Wills and Trusts

Wyatt, Tarrant & Combs, LLP

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Estate of Kite: Sale of Business to Children for a Deferred Private Annuity

In Estate of Virginia V. Kite et al. v. Commissioner, T.C. Memo. 2013-43, the court confronted the sale of a partnership (“KIC”) in 2001 by Mrs. Kite to her children, in exchange for a private annuity that would begin in 10 years. Mrs. Kite was then 74 and had a greater than 50% chance of living for more than 18 months and in fact she had a 12.5 year life expectancy. However, Mrs. Kite died in 2004. The Court upheld the transaction as being bona fide for full and adequate consideration, stating as follows:

Before participating in the annuity transaction, Baldwin [another limited partnership], which was wholly owned by the Kite children or their trusts, contributed approximately $13.6 million of assets to KIC. As a result, the Kite children did not need to rely on the assets already held by KIC to make the annuity payments. In addition, the Kite children did not transfer the assets underlying the KIC interests back to Mrs. Kite after the annuity transaction was completed. In fact, they did not make any distributions from KIC, but allowed the KIC assets to accumulate in order to have income available when the annuity payments became due. The Kite children therefore expected to make payments under the annuity agreements and were prepared to do so.

Mrs. Kite also demonstrated an expectation that she would receive payments. Mrs. Kite actively participated in her finances and over the course of her life demonstrated an immense business acumen. Accordingly, it is unlikely that Mrs. Kite would have entered into the annuity agreements unless they were enforceable and, more importantly, she could profit from them. In addition, Mrs. Kite, unlike the surviving spouse in Estate of Hurford, was not diagnosed with cancer or other terminal or incurable illness. In fact, the record, which includes a letter from Mrs. Kite’s physician, establishes to the contrary — that Mrs. Kite was not terminally ill and she did not have an incurable illness or other deteriorating physical condition. Mrs. Kite and her children reasonably expected that she would live through the life expectancy determined by IRS actuarial tables, which was 12.5 years after the annuity transaction. Indeed, if Mrs. Kite lived to her life expectancy as determined by IRS actuarial tables, she would have received approximately $800,000 more in annuity payments than the value of her KIC interests. At a minimum, Mrs. Kite would have made a profit with the potential of a greater return if she lived longer. Continue reading


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Power to Amend is Not Power to Revoke

Power to Amend is Not Power to Revoke

In Nederlander v. Papiano, 2012 WL 733888 (Cal.App. 2 Dist. 2012), the settlor of a revocable trust retained a power to amend the trust unilaterally but could only revoke the trust with the consent of non-adverse trustees.  As he needed or wanted money over the years he amended the trust to take money out.  The court concluded that amendments were really revocations and held the trustee liable.  The opinion states:

But we find it unnecessary to determine whether Scott needed to obtain the trustees’ consent for amendments generally or whether the drafting error would have necessitated a modification of the express terms of the trusts. Rather, we only decide whether Scott could use the amendment provision to effectuate a revocation without the trustees’ consent. We conclude that the eight purported amendments functioned as partial revocations because the only purpose they served was to allow Scott to withdraw funds, and their only effect was on the corpus of each trust. (See Rest.3d Trusts, § 63, com. e, p. 446 [power to revoke in part allows settlor to withdraw some rather than all property from trust].) These amendments did not modify any of the terms of the trust documents and did not delete the consent requirement for full or partial revocation. Since the trust instruments expressly require that the trustees consent to revocation, it follows that amendments used solely to revoke the trusts required the trustees’ consent. Any other interpretation would render the limitation placed on the settlor’s power to revoke meaningless and would defeat the settlor’s expressed intent.

We disagree with appellant that the drafter’s chosen nomenclature determines the effect of the amendments. The trust instruments do not state that a writing is effective as an amendment or a revocation only if it is appropriately titled. Nor do we agree that exempting each withdrawal from all trust provisions to the contrary can properly be characterized as amending the trusts. The settlor has a right to borrow funds with interest or security, and he also has the right to withdraw funds by partially revoking the trusts, but only with the trustees’ consent. (Art. 4, ¶ CC; Art. 6, ¶ A) Each trust amendment purported to suspend all trust provisions, so that Scott could withdraw funds. Each then provided that, except for that withdrawal, all terms and provisions “shall remain intact and in full force and effect.” The amendments did not change the beneficiaries’ rights or the trustees’ duties. (Cf. Heifetz v. Bank of America (1957) 147 Cal.App.2d 776, 783 ( Heifetz) [settlor amended trust to eliminate all beneficiaries except her daughter and with daughter’s consent revoked trust].) Thus, by their own terms, they did not change the trusts in any way, aside from reducing the corpus.

In the petition for rehearing, appellant argues that Heifetz, supra, 147 Cal.App.2d 776 mandates a contrary result. We do not agree. The trust instrument in that case allowed the settlor to revoke the trust but did not expressly reserve a right to amend. ( Id. at p. 778.) A later amendment made irrevocable a trust corpus of up to $150,000. ( Id. at p. 779.) The appellate court implied the settlor’s power to amend from her reserved power to revoke the trust. ( Id. at p. 782.) The court held the amendment that made the trust irrevocable up to $150,000 left the settlor free to revoke the trust in other respects, such as by subsequently eliminating all beneficiaries except her daughter. ( Id. at p. 785.) She was then free to revoke the trust with the consent of the sole remaining beneficiary. ( Ibid.)

It is important to point out not only what Heifetz involved, but also what it did not. The case did not involve a conditionally revocable trust that required the trustee’s consent to revocation as a protection against the settlor’s subsequent improvident change of mind. The Heifetz court’s reasoning about the settlor’s freedom to change her mind applied to a trust revocable in all respects other than the corpus amount. ( Heifetz, supra, 147 Cal.App.2d at p. 785.) The implied power to amend was coextensive with that partial power to revoke. ( Ibid.) In contrast, Scott did not have an unfettered right to change his mind if the change would result in a full or partial revocation.

Additionally, appellant assumes that, like the settlor in Heifetz, Scott first amended the trusts to deprive the beneficiaries of their rights and then drew down the trust corpus. But as we have explained, the amendments, as drafted, did not change the beneficiaries’ rights or the trustees’ duties. Rather, they allowed Scott to withdraw funds, notwithstanding the beneficiaries’ unaltered rights, the trustees’ unaltered duties to the beneficiaries, and the requirement that the trustees consent to any full or partial revocation. They affected the corpus of the trusts and nothing else. It is important to recall that the provision requiring the trustees’ consent for any revocation was included for the express purpose of protecting the beneficiaries from the kind of action Scott took against their interests.

In the two other cases appellant cites, the courts declined to imply a general power to amend or revoke expressly irrevocable trusts from either the settlor’s right to withdraw trust assets or from the settlor’s subsequent conduct. (See Crook v. Contreras (2002) 95 Cal.App.4th 1194, 1209; Laycock v. Hammer (2006) 141 Cal.App.4th 25, 30–31.) Like Heifetz, these cases do not involve conditionally revocable trusts, and their reasoning does not support appellant’s position. Because they partially revoked the trust’s corpus, the purported amendments required the trustees’ consent.

Turney P. Berry

Louisville, Kentucky

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Effects of limitations on Crummey Withdrawal Rights: in terrorem clauses and Mandatory Arbitration provisions

What is the effect of a mandatory arbitration and in terrorem clause on Crummey rights? In CCA 20120826 an issue was whether purported withdrawal rights were sufficient to create a present interest. The CCA states:

To be a present interest, a withdrawal right must be legally enforceable. For example, if a trust provides for withdrawal rights, and the trustee refuses to comply with a beneficiary’s withdrawal demand, the beneficiary must be able to go before a state court to enforce it. See Cristofani v. Commissioner, 97 T.C. 74 (1991); Restatement of the Law of Trusts § 197 (Nature of Remedies of Beneficiary); Bogert, Trusts and Trustees Vol. 41, § 861 (Remedies of the Beneficiary and Trustee).

As a matter of public policy, the federal courts are the proper venue for determining an individual’s federal tax status, and the federal courts are not bound by the determinations of a private forum (such as Other Forum) concerning such status. Alford v. United States, 116 F.3d 334 (8th Cir. 1997). Likewise, as a matter of public policy, a State court will not take judicial notice of a private forum’s (or group’s or sect’s) construction and determination of State law pertaining to a trust agreement, such as the Trust in this case. Cite 2. These determinations are strictly within the purview of the State courts. Cite 3; Cite 4.

Under State law, a trust clause may prohibit a beneficiary from seeking civil redress. Cite 5. Although the State legislature made a public policy decision to allow a beneficiary to make certain inquiries without fear of risking forfeiture, these “safe harbors” are not relevant here. Cite 6.

Under the terms of the Trust in this case, a beneficiary cannot enforce his withdrawal right in a State court. He may only press his demand before an Other Forum and be subject to the Other Forum’s Rules. Notwithstanding any provisions in the Trust to the contrary, the Other Forum will not recognize State or federal law. If the beneficiary proceeds to a State court, his existing right to income and/or principal for his health, education, maintenance and support will immediately terminate. He will not receive any income or principal for his marriage, to buy a home or business, to enter a trade, or for any other purpose. He will not have withdrawal rights in the future, and his contingent inheritance rights will be extinguished. Thus, a beneficiary faces dire consequences if he seeks legal redress. As a practical matter, a beneficiary is foreclosed from enforcing his withdrawal right in a State court of law or equity.

Withdrawal rights such as these are not the legally enforceable rights necessary to constitute a present interest. Because the threat of severe economic punishment looms over any beneficiary contemplating a civil enforcement suit, the withdrawal rights are illusory. Consequently, no annual exclusion under § 2503(b) is allowable for any of the withdrawal rights. See Rev. Rul. 85-24, 1985-1 C.B. 329; Rev. Rul. 81-7, 1981-1 C.B. 474.

Is the ruling correct? In Rev. Rul. 83-108 notice was not given in the year of the gift at all, but rather was given in the next year. No notice is arguably a greater obstacle to the exercise of withdrawal rights than mandatory arbitration or an in terrorem clause. On the other hand, may a cut off of rights be so substantial as to de facto limit a purported withdrawal right?

Turney P. Berry
Louisville, Kentucky

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LP and LLC Interests As Present Interests

The issue of whether the gift of a limited partnership or limited liability company qualifies for the annual exclusion arose in Hackl v. Commissioner, 118 T.C. 279 (2002), affd. 335 F.3d 664 (7th Cir. 2003) with the lower court and Seventh Circuit deciding such interests were future interests because the interests received by the donees were restricted and the asset in the entity was a tree farm. In Price v. Commissioner, T.C. Memo, 2010-2, the Tax Court followed Hackl and, arguably, expanded its reach. The opinion focuses on the inability of the partners to compel distributions or to transfer the units.

It is undisputed that under the partnership agreement the donees have no unilateral right to withdraw their capital accounts. Furthermore, section 11.1 of the partnership agreement expressly prohibits partners from selling, assigning, or transferring their partnership interests to third parties or from otherwise encumbering or disposing of their partnership interests without the written consent of all partners. As stated with respect to analogous circumstances in Hackl v. Commissioner, 118 T.C. at 297, transfers subject to the contingency of approval (by the LLC manager in Hackl and by all partners in the instant cases) “cannot support a present interest characterization, and the possibility of making sales in violation thereof, to a transferee who would then have no right to become a member or to participate in the business, can hardly be seen as a sufficient source of substantial economic benefit.”

Moreover, because of the operation of section 11.2 of the partnership agreement, it appears that the donees are not even properly characterized as limited partners in the partnership.


But even if it were to be assumed, contrary to the foregoing analysis, that the donees did somehow become substituted limited partners, it would not affect our conclusion that contingencies stand between the donees and their receipt of economic value for the transferred partnership interests so as to negate finding that the donees have the immediate use, possession, or enjoyment of the transferred property. Pursuant to section 11.1 of the partnership agreement, unless all partners consented the donees could transfer their partnership interests only to another partner or to a partner’s trust. In addition, any such purchase would be subject to the option-to-purchase provisions of section 11.4 of the partnership agreement, which gives the partnership itself or any of the other partners a right to purchase the property according to a complicated valuation process but without providing any time limit for exercising the purchase option with respect to a voluntary transfer.


Because the partnership owned real properties generating rents under long-term leases, we believe that the partnership could be expected to generate income at or near the time of the gifts. The record fails to establish, however, that any ascertainable portion of the income would flow steadily to the donees. To the contrary, the record shows that the partnership’s income did not flow steadily to the donees–there were no distributions in 1997 or 2001.

Pursuant to the partnership agreement, profits of the partnership were distributed at the discretion of the general partner, except when otherwise directed by a majority in interest of all the partners, both limited and general. Furthermore, the partnership agreement stated that “annual or periodic distributions to the partners are secondary to the partnership’s primary purpose of achieving a reasonable, compounded rate of return, on a long-term basis, with respect to its investments.”

Petitioners allege that the partnership is expected to make distributions to cover the donees’ income tax liabilities arising from the partnership’s activities. Section 7.3 of the partnership agreement, however, clearly makes such distributions discretionary: “Neither the partnership nor the general partner shall have any obligation to distribute profits to enable the partners to pay taxes on the partnership’s profits.” Because the timing and amount of any distributions are matters of pure speculation, the donees acquired no present right to use, possess, or enjoy the income from the partnership interests.

Without citation of legal authority, petitioners contend that the general partner has a “strict fiduciary duty” to make income distributions to the donees. We are not persuaded that such a fiduciary duty, if it exists, establishes a present interest in a transferred limited partnership interest where the limited partner lacks withdrawal rights.10 Moreover, because (as previously discussed) the donees are not substituted limited partners, there is significant question as to whether under Nebraska law the general partner owes them any duty other than loyalty and due care.11 Cf. Kellis v. Ring, 155 Cal. Rptr. 297 (Ct. App. 1979) (holding that under California law the assignee of a limited partner’s partnership interest could not bring suit against the general partner for alleged breaches of fiduciary duty).

A common suggestion since Hackl has been that donees be given a put right to the donor. Although not squarely addressed by Judge Thornton the language of the opinion suggests that could be ineffective:

Petitioners allude to the possibility of the donees’ selling their partnership interests to the general partner. It must be remembered, however, that the general partner is owned by petitioners and that its president is Mr. Price, who engineered the gifts of partnership interests to his children in the first instance. If the possibility of a donor’s agreeing to buy back a gift sufficed to establish a present interest in the donee, little would remain of the present interest requirement and its statutory purpose would be subverted if not entirely defeated.

The same issue arose in district court in John W. Fisher et ux. v. United States, 105 A.F.T.R.2d 2010-1347 (S.D. Ind. March 11, 2010). There an LLC owned undeveloped land on Lake Michigan. The short opinion rejects the taxpayers’ claims of an annual exclusion:

The Fishers make three arguments in support of their assertion that the transfers of interests in Good Harbor to the Fisher Children were gifts of “present interests in property.” Treas. Reg. § 25.2503-3(b). The Court considers each in turn. First, the Fishers argue that upon transfer, the Fisher Children possessed the unrestricted right to receive distributions of Good Harbor’s Capital Proceeds. However, under the Operating Agreement, any potential distribution of Good Harbor’s Capital Proceeds to the Fisher Children was subject to a number of contingencies, all within the exclusive discretion of the General Manager. Operating Agreement §§ 4.2.3-.3.4. Accordingly, the right of the Fisher Children to receive distributions of Good Harbor’s Capital Proceeds, when such distributions occur, is not a right to a “substantial present economic benefit.” Hackl, 335 F.3d at 667; see Commissioner v. Disston, 325 U.S. 442, 449 (1945) (holding that when a trust provides for the distribution of the corpus or trust income only after some uncertain, future event, the trustee possesses a future interest.)

Second, the Fishers argue that upon transfer, the Fisher Children possessed the unrestricted right to possess, use, and enjoy Good Harbor’s primary asset, the Lake Michigan beach front property. See Pls.’ Br., Dkt. No. 33, at 9 (citing the affidavit of one of the Fisher Children, James A. Fisher). However, there is no indication from Good Harbor’s Operating Agreement that this right was transferred to the Fisher Children when they became “Member[s]”8 and “Interest Holder[s].”9 Regardless, the right to possess, use, and enjoy property, without more, is not a right to a “substantial present economic benefit.” Hackl, 335 F.3d at 667. It is a right to a non-pecuniary benefit.

Lastly, the Fishers assert that upon transfer, the Fisher Children possessed the unrestricted right to unilaterally transfer their interests in Good Harbor. The Fishers argue that this right is a present interest in property. Cf. Hackl, 335 F.3d at 667-68 (holding that the Hackls’ gifts were not gifts of present interests, because “Treeco’s restrictions on the transferability of the shares meant that they were essentially without immediate value to the donees.”).

Under Section 6.1, the Fisher Children may unilaterally transfer their right to receive distributions from Good Harbor, but only if certain conditions of transfer are satisfied. Operating Agreement § 6.1.1-6.1.5. Among these conditions is Good Harbor’s right of first refusal, which effectively prevents the Fisher Children from transferring their interests in exchange for immediate value, unless the transfer is to one of the Fisher’s descendants (a “family member”). Id. § 6.1.4-6.1.5. Even an attempted transfer to a family member is not without restrictions. Id. §§ 6.1-, 6.1.5. Therefore, due to the conditions restricting the Fisher Children’s right to transfer their interests in Good Harbor, it is impossible for the Fisher Children to presently realize a substantial economic benefit. Cf. Wooley v. U.S., 736 F.Supp. 1506, 1509 (S.D. Ind. 1990) (Dillin, J.) (holding that Wooley’s gifts to his partners’ capital accounts were gifts of present interests, because “each partner had the unrestricted and immediate right to withdraw [the] gifts. . . .”).

The Tax Court reached the contrary conclusion in Estate of George H. Wimmer et al. v. Commissioner, T.C. Memo. 2012-157 (2012). There the partnerships were initially created in California but moved, in 1997, to Georgia, and owned marketable securities. The transfers at issue were made in 1996-2000. The court noted that the partnership would receive income and thus the partners would owe income tax. Under California and Georgia law, unmodified by the partnership agreement, the general partner had a fiduciary duty to distribute tax liability amounts to the partners. The opinion states:

In describing the general partners’ powers, the partnership agreement, as initially written and as restated, provided that the general partners “possess full and exclusive power to manage, control, administer and operate Partnership business and affairs * * * subject, in all events, to fiduciary duties to Limited Partners and the continuing duty to advance the Partnership’s purposes and best interests”. Under California law, partners have fiduciary duties toward each other and because of such duties may not take advantage of, or otherwise put adverse pressure on, other partners when conducting partnership business. See, e.g., Leff v. Gunter, 658 P.2d 740, 744 (Cal. 1983); BT-I v. Equitable Life Assurance Soc’y, 89 Cal. Rptr. 2d 811, 815-816 (Ct. App. 1999) (citing Cal. Corp. Code sec. 15643 (West 1991) (repealed 2006)). In Georgia, general partners owe fiduciary duties to limited partners, including the duty to act in the utmost good faith and with the finest loyalty, which the limited partners are entitled to enforce. See, e.g., Hendry v. Wells, 650 S.E.2d 338, 346 & n.9 (Ga. Ct. App. 2007).

According to the Grandchildren Trust documents, the trust’s only asset was a limited partnership interest, which, given the transfer restrictions described above, could not be liquidated or otherwise exchanged for cash. Notably, the partnership’s sole asset was dividend-paying stock.9 As a limited partner, and on behalf of the Grandchildren Trust, the trustee was allocated its proportionate share of the dividends paid each year. Because the Grandchildren Trust had no other source of income, distributions of partnership income to the trustee were necessary to satisfy the Grandchildren Trust’s annual Federal income tax liabilities. The Court holds that the necessity of a partnership distribution in these circumstances comes within the purview of the fiduciary duties imposed on the general partners. Therefore, the general partners were obligated to distribute a portion of partnership income each year to the trustee.

The partnership agreement provided that after allocating partnership net profits and losses, and every item of income, gain, loss, deduction, and credit proportionately among the partners in accordance with their respective percentage interests consistent with section 704, distributions of net cash flow shall be made to the partners in proportion to their respective percentage interests. Because distributions must be pro rata, any distribution to the trustee triggered proportionate distributions to the other partners. The estate has thus proven that, on the date of each gift, some portion of partnership income was expected to flow steadily to the limited partners. Indeed, the record shows that the partnership made distributions pro rata from dividends paid each year at issue.10

Finally, the Court holds that, with respect to the third prong, the portion of income flowing to the limited partners could be readily ascertained. The partnership held publicly traded, dividend-paying stock and was thus expected to earn dividend income each year at issue. Because the stock was publicly traded, the limited partners could estimate their allocation of quarterly dividends on the basis of the stock’s dividend history and their percentage ownership in the partnership.

Footnote 10 is as follows:

The Court notes that, unlike the taxpayers in Hackl and Price, decedent, in his fiduciary capacity as general partner of the partnership, made distributions each year at issue and was required to do so. See Hackl v. Commissioner, 118 T.C. 279, 298 (2002), aff’d, 335 F.3d 664 (7th Cir. 2003); Price v. Commissioner, T.C. Memo. 2010-2.

Wimmer suggests that limited partnership gifts have certain advantages over LLC unit gifts. The effect of a present interest requirement, if any, on charitable gifts ought be considered too.

Turney P. Berry
Louisville, Kentucky