in trust for) a noncharitable beneficiary named in the CLAT. An inter vivos CLAT conforming with applicable statutory requirements qualifies the gift of an interest in the CLAT for the gift tax charitable deduction and/or the estate tax charitable deduction, while a testamentary CLAT results in the value of the charitable lead annuity interest being deductible by the decedent’s estate. Given the obvious benefits that a CLAT can provide, any estate planner drafting one should ensure full compliance with the IRC by paying close attention to the new sample drafting language (with accompanying annotations) published in Rev. Procs. 2007-45 and 46.

Among one of the more important annotations found in Rev. Procs. 2007-45 and 46 is the annotation regarding guaranteed annuity amounts. For one thing, in order to qualify for an estate tax charitable deduction, a CLAT must provide for the payment of a guaranteed annuity amount at least annually to a qualified charitable organization for each year during the annuity period. To qualify as “guaranteed,” the annuity amount must be determinable. It is “determinable” if the exact amount that must be paid under the conditions specified in the instrument may be ascertained as of the appropriate valuation date. A charitable interest expressed as the right to receive an annual payment from a trust equal to the lesser of a sum certain or a fixed percentage of the trust assets (determined annually) is not a guaranteed annuity interest. An annuity interest is also not guaranteed if the trustee has the discretion to commute and prepay the charitable interest prior to the termination of the annuity period.

For other drafting considerations and useful annotations see Rev. Proc. 2007-45 and 46.

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Beginning in 2008, Congress will ratchet up the restrictions imposed by the so called "kiddie tax " by increasing the age under which children are taxed at their parents' marginal rate for unearned income.  The new cut off age will be age 18 and younger, or age 23 and younger for "children" who are full-time students. 

In this recent article on Investors.com authored by Donald Jay Korn for Investors Business Daily, Korn discusses the new law, which targets upper-income families, and is designed to prevent such families from shielding income on dividends and long term gains by shifting such income to their children.

"A partial remedy for parents in higher brackets was to give appreciated assets they wanted to sell to their kids.  That was especially attractive if the kids were in the two lowest tax brackets [which owe 0% on most dividends and long term gains].  They could sell the assets and owe no tax."

While the increased restrictions do exclude married children who file joint returns, as well as children whose own earned income constitutes more than one-half of their support, it would seem these exceptions will be applicable in only a small percentage of cases.   

Finally, although the new law does impose increased restrictions, parents can still always save in gains taxes by transferring assets to their children to hold until after the child graduates college, and then having the child sell at his own (and most likely much lower) tax rate. 

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In the April 23, 2007 publication of the Federal Register, the U.S. Treasury proposed several amendments to the regulations on claims against estates governed by Section 2053 of the Internal Revenue Code. The most notable proposed changes include:

1.  Events occurring after a decedent's death will be considered when determining the amount deductible under all provisions of Section 2053;

2.  Deductions under Section 2053 will be limited to amounts actually paid by the estate in satisfaction of deduct able expenses and claims;

3.  A protective claim for refund may be filed before the expiration of the period of limitations for claims for refund in order to preserve the estate's right to claim a refund if the amount of a liability will not be ascertainable by the time of the expiration of the period of limitations for claims of refund; and

4.  No deduction may be taken on an estate tax return for a claim that is potential, unmatured, or contested at the time the return is filed.

The proposed regulations serve as a reaction to a history of inconsistent case law regarding whether post-death events should be taken into account in valuing claims against an estate.  Unlike Section 2031, Section 2053 does not contain a specific directive to value a deductible claim at its date of death value.  As a result of this vagueness, courts have gone both ways, resulting in the inconsistent treatment of estates for estate tax purposes. The Treasury hopes that by adopting the proposed regulations, Section 2053 will be construed and applied the same way in all jurisdictions. 

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In Estate of Erickson, the U.S. Tax Court finds the assets of yet another family limited partnership includable in the decedent's gross estate for estate tax purposes. 

With a fact pattern strikingly similar to that of Estate of Korby, (a case I previously wrote about here) it is no wonder the U.S. Tax Court came out the same way in Estate of Erickson.  In Estate of Erickson, the court recounted yet another case where the suspicious fact pattern and timing of events surrounding the creation, funding, and management of a family limited partnership led the court to conclude that the property transferred to the partnership were includable in the decedent's gross estate. 

Just as in Estate of Korby, the court invoked the following three prong test to determine whether the property was properly includable in the decedent's gross estate:

1.  Did the decedent make an inter vivos transfer of the property?

2.  Did the decedent retain a right or interest in the transferred property that he or she did not relinquish until death?

3.  Was there an absence of a bona fide sale for adequate and full consideration?

The court answered each of these three questions in the affirmative, and in doing so looked to the following factual circumstances present in the case:

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In reading the United States Tax Court's memorandum regarding the Estate of Gimbel, I could not help but be reminded of just how important it is to have a thorough estate plan in place.  By thorough, I mean that aside from having all the appropriate estate planning documents in order, the estate's assets are arranged so that they systematically and as effortlessly as possible follow the scheme laid out in the estate planning documents.

Georgina Gimbel died owning 3,601,267 shares in Reliance Steel and Aluminum Company, a publicly traded company that had been founded by the uncle of her predeceased husband.  Of those shares (which represented approximately 13% of the company's outstanding stock), approximately 3,548,450 were unregistered.  This, along with the fact that the decedent held such a large number of shares so as to qualify her as an "affiliated person" under federal securities law, meant that the shares could be sold on the public market only under extremely limited conditions.  Taking this into account, the estate argued for a 17% valuation discount, while the IRS was only willing to allow a 9% discount.  Inevitably, valuation experts were hired, disagreements as to the proper method for valuing the stock ensued, and the case wound up before the U.S. Tax Court. 

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Why, when certain circumstances are present, the assets in a family limited partnership can be included in the decedent's gross estate.

Section 2036 of the Internal Revenue Code provides:

"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…by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death…the possession or enjoyment of, or the right to the income from, the property."

In Estate of Korby v. Commissioner of Internal Revenue, the Eighth Circuit Court of Appeals held that this provision can, in certain circumstances, also apply to family-created limited partnerships.

In Korby, a married couple created a limited partnership and funded it with a total of $1,888,704.00 worth of assets.  The couple’s living trust obtained a 2% general partnership interest, while the couple itself obtained a 98% limited partnership interest.  The couple proceeded to gift their 98% limited partnership interest to four irrevocable trusts created for their sons. When both husband and wife passed away, neither estate tax return included the value of the estate assets that had been transferred to the partnership, and the IRS issued notices of deficiency as to both of the estates. The IRS argued that the full value of the partnership assets was includable in the gross estate because the couple had retained "for their lives ‘the possession or enjoyment of, or the right to the income from, the property."  The Eighth Circuit Court of appeals agreed with the IRS’s position.

How did the court reach this conclusion?

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