LAURENCE KEISER, J.D., LL.M. (TAX), CPA
Stern Keiser & Panken, LLP
1025 Westchester Avenue
White Plains, New York 10604
(914) 428-8800
Although New York Surrogate’s court decisions rarely deal with Federal estate tax issues, practitioners should be aware of the recent decision by Judge Nora Anderson in Matter of Carcanagues 2014-3399 NYLJ120276601551. The case involves a petition to reform a trust, but more importantly points out the need to review all estate planning documents and their tax consequences after marriage.
The case dealt with a same-sex marriage in New York after enactment of the Marriage Equality Act dated June 24, 2011 (“the Act”), but is equally applicable to all.
The facts are fairly common. In June of 1977, Jacques Carcanaques (hereafter “Jacques”) established a revocable living trust. He was the sole beneficiary and sole trustee during his lifetime. At his death, the sole primary beneficiary became his then partner in a civil union, Sergio Francescon (hereafter “Sergio”) who then became a co-trustee, along with Jacques’ lawyer. Sergio was entitled to the Trust’s “net income” and was a discretionary principal beneficiary for his health, support and maintenance.
At that time, prior to the Act, this was a common way for unmarried people to pass property. Though there would not be a marital deduction and tax might be due at the first death, the trust would not be included in the second estate because that decedent was not the transferor. Conversely, leaving property outright to an unmarried partner could produce a tax disaster, i.e. tax in both estates, perhaps with no credit for prior estate tax paid.
Early in 2013, Jacques was diagnosed with a terminal illness. On October 3, 2013, Jacques and Sergio married. Jacques died on January 13, 2014.
In August of 2013, the U.S. Treasury Department and IRS announced that some-sex couples who were legally married would be considered married for all Federal tax purposes including gift and estate taxes.
When Jacques and Sergio married, they became entitled to the Qualified Terminable Interest Property (“QTIP”) provisions of Internal Revenue Code Section 2056(b)(7) and the tax consequences expressed above would have been reversed. Jacques’ estate could have gotten a marital deduction (leaving more net assets for Sergio’s support) and the principal of the trust would then be taxable in Sergio’s estate.
We are not told of the extent of Jacques’ assets, only that the trust contained a commercial condominium and cooperative apartment in Manhattan.
To get a marital deduction under IRC§ 2056(b)(7) among other requirements, the surviving spouse must have the absolute right to all trust income. After Jacques death, the trust was reviewed.
Questions were raised about whether the trust would qualify for the marital deduction. The Trustees identified three trust provisions as ambiguous. There was a provision allowing the trustee to withhold distributions in case of a disability. This included physical disability, but also divorce, bankruptcy, or a large unsatisfied and enforceable judgment. So there was a possibility that Sergio would not get all the income.
In addition, at Jacques death, the trustees could pay the principal of the trust “and accumulated income” to the remaindermen (who were the grantor’s sisters). It might be argued that this inferred that Sergio would not get all the income from the Trust.
Also, the trustees were allowed to retain and acquire non-income producing properties. To get a marital deduction, generally, the spouse must have the right to demand that the trustees make the property productive.
So the Trustees requested reformation of the above provisions to provide for Sergio in the manner the grantor intended and to take advantage of the marital deduction.
The Court held that it had the power to reform the instrument to effectuate the decedent’s intent. However the power to reform should be applied sparingly and could be used only if literal application of the instrument’s provisions would frustrate testator’s actual intent as reflected in the entire document.
There was no intent expressed in the trust document to obtain the marital deduction. “Indeed, grantor could not have intended that the trust qualify for the marital deduction since, at the time of the Trust’s creation in 1997, same-sex marriages were prohibited in every state.”
Further, because the parties were not married at the time of the trust’s creation, the general rule that testamentary provisions be construed in a spouse’s favor had no application.
Citing Matter of Tamargo 220-NY 225 (1917), the Court concluded that “when the purpose of the testator is reasonably clear by reading his words in their natural and common sense, the Courts might not have the right to annul or pervert that purpose upon the grounds that a consequence of it might not have been thought of or intended by him”.
For practitioners, the very important take-away from the case is not to assume that a change in the law, even a beneficial change in the law, does not require a change in existing documents. Practitioners must advise clients that any change in personal circumstances should cause a review of wills, trusts, and other estate planningdocuments.
Of course, since the trust does not qualify for QTIP treatment and the election can not be made, there will not be double taxation. The remaining principal of the trust will not be included in Sergio’s estate at his death. But the acceleration of the tax to the first death is obviously a situation that Sergio wished to avoid.