Wills and Trusts

Wyatt, Tarrant & Combs, LLP

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Arbitration Provisions

Arbitration Provisions

Is a trust provision requiring that the trustee and beneficiaries submit to binding arbitration enforceable on the beneficiaries?  Not in California, held the California Court of Appeals in Diaz v. Bukey, 125 Cal.Rptr.3d 610 (Ca. App. Ct. 2011).  The court followed an Arizona decision which it summarized as follows:

In Schoneberger v. Oelze (2004) 208 Ariz. 591, 96 P.3d 1078, the court construed an arbitration provision in a trust substantially similar to that involved here. We find its reasoning persuasive. In Schoneberger, two trust beneficiaries filed separate, but similar, lawsuits against the settlors and trustees of the trusts asserting claims of breach of trust, conversion and fraudulent concealment, mismanagement and dissipating trust assets. Among other relief, each beneficiary demanded an accounting.

Defendants answered, denied the allegations of wrongdoing and alleged that the beneficiaries’ claims were subject to mandatory arbitration under the Arizona arbitration statute. The defendants asserted the arbitration clauses in the trust documents constituted provisions in a written contract requiring arbitration, and although the beneficiaries were not signatories to the trusts, they were nevertheless obligated to arbitrate as third party beneficiaries. Alternatively, they contended the beneficiaries were equitably estopped from objecting to arbitration as they were affirmatively seeking benefits under the trusts. The beneficiaries opposed defendants’ motion to compel arbitration. They argued the arbitration provisions in the trusts were unenforceable because the trusts were not contractual agreements. They also asserted that, as nonsignatories to the trust documents, they had never agreed to arbitrate their claims against the defendants.

In Schmitz v. Merrill Lynch, 939 N.E.2d 40 (Ill. App. 2010) the trustee entered into a “client relationship agreement” with an investment advisor that contained an arbitration provision.  The provision did not bind the beneficiaries because the beneficiaries were not contractually bound to the investment advisor.

In Rachal v. Reitz, 2013 Tex. LEXIS 348 (2013), the could held that an arbitration clause in trust was enforceable against non-signatory beneficiaries.  A.F. Reitz established a trust for the benefit of his son, John, and appointed himself as initial trustee and Hal Rachal Jr. as successor trustee. After A.F. Reitz died, Rachal became trustee of the trust.  John sued Rachal as trustee alleging breach of fiduciary duty by failure to account and looting of the trust for personal gain. The trustee moved to compel arbitration of the suit under the arbitration provision in the trust. The trial court denied the motion and the trustee appealed.

On appeal, the Texas Court of Appeals sitting en banc (with four dissenting justices) affirmed on the grounds that: (1) the trust document did not satisfy the requirement for a valid contract; and (2) the settlor’s intent does not transform the trust into a contract to arbitrate between the successor trustee and the beneficiary.

The Texas Supreme Court reversed the Court of Appeals and held that the arbitration clause was enforceable, on the grounds that:  (a) Texas courts enforce the settlor’s intent over the objections of the beneficiaries that disagree with the trust terms; (b) The Texas Arbitration Act applies to written “agreements”, and the Texas legislature could have limited the Act to “contracts” and did not do so, therefore the legislature intended to include all agreements and not just contracts; (c) the Act does not define “agreements”, but the common definition is a manifestation of mutual assent; (d) mutual assets to an arbitration provision exists where a non-signatory party has obtained or is seeking substantial benefit under an agreement through the doctrine of “direct benefits estoppels”; (e) deemed assent exists here through direct benefits estoppels because the trust beneficiary did not disclaim his interest in the trust, did not challenge the validity of the trust, and attempted to enforce his rights under the trust and sought the benefits provided to him under the terms; (f) a valid underlying contract is not required to apply direct benefits estoppel; (g) the claims in this case were within the scope of the arbitration provision, which required arbitration of “any dispute of any kind involving this Trust or any of the parties or persons connected herewith”; and (h) the other trust provisions that exonerate the trustee from liability do not defeat the arbitration provision which applies “notwithstanding anything herein to the contrary” and could apply where a claim is filed in court and the direct benefits estoppel doctrine does not apply (which presumably would mean only claims by non-beneficiaries under the court’s reasoning).

Turney P. Berry

Louisville, Kentucky



Kentucky Uniform Trust Code

Effective July 15, 2014, Kentucky will join the ranks of states that have adopted the Uniform Trust Code (UTC).  Although not yet codified and still only available as HB 78, Kentucky’s version of the UTC will be codified as KRS Chapter 386B.  The UTC has been enacted in 26 1 States including Missouri, Ohio, Tennessee (read Rob Malin’s post regarding Tennessee’s not so uniform trust code here), Virginia and West Virginia.  The purpose and intent in enacting the UTC is to codify the common law principles and standards regarding trusts and trustees including the duties of loyalty, care, notice, inform and report, and prudent investment for both corporate and individual trustees.  The UTC is a comprehensive statute that fills in the gaps of current Kentucky law both statutory and common.  Among the important matters the UTC addresses are the following:

Trustee Investment Standard.

Section 782 provides that the “prudent investor” rule of KRS 286.3-277 will apply to all trustees. Current law provides that the prudent investor rule applies to corporate trustees while a confusing mix of the common law “prudent man” rule and the “legal list” of KRS 386.020 applies to individual trustees. There is no discernible reason for applying different investment rules to corporate and individual trustees and Kentucky is unique in doing so. This change conforms Kentucky law with the law in the overwhelming majority of states.


Section 15 of the UTC clarifies which court has subject-matter jurisdiction over trust matters.  The current law is confusing because it is unclear whether an inter vivos trust is a “probate” matter over which the district court has jurisdiction, although in many cases it is clear that the district court is the appropriate forum.  Under the UTC, absent specific language in another statute, the District and Circuit Courts have concurrent jurisdiction over all trust actions. The District Court has exclusive jurisdiction over actions first filed there unless an opposing party files an action involving the same matter in Circuit Court within 20 days, in which case the district court is divested of jurisdiction.  The rational of this rule is that if the matter truly is “adversarial” then the opposing party should be allowed to bring the matter before the court that is best suited to handle contested issues.  However, if all parties are in agreement that the matter is best handled in District Court then the matter should be allowed to stay in District Court.  This change does not affect the Circuit Court’s jurisdiction over matters specifically granted by other statutes.

Capacity to create or revoke a revocable trust.

Section 46 provides that the capacity required to create or revoke a revocable trust is the same as required to make a will.

Revocable Trusts are Subject to the Claims of the Settlor’s Creditors.

Section 43 clarifies that the assets of a revocable trust can, upon the death of the settlor, be subjected to the claims of the settlor’s creditors if the settlor’s estate has insufficient assets with which to satisfy the claims. This is an issue which has been the subject of litigation and the UTC resolves the issue by adopting a rule of fairness.

Revocation of a Revocable Trust.

Section 47 sets forth rules regarding the revocation of a revocable trust, including under what circumstances a revocable trust may be revoked by a later will of the settlor, when an attorney-in-fact may revoke a revocable trust, and when a conservator or guardian may revoke a revocable trust.

Statute of Limitations for Breach of Trust and to Contest Validity of a Revocable Trust.

The UTC clarifies the statute of limitations for breach of trust, which under current law is unclear.  Section 83 provides a short one year limitations period if a Trustee adequately discloses the existence of a potential claim and informs the beneficiary of the time allowed for commencement of a proceeding. If no such disclosure is provided, Section 83 provides that limitations does not run on a claim for breach of fiduciary duty until five years after the first to occur of the trustee’s removal, death or resignation or the termination of the trust or termination of the beneficiary’s interest in the trust. Section 49 provides that an action to contest a revocable trust must be brought within two years after the settlor’s death, which is the same rule applicable to will contests.

Virtual Representation.

Current law is uncertain regarding who can bind or represent  unborn, minor or unascertainable beneficiaries.  Sections 18-22 of the UTC set forth clear rules regarding the representation of the interest of another including when virtual representation may apply and when it does not.  Section 20 lists who with a special relationship to another person may bind that other person.  For example, a parent may bind a child absent a conflict of interest.  Section 21 sets forth the general rule that a person with a substantially identical interest can bind an otherwise unrepresented minor, incapacitated, or unborn person or a person not reasonably ascertainable.

Notice and Duty to Inform.

Section 7 of the UTC clarifies how a Trustee must give notice and Section 72 clarifies to whom a Trustee owes a duty to inform and report and what information must be given.  Section 72 requires the trustee within 60 days of its acceptance of the trust to provide the “qualified beneficiaries” (essentially those beneficiaries currently entitled to distributions, the immediate successor beneficiaries and those who would receive the trust property if the trust terminated) certain relevant information, including notice of the existence of the trust, the identity of the settlor, and the right to receive a copy of the trust instrument. Section 72 also sets forth the trustee’s duty to account to the beneficiaries. Section 72(2) specifies the extent to which the settlor may circumscribe the trustee’s duty to provide information regarding the trust.

Settlement Agreements Relating to Trusts.

In order to enhance judicial economy, Section 9 of the UTC provides for specific non-judicial settlement agreements between persons interested in a trust, including, for example, settlements relating to the meaning of the terms of a trust instrument. This provision facilitates the making of agreements by giving such agreements the same effect as if approved by the court, provided the agreement contains terms and conditions that a court could properly approve and would not be contrary to law.  Section 33 codifies the common law rule that a noncharitable trust may be modified or terminated without court approval provided the settlor and all beneficiaries consent.

Elder Law.

Section 11 of the UTC abolishes the doctrine of worthier title as applied to trusts.  Abolition of this doctrine insures that certain benefits of federal law, including the right of a disabled person under the age of 65 to create a supplemental needs trust for his own benefit provided that at death any assets remaining in the trust are used to reimburse the state for Medicaid benefits provided to the settlor during his or her lifetime. All of the states which border Kentucky have abolished this doctrine with the exception of Ohio. The UTC also includes a specific statement that the creator of a first party supplemental needs trust is not a “settlor” of the trust for purposes of the spendthrift statute. Section 41(8)(a)(4) – (6). Section 73 confirms that a settlor may create a purely discretionary trust.

Distributions from Trusts.

To further promote the expeditious distribution of trust assets and address the often time consuming and costly dilemma that can arise when a trustee is reluctant to make a distribution absent beneficiary approval and the beneficiary is reluctant to approve until the assets have been distributed, the UTC has two specific sections (76 and 77) regarding trust distributions. Section 76 applies to all distributions unless the expedited distribution method in Section 77 is invoked.  The expedited distribution method would only apply if all of the interested parties are in agreement and would provide for a simpler method of distributing assets when the distribution is one that is considered routine or directed by the trust document itself.

Pet Trusts.

Section 30 authorizes the creation of a trust for the benefit of an animal and provides rules with respect to such trusts.

Charitable Trusts.

Section 27 clarifies that the court may select the charitable purpose or beneficiaries of a charitable trust if the terms of the trust do not indicate a particular beneficiary or purpose. Section 55(2)(c) provides that the trustee of a charitable trust may be removed upon the request all of the qualified beneficiaries provided notice is given to the Attorney General and the court finds that removal of the trustee best serves the interests of all of the beneficiaries.

Modifications to Advance the Purposes of the Trust.

Section 34 authorizes the court to modify a trust to meet changes in circumstances not anticipated by the settlor provided any such modification would further the purposes of the trust.


Section 66 authorizes the trustee to delegate duties and powers that a prudent person of comparable skills could properly delegate under the circumstances. Section 75(29) authorizes a trustee to employ an agent to perform any act of administration, whether or not discretionary.

Proposed Distribution.

Section 76 authorizes a trustee to present a proposal for distribution upon termination of the trust. If the beneficiary does not object to the proposal within 30 days the beneficiary has no right to object provided the trustee notifies the beneficiary of the right to object and the time for doing so. This provision brings the “proposed” settlement procedure applicable to estates pursuant to KRS 395.627 into the law of trusts.

Beth Anderson

Louisville, Kentucky

 1 Alabama, Arizona, Arkansas, District of Columbia, Florida, Kansas, Maine, Massachusetts, Michigan, Missouri, Montana, Nebraska, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Utah, Vermont, Virginia, West Virginia, Wyoming.

2 All references to UTC sections are as listed in HB 78

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Effectiveness of Defined Value Clauses and Formula Gifting

In John H. Hendrix et ux. v. Commissioner, T.C. Memo. 2011-133, the taxpayer assigned fixed dollar amounts of S corporation stock to GST trusts – by gift and a sale for a note – with any (all) excess being assigned to a donor advised fund at a community foundation. The assignments required that the assignees determine among themselves the number of shares each would have and disputes would be decided by arbitration. The allocation was agreed to among the donees about a month after the assignments. The family had an appraiser and the community foundation had a second appraiser review the appraisal for fairness. The court upheld the effectiveness of the allocation.

The Tax Court approved a charitable allocation clause in Estate of Anne Y. Petter et al. v. Commissioner, T.C. Memo. 2009-280. Mrs. Petter created the Petter Family, LLC (PFLLC) and funded it with UPS stock. Mrs. Petter then gave units to two grantor trusts, sold additional units to those trusts, and made a gift to two community foundations of still more units. The transfers were by formula:

“Transferor wishes to assign 940 Class T Membership Units in the Company (the “Units”) including all of the Transferor’s right, title and interest in the economic, management and voting rights in the Units as a gift to the Transferees.” Donna’s document is similar, except that it conveys Class D membership units. Section 1.1 of Terry’s transfer document reads:

Transferor * * *

1.1.1 assigns to the Trust as a gift the number of Units described in Recital C above that equals one-half the minimum dollar amount that can pass free of federal gift tax by reason of Transferor’s applicable exclusion amount allowed by Code Section 2010(c). Transferor currently understands her unused applicable exclusion amount to be $907,820, so that the amount of this gift should be $453,910; and

1.1.2 assigns to The Seattle Foundation as a gift to the A.Y. Petter Family Advised Fund of The Seattle Foundation the difference between the total number of Units described in Recital C above and the number of Units assigned to the Trust in Section 1.1.1.

The gift documents also provide in section 1.2:

The Trust agrees that, if the value of the Units it initially receives is finally determined for federal gift tax purposes to exceed the amount described in Section 1.1.1, Trustee will, on behalf of the Trust and as a condition of the gift to it, transfer the excess Units to The Seattle Foundation as soon as practicable.

The Foundations similarly agree to return excess units to the trust if the value of the units is “finally determined for federal gift tax purposes” to be less than the amount described in section 1.1.1.


Recital C of the sale documents reads: “Transferor wishes to assign 8,459 Class T [or Class D] Membership Units in the Company (the “Units”) including all of the Transferor’s right, title and interest in the economic, management and voting rights in the Units by sale to the Trust and as a gift to The Seattle Foundation.” Section 1.1 reads:

Transferor * * *

1.1.1 assigns and sells to the Trust the number of Units described in Recital C above that equals a value of $4,085,190 as finally determined for federal gift tax purposes; and

1.1.2 assigns to The Seattle Foundation as a gift to the A.Y. Petter Family Advised Fund of The Seattle Foundation the difference between the total number of Units described in Recital C above and the number of Units assigned and sold to the Trust in Section 1.1.1.

Section 1.2 of the sale documents differs slightly from section 1.2 of the gift documents. In the sale documents, it reads: “The Trust agrees that, if the value of the Units it receives is finally determined to exceed $4,085,190, Trustee will, on behalf of the Trust and as a condition of the sale to it, transfer the excess Units to The Seattle Foundation as soon as practicable.” Likewise, the Seattle Foundation agrees to transfer shares to the trust if the value is found to be lower than $4,085,190.

The court found no abuse in this sort of formula transfer:

The Fifth Circuit held in McCord that what the taxpayer had given was a certain amount of property; and that the appraisal and subsequent translation of dollar values (what the donor gave each donee) into fractional interests in the gift (what the donees got) was a later event that a court should not consider. 461 F.3d at 627. In Christiansen, we also found that the later audit did not change what the donor had given, but instead triggered final allocation of the shares that the donees received. 130 T.C. at 15. The distinction is between a donor who gives away a fixed set of rights with uncertain value — that’s Christiansen — and a donor who tries to take property back — that’s Procter. The Christiansen formula was sufficiently different from the Procter formula that we held it did not raise the same policy problems.

A shorthand for this distinction is that savings clauses are void, but formula clauses are fine. But figuring out what kind of clause is involved in this case depends on understanding just what it was that Anne was giving away. She claims that she gave stock to her children equal in value to her unified credit and gave all the rest to charity. The Commissioner claims that she actually gave a particular number of shares to her children and should be taxed on the basis of their now-agreed value.

Recital C of the gift transfer documents specifies that Anne wanted to transfer “940 Class T [or Class D] Membership Units” in the aggregate; she would not transfer more or fewer regardless of the appraisal value.18 The gift documents specify that the trusts will take “the number of Units described in Recital C above that equals one-half the * * * applicable exclusion amount allowed by Code Section 2010(c).” The sale documents are more succinct, stating the trusts would take “the number of Units described in Recital C above that equals a value of $4,085,190.” The plain language of the documents shows that Anne was giving gifts of an ascertainable dollar value of stock; she did not give a specific number of shares or a specific percentage interest in the PFLLC. Much as in Christiansen, the number of shares given to the trusts was set by an appraisal occurring after the date of the gift. This makes the Petter gift more like a Christiansen formula clause than a Procter savings clause.

In actual fact, the IRS on audit determined that the PFLLC units were worth more than the taxpayer’s appraiser. Thus, additional units were allocated to charity and Mrs. Petter was eligible for an additional income tax deduction. But, as of what date? The court concluded as of the date of the original transfer:

Here we have a conundrum, for the events of the gift happened as follows:

  • March 22, 2002 — Gift of 940 shares, split between trusts and foundations. Letters of intent to foundations.
  • March 25, 2002 — Sale to trusts
  • April 15, 2002 — Moss Adams appraisal report
  • Later in 2002 — The Seattle Foundation “books” the value of the allocated shares on the basis of the Moss Adams appraisal. The Kitsap Community Foundation’s records recognize the A.Y. Petter Family Advised Fund as of December 31, 2002. In May 2003, Richard Tizzano, president of the Kitsap Community Foundation, signed Anne’s Form 8283 for 2002, acknowledging receipt of PFLLC units on March 22, 2002.
  • Fall 2007 — Bill Sperling [of the Seattle Foundation] notified of new appraisal for PFLLC units and beginning of reallocation.
  • February 2008 — Tax Court trial. Reallocation ongoing.

Anne says she should be able to take the entire charitable deduction at the time of the gift, in 2002. The Commissioner says that only some of the stock went to the charities in 2002, which means Anne or her estate should take a deduction for the gift of the rest of the stock in some later year not before us.

Section 25.2511-2(a), Gift Tax Regs., provides: “The gift tax is not imposed upon the receipt of the property by the donee, nor is it necessarily determined by the measure of enrichment resulting to the donee from the transfer, nor is it conditioned upon ability to identify the donee at the time of the transfer.” Anne made a gift for which, at the time of transfer, the beneficiaries could be named but the measure of their enrichment could not yet be ascertained. The Commissioner is comfortable with this ambiguity when considering whether the gift is completed or not, and states that tax treatment should not change simply because a donee’s identity becomes known at a date later than the date of the transfer. By analogy, we see no reason a donor’s tax treatment should change based on the later discovery of the true measure of enrichment by each of two named parties, one of whom is a charity. In the end, we find it relevant only that the shares were transferred out of Anne’s name and into the names of the intended beneficiaries, even though the initial allocation of a particular number of shares between those beneficiaries later turned out to be incorrect and needed to be fixed.


The allocation of units based on the Moss Adams appraisal, as an event occurring after the date of the gift, is outside the relevant date of the transfer, so anything that worked to change that allocation after the fact is not relevant to our current inquiry. We also don’t consider dispositive the date when the charities “booked” the value of the units, or the amounts the charities booked at the time of the initial transfer, both because those actions also occurred after the transfer and because Anne had no control over the Foundations’ internal accounting practices. We therefore agree with Anne that the appropriate date of the gift for tax purposes is March 22, 2002. The parties will submit calculations reflecting the amount of the gift and corresponding charitable deduction.

The Ninth Circuit upheld the Tax Court in Estate of Anne Y. Petter et al. v. Commissioner, (9th Cir. 2011). The IRS did not make a broad Procter type argument but rather argued that where a formula allocated assets to charity based on values as finally determined for Federal gift tax purposes, the audit itself was a condition precedent that ought to void the gift tax charitable deduction for any additional transfers to charity on account of the audit. The Ninth Circuit disagreed, stated:

Ultimately, the IRS argues that because the foundations would not have received the additional units but for the IRS audit, the additional transfer of units to the foundations was dependent upon a condition precedent. Adopting the IRS’s “but for” test would revolutionize the meaning of a condition precedent. In one sense, the IRS is correct that but for its audit, the foundations would not have obtained additional LLC units, but that is because the IRS believed the estimated value was not the true fair market value. Either of the trusts or either of the foundations could also have challenged the Moss Adams valuation of the LLC units, although it was unlikely that they would have done so. But this practical reality does not mean that the foundations’ rights to additional LLC units were contingent for their existence upon the IRS audit. Treasury Regulation § 25.2522(c)-3(b)(1) asks whether a transfer “is dependent upon . . . a precedent event in order that it might become effective,” not whether a transfer is dependent upon the occurrence of an event so that the transferred assets actually change hands. An analogy to a simple contract illustrates this point. Consider a contract between A and B, in which A agrees to pay B $1000 in exchange for B’s services. If A enters into this contract knowing that he has no intention to pay and if B then performs his side of the bargain, B will receive the $1000 only if he sues A in court. But for B’s lawsuit, B would not receive the money he deserves. But B’s filing of the lawsuit — though an event that must occur for B to be paid — is not a condition precedent to B’s receiving the $1000. That is so because B’s entitlement to this sum is in no way dependent upon the filing of a lawsuit; A’s duty to perform arose when B performed under the contract.

Citing I.R.C. § 2001(f)(2), the IRS further argues that a value as finally determined for gift tax purposes means the value shown on a taxpayer’s return, unless the IRS conducts a timely audit and challenges that value. Because the Taxpayer used the term “as finally determined for federal gift tax purposes,” the IRS claims that rather than transferring a particular number of units whose fair market value added up to the dollar amounts specified in the transfer agreements, the Taxpayer actually transferred a particular number of units whose pre-defined value — $536.20 per unit, the value reported on the Taxpayer’s gift tax return — added up to those dollar amounts. “And at that value, the foundations had rights to 1,773.91 and 93.47 units, and no more. The additional 4,503.82 and 237.04 units that the foundations subsequently were to receive were the result of the audit and the parties’ agreement that the value of each unit was $744.74.”

But the Taxpayer’s transfer agreements do not specify the value of an individual LLC unit. The gift documents assign to each of the two foundations the difference between 940 units and “the number of Units . . . that equals [$453,910],” while the sale documents assign to one foundation the difference between 8459 units and “the number of Units . . . that equals a value of $4,085,190 as finally determined for federal gift tax purposes.” Aside from the fact that only the dollar formula clause of the sale documents uses the phrase “as finally determined for federal gift tax purposes,” a taxpayer who files a return cannot conjure up a value for federal gift tax purposes out of thin air; rather, she must use federal gift tax valuation principles. Under these principles, the value of an asset “as finally determined for federal gift tax purposes” is the fair market value of that asset. See Treas. Reg. § 25.2512-1 (“[I]f a gift is made in property, its value . . . is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.”); cf. Succession of McCord v. Comm’r, 461 F.3d 614, 627 n.34 (5th Cir. 2006) (“There is no material difference between fair market value determined under Federal gift tax valuation principles and fair market value as finally determined for Federal gift tax purposes.” (citation and internal quotation marks omitted)). Thus, the Taxpayer did not transfer to the foundations the number of units equal to a defined dollar amount divided by $536.20; rather, she transferred the number of units equal to the defined dollar amount divided by the fair market value of a unit. The Moss Adams appraisal confirms this point; it states, on the first page, that its purpose “is to express an opinion of the fair market value of the [units].”

The opinion concludes with the suggestion that the IRS change its regulations:

Contrary to the IRS’s argument, the additional transfer of LLC units to the foundations was not subject to a condition precedent within the meaning of Treasury Regulation § 25.2522(c)-3(b)(1). Under the terms of the transfer documents, the foundations were always entitled to receive a predefined number of units, which the documents essentially expressed as a mathematical formula. This formula had one unknown: the value of a LLC unit at the time the transfer documents were executed. But though unknown, that value was a constant, which means that both before and after the IRS audit, the foundations were entitled to receive the same number of units. Absent the audit, the foundations may never have received all the units they were entitled to, but that does not mean that part of the Taxpayer’s transfer was dependent upon an IRS audit. Rather, the audit merely ensured the foundations would receive those units they were always entitled to receive. Accordingly, we hold that Treasury Regulation § 25.2522(c)-3(b)(1) does not bar a charitable deduction equal to the value of the additional units the foundations will receive. “[W]e expressly invite[ ] the Treasury Department to ‘amend its regulations’ if troubled by the consequences of our resolution of th[is] case.” Mayo Found. for Med. Educ. & Research v. United States, 131 S. Ct. 704, 713 (2011) (quoting United Dominion Indus., Inc. v. United States, 532 U.S. 822, 838 (2001)).

In Joanne M. Wandry et al. v. Commissioner, T.C. Memo. 2012-88, the issue was whether a formula clause, not involving a charity, would be effective. The clause in question read like this:

I hereby assign and transfer as gifts, effective as of January 1, 2004, a sufficient number of my Units as a Member of Norseman Capital, LLC, a Colorado limited liability company, so that the fair market value of such Units for federal gift tax purposes shall be as follows:

Name                                                Gift Amount
Kenneth D. Wandry                           $   261,000
Cynthia A. Wandry                                  261,000
Jason K. Wandry                                     261,000
Jared S. Wandry                                      261,000
Grandchild A                                               11,000
Grandchild B                                                11,000
Grandchild C                                                11,000
Grandchild D                                                11,000
Grandchild E                                                11,000

Although the number of Units gifted is fixed on the date of the gift, that number is based on the fair market value of the gifted Units, which cannot be known on the date of the gift but must be determined after such date based on all relevant information as of that date. Furthermore, the value determined is subject to challenge by the Internal Revenue Service (“IRS”). I intend to have a good-faith determination of such value made by an independent third-party professional experienced in such matters and appropriately qualified to make such a determination. Nevertheless, if, after the number of gifted Units is determined based on such valuation, the IRS challenges such valuation and a final determination of a different value is made by the IRS or a court of law, the number of gifted Units shall be adjusted accordingly so that the value of the number of Units gifted to each person equals the amount set forth above, in the same manner as a federal estate tax formula marital deduction amount would be adjusted for a valuation redetermination by the IRS and/or a court of law.

An appraisal determined that a 1% interest was worth $109,000, thus the Form 709 showed that each child received 2.39% and each grandchild 0.101%. On audit the IRS determined an increase and before the Court the parties agreed that 2.39% was worth $315,000 and 0.101% worth $3,346. The Court rejected the Procter argument:

Respondent argues that the public policy concerns expressed in Procter apply here. We disagree. As we have previously stated, the Supreme Court has warned against invoking public policy exceptions to the Code too freely, holding that the frustration caused must be “severe and immediate”. See Commissioner v. Tellier, 383 U.S. 687, 694 (1966). In Estate of Petter v. Commissioner, T.C. Memo. 2009-280, we held that there is no well-established public policy against formula clauses. The Commissioner’s role is to enforce tax laws, not merely to maximize tax receipts. See Estate of Christiansen v. Commissioner, 586 F.3d at 1065. Mechanisms outside of the IRS audit exist to ensure accurate valuation reporting. Id. For instance, in the cases at hand the donees and petitioners have competing interests because every member of Norseman is entitled to allocations and distributions based on their capital accounts. Because petitioners’ capital accounts were understated, the donees were allocated profits or losses that should have been allocated to petitioners. Each member of Norseman has an interest in ensuring that he or she is allocated a fair share of profits and not allocated any excess losses.

With respect to the second and third Procter public policy concerns, a judgment for petitioners would not undo the gift. Petitioners transferred a fixed set of interests to the donees and do not seek to change those interests. The gift documents do not have the power to undo anything. A judgment in these cases will reallocate Norseman membership units among petitioners and the donees. Such an adjustment may have significant Federal tax consequences. We are not passing judgment on a moot case or issuing merely a declaratory judgment.

In Estate of Petter we cited Congress’ overall policy of encouraging gifts to charitable organizations. This factor contributed to our conclusion, but it was not determinative. The lack of charitable component in the cases at hand does not result in a “severe and immediate” public policy concern.

The IRS can be expected to object that the donors do not have the same interest in enforcing an accurate gift that a charity would. Discussing Petter the opinion states:

Respondent does not interpret Estate of Petter properly. The Court of Appeals described the nature of the transfers and the reallocation provision of the clause at issue in Estate of Petter as follows:

Under the terms of the transfer documents, the foundations were always entitled to receive a predefined number of units, which the documents essentially expressed as a mathematical formula. This formula had one unknown: the value of a LLC unit at the time the transfer documents were executed. But though unknown, that value was a constant, which means that both before and after the IRS audit, the foundations were entitled to receive the same number of units. Absent the audit, the foundations may never have received all the units they were entitled to, but that does not mean that part of the Taxpayer’s transfer was dependent upon an IRS audit. Rather, the audit merely ensured the foundations would receive those units they were always entitled to receive. * * *

Id. at 1023. We apply each part of the Court of Appeals’ description above to petitioners’ gifts:

Part I: “Under the terms of the transfer documents, the foundations were always entitled to receive a predefined number of units, which the documents essentially expressed as a mathematical formula.”

Here, under the terms of the gift documents, the donees were always entitled to receive predefined Norseman percentage interests,5 which the gift documents essentially expressed as a mathematical formula. For each of petitioners’ children, this formula was expressed as:

x = _______________
FMV of Norseman

Similarly, for petitioners’ grandchildren this formula was expressed as:

x = _______________
FMV of Norseman

Part II: “This formula had one unknown: the value of a LLC unit at the time the transfer documents were executed. But though unknown, that value was a constant”

Petitioners’ formula had one unknown, the value of Norseman’s assets on January 1, 2004. But though unknown, that value was a constant. The parties have agreed that as of January 1, 2004, the value of a 2.39% Norseman membership interest was $315,800. Accordingly, the total value of Norseman’s assets on January 1, 2004, was approximately $315,800 divided by 2.39%, or approximately $13,213,389. This value was a constant at all times.

Part III: “[B]efore and after the IRS audit, the foundations were entitled to receive the same number of units.”

Before and after the IRS audit the donees were entitled to receive the same Norseman percentage interests. Each of petitioners’ children was entitled to receive approximately a 1.98% Norseman membership interest.

1.98% = ___________

Similarly, each of petitioners’ grandchildren was entitled to receive approximately a .083% Norseman membership interest.

.083% = ___________

Part IV: “Absent the audit, the foundations may never have received all the units they were entitled to, but that does not mean that part of the Taxpayer’s transfer was dependent upon an IRS audit. Rather, the audit merely ensured the foundations would receive those units they were always entitled to receive.”

Absent the audit, the donees might never have received the proper Norseman percentage interests they were entitled to, but that does not mean that parts of petitioners’ transfers were dependent upon an IRS audit. Rather, the audit merely ensured that petitioners’ children and grandchildren would receive the 1.98% and .083% Norseman percentage interests they were always entitled to receive, respectively.

It is inconsequential that the adjustment clause reallocates membership units among petitioners and the donees rather than a charitable organization because the reallocations do not alter the transfers. On January 1, 2004, each donee was entitled to a predefined Norseman percentage interest expressed through a formula. The gift documents do not allow for petitioners to “take property back”. Rather, the gift documents correct the allocation of Norseman membership units among petitioners and the donees because the K&W report understated Norseman’s value. The clauses at issue are valid formula clauses.

The IRS non-acquiesced in Wandry but did not appeal, 2012-46 I.R.B. 543.

A key issue is ensuring that the gift tax return reflects the formula, rather than merely stating the result of the formula.

Turney P. Berry
Louisville, Kentucky


Tennessee Trust Lawyers Have More Tools Than Ever Before

Tennessee is without a doubt one of the leading Trust Law jurisdictions, and Tennessee estate planners have more tools than ever before.

In 2000, Tennessee adopted the Uniform Principal and Income Act which provides certainty and safe harbor to Trustees with respect to trust accounting principles. In 2002, the Uniform Prudent Investor Act did the same with respect to the management of trust investments.

In 2004, Tennessee adopted the Uniform Trust Code (one of the first five jurisdictions to adopt it). Although the Trust Code did not diverge significantly from the common law, it made Tennessee Trust Law more accessible and cohesive. Among other things, the Trust Code gave Tennessee attorneys innovative methods such as virtual representation, Non-Judicial Settlement Agreements, and judicial and non-judicial trust modifications and terminations to deal with some of Trust Law’s most vexing issues.

The year 2007 brought a 360 year rule against perpetuities (which coincidentally I may be able to thank for my job!), self-settled asset protection trusts (innocuously named the Tennessee Investment Services Act), and updates to the now non-uniform Tennessee Uniform Trust Code which allowed beneficiaries to serve as their own trustee without jeopardizing the spendthrift protections granted to them by the trust.

The year 2010 brought further Trust Code updates, but most importantly brought the Tennessee Community Property Trust Act which allows a married couple to establish a joint revocable trust that has some unique and advantageous income tax consequences. Even apart from the income tax advantages of the Community Property Trust, the trust has a more subtle benefit: a joint plan. Rather than the traditional tax plan of splitting assets between spouses, this joint trust allows couples to put all of their assets into a single joint trust. Practitioners can tell you that clients have always been uncomfortable splitting up their assets for tax purposes. However, clients have just loved being able to put their assets into a single joint trust. Read more about Community Property Trusts here.

In 2012, Tennessee retroactively repealed the Tennessee Gift Tax and gradually repealed the Tennessee Inheritance Tax through 2016. Read more here.

Finally, 2013 brought comprehensive reform to the (now ironically named) Tennessee Uniform Trust Code. As is discussed in a previous post, 2013’s reform essentially did three things: (1) enhance asset protection for beneficiaries, (2) protected Trustees by giving them far more discretion, and (3) allowed for directed trusts to allow trusts to segregate the roles of investment and trust administration. Another change enhanced the attractiveness of Tennessee Asset Protection Trusts. Read more here.

The Reveal. So. . . What’s next? Come July 1, 2014 Tennessee Attorneys will have yet another arrow in their estate planning quiver: The Tenancy by the Entirety Joint Revocable Trust was signed into law on . Click here for a summary of Public Chapter 829.

A Tenancy by the Entirety Joint Revocable Trust (“TE Trust”) will be immensely useful. Sure, some clients will be more appropriate for a Community Property Trust to get a double basis step-up, but many could use the asset protection advantages of a TE Trust. Generally, whether property is held as tenancy by the entirety is a question of intent and is most often seen with the family home. Now practitioners can take the opportunity to protect their clients (and the surviving spouses most of all) by removing any doubt.

Just like other property held as tenants by the entirety, assets held in the TE Trust will pass free from the creditors of first spouse to die. Joint creditors and creditors of the survivor will still be able to levy against assets held in the trust. Perhaps use of a disclaimer trust in the TE Trust could avoid creditors of the survivor, but that may be pushing it.

Eight other states have specifically authorized such joint trusts. Click here to read more.

This is no do-it-yourself project either. Care must be taken to ensure that upon funding, the intricacies of the notice requirements in the statute have been followed in order to obtain the allowed protection.

Practitioners, update your forms and get ready.

Advisers, keep this in mind for your clients that have any possibility of asset protection issues (i.e., Dr. Klutz).

Stay Tuned.

Rob Malin


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Termination of QTIP Trust in Prearranged Transaction

In Estate of Virginia V. Kite v. Commissioner, T.C. Memo 2013-43, the decedent’s children, as trustees of the QTIP trust for their mother, terminated the QTIP and distributed the assets (a partnership known as “KIC”) to her revocable trust. Two days later, those assets were sold to her children (and their trusts) for private annuities.

The termination of the QTIP trusts and the transfer of the trust assets to the children were treated as a single transaction for §2519 purposes. Pursuant to Treas. Reg. §25.25190-1(f), the decedent disposed of her qualifying income interests, which were traceable from KIC to the QTIP. Thus, the sale of KIC was subject to gift tax to the extent of the fair market value of the entire property subject to the decedent’s qualifying income interest, as of the date of the annuity transaction, less the value of the decedent’s qualifying income interest.

In an unpublished opinion on October 25, 2013 (No. 6772-08), the Tax Court held that the value of the private annuity was acquired for full and adequate consideration, but that there was gift tax owed on account of the termination of the QTIP itself. Combined, the two opinions are confusing and produce little reliable guidance going forward.

Turney P. Berry
Louisville, Kentucky

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Right to an Accounting

Wilson v. Wilson, 690 S.E.2d 710 (N.C. Ct. App. 2010)Irrevocable trust beneficiaries brought suit against the trustee for breach of fiduciary duty.  The beneficiaries requested that the trustee provide an accounting of the trusts, alleging that the trustee had allowed the settlor to take control of the trusts and invest the assets in his personal speculative business ventures.  Beneficiaries also alleged that the trustee breached his fiduciary duty by failing to distribute income to the beneficiaries.

The trustee, in response to the request for an accounting, claimed that pursuant to the provisions of a trust, information in the nature of inventories, appraisals, reports or accounts was not required to be provided to any court or any beneficiary.  The trustee then filed a motion for a protective order.  The trial court granted the trustee’s motion, citing §361C-1-105 of the North Carolina UTC (no aspect of a trustee’s duty to inform beneficiaries is mandatory).  Plaintiff appealed, claiming the trial court misinterpreted the North Carolina UTC.

The court of appeals overruled the trial court, concluding that the information sought by the trustees was reasonably necessary to enforce their rights under the trust, and therefore could not be withheld.  The court reasoned that although the North Carolina UTC does not include portions of the UTC that require the trustee to keep beneficiaries reasonably informed about the trust administration, the North Carolina UTC does provide that the trustee has the duty to act in good faith.  Under the Restatement (Second) of Trusts Section 173, “the beneficiary is entitled to such information as is reasonably necessary to enable him to enforce his rights under the trust or to prevent or redress a breach of the trust.”  The court noted that “[a]ny other conclusion renders the trust unenforceable by those it was meant to benefit.”  The court determined that the information sought by the beneficiaries was reasonably necessary to enable them to enforce their rights under the trust.  Finally, the court explained that even if the settlor provides in the trust that an accounting is not required to be provided to any court or beneficiary, the trustee will be required in a suit for an accounting to show that he faithfully performed this duty.

The trust at issue in Zimmerman v. Zirpolo Trust, 2012 WL 346657 (Ohio App. 5 Dist.), contained this provision:

“[T]he Trustee shall use their best efforts to provide no information about the trust proceeds to the beneficiaries. It is my intention that the beneficiaries have no information about the proceeds until they are entitled to receive the proceeds.”

However, the relevant Ohio statute requires provision of information:

R.C. 5808.13 provides: “(A) A trustee shall keep the current beneficiaries of the trust reasonably informed about the administration of the trust and of the material facts necessary for them to protect their interests. Unless unreasonable under the circumstances, a trustee shall promptly respond to a beneficiary’s request for information related to the administration of the trust.

The Court held that the statute controlled notwithstanding the trust provision.

In Bright v. Bashekimoglu, Record No. CL10-7348 (Va. 2012), the Virginia Supreme Court enforced trust terms that override the trustee’s duty to disclose under the UTC.  In 2008, Melih Bashekimoglu created a revocable trust with himself and his wife as co-trustees.  The trust terms provide as follows with respect to disclosure of trust information to the beneficiaries:

During any period that I am alive but incapacitated, and after my death, my Trustee will deliver any notice, information, or reports which would be otherwise be required to be delivered to me or a Qualified Beneficiary to a person designated by my Trustee.  To preserve my privacy and the privacy of Qualified Beneficiaries under my trust agreement, while I am alive I request that my Trustee not provide any copies of my trust agreement or any other information which may otherwise be required to be distributed to any beneficiary under Virginia law to any beneficiary to whom the information is not directly relevant.  The designated person may, in his or her sole discretion, and without waiver, distribute copies of all or any part of my trust agreement or other relevant information about my trust to one or more Qualified Beneficiaries or other interested parties during any period that I am incapacitated.

Melih died in 2009.  Under the trust terms, his wife and two of his children were named as trust beneficiaries.  A third child, Suzan Bright, was a contingent beneficiary and only entitled to distributions in the event her mother and two siblings predecease her.  Before and after Melih’s death, Suzan repeatedly requested information about the trust from her mother but was denied.

In 2010, Suzan sued her mother as sole trustee for information about the trust.  The trial court denied claim and she appealed.  On appeal, the Virginia Supreme Court affirmed the trial court and denied Suzan information about the trust on the grounds that:  (1) Suzan’s counsel conceded that she is a nonqualified beneficiary; (2) the trust terms modified the requirements of the Virginia Uniform Trust Code; (3) the trust terms modified the UTC rule that a nonqualified beneficiary may request information, and gave the trustee the discretion to decide whether to distribute the information, and therefore Suzan is not entitled to the information.

In Miness v. Deegan, 2013 NY Misc. LEXIS 1983 (2013), the trustee of a New York insurance trust was required to account to beneficiaries, regardless of trust terms providing for accounting only to settlor during settlor’s lifetime.

Michael Miness created an irrevocable insurance trust in 1988 for the benefit of his spouse and descendants, with two non-beneficiary co-trustees.  One of the trustees resigned in 2009.  The settlor’s children petitioned to compel the resigning co-trustee to account for his actions as trustee.  The resigning trustee refused to account based on trust terms that provided that during the life of the settlor the trustee would account only to the settlor.

Because of their pecuniary interest in the trust, and the fact that the statute of limitations on their claims against the resigning co-trustee could expire while the settlor was still alive, the court ordered the resigning co-trustee to account notwithstanding the trust terms.

In re Rolf H. Brennemann Testamentary Trust, 21 Neb.App. 353 (Ct App NE Oct. 1, 2013), In the 1976 a testamentary trust is created by husband’s will and holds interest in company with the sole asset as a 5,000 plus acre farm.  Terms of the trust provide income for life of surviving spouse then income to surviving children in equal shares and upon death of last surviving child the principal is to be divided and distributed to the then surviving grandchildren.  Co-Trustees were the three children but at the death of a child such child’s oldest son could serve as Trustee.  Over the years the farm become heavily encumbered by debt and no longer produces the income necessary for spouse.  Trustees sought and received court approval to vote the company stock to sell the farm to one of the children for a 10 year installment sale which was later extended for another ten years.  In 2010, one of the grandchildren filed a petition in the court for breach of duty for trustees failure to inform and report and sought to compel an accounting from the trustees.

Because the trust existence spanned several decades and during such time there had be a change in trustees as well as change in trust law the decision as to whether the trustees breached their duty to inform is broken down into three time frames, 1976 to 2002 (time during which original three trustees served), 2002 to 2004 (new trustees but old trust law applied), and 2005 to 2009 (new trustees and new trust law).

The lower court determined that at no point in time had plaintiff beneficiary met her burden of proof to show that the trustees had breach their duty to inform and therefore dismissed her claims.

The court of appeals reversed the lower court’s decision in that plaintiff did present evidence for the first and third time frames showing that trustees breached their duty to inform but that they adequately informed her during the second time frame.

Trustees did not send any information and could not produce any documentation prior to 2002, “[h]owever, the trust did not suffer any loss due to that breach and, thus, was harmless.  Under the prior trust law of Nebraska, the accountings sent to the beneficiary in the form of a schedule K-1 were adequate to inform the beneficiary because she did not request further information, therefore the trustees did not breach their duty during the second time period.  However, after 2004, Nebraska adopted the Uniform Trust Code and the court held that the schedules K-1 sent to the beneficiary were not adequate under the new standards, however, their breach was cured upon the filing of an adequate accounting.

Turney P. Berry

Louisville, Kentucky

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No QTIP Election Unless Necessary to Reduce Estate Tax

If Fred dies in 2011 with a $4,000,000 estate and is survived by his second wife, Mabel, Fred’s estate plan may provide for a QTIP-eligible trust for Mabel’s benefit, remainder to Fred’s children. Although the QTIP election is not necessary in order to zero out Fred’s estate taxes, making a QTIP election could be desirable because of potential increase in basis at Mabel’s subsequent death if the trust assets were included in her estate.

Rev. Proc. 2001-38 precludes the QTIP election unless doing so reduces the estate tax. Thus a change in basis may be achieved only by giving the surviving spouse some modicum of control over the assets to be included in the spouse’s estate (e.g. a testamentary power of appointment in favor of the creditors of her estate). See e.g. PLRs 200407016, 200603004, and 201112001. The original policy was to help taxpayers avoid inclusion in the survivor’s estate of “unnecessary” assets. Such a policy might support allowing a QTIP election to achieve a basis change at the second spouse’s death but there is scant authority to support the argument.

In PLR 201338003 the surviving spouse or executor properly allocated all assets to the credit shelter trust but listed those assets on Schedule M of the 706 and was deemed to have made a QTIP election. The PLR applied Rev. Proc. 2001-38 to void the QTIP election.

Turney P. Berry
Louisville, Kentucky