Estates & Trusts Archives - The National Law Forum

Court Rejected A Trustee’s Objection To Personal Jurisdiction In His Individual Capacity But Affirmed The Objection In His Capacity As Trustee

In Hanschen v. Hanschen, a trustee challenged a default judgment. No. 05-19-01134-CV, 2020 Tex. App. LEXIS 4075 (Tex. App.—Dallas May 28, 2020, no pet. history). The family sued the trustee in his personal capacity and in his capacity as trustee for breaching fiduciary duties. While the trustee was in Texas, the family served him in his personal capacity. The family then obtained a default judgment against him in both capacities when he did not file an answer. Later, the trustee filed a special appearance challenging the court’s personal jurisdiction, and the trial granted the motion. The family then appealed.

The court of appeals reversed the special appearance against the trustee in his personal capacity. The court held that because the trustee was personally served in Texas, the trial court had personal jurisdiction over him:

In this case, the family personally served James with the petition and citation while he was in Texas. The family concedes they “have never asserted that Texas has general jurisdiction over James or that the traditional minimum contacts analysis would be met in the absence of his physical presence.” They are correct and the case law is clear that a trial court has authority to exercise in personam jurisdiction over a nonresident where the court’s jurisdiction grew out of the personal service of citation upon the nonresident within the state. A nonresident, merely by reason of his nonresidence, is not exempt from a court’s jurisdiction if he voluntarily comes to the state and thus is within the territorial limits of such jurisdiction and can be duly served with process.

Id. The trustee also argued that the court did not have adequate jurisdiction over him in his personal capacity because there were no claims against him in that capacity, but the court of appeals disagreed:

While we may agree with James that the default judgment granted relief against the entities for which it would be necessary for Texas courts to have jurisdiction over James in representative capacities, the family’s petition pleaded causes of action against James individually for breaches of fiduciary duties arising from his role as trustee of the Progeny Trust and his roles in NBR-C2, NBR-C3, and NBR-Needham. The family seeks exemplary damages against James for these alleged breaches of fiduciary duties. James does not make a specific argument why these claims are not pleaded against him personally. In Texas, generally an agent is personally liable for his own tortious conduct. For these reasons, we agree with the family that James was personally served with process in Texas, so the trial court has personal jurisdiction over him in that capacity.

Id.

The court of appeals then turned to whether the trial court had personal jurisdiction over the trustee in his capacity as trustee. The court noted that the citation was not issued to him in that capacity. The court held that this defect was dispositive and affirmed the special appearance for the trustee in his representative capacity:

We have held, “[t]he capacity in which a non-resident has contact with a forum state must be considered in the jurisdictional analysis.” James was not served with a citation directed to him in any representative capacity; only “JAMES HANSCHEN WHEREEVER HE MAY BE FOUND.” At oral argument, the family argued the listing of all the parties in the citation was sufficient to constitute service on James in each representative capacity he was listed as a defendant. We reject this contention and the family’s counsel acknowledged in oral argument a citation addressed to one defendant inadvertently served on a different, unrelated defendant would not constitute good service of process merely because all defendants’ names were in the list of defendants in the style of the lawsuit… In this case, James was not served with citations which were returned to the court clerk stating he had been served in his representative capacities. Any failure to comply with the rules regarding service of process renders the attempted service of process invalid, and the trial court acquires no personal jurisdiction over the defendant. A default judgment based on improper service is void. Accordingly, the trial court did not have personal jurisdiction over James in his representative capacities.

Id.

ARTICLE BY David Fowler Johnson at Winstead.

For more on trustees, see the National Law Review Estates & Trusts law section.

Court Holds That A Deceased Testamentary Trust Beneficiary Can Still Be A Beneficiary

In In the Estate of Mendoza, a decedent’s son’s children filed a petition claiming their entitlement to their father’s beneficial interest in a trust created under the decedent’s will. No. 04-19-00129-CV, 2020 Tex. App. LEXIS 1845 (Tex. App.—San Antonio March 4, 2020, no pet. history). The son had predeceased the decedent. The decedent’s daughters moved for summary judgment on the sole ground that a dead person could not be a beneficiary of a trust. The trial court granted the daughters’ summary judgment motion. The son’s children appealed.

The court of appeals reversed the summary judgment, holding that the mere fact that the decedent’s son predeceased the decedent did not establish the son’s beneficial interest in the trust created under the decedent’s will lapsed as a matter of law. The daughters argued that a dead person cannot be a beneficiary of a trust and cited to Longoria v. Lasater, 292 S.W.3d 156, 167 (Tex. App.—San Antonio 2009, pet. denied) and Section 112, comment f of the Restatement (Second) of Trusts. However, the court of appeals held that the daughters ignored the difference between an inter vivos trust, which was the type of trust analyzed in Longoria, and a testamentary trust. The court cited to Section 112, comment f, of the Restatement (Second) of Trusts:

A person who has died prior to the creation of a trust cannot be a beneficiary of the trust. Thus, if property is transferred inter vivos [i.e., not by will] in trust for a named person who is dead at the time of the transfer, no trust is created… So also, if a testator devises property in trust for a person who predeceases him, the devise of the beneficial interest lapses, and the person named as trustee ordinarily holds the property upon a resulting trust for the estate of the testator. By statute, however, in many States a devise does not lapse under certain circumstances, as for example if the devisee leaves a child; and under similar circumstances a devise of the beneficial interest under a trust does not lapse.

Id. (citing Restatement (Second) of Trusts § 112 cmt. f (1959) (internal citation omitted); see also Restatement (Third) of Trusts § 44 reporter’s notes on cmt. d (2003) (citing authorities discussing the application of the lapse doctrine and anti-lapse statutes to persons taking under trusts created by a will and noting “[a] comprehensive discussion of the lapse doctrine and anti-lapse statutes is beyond the scope of this Restatement”)). Accordingly, the court of appeals concluded: “the trial court erred in granting summary judgment in favor of the Daughters based on the mere fact that Eduardo predeceased Jose because that fact alone did not establish Eduardo’s beneficial interest lapsed as a matter of law.” Id. Further, the court refused to address an argument about Texas’s anti-lapse statutes because the arguments had not properly raised below. The court reversed the summary judgment and remanded for further proceedings.

ARTICLE BY David Fowler Johnson of Winstead.

For more on Estates and Trusts, see the National Law Review.

529 Plans: Estate Planning Magic

The most common way to reduce state and federal estate taxes is to make lifetime gifts to irrevocable trusts. However, in order for an irrevocable trust to escape estate taxation at the grantor’s death, the grantor may not retain the power to “designate the persons who shall possess or enjoy the property or the income therefrom.” (IRC § 2036(a)(2).) In other words, the grantor cannot change the beneficiaries of the trust.

This poses a problem. What if circumstances change? What if a grantor creates a trust for a child, but the child no longer needs the funds? What if the grantor ends up needing the funds themselves? A grantor can build flexibility into irrevocable trusts by granting powers of appointment to the beneficiaries or by appointing a trust protector, but these powers may not be held by the grantor. Thus, reluctance to give up control keeps many clients from making gifts to irrevocable trusts.

The general rule that a grantor must relinquish all control over gifted assets has been seared into the mind of every estate planning professional fearful of accidentally causing estate tax inclusion. But there is one exception: the humble 529 Plan.

Section 529 of the Code contains a shocking statement:

“No amount shall be includible in the gross estate of any individual for purpose of [the estate tax] by reason of an interest in a qualified tuition program.” (IRC § 529(c)(4)(A))

There are, of course, exceptions. 529 plans are (likely) includible in the estate of the beneficiary upon the beneficiary’s death. Also, if the grantor has made the election to “front load” five years of annual exclusion gifts to the 529 Plan (discussed further below) and dies before the five years expires, a portion of the gifted amount will be includible in the grantor’s estate.

Still, 529 Plans offer unparalleled flexibility in estate tax planning. A grantor can remain the “owner” of a 529 Plan and retain the power to change the beneficiary to a qualifying family member (which includes grandchildren, nieces and nephews, and others), while still removing the assets in the 529 Plan from his or her estate. This is in contrast with an irrevocable trust, in which the grantor cannot act as trustee and cannot retain the power to change the beneficiaries.

The other “magic” of 529 Plans is the ability to “front load” annual exclusion gifts. The annual exclusion from gift tax allows a grantor to transfer up to $15,000 per year, per person. But, if a grantor makes the proper election on a gift tax return, he or she can make five years of annual exclusion gifts in a single year and use no transfer tax exemption. If the grantor is married and elects “gift‑splitting,” the couple can transfer $150,000 to a 529 Plan in a single year and use no estate and gift tax exemption.

529 Plans are, of course, designed for education, and are not complete substitutes for irrevocable trusts. The “earnings portion” of non-qualified distributions (i.e., distributions not used for “qualified higher educational expenses”) from a 529 Plan are subject to ordinary income tax at the beneficiary’s tax rate plus a 10% penalty, and for this reason, care should be taken not to “overfund” a 529 Plan. However, 529 Plans can nevertheless serve as effective wealth transfer vehicles because of their income tax benefits and the high probability that a grantor will wish to make significant contributions to the education of at least some members of his or her family. Combined with their unparalleled estate tax features, this makes 529 Plans “estate planning magic.”

ARTICLE BY Luke Harriman of Much Shelist, P.C.

For more Estate Planning, see the Estates & Trusts section of the National Law Review.

Choosing a Trustee for Your Children – Should Foreign Family Members Apply?

Often the most difficult decision parents need to make when writing a Will is whom to appoint as the trustee for their children. The choice becomes particularly tricky for clients whose families live outside the U.S. since choosing a foreign trustee will cause the children’s trusts to be classified under U.S. income tax laws as “foreign trusts” – with lots of ensuing complications.

Under the Internal Revenue Code, trusts are by default “foreign trusts” for U.S. income tax reporting purposes unless a U.S. court exercises both primary supervision over the administration of the trust (the “court test”), and one or more U.S. persons have authority to control all substantial decisions of the trust (the “control test”). The choice of a foreign trustee causes the trust to flunk the control test because a non-U.S. person controls substantial decisions of the trust. Being classified as a foreign trust results in some problematic U.S. income tax consequences. For example:

U.S. beneficiaries who receive distributions from the trust will be taxed to the extent that any trust income, including foreign-source income and capital gains, is included in the distribution. Normally, non-U.S. source income and realized capital gains are not deemed to constitute any part of a distribution to a beneficiary unless specifically allocated to a beneficiary. The foreign trust rules change this tax treatment such that non-U.S. source income, as well as capital gains, are deemed to be part of any taxable income distributed to a U.S. beneficiary.
Trust income not distributed in the year it is earned becomes undistributed net income (UNI). If, in a later year, a trust distribution to a U.S. beneficiary exceeds that year’s trust income, the distribution carries out UNI and is deemed to include the accumulated income and capital gains realized by the foreign trust in prior years. These gains do not retain their character but rather are taxable to the U.S. beneficiary at ordinary income tax rates.
Also, to the extent that a distribution to a U.S. beneficiary exceeds the current year’s trust income, a non-deductible interest charge will be assessed on the tax that is due with respect to the accumulated income and capital gains that are now deemed distributed. This charge is based upon the interest rate imposed upon underpayments of federal income tax and is compounded daily.
Finally, accumulated income and capital gains are taxable to the U.S. beneficiary at the beneficiary’s ordinary income tax rate for the years during which it was earned under a complex formula designed to capture the U.S. tax that would have been payable if the accumulations had been distributed in the years earned – called the “throwback tax”.

Foreign trusts also trigger additional reporting obligations that carry heavy penalties for failure to comply. A U.S. beneficiary who receives a distribution from a foreign trust must file Form 3520 (“Annual Return to Report Transactions with Foreign Trusts”) reporting the distribution and the character of the distribution. The failure-to-file penalty is equal to 35 percent of the gross distribution.

Recognizing, however, that a domestic trust can inadvertently become a foreign trust through changes in the identity of the trustee – such as a trustee’s resignation, disability, or death (but not removal) or the trustee ceasing to be a U.S. person (i.e. change of residency or expatriation) – U.S. Treasury Regulations provide for a 12-month period within which to cure the unintentional conversion. The trust can replace the foreign trustee with a U.S. person trustee, or the foreign person can become a U.S. person during these 12 months. The foreign person can effectuate the cure simply by making the United States his place of residence; he need not become a U.S. citizen.

Rather than rely upon the 12-month cure period, however, a trust agreement should provide for a means to remove a non-U.S. person trustee to assure that the trust qualifies as a domestic trust. Trustee removal and appointment provisions are critical but should be reserved to individuals or entities in the United States. These powers can also create inadvertent gift and estate tax issues, so consulting a qualified trusts and estates lawyer to draft them is critical.

To avoid these problems, it might seem to make sense to allow the foreign trustee to appoint a U.S. co-trustee or to grant certain reserved powers over the trust to a foreign family member in lieu of naming them as trustee (for example, reserving to them the power to remove and replace the U.S. trustee.) But this will not solve the problem. A trust is defined as foreign unless it satisfies both the court test and the control test.

The safe harbor provisions of the court test require that the trust must “in fact” be administered exclusively within the United States, meaning that the U.S. trustee must maintain the books and records of the trust, file the trust tax returns, manage and invest the trust assets, and determine the amount and timing of trust distributions.
The safe harbor provisions of the control test provide that, in addition to making decisions related to distributions, the U.S. trustee must be entirely responsible for a laundry list of decisions including selecting beneficiaries, making investment decisions, deciding whether to allocate receipts to income or principal, deciding to terminate the trust, pursue claims of the trust, sue on behalf of or defend suits against the trust, and deciding to remove, add or replace a trustee or name a successor trustee.

And just to be sure, a well-written document should include a backstop provision that requires the trust to always qualify as a U.S. trust for income tax purposes and to have a majority of U.S. trustees. The inclusion of such a provision, at the very least, alerts those administering the trust to consider these issues before making any changes to the trustee or after an inadvertent change in trustees has occurred.

The increase in cross-border families and multinational asset portfolios have added complexities to the financial planning of families. Familiarity with the impact that these rules may have to existing or proposed estate plans is critical when designing a comprehensive plan for clients.

ARTICLE BY Carolyn A. Reers and Mi-Hae Kim of Wiggin and Dana LLP.

For more on wills and inheritance trusts, see the National Law Review Estates & Trusts law section.

Letters of Wishes: An Administrative and Moral Headache in Disguise?

1. LETTERS OF WISHES ARE THEORETICALLY SOUND

Trustees may have difficulties determining whether to make distributions when the grantor’s intentions are unclear. Consider a trust provision that provides for a beneficiary’s support in the form of reasonable medical expenses. The trust’s sole beneficiary approaches the trustee requesting a distribution for a gastric bypass surgery. The surgery can cost upwards of $45,000 and is the preferred method of achieving seventy-five pounds of weight loss. However, the surgery may be unsuccessful, and may result in post-operation complications and side effects that could impact the beneficiary’s health and require further distributions. Is the surgery a reasonable medical expense? Should the trustee make the distribution for the surgery?

Depending on the trustee, and his or her relationship to the grantor, the answer to the above questions is likely different. Scholars suggest that trustees should administer a trust “in [the] state of mind in which it was contemplated by the settlor that [the trustee] would act.”^[1] If a spouse is serving as a trustee, he or she seemingly has ample opportunity to determine the grantor’s intent. If the drafting attorney is the trustee, the trustee may have gathered insight into the grantor’s mindset and goals while drafting the trust that could be applied to administration. Consider next a corporate trustee who enters the picture well after the grantor’s death. These trustees may have never met the grantor and are unlikely to have anything more than the trust instrument to guide administration. When contemplating a distribution to a beneficiary, each trustee should rely on the terms of the trust to determine whether the distribution should be made, although it is likely that each trustee’s perspective and relationship with the grantor will impact his or her decision.

A significant challenge many trustees face is that terms like health, education, maintenance, support, and best interests are as common in trust instruments as they are interpretive. Because these terms are interpretive, their application can be challenging even for the most diligent trustee; the interplay between these interpretive words/phrases and social, economic, and legal changes that occur during the administration of a trust can prove difficult to manage. In determining whether to make a discretionary distribution what must, or may the trustee rely on? Just the trust instrument? Extrinsic evidence? Personal opinion?

A. Enter the Letter of Wishes

A letter of wishes is a document that allows a grantor to express his or her goals for the trust. Information included can vary, but they offer information about how the grantor wants the trust to be administered by giving insight into the grantor’s state of mind, opinions on distributions, and issues that may arise with the trust’s beneficiaries.^[2] These letters can serve two separate but equally important purposes. First, a letter of wishes can give the grantor the sense that the trustee fully understands their goals for the trust and can administer it in accordance with those goals. Second, letters of wishes can give a trustee something to proverbially hang their hat on when looking for guidance as to whether to make a distribution as the letter can clarify a trust instrument’s general terms.

In the example above, a letter explaining the trustee’s hesitance toward making distributions for cosmetic medical procedures would be valuable. Instead of guesswork, a letter outlining the grantor’s interpretation of the trust’s terms can assist a trustee in choosing to make distributions with greater confidence and flexibility.^[3] This is the crux of the argument for many proponents of letters of wishes.^[4]

2. LOGISTICS OF INCORPORATING A LETTER OF WISHES INTO AN ESTATE PLAN

Though letters of wishes are thought of as an informal tool^[5] drafted by the grantor for the trustee’s benefit, the timing and method of drafting should be considered in relation to state trust laws by any practitioner who recommends its use to a client. Consideration should also be given to whether the letter should be incorporated into the trust as an exhibit or whether the letter should bind the trustee.

A. What is the Ideal Time to Draft a Letter of Wishes?

Practitioners should consider advising clients to draft letters of wishes close to the time the trust is settled in order to avoid disputes over whether the letter is representative of the grantor’s intent.^[6] The following is illustrative: in 2017, immediately after selling his business, at his attorney’s advice, Grantor executes a discretionary trust for Grantor’s grandchildren to provide for their college educations. In 2022, the Grantor is now retired and has time to finally read the education trust that his attorney prepared for him. At that time, the Grantor writes a letter of wishes explaining the grantor’s preference for distributions from the trust that further the pursuit of a STEM college education by Grantor’s grandchildren. Shortly thereafter, all but one of Grantor’s grandchildren enroll in college to pursue liberal arts degrees. The golden grandchild enrolls in a STEM program at his grandfather’s alma mater. The letter of wishes, drafted well after a significant passage of time, reflects that perhaps the Grantor’s opinions and relationships with his grandchildren may have changed. The trust does not have sufficient funds to cover the college tuition for all of the grandchildren and so the trustee must determine whether or not to make tuition payments for each grandchild or only certain grandchildren. What is the trustee to do – follow the terms of the trust or follow the current wishes of the grantor? Because of the timing as to the execution of the letter of wishes – there is an argument that the letter of wishes should be ignored.

Hugh v. Amalgamated Tr. & Sav. Bank^[7] illustrates how timing can impact the effectiveness of a grantor’s extrinsic letters.^[8] In Hugh, the Illinois Court of Appeals determined that the grantor did not gift land to a trust for the benefit of his grandchildren in part because letters expressing the grantor’s desire that the land be gifted to the grandchildren’s trust were delivered to the trustee several years after the trust was settled.^[9]The court noted that the grantor’s exercise of dominion and control over the land in the time between when the grantor settled the trust and drafted the letters and when the letters were actually delivered to the trustee indicated that the grantor’s intent was to retain the property and not to make a gift.^[10] Therefore, given the complications that may arise, the timing of the letter is very important.

B. How Involved Should an Estate Planning Attorney be in Drafting a Letter of Wishes?

Practitioners should consider their own involvement in drafting a letter of wishes and how differing degrees of involvement can impact the trust. Letters of wishes are often personal documents that allow a grantor to express his or her feelings about beneficiaries, philosophy on distributions, and goals for how the grantor’s legacy should be maintained.^[11] Though the letter may be of great importance to the grantor, significant attorney involvement can complicate the trust drafting process by risking inclusion of precatory language in the trust instrument and presenting an opportunity for a grantor to incur significant legal fees for something of questionable utility. Executing a letter of wishes in conjunction with a trust instrument may cause a grantor to request that language from the letter be incorporated into the trust. Though many estate planning clients are sophisticated, the risk of creating ambiguity in the trust with emotional, personal, and imprecise language may be lost on them.^[12] This risk should not be lost on their attorney. Time constraints and workload may cause estate planning attorneys to devote little thought to the letter of wishes, even though the letter may be important to the client and may risk insertion of precatory language into the trust document.

C. To be Effective, Must a Letter of Wishes be Incorporated into the Trust?

As letters of wishes are not legally binding on the trustee in and of themselves,^[13] grantors must rely on a trustee feeling morally and ethically obligated to administer the trust in accordance with the letter. A solution to this problem may be to incorporate the letter of wishes into the trust as an exhibit. Matter of Estate of Kirk suggests that this option may be feasible as the court found a handwritten note attached to a formal trust amendment to be part of the amendment for purposes of administering the trust.^[14] However, some scholars counsel against this, as attaching the letter as an exhibit would make the letter discoverable by beneficiaries, who may use the letter as an opportunity to increase the likelihood of getting a distribution or may find the letter hurtful.^[15] Practitioners should counsel clients using this option to be sure that the letter does not contradict the trust instrument’s terms. Contradictions of this sort could be used as evidence of ambiguity, subjecting the trust to attacks from dissatisfied beneficiaries.

D. Should the Letter be Binding on the Trustee?

Scholars agree that letters of wishes should be made explicitly non-binding on the trustee, arguing that binding letters would interfere with the trustee’s discretion and hinder administration.^[16]This argument is bolstered by the fact that the purpose of using more general language in a trust instrument is to provide the trustee with flexibility so that the trust can adapt to social, legal, and economic changes that impact administration.^[17] Although the lack of litigation over letters of wishes may indicate that letters of wishes are often taken into account and used in administering the trust,^[18] grantors should understand that the letters are deliberately non-binding in order to reap the benefits of adaptability. Grantors and their counsel should evaluate the risks of making a letter of wishes binding, and consider the benefits of a non-binding instrument.

3. DIGGING DEEPER: ARE LETTERS OF WISHES TRULY A POSITIVE ADDITION TO AN ESTATE PLAN?

Fast forward 10 years in the hypothetical posed in Part 1. Suppose you are approached by the trustee who has just found the letter expressing the grantor’s distaste for cosmetic procedures. Also assume that the trustee just received the gastric bypass distribution request. The trustee asks the attorney whether he or she must rely on the letter, what do you tell them? What if they ask whether they can exercise their discretion? Or what the trustee’s moral obligations are? Could the letter be deemed an amendment? The answers are unclear, but the following section applies scholarly opinion, statutory authority, and case law to explain how these issues can be addressed by practitioners.

A. Does the Trustee Have to Rely on the Letter?

While scholarly opinion is generally favorable toward letters of wishes, issues can complicate the positive purpose for which these letters are drafted. The first issue is whether the trustee has any obligation to rely on a letter of wishes. While trustees have historically abided by letters of wishes,^[19] the letters are usually non-binding and often do not need to be disclosed to beneficiaries.^[20] This means that the trustee has no legal obligation to make or forego making distributions in accordance with a letter of wishes.^[21] Further, as noted by the restatement, letters of wishes are generally considered private correspondence between the grantor and trustee that offer guidance to the trustee, suggesting that the trustee has no duty to consider or abide by the letter in making a discretionary distribution.^[22] Practitioners should be sure to discuss this with clients when deciding who to name as trustee to ensure that the client picks a trustee who is capable of managing the trust financially and effectuating the grantor’s intent to the full extent allowed by the law.

B. If the Trustee Wants to Consider a Grantor’s Letter of Wishes, Can They?

Further, a trustee may not be able to consider a grantor’s letter of wishes even if they want to. For example, Illinois common law provides that the general goal in construing a trust is to determine the grantor’s intent and to give effect to that intent if it is not contrary to law or public policy.^[23] The grantor’s intent is to be determined solely by reference to the plain language of the trust itself.^[24]Extrinsic evidence is only appropriate if the trust is ambiguous and the grantor’s intent cannot be ascertained.^[25] When the language of a document is clear and unambiguous, a court should not modify or create new terms.^[26] While Illinois courts have not addressed how a letter of wishes should be treated in relation to these rules of interpretation, Illinois’ Court of Appeals in In re Estate of Crooks noted that a decedent’s letter directing parcels of land to be transferred to him individually—which contradicted his previously executed will, trust, and quitclaim deeds directing the parcels to be transferred to a revocable trust—could not be used by a disgruntled heir to create an ambiguity in the decedent’s will, trust, or quitclaim deeds.^[27] This suggests that a letter of wishes would be treated similarly unless there was an ambiguity in the four corners of the trust.

Practitioners should ensure that they are familiar with the statutes and common law governing trust interpretation for the state that governs the trusts they administer. While Illinois is fairly restrictive as far as what the trustee can rely on in administering the trust, Florida is more liberal.^[28] In Kritchman v. Wolk, Florida’s Court of Appeals found that co-trustees of a revocable trust breached their duties of prudent administration and impartiality by failing to pay a beneficiary’s education expenses as requested in a letter from the grantor to the co-trustees prior to her death.^[29] As such, the state where a letter of wishes is executed could impact whether a trustee may refer to it in administering the trust.^[30]Further, the trust’s terms should be considered carefully to determine whether a letter of wishes or other written directive from the grantor should have any impact on administering the trust.

C. Moral and Ethical Obligations

While a trustee is unlikely to be required by law to consider a letter of wishes when administering a trust—and may, in fact, be prohibited from considering such a letter—they may feel a moral or ethical obligation to consider the grantor’s wishes when making discretionary distributions. Scholars suggest that trustees should administer trusts “in the state of mind contemplated by the settlor.”^[31] Scholars also note that letters of wishes are “[m]oral and emotional accompaniments to a formal distribution scheme, [which]. . . have an important role to play in the planning process.”^[32] This suggests that trustees may feel obligated to administer a trust consistently with a grantor’s letter of wishes. However, as shown by Kritchman, trustees without a personal connection to the grantor may feel no obligation to administer trusts in accordance with a grantor’s letter of wishes and may instead rely solely on the terms of the trust.^[33] grantors and attorney’s should consider a potential trustee’s moral or ethical disposition towards a letter of wishes because this sense of obligation may depend on the trustee’s relationship with the grantor.^[34]

D. Is the Letter an Amendment?

Depending on the circumstances under which a letter is drafted and signed, in addition to the letter’s content, some could argue that a letter of wishes is an amendment to a trust. Though many trust statutes require amendments to be made in accordance with the trust’s terms, a significant number of states allow a trust to be amended “by any other method manifesting clear and convincing evidence of the settlor’s intent.”^[35]Arguably, a letter of wishes expressing a grantor’s specific desire as to what distributions should and should not be made could function as an amendment. However, no United States federal or state court has addressed the issue.

In Illinois, a trust can be amended by reserving the right to amend in the trust instrument.^[36] If the trust instrument specifically describes the method for amendment then that method alone must be used to amend the trust.^[37] Scholars suggest that Illinois trusts should be drafted in such a way that all amendments must be prepared by a lawyer familiar with the trust instrument.^[38]Despite this guidance, the status of a letter of wishes as an amendment to an Illinois trust uncertain. While it is possible that a letter of wishes could be drafted in such a way that it meets the trust’s requirements, it is dependent on the trust instrument’s amendment provision(s). If the grantor wants their letter to function as an amendment, the trust instrument would need to be drafted to ensure that the letter meets the trust instrument’s formal requirements. Drafting a trust instrument in this way may not be advisable because of the potential for introducing precatory language and ambiguity into the trust.

An example serves to further illustrate this issue. Consider a marital trust instrument that allows discretionary distributions for either the beneficiary-spouse’s support or best interests. Assume that both terms are defined with substantive differences. Suppose the grantor drafts a subsequent letter of wishes explaining how the grantor would determine what is in his or her spouse’s best interest, but uses language that mirrors the trust instrument’s definition of support. Should the trust be considered amended to reflect a support standard for all discretionary distributions? The answer depends on the letter’s wording, governing state law, and the trust’s terms. In Illinois, such a letter would be unlikely to amend the trust unless the trust instrument’s amendment provision was drafted to allow for such a letter to function as an amendment.[39] However, a letter of wishes may be more likely to amend a trust in states like Wisconsin^[40] and Kentucky^[41] that follow the UTC’s more lenient provision.^[42]

4. CONCLUSION

While letters of wishes may aid a trustee in administering a discretionary trust and provide the grantor with peace of mind, grantors and their counsel should think carefully about whether a letter of wishes is appropriate for the grantor’s situation. The uncertain state of the law as to the effect that a letter of wishes has on trust administration suggests there is more to letters of wishes than meets the eye. Though scholars generally praise letters of wishes as a means for a grantor to “communicate their cultural beliefs, values, and practices”^[43] or as “helpful to a trustee in ascertaining the settlor’s state of mind, objectives, and purposes in establishing [a] discretionary trust,”^[44] counsel should be aware that a letter may cause problems in administering the trust instead of solving them.^[45] Practitioners who recommend a letter of wishes and/or whose clients choose to include them in their estate plan should advise clients as to the uncertain status of letters of wishes as a viable estate planning tool. Further, any decision to include a letter of wishes in an estate plan should only be made with an understanding of state trust statutes and case law and careful consideration of who to name as trustee.

[1] Austin Wakeman Scott & William Franklin Fratcher, The Law of Trusts § 187 (2006).
[2] See Alexander A. Bove, Jr., The Letter of Wishes: Can We Influence Discretion in Discretionary Trusts?, 35 ACTEC J. 38, 39 (2009).
[3] Id.; Edward C. Halbach, Problems of Discretion in Discretionary Trusts, 61 Colum. L. Rev. 1425 (1961) (arguing that the trustee should be given notice of the trust’s purpose and the grantor’s goals and beliefs to administer the trust in the way the grantor intended).
[4] See e.g., Bove, supra note 2, at 43; Henry Christensen III, 100 Years is a Long Time – New Concepts and Practical Planning Ideas, SN025 ALI-ABA 149, 183–84 (2007) (“[A letter of wishes] permits much more flexibility to. . . the trustee, who has more flexibility built into the trust instrument to exercise powers consistently with the intent of the settlor, rather than at the precise direction of the settlor, which was usually expressed in the vacuum of unknown and unanticipated events.”).
[5] Christensen, supra note 4, at 185.
[6] See Wakeman & Fratcher, supra note 1.
[7] 602 N.E.2d 33 (Ill. Ct. App. 1992).
[8] Note that the Hugh court referred to the grantor’s letters as “letters of direction” as opposed to “letters of wishes.” That said, the grantor’s “letter of direction” served essentially the same purpose that a letter of wishes would have.
[9] Id. at 35.
[10] Id. at 35–37.
[11] Bove, supra note 2 at 40; Deborah S. Gordon, Letters Non-Testamentary, 62 U. Kan. L. Rev. 585, 589 (2014).
[12] Both precatory language and ambiguity should be avoided in trust instruments. Trusts with patent or latent ambiguities are subject to having extrinsic evidence used in interpretation. See Koulogeorge v. Campbell, 983 N.E.2d 1066, 1073 (Ill. App. Ct. 2012). Further, including precatory language in a trust runs the risk that the preacatory terms will not be binding on the trustee. See Duvall v. LaSalle Nat. Bank, 523 N.E.2d 974 (Ill. Ct. App. 1988).
[13] See infra § 3(a).
[14] 907 P.2d 794 (Idaho 1995).
[15] See Bove, supra note 2, at 43.
[16] Id. at 43–44 (“Binding instructions on the trustee can interfere with the concept of full discretion and undermine or diminish the opportunity of exercising that judgment. If such instructions are that important and inflexible, they should be included in the body of the trust. . .”); Christensen, supra note 4, at 183–84.
[17] Gordon, supra note 10, at 616.
[18] Christensen, supra note 4, at 183–84. This lack of case law may also be explained by the fact that letters of wishes are likely to be considered non-discoverable trust documents. As such, beneficiaries are unlikely to see letters of wishes unless the trustee voluntarily discloses them.
[19] Id. at 184 (describing how letters of wishes are widely used and that trustees often fulfill their duties as outlined in letters of wishes).
[20] Restatement (Third) of Trusts § 87 cmt. 3 (2007); Bove, supra note 2, at 43–44; Christensen, supra note 4, at 184; Steven M. Fast and Steven G. Margolin, Whose Trust is it Anyway?, SM001 ALI-ABA 187, 199-200 (2006).
[21] Note that some foreign jurisdictions legally require a trustee to consider a letter of wishes in making trust distributions. That said, these jurisdictions do not require the trustee to make discretionary distributions in accordance with the letters nor do the letters create any additional duty for the trustee. Bove, supra note 2, at 41; see also, Anguilla Trusts Ordinance 1994 §13(4); Belize Trusts Act 1992 §13(4); and Niue Trusts Act 1994, §14(4).
[22] Restatement (Third) of Trusts § 87 cmt. 3 (2007); see also Bove, supra note 2 at 42.
[23] Citizens Nat. Bank of Paris v. Kids Hope United, Inc. 922 N.E.2d 1093 (Ill. 2009).
[24] Koulogeorge v. Campbell, 983 N.E.2d 1066 (Ill. App. Ct. 2012).
[25] Stein v. Scott, 625 N.E.2d 713 (Ill. App. Ct. 1993).
[26] Ruby v. Ruby, 973 N.E.2d 36 (Ill. App. Ct. 2012).
[27] 638 N.E.2d 729 (Ill. App. Ct. 1994). However, the court suggested that if the letter, will, trust, and quitclaim deeds had been executed simultaneously, the letter could indicate an ambiguity for which extrinsic evidence could be admitted to determine the decedent’s intent. The Idaho Supreme Court dealt with a similar issue, but decided differently in Matter of Estate of Kirk. 907 P.2d 794 (Idaho 1995). In Kirk, the court allowed a settlor’s handwritten note to be considered for purposes of construing her previously executed trust agreement. Id.
[28] See Fla. Stat. Ann. § 736.0804 (2017) (requiring a trustee to “administer the trust as a prudent person would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust.”) (emphasis added).
[29] 152 So.3d 628, 631–32 (Fla. Dist. Ct. App. 2014). Note, however, that the grantor’s letter differed from a standard letter of wishes as it was delivered to the trustee during the grantor’s lifetime pursuant to the trust instrument’s provision allowing her to direct the trust to make payments as requested. Id. at 629–30.
[30] See e.g., Baker v. Wilburn, 456 N.W.2d 304, 306 (S.D.1990) (“[W]hen two or more instruments are executed at the same time by the same parties, for the same purpose and as part of the same transaction, the court must consider and construe the instruments as one contract.”).
[31] Wakeman & Fratcher, supra note 1; Bove, supra note 2, at 38.
[32] Gordon, supra note 10, at 617.
[33] Kritchman v. Wolk, 152 So.3d 628, 630–31 (Fla. Dist. Ct. App. 2014) (describing trustee/defendant’s position that the terms of the trust nullified all of the grantor’s written directives).
[34] See id. at 615 (“These letters, which in general avoid theatricality for simplicity and performance for connection, reinforce the social relationship between writer and recipient without disrupting the estate plan or manipulating the beneficiaries.”).
[35] Unif. Trust Code § 602; see also, Colo. Rev. Stat. Ann. § 15-16-702; Fla. Stat. Ann. § 736.0602(3)(b)(2); Mich. Comp. Laws Ann. § 700.7602; Mont. Code Ann. § 72-38-602; ; N.H. Rev. Stat. § 564-B:6-602; Ohio Rev. Code Ann. § 5806.02; S.C. Code Ann § 62-7-602; Wyo. Stat. Ann. § 4-10-602.
[36] Parish v. Parish, 193 N.E.2d 761, 766 (Ill. 1963).
[37] Id.; Northwestern University v. McLoraine, 438 N.E.2d 1369 (Ill. App. Ct. 1982).
[38] Robert S. Hunter, § 213:23. Amending the trust agreement, 19 Ill. Prac., Estate Planning & Admin (4th ed. 2016).
[39] Supra § 3(d).
[40] Wis. Stat. Ann. § 701.0602 (2017).
[41] Ky. Rev. Stat. Ann. § 386A.2-020 (2017).
[42] Unif. Trust Code § 602.
[43] Gordon, supra note 17, at 617.
[44] Bove, supra note 2, at 39.
[45] See e.g., Matter of Estate of Kirk, 907 P.2d 794 (Idaho 1995) (describing a conflict between potential beneficiaries over changes in their interests in the decedent’s trust caused by decedent’s handwritten letter attached to a trust amendment).

ARTICLE BY Grant R. Hendricks of Horwood Marcus & Berk Chartered.

For more on Trusts, Grantors and Beneficiaries, see the National Law Review Estates & Trust law section.

Of Passion, Prejudice And Punitive Damages

Addressing an issue of damages, the US Court of Appeals for the Ninth Circuit vacated the district court’s grant of punitive damages in favor of the plaintiff, finding “passion and prejudice” mitigated finding of “malice”. Waverly Scott Kaffaga, as Executrix of the Estate of Elaine Anderson Steinbeck v. The Estate of Thomas Steinbeck et al., Case No. 18-55336 (9th Cir. Sept. 9, 2019) (Tallman, J).

The lawsuit related to decades of litigation among the heirs to John Steinbeck’s registered copyrights to his works, including The Grapes of Wrath, Of Mice and Men, East of Eden and The Pearl. When Steinbeck died in 1968, he left interest in his works to his third wife, Elaine. Steinbeck’s two sons by a previous marriage each received $50,000. In the 1970s, the sons obtained rights in their father’s works when interests in works were renewed pursuant to US Copyright law.

In 1983, changes in the law prompted Elaine and the sons to enter into an agreement that provided each of them with an equal share of the royalties and gave Elaine “complete power and authority to negotiate, authorize and take action with respect to the exploitation and/or termination of rights” in the works. In 2003, Elaine passed away, and her daughter, Waverly Kaffaga, assumed the role of successor under the 1983 agreement. The sons challenged the validity of the 1983 agreement, and the US Court of Appeals for the Second Circuit determined that the agreement was valid and enforceable. Despite losing in court, one of the sons, Thomas Steinbeck, along with his wife Gail and Gail’s media company, filed a lawsuit in California asserting rights to the works that the courts had already told them they did not have. The district court held, and the Ninth Circuit affirmed, that the Steinbecks’ claims were barred by collateral estoppel.

Kaffaga countersued Thomas and Gail for their attempts to assert various rights in the works despite having no rights. Those attempts led to multiple Hollywood producers abandoning negotiations with Kaffaga to develop screenplays for the works. The district court granted Kaffaga summary judgment on her breach of contract and slander of title claims, citing many detailed facts it believed supported those claims. The district court let the jury decide on her claim of tortious interference. The jury unanimously found for Kaffaga and awarded $5.25 million in compensatory damages and $7.9 million in punitive damages, including $6 million against Gail individually.

On appeal, the Ninth Circuit found clear support in the record for the lower court’s decisions, save for one—punitive damages. There, the appellate court noted that although Kaffaga had the better argument, and although there was ample evidence of defendants’ malice in the record to support the jury’s verdict, triggering punitive damages, Kaffaga missed one key piece of evidence.

Under California law, there is a “passion and prejudice” standard that measures the amount of punitive damages against the ratio between damages and the defendant’s net worth. It is the plaintiff’s burden to place into the record “meaningful evidence of the defendant’s financial condition” to support a defendant’s ability to pay.” Thus, for the punitive damage award to stand, the record needed to contain sufficient evidence of Gail’s assets, income, liabilities and expenses. Here, Kaffaga failed. Although Gail testified that she received approximately $120,000 to $200,000 per year from domestic book royalties, Kaffaga introduced no estimate of Gail’s potential income from the four television series and six feature films in development, nor did she introduce an estimate of the total value of Gail’s other intellectual property assets. The Ninth Circuit found that Kaffaga failed to meet her burden of placing into the record “meaningful evidence” of Gail’s financial condition showing that she had the ability to pay any punitive damages award as required by California law. The Ninth Circuit therefore vacated the almost $6 million punitive damages award.

Practice Note: When seeking punitive damages in California, the moving party must place “meaningful evidence” of the non-moving party’s financial condition and ability to pay any punitive damages awarded, including their assets, income, liabilities and expenses. If there are problems obtaining such evidence during discovery, procedures such as a motion to compel or proposing an appropriate adverse inference instruction at trial are in order.

ARTICLE BY Jodi Benassi of McDermott Will & Emery.

For more copyright inheritance, see the National Law Review Estates & Trusts or Intellectual Property law pages.

What is a Holographic Will?

When a loved one passes, questions may arise as to who possesses the Decedent’s Last Will and Testament. If a formal document exists that was validly executed and was drafted by an attorney, chances are that the document is a valid Last Will and Testament unless a challenge is levied against it. What may become problematic is when a handwritten document in the testator’s own handwriting is discovered. The question then becomes if this handwritten document is a valid Last Will and Testament of the Decedent. In general, a handwritten instrument of this nature is called a Holographic Will, and may be enforceable provided certain requirements are met.

Typically, Courts often do the best they can to accept as a Last Will and Testament a writing by the Decedent where it is clear that the Decedent intended the instrument to be their Last Will and Testament. That is because the Courts would rather enforce the wishes of the Decedent than to allow the document to be invalidated based upon a mere formality. Perhaps the least formal of all Last Wills and Testaments which may be admitted to Probate is a document called a Holographic Will. These documents are relatively simple and are akin to something that a Decedent wrote on a piece of notebook paper and signed. The requirements of a Holographic Will are set forth below.

In general, pursuant to New Jersey S.A, 3B:3-2B, a Will can be considered a Holographic Will and admitted to Probate if the signature and the material portions of the document are in the Decedent’s handwriting. The Holographic Will must have all material testamentary provisions in the handwriting of the testator and also must be signed by the testator. What this means is that the provisions in the Will which dispose of the Decedent’s property must be in their own handwriting and not the handwriting of another. Further, the Will must be signed by the Decedent and not another party. As noted, this is a very simple instrument and is akin to a piece of notebook paper upon which a Decedent described how to transfer his/her property.

Provided the Will meets the requirements of a Holographic Will, it may be admitted to Probate and the Decedent’s Estate may be distributed in this regard. Different things could occur if not all the Decedent’s property is disposed of pursuant to a Holographic Will, however, that is best left for another blog. The purpose of this blog is to merely highlight one potentially type of valid Last Will and Testament which is informal in nature.

Article by Paul W. Norris of Stark & Stark.

For more on wills & testaments, see the National Law Review Estates & Trusts law page.

Securing Your Pet’s Future with Estate Planning

Have you thought about what would happen to your pet in the event of your death or incapacity? Approximately two-thirds of American households own a pet, and while we have many people in our busy lives, our pets have only us. Pet owners often lament that beloved animal companions don’t live as long as we do, but they still warrant consideration in our estate plans because we don’t know what the future will bring. This is especially true for animals with longer life expectancies or higher costs of care, such as dogs, cats, horses, parrots, turtles and animals with special needs.

Without provisions for your pet in your living trust, in the short term your pet could go days at home without food and water, and could feel panicked, distressed or abandoned. In the long term, your pet could end up with someone you don’t want them to end up with, or at a shelter where he or she could be euthanized. Contrary to popular belief, informal arrangements are generally not legally enforceable and simply adding your pet to your will often isn’t enough. Your pet will need care long before your will is probated, and wills offer no ongoing control or oversight for your pet, the caregiver or funds left for your pet.

Including the following documents in your estate plan can help to ensure that someone has access to your home and authorization to care for your pets in the short term, and can ensure that you decide who will ultimately care for your pets, and how they will be cared for, if you die or become incapacitated.

Pet Trust

A pet trust is a great way to ensure that your pet is cared and provided for after your death. The pet trust may be a part of your existing trust or may be a completely separate trust. It allows you to name the caretaker of your pets and creates a fiduciary obligation on the named caretaker to care for your pet in the manner described in your trust. You will provide money for your pet to be cared for, and the trustee of the trust will disburse funds to the caretaker or directly to a service provider to pay for your pet’s care. The trustee is similarly under a fiduciary obligation to ensure that the trust funds are used only for the purposes described by your pet trust.

A pet trust also allows you to name successive caretakers in case your preferred caretaker becomes unable or unwilling to take care of your pet, for example, if he or she has a change in life circumstances (e.g. medical concerns or new family obligations, among other reasons). Without a pet trust, on the other hand, your pet becomes the legal property of the person who assumes care of the pet, and the new owner may make decisions about the pet’s future that you might disagree with. If the new owner doesn’t make any formal arrangements, your pet’s future could be in limbo if something happens to the new owner. If you want to maintain control over the succession of caregivers for your pet, a pet trust drafted by an experienced estate planning attorney is crucial and affords the best long term protection for your pet.

Durable Power of Attorney for Pet Care

The Durable Power of Attorney for Pet Care allows you to authorize someone else to seek medical care for your pet and specify to what extent the agent may act on your behalf. This document can also be used by a pet caretaker while you are away on business or vacation. Alternatively, if your own Durable Power of Attorney is “effective immediately” rather than “effective upon incapacity” (sometimes called “springing”), provisions for your pet may instead be added to your own Durable Power of Attorney.

Care Instructions

Pet care instructions will accompany the instructions in your pet trust. It is important to have these as a separate document that will be incorporated into your pet trust by reference so that you can change your pet care instructions as your pet’s needs and tastes change without having to update your trust. The pet care instructions should be reviewed and updated frequently to ensure that food requirements, medical information and emergency contacts are up to date. It’s also a good idea to include information about what your pet likes and doesn’t like, any quirks your pet may have, and generally anything else you would want someone caring for your pet to know. This versatile document, like the Durable Power of Attorney for Pet Care, can also be left with someone caring for your pet while you are away on business or vacation.

Importantly, if your pet is ever in a situation where the pet will need to be adopted to a new family, these instructions provide valuable information to the agency that will assist them in making sure a first match is successful, rather than, for example, adopting your pet to a family with young children only to have your pet returned when it becomes apparent that your pet is fearful of children. An owner’s death is stressful for an animal, so ensuring a successful first match with an adopter is imperative.

Wallet Card

This extra protection will immediately notify someone that you have pets at home if you are found to be deceased or incapacitated somewhere other than your home. Similar to adding “in case of emergency” contacts to your phone, having information in your wallet about who should be contacted to quickly provide care to your pets in such a situation can be the difference between your pets being cared for quickly or being home alone for days without food or water.

Article by Rebecca K. Wrock of Varnum LLP.

For more on estate planning, please see the National Law Review Estates & Trusts page.

Estate Planning Opportunities Arising from Recent Landmark Supreme Court Decisions Concerning Marriages of Same-Sex Couples

On June 26, 2013, the US Supreme Court (the “Supreme Court”) struck down Section 3 of the federal Defense of Marriage Act (DOMA) as unconstitutional in the case of United States v. Windsor (“Windsor”). In a related case, the Supreme Court also dismissed an appeal from the federal district court ruling that struck down California’s Proposition 8 (which overturned marriages of same-sex couples in California) as unconstitutional in the case of Hollingsworth v. Perry (“Perry”), leaving intact the district court’s ruling that Proposition 8 is unconstitutional and cannot be enforced. This advisory summarizes the estate and income tax planning opportunities and other topics for consideration arising from the Windsor and Perry decisions. Married same-sex couples should consult with their advisors in light of their particular facts and circumstances in order to take maximum advantage of the change in the law. Unmarried same-sex couples should now consider whether to marry.

In Windsor, Edith Windsor and Thea Spyer, a same-sex couple, were married in Canada in 2007 after having been together in New York for over forty years. New York law did not permit marriages between same-sex couples at the time but recognized marriages of same-sex couples performed in other jurisdictions. Spyer died in 2009, and Windsor inherited all of Spyer’s estate as Spyer’s surviving spouse. However, because of DOMA, which defines “marriage” as “a legal union between one man and one woman as husband and wife” and “spouse” as “a person of the opposite sex who is a husband or a wife”, the federal government refused to recognize the couple’s marriage for federal estate tax purposes. As a result, Windsor’s inheritance from Spyer was not entitled to the unlimited marital deduction from federal estate tax that would have been available had Windsor and Spyer’s marriage been recognized by the federal government. After paying the estate taxes owed on her inheritance as a result of DOMA, Windsor sued for a refund of the estate taxes on the grounds that DOMA unconstitutionally discriminated against same-sex married couples. Windsor prevailed in the US District Court for the Southern District of New York and also in the US Court of Appeals for the Second Circuit. The Supreme Court has now agreed with Windsor, holding that “DOMA seeks to injure the very class [of married same-sex couples] New York seeks to protect. By doing so it violates basic due process and equal protection principles applicable to the Federal Government.” The Supreme Court further explained that DOMA’s “demonstrated purpose is to ensure that if any State decides to recognize same-sex marriages, those unions will be treated as second-class marriages for purposes of federal law.”

In Perry, two same-sex couples wished to become married in California. Though the California Supreme Court held in 2008 that the California Constitution required the State of California to recognize marriages of same-sex couples, California voters passed Proposition 8 later the same year, amending the California Constitution to provide that only “marriage between a man and a woman is valid and recognized in California.” As a result of Proposition 8’s passage, the two couples were unable to marry. They sued the California governor, attorney general and various other state and local officials responsible for enforcing California’s marriage laws (the “California officials”), claiming that Proposition 8 violated their rights to due process and equal protection under the US Constitution. In the US District Court for the Northern District of California (the “district court”), the California officials refused to defend Proposition 8, but the private parties who were the proponents of Proposition 8 (the “Proposition 8 proponents”) successfully intervened to defend the measure. After the district court held that Proposition 8 was unconstitutional, the California officials declined to appeal the decision and the Proposition 8 proponents appealed. The US Court of Appeals for the Ninth Circuit upheld the district court’s ruling that Proposition 8 was unconstitutional. The Supreme Court dismissed the appeal from the district court on the grounds that the Proposition 8 proponents lacked standing to appeal because they were merely private parties and were not properly authorized under state law to defend the constitutionality of Proposition 8. As a result of the Supreme Court’s ruling, the district court’s ruling that Proposition 8 is unconstitutional remains in place and California soon will be required to permit same-sex couples to marry. As a result of the Windsor decision, such marriages also will be entitled to federal recognition.

Estate Planning Opportunities Arising from Windsor

The Supreme Court’s ruling in Windsor requires the federal government to recognize marriages of same-sex couples. Note, however, that the Supreme Court limited the scope of its decision to “lawful marriages”. Therefore, the decision likely will not be interpreted to require the federal government to recognize so-called “marriage equivalent” status that is not actually “marriage” under state law, i.e., civil unions, domestic partnerships and registered domestic partnerships. The District of Columbia and thirteen states permit marriages of same-sex couples. Those states are California (effective once the stay issued by the Ninth Circuit is lifted pursuant to the Perry decision, which is likely to be imminent), Connecticut, Delaware (effective July 1, 2013), Iowa, Maine, Maryland, Massachusetts, Minnesota (effective August 1, 2013), New Hampshire, New York, Rhode Island (effective August 1, 2013), Vermont and Washington.

Another unresolved issue is whether the Supreme Court’s decision applies to married same-sex couples who lawfully married in a jurisdiction that permits marriages of same-sex couples (e.g., New York), but who are domiciled and/or resident in a state that does not permit or recognize such marriages (e.g., Texas). Accordingly, until these issues are resolved as a result of subsequent litigation, legislation and/or regulation, it is not clear whether Windsor will be interpreted also to apply to same-sex couples with a marriage-equivalent status (but not marriage) or married same-sex couples who are domiciled and/or resident in a state that does not permit and/or recognize marriages of same-sex couples.

Against that background, at a minimum, married same-sex couples domiciled and/or resident in states that permit and/or recognize marriages of same-sex couples likely will be entitled to the more than 1,000 benefits available to married opposite-sex couples under federal law. Some of those 1,000 benefits present immediate estate planning opportunities, including the following:

1. Review estate planning documents to ensure that the amount and structure of any spousal bequests remain appropriate.

Federal recognition of marriages of same-sex couples leads to the availability of the unlimited marital deduction from federal estate tax and gift tax for transfers between same-sex spouses. Existing estate planning documents may have been drafted with the assumption that any gift or bequest to a spouse of the same sex over and above the individual’s applicable exclusion amount from federal estate tax and/or federal gift tax (the “Applicable Exclusion Amount” —currently $5,250,000, adjusted annually for inflation) would be subject to federal estate tax (currently at a maximum rate of 40%). However, that assumption is no longer true. Indeed, such gifts and bequests, if properly structured, are now entitled to the unlimited marital deduction. In addition, under the so-called “portability” provisions of federal gift and estate tax laws, under certain circumstances a surviving spouse of the same sex will also be entitled to use any portion of the deceased spouse’s unused Applicable Exclusion Amount (the “DSUE”), allowing the surviving spouse to make additional tax-free gifts and/or reduce the amount of estate taxes owed upon the surviving spouse’s death (note, however, that DSUE does not increase the surviving spouse’s applicable exemption from the federal generation-skipping transfer tax (“Federal GST Exemption”)). Accordingly, a married same-sex couple may wish to modify their estate planning documents to provide that any assets included in their estates in excess of the Applicable Exclusion Amounts will pass to the surviving spouse, either outright or in a properly structured marital trust for the spouse’s benefit, thus deferring all federal estate taxes until the death of the surviving spouse.

Estate planning documents may also be revised, if appropriate, to include a separate marital trust that is designed to permit a spouse to use any of the individual’s unused Federal GST Exemption that remains after the individual’s death.

2. Review retirement account beneficiary designations and joint and survivor annuity elections to ensure that they remain appropriate.

A surviving spouse is entitled to roll over a decedent spouse’s retirement account into the surviving spouse’s retirement account without being required to take minimum distributions or lump sum distributions until such time as the surviving spouse ordinarily would be required to take minimum distributions (usually upon reaching age 70½). As a result of the Windsor decision, this benefit is now available to married same-sex couples. Accordingly, married same-sex spouses should consider naming each other as the beneficiary of his or her retirement accounts in order to defer income tax on the rolled over retirement account as long as possible.

With regard to any retirement plans that are covered by the Employee Retirement Income Security Act of 1974 (ERISA), the spouse of a participant in such a plan may automatically be a beneficiary of the retirement plan as a result of the Windsor decision. Accordingly, if a participant in an ERISA-covered plan (e.g., a 401(k) plan) wishes to designate someone other than his or her spouse as a beneficiary, such participant will need to obtain the consent of his or her spouse to make such a designation effective. Prior to Windsor, consent was not needed from a spouse of the same sex. However, afterWindsor, such consent is now required. Separately, if a participant previously made an election to waive joint and survivor annuity benefits after the date of the marriage, the participant may be able to make a new election at this time, and a new election may be required in order to be valid if the marriage is newly recognized under Windsor.

3. Consider replacing individual life insurance policies with survivor policies.

Many same-sex spouses previously purchased individual life insurance policies of which the other spouse is the beneficiary (either directly via beneficiary designation or indirectly through a life insurance trust) in order to provide the surviving spouse with sufficient liquid assets that may be used to pay federal estate taxes due upon the death of the first to die. With the unlimited marital deduction and DSUE now available to married same-sex couples, as explained above, there may be little or no need for such liquidity upon the death of the first spouse to die. Thus, a married same-sex couple should consider replacing such individual policies with so-called “survivor” or “second-to-die” policies that pay benefits only upon the death of the surviving spouse. Such policies will still provide liquidity to children or other beneficiaries of the married same-sex couple and are generally less expensive than individual policies having the same death benefits.

4. Consider splitting gifts between spouses.

Until now, each spouse could make gifts only up to the annual exclusion amount from federal gift tax and/or federal generation-skipping transfer tax (the “Annual Gift Tax Exclusion Amount” and the “Annual GST Exclusion Amount”, respectively—each currently $14,000) without using any portion of his or her Applicable Exclusion Amount. Going forward, however, each spouse may now make gifts from his or her own assets and, with the other spouse’s consent, have such gifts deemed to have been made one-half by the other spouse for purposes of federal gift tax and GST tax laws. Both spouses acting together in this way currently may give up to $28,000 to any individual without using any portion of either spouse’s Applicable Exclusion Amount (note that the Annual GST Exclusion Amount does not always apply to gifts made in trust).

5. Amend previously filed federal estate, gift and income tax returns and/or file protective claims as appropriate.

Gifts made to spouses. If one spouse previously made taxable gifts to the other spouse and reduced the donor’s Applicable Exclusion Amount by the amount that the gift exceeded the Annual Gift Tax Exclusion Amount and/or the donor’s Federal GST Exemption by the amount that the gift exceeded the Annual GST Tax Exclusion Amount, it may be possible to amend the donor’s prior gift tax returns (subject to the limitations period discussed below) and retroactively claim the marital deduction for the gifts made in those years, thus increasing the donor’s Applicable Exclusion Amount and/or reclaim the Federal GST Exemption used. By doing so, the donor may make additional tax-free gifts and/or reduce federal estate and/or GST taxes due upon his or her death. Similarly, any gift taxes or GST taxes actually paid may be refundable.

Gifts made to third parties. To the extent that either spouse previously used a portion of his or her Applicable Exclusion Amount and/or paid gift taxes or GST taxes by making gifts to third parties over and above his or her Annual Gift Tax Exclusion Amount and/or Annual GST Exclusion Amount, it may be possible to amend prior federal gift tax returns in order to retroactively split such gifts with the other spouse, thus increasing the donor’s Applicable Exclusion Amount and/or Federal GST Exemption. Again, doing so will allow the donor to make additional tax-free gifts and/or reduce federal estate taxes and GST taxes due upon the donor’s death. Similarly, any gift or GST taxes actually paid may be refundable.

Inheritances from decedent spouses. In cases where a decedent spouse’s estate paid federal estate taxes on assets that were inherited by a surviving spouse of the same sex, it may be possible to amend the decedent spouse’s federal estate tax return (subject to the limitations period discussed below) and retroactively claim a refund for the estate taxes paid. If the decedent spouse’s estate did not pay estate taxes and he or she died in 2010 or a subsequent year, under the portability provisions of federal estate tax laws, the surviving spouse may be able to claim the deceased spouse’s DSUE, thus allowing the surviving spouse to make additional tax-free gifts and/or reduce the amount of estate taxes owed upon the surviving spouse’s death (note, however, that DSUE does not increase the surviving spouse’s Federal GST Exemption).

Income taxes. Both spouses may also amend prior year income tax returns to change their filing status from single to married filing jointly and obtain a refund if the amount of tax owed based on their married filing status is less than that owed based on their prior single status.

Retroactivity. The extent to which married same-sex couples will be allowed to amend prior tax returns depends on the extent to which Windsor is applied retroactively and whether the applicable limitations period has passed with regard to each tax return (i.e., ordinarily three years from the date the tax return was originally due or filed (if on extension) or two years from the date the tax was paid, whichever is later). For example, it may no longer be possible to amend a 2009 individual income tax return due on April 15, 2010, that was not put on extension, but individual income tax returns for 2010, 2011 and 2012 likely may be amended. That said, it is conceivable that the Internal Revenue Service (IRS) will permit amendments as far back as the year of the marriage on the basis that neither spouse lawfully could have amended his or her tax returns prior to theWindsor decision. In either case, it will take some time for the IRS to develop policies and procedures to implement Windsor, and amended returns should be filed in accordance with applicable published guidance from the IRS, if available. In any situation where the limitations period is about to expire for a particular tax return, a married same-sex couple should consider filing a protective claim for a refund with the IRS in order to preserve the ability to obtain such a refund after the IRS has provided a means to amend the return.

6. Reside in a state that permits and/or recognizes marriages of same-sex couples.

If a married same-sex couple was lawfully married in a jurisdiction that permitted the marriage but now reside in a state that does not permit and/or recognize the marriage, that couple should consider moving to a state that either permits marriages of same-sex couples or recognizes such marriages lawfully performed in other states if they wish to be certain to enjoy the federal benefits now potentially accorded to marriages of same-sex couples.

7. Non-citizen spouses should consider seeking permanent residency and/or becoming citizens.

Until now, non-citizen spouses were not eligible for citizenship or permanent residency on the basis of their marriage to a spouse of the same sex who was a US citizen. As a result of the Windsor decision, however, non-citizens may be eligible for permanent residency and/or citizenship on that basis. Though there are many benefits to becoming a permanent resident or citizen, there are also numerous tax and non-tax consequences that should be carefully considered before making such an important decision.

Estate Planning Opportunities Arising from Perry

California will now be required to permit marriages of same-sex couples, but other states that do not permit and/or recognize marriages of same-sex couples will not be required to do so. California married same-sex couples will enjoy all of the benefits available to married couples under federal law and thus should consider the above recommendations. In addition, married same-sex couples in California should consider the following recommendations:

1. Amend previously filed California income tax returns and/or file protective claims as appropriate.

Married same-sex couples may be permitted to amend prior year California income tax returns to change their filing status and obtain a refund for any income taxes that were overpaid. Note that the normal limitations period for amending California returns expires four years after the original due date of the return (or the actual filing date if the return was put on extension) or one year from the date the tax was paid, whichever occurs later. If the limitations period for any particular tax return is about to expire, a married same-sex couple should consider filing a protective claim for a refund until such time as the State of California provides appropriate guidance for amending prior returns. Note that, as discussed above with regard to the limitations period for federal tax returns, it is conceivable that a married same-sex couple may be permitted to amend their returns through the first year of their marriage.

2. Amend previously filed tax returns and/or file protective claims with other states as appropriate.

Married same-sex couples may also be entitled to amend prior gift tax and/or estate tax returns filed with other states that recognized marriage but not marriage equivalents (e.g., California registered domestic partnerships) at the time in question and receive a refund of taxes paid and/or reclaim any state gift tax and/or estate tax exemption. Again, the limitations period (if one applies) for amending such returns will vary by state. If the limitations period for any particular tax return is about to expire, a married same-sex couple should consider filing a protective claim for a refund until such time as the state provides appropriate guidance for amending prior returns.

Article By:

Trusts and Estates Practice

Katten Muchin Rosenman LLP

Eleventh Hour Fiscal Cliff Deal – What Does it Mean for Canadians?

Just hours before midnight on New Years Eve, the US Senate hammered out a tentative deal to avoid sending the country over the Fiscal Cliff. Yesterday, a reluctant, Republican-controlled House of Representatives has also blessed the plan, which deals with many of the major tax issues at stake, while pushing back the spending issues to later into the new year.

The “Fiscal Cliff”, a term coined by Ben Bernanke, the Chairman of the Federal Reserve, refers to the cumulative effect of spending cuts and tax increases, which were scheduled to occur January 1, 2013 as a result of the expiry of several pieces of legislation. The issue has received a great amount of press in recent months, as commentators continued to hope that Congress would agree on compromise legislation to soften the economic blow. In this post, we will outline the primary cross border tax impacts on Canadians.

Federal Estate Tax

For Canadians with interests in the US, the primary consequence of going over the Fiscal Cliff would relate to the federal estate tax. The Canada – US Tax Treaty allows Canadian residents to piggy-back onto some estate tax exemptions that are available to US citizens and residents. In particular, in 2012, there was a $5.12 million exemption from estate tax, such that only estates worth greater than that amount would end up paying taxes, and the maximum rate was capped at 35%. The looming Fiscal Cliff threatened to bring us back to the $1 million exemption amount at maximum rate of 55%, which was in effect when President Bush took office in 2001. Note that this is not a capital gains tax on death, as we have in Canada. This tax applies to the fair market value of assets at the time of death.

The good news for Canadians is that the deal will extend the $5.12 million exemption amount, which will increase with inflation. The maximum rate will increase to 40% on a permanent basis. As a consequence, if a Canadian owns US assets (such as real estate or US securities) worth more than $60,000, and passes away with a worldwide estate valued in excess of $5.25 million, some US estate tax is likely going to be payable. It is important to note that the worldwide estate value includes everything: real estate, investment accounts, RRSPs, business interest, even the proceeds of life insurance. However, the tax is only applied against the value of the US situated assets, and some tax credits ought to be available under the Tax Treaty thanks to the extension of the high exemption amount.

Nonetheless, it remains worthwhile for high-net worth Canadians to evaluate their estate tax exposure and hold US assets in Cross Border structures that minimize or eliminate the potential for US estate tax liability.

Income and Capital Gains Tax

Most of the press on the Fiscal Cliff has centered on the increases in income tax rates. This issue is very unlikely to cause Canadian residents much concern, even though US income tax may be payable. Since Canadian residents pay Canadian tax on their world wide income, any US source income earned by a Canadian will be added on the top of their Canadian income, such that it will be taxed at a relatively high marginal rate. In contrast, that same US sourced income will be taxed in the US at the lower marginal rates, and Canada will give a credit for US tax paid. As such, as long as the marginal rate in the US is lower than the marginal rate in Canada on the same income (which it clearly will), increases in US income tax rates will not be noticed by Canadians when the dust settles at the end of a tax year.

One expiring tax cut that was not renewed under the Eleventh Hour Deal relates to the long-term capital gains tax rate on the disposition of capital assets. This is one tax increase that will be felt by some Canadians. In Canada, we pay regular income tax on half of the capital gain. As such, if the gain pushes a taxpayer into the top marginal rate in Canada, the effective capital gains tax rate ranges from approximately 19.5% in Alberta to almost 25% in Quebec. In 2012, the US federal capital gains tax for individuals who had held an asset for longer than one year was capped at 15% on the gain. That rate has increased to 20% with the Fiscal Cliff Deal (high income earners will pay 23.8% including an “Obamacare” surcharge). Where state-level tax also applies, the US capital gains tax may well exceed that owed in Canada, resulting in a higher overall tax burden. For example, California has a state capital gains tax rate of 9.3%. Therefore, any Canadian selling a California property will owe more tax to the US (combined rate of 29.3%) than to Canadian jurisdictions. Other states have a lower rate of tax, such that the effective US rate may not exceed the Canadian rates. For example, Florida does not impose a capital gains tax on individuals, trusts, or limited partnerships.

Market Volatility

The other aspect of the Fiscal Cliff that may affect Canadians is the most difficult to anticipate. Many economics were predicting that the overall effect of the Fiscal Cliff would send the US back into recession. This was the concern that prompted Bernanke and others to characterize the issue as a ‘cliff’ connoting catastrophic economic consequences. While the economy should respond favorably to the agreement that Congress passed, there are many pressing issues that were simply deferred in this week’s deal. Many of the spending cuts, which are thought to jeopardize the economic recovery, were pushed back two months for Congress to resolve later on. If worst fears are realized, the value of many US assets may decline as economic conditions generally erode.

As cross border tax and estate planners, we often advise Canadian clients to consider repositioning their investment portfolios to exclude directly held US securities because of the US estate tax exposure they represent. If you believe that the fiscal transition will negatively impact the value of US securities, it may be a good time to discuss repositioning with your investment advisor.

Article By:

Jonah Z. Spiegelman

Altro Levy LLP

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1. LETTERS OF WISHES ARE THEORETICALLY SOUND

A. Enter the Letter of Wishes

2. LOGISTICS OF INCORPORATING A LETTER OF WISHES INTO AN ESTATE PLAN

A. What is the Ideal Time to Draft a Letter of Wishes?

B. How Involved Should an Estate Planning Attorney be in Drafting a Letter of Wishes?

C. To be Effective, Must a Letter of Wishes be Incorporated into the Trust?

D. Should the Letter be Binding on the Trustee?

3. DIGGING DEEPER: ARE LETTERS OF WISHES TRULY A POSITIVE ADDITION TO AN ESTATE PLAN?

A. Does the Trustee Have to Rely on the Letter?

B. If the Trustee Wants to Consider a Grantor’s Letter of Wishes, Can They?

C. Moral and Ethical Obligations

D. Is the Letter an Amendment?

4. CONCLUSION

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Pet Trust

Durable Power of Attorney for Pet Care

Care Instructions

Wallet Card

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Estate Planning Opportunities Arising from Windsor

1. Review estate planning documents to ensure that the amount and structure of any spousal bequests remain appropriate.

2. Review retirement account beneficiary designations and joint and survivor annuity elections to ensure that they remain appropriate.

3. Consider replacing individual life insurance policies with survivor policies.

4. Consider splitting gifts between spouses.

5. Amend previously filed federal estate, gift and income tax returns and/or file protective claims as appropriate.

6. Reside in a state that permits and/or recognizes marriages of same-sex couples.

7. Non-citizen spouses should consider seeking permanent residency and/or becoming citizens.

Estate Planning Opportunities Arising from Perry

1. Amend previously filed California income tax returns and/or file protective claims as appropriate.

2. Amend previously filed tax returns and/or file protective claims with other states as appropriate.

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Federal Estate Tax

Income and Capital Gains Tax

Market Volatility

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