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The Will & The Way, April 2014 – a publication of the Estate Planning & Fiduciary Law Section of the North Carolina Bar Association (NCBA)

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As published in the April 2014 edition of The Will & The Way, a publication of the Estate Planning and Fiduciary Law Section of the North Carolina Bar Association. 

Federal Case Law Developments

Supreme Court Grants Cert on Whether Inherited IRAs are Retirement Funds in Debtor’s Hands and Exempt from Bankruptcy Estate.

In In re Heffron-Clark, 714 F.3d 559 (7th Cir. 2013), the Seventh Circuit Court of Appeals addressed whether a non-spousal inherited IRA qualified for the “retirement funds” exemption set forth in Section 522(b)(3)(C) and (d)(12) of the Bankruptcy Code. The Bankruptcy Court held initially that a non-spousal inherited IRA did not represent “retirement funds” in the hands of the debtor and was not exempt thereunder. The District Court reversed and held that any money representing “retirement funds” in the decedent’s hands must be treated the same way in the successor’s hands. The Seventh Circuit Court of Appeals reversed the District Court and held that the Bankruptcy Court “got [it] right” because inherited IRAs are not savings reserved for use after the owner stops working. The Supreme Court recently granted cert on this issue, 2013 WL 4776520 (Nov. 26, 2013), as the Seventh Circuit decision conflicts with those of the Fifth and Eighth Circuits.

Tax Court Includes In Gross Estate Full Fair Market Value of GRAT and QPRT Assets.

In Estate of Trombetta v. Comm’r, T.C.M. 2013-234 (Oct. 21, 2013),decedent transferred rental properties and a personal residence into a Grantor Retained Annuity Trust (GRAT) and a Qualified Personal Residence Trust (QPRT), respectively, during her lifetime. She died during the original respective annuity and retained use terms, but before her death she had attempted to relinquish her interests in the trusts by reducing their terms. Were the date of death values of the transferred property includable under Code Sections 2036(a) (i.e., a transfer without adequate and full consideration and with a retained interest); 2038(a)(1) (i.e., a transfer subject to decedent’s ability to alter, amend, revoke, or terminate); or 2035(a) (i.e., relinquishment of a power during 3-year period ending at death where such power would otherwise be includable under, in this case, Code Section 2036 or 2038)? The estate argued that Code Section 2036(a) did not apply to the GRAT, and that the GRAT property should not be included in the gross estate because (i) the transfers were bona fide sales for value, and (ii) decedent did not retain an interest in the properties during her life. The court denied that the transfer was a bona fide sale for value because when the gift was made, she did not receive full and adequate consideration, but instead was entitled to receive present value of the annuity payments. In fact decedent had reported a gift equal to the difference between the fair market value of the properties and the then present value of the annuity payments. The court also found that the transfers were testamentary in nature, as the trust term and trust termination provisions were tied to decedent’s date of death. Moreover, the execution of the trust occurred at the same time as that of the will. The estate further argued that there was a legitimate non-tax reason to qualify the transfer as arm’s length in that she no longer wished to be involved in the management of the apartment units. However, the trust language did not expressly exclude her from managing the properties, and throughout the trust term decedent continued to manage the properties actively. The court also found that decedent retained an interest in the properties during her life. She continued to manage the properties, routinely and unilaterally adjusted the annuity payments to herself during the trust term, and retained the right to receive all excess trust income. Accordingly, Code Section 2036(a) applied to include the full value of the GRAT properties in decedent’s estate. The estate’s final argument was that the reduction of the GRAT terms, which eliminated decedent’s ability to receive fixed annuity payments or excess income, was an exercise of a power and not a relinquishment of a power under Code Section 2035(a). The court held that by extinguishing the power retained by decedent during that time the transfer was in fact a relinquishment of a power under Code Section 2035(a). Finally, the estate acknowledged inclusion of the residence (QPRT property) but took the position that only the home’s rental value, not its full fair market value, be included in the gross estate. The court held that the entire fair market value under Code Section 2036(a) was included because decedent had the right to reside in the residence and actually was residing in the residence at the time of her death. With respect to the GRAT properties, the court determined that the estate was entitled to a mortgage indebtedness deduction given that the decedent was personally liable for such indebtedness, which was secured by GRAT assets. Finally, the court rejected the estate’s claim for a charitable deduction, as the QPRT terminated before death and title passed to decedent’s children then as opposed to a testamentary charitable remainder trust at death.

Tax Court Invokes Duty of Consistency for Basis Reporting.

In Van Alen v. Comm’r, T.C.M. 2013-235 (Oct. 21, 2013),the court invoked the doctrine of consistency to prevent individual beneficiaries of a trust that received their father’s cattle ranch upon his death from reporting basis for income tax purposes that was inconsistent with the value reported for estate tax purposes. The value of property for estate tax purposes is the fair market value at decedent’s death. Fair market value is the highest and best use of the property. Code Section 2032A provides an exception to fair market value to allow for actual use value on the date of decedent’s death. The executor elects special use valuation, and each person with an interest in the property must sign and file a personal liability agreement. Here the parties agreed that the special use valuation requirements were met, but they disputed the estate valuation’s effect on the trust’s basis in the ranch. Upon decedent’s death, the California deputy probate referee valued the ranch at $1,963,000. However, the estate reported the ranch’s fair market value at $427,500 and its Code Section 2032A special use value at $144,823. The Service alleged understatement and asserted that the value was in fact $427,500. The estate responded with an amended—and even lower—special use value of $98,735. The Service accepted the lower special use value presumably because other asset values had been increased resulting in higher total estate taxes paid. Ten years later the trust sold a conservation easement for $910,000, and after subtracting basis of about $100,000 and other trust deductions, the trust issued to each beneficiary a K-1 reporting long-term capital gain (LTCG) of $360,000. The trust later filed an amended fiduciary income tax return claiming almost twice as much basis, and each beneficiary received an amended K-1 showing a lower LTCG of $310,000. Neither beneficiary reported the gain and both received IRS “CP2000” mismatch notices. Neither beneficiary paid the proposed balance due. One of the beneficiaries called a CPA, who then called a friend who happened to be the California deputy probate referee who back in 1994 had appraised the property at $1,963,000, the date of death value for probate purposes. The referee gave his field notes to the CPA. The CPA then submitted a second amended fiduciary income tax return reporting the basis at slightly less than $900,000, decreasing total LTCG to less than $25,000. Relying on Revenue Ruling 54-97, 1954-1 C.B. 113, the CPA asserted that the reduction in LTCG was due to a mistake in value. The statute of limitations had passed on the estate tax return so the IRS could not collect any estate tax deficiency as a result of the change in basis position ten years later. The court invoked the equitable doctrine of the duty of consistency. Also known as quasi-estoppel, the duty is based on the idea that a taxpayer must be consistent with the taxpayer’s tax treatment of items and cannot benefit from prior error or omission. The court cited three conditions: (i) taxpayer’s representation, (ii) Commissioner’s reliance thereon, and (iii) taxpayer’s attempt after the running of the statute of limitations to change the previous representation or re-characterize the situation in a way that harms the Commissioner. The court held that even if the basis calculation for estate tax purposes was incorrect, the individual trust beneficiaries who consented to the original special use valuation on the estate tax return cannot change their position to their advantage on the later-filed trust fiduciary income tax return.

Post-Termination Sale of QTIP Assets Leaves Taxable Gift of Remainder Interest.

Estate of Virginia V. Kite, T.C. No. 6772-08 (gift tax) and 6773-08 (estate tax) (Oct. 25, 2013) (unpublished), appeal from “Kite I”, T.C.M. 2013-43 (Feb. 7, 2013), was a gift tax case that addressed issues raised upon audit of decedent’s estate tax return. Decedent gifted assets to a QTIP trust for her husband a week before his death. After his death, the QTIP assets remained in trust for the decedent. This QTIP trust, another QTIP trust funded at decedent’s husband’s death, and a general power of appointment marital trust invested all their assets in a family limited partnership (FLP). The trusts’ FLP interests were then sold in exchange for notes and the notes were contributed to a general partnership. The trusts were terminated and the general partnership interests were distributed from the trusts to decedent who sold them to her children in exchange for a deferred annuity. The term of the annuity was 10 years, and decedent’s then life expectancy was 12.5 years. She died in the third year prior to receiving any payments. The issue was whether under Code Section 2519 the disposition was a deemed transfer of any part of a qualifying income interest, which is treated as a transfer of the value of the QTIP property less the value of the qualifying income interest. The children argued that the entire transaction was not subject to gift tax as it was a bona fide sale for adequate and full consideration. However, in an analysis of Code Sections 2511 and 2519, the court determined that the remainder interest was a future interest belonging to the beneficiaries, not decedent. Thus, decedent could not have transferred it for any consideration, as it did not belong to her. The court found that the related termination of the QTIP trust and sale of assets to the children in exchange for private annuities constituted a termination of a qualifying income interest by decedent, which resulted in a taxable gift under Code Section 2519 of the value of the remainder interest in the QTIP property. The court did not reduce the value of the gift by the consideration received by decedent in holding that a “deemed transfer of a remainder interest under Code Section 2519 cannot be made for full and adequate consideration.”

Estate’s Failure to Qualify Its Appraiser as Expert Prompts Court to Accept IRS Discounts.

Estate of Tanenblatt v. Comm’r, T.C.M. 2013-263 (Nov. 18, 2013) addressed valuation of a limited liability company interest for estate tax purposes. Decedent died in 2007, the estate timely filed IRS Form 706, and the Service determined an estate tax deficiency of $309,547. The issue was fair market value of decedent’s 16.667% interest in the LLC, which owned a commercial building in New York City. IRS Form 706 reported an appraised LLC value using net asset value (NAV) of the LLC and 20% and 35% minority and marketability discounts, respectively. The Service used the same NAV, but it challenged the percentage discounts. In preparation for trial, the estate hired a new valuation expert whose report supported use of the income and NAV approaches, with appropriate weight indicated, to determine the LLC value prior to application of the discounts to the estate’s interest. The expert also used a lower value of the interest on account of its classification as an assignee interest. The court first addressed an evidentiary issue regarding expert testimony. The estate’s valuation expert refused to testify on account of a fee dispute. However, the estate attempted to use the court’s stipulation procedure to get the expert’s report into evidence anyway. Typically reports and documents attached to court filings can be stipulated to and allowed as evidence without formal testimony. The estate attached the expert’s report to a court filing and argued that it should be admitted as a result of that stipulation procedure. However, the court rejected this attempt to bypass the expert testimony requirements in the Federal Rules of Evidence and in so doing did not allow the report to be entered into evidence. In valuing the interest, the appraiser classified what was received by the beneficiaries as an assignee’s interest as opposed to a member’s interest in the LLC, thus warranting a higher discount percentage and yielding a lower value for estate tax purposes. According to the court, the interest should have been valued at what decedent had at death, that is, a membership interest with the attendant voting and control benefits and burdens. The court held that the interest was properly characterized as a member’s interest at death, and that any reduction in value was appropriately reflected in the minority and marketability discounting. Absent the estate’s expert testimony and without the estate’s valuation report in evidence, the court accepted the Service’s (lower) 10% and 26% discounts for lack of control and marketability, respectively, and did not consider the arguments related to the valuation based on a weighted approach because the Service’s expert testimony was the only evidence admitted to support valuation of the LLC interest.

Distribution of Net Proceeds From Surrendered Life Insurance Policy In Excess of Investment Constitutes Gross Income.

In Brach v. Comm’r, T.C. Summary Opinion 2013-96 (Dec. 2, 2013),the taxpayer obtained from Guardian Life Insurance Co. (Guardian) in 1984 a life insurance policy on his life. The policy had two portions: a cash value portion that grew with the policy’s age and a dividends portion that grew with the policy’s investments. He could borrow against the policy an amount not in excess of cash value—and he did so in 1995 but never repaid the loan. Moreover, he could terminate the policy and receive as a distribution the cash value plus any accrued dividends less outstanding debts against the policy. In 2010 he surrendered the policy because he was unable to make the premium payments or loan repayments. The policy’s gross surrender value reported on IRS Form 1099-R was $65,903, i.e., taxpayer’s investment (premium and other consideration) of $32,778, plus $33,125 (interest and other policy earnings over time). However, the taxpayer actually received net proceeds of $3,786, as Guardian had retained the difference as full repayment of the policy loan. Taxpayer engaged an enrolled agent to prepare his IRS Form 1040, and the agent included in gross income only the $3,786 amount actually received. Taxpayer was insolvent and the agent believed that taxpayer was not required to report income believed by the agent to be discharge of indebtedness income. The court ruled that there was a deficiency in gross income and that the full income amount, including what was applied to repayment of the loan, had to be treated as a distribution to taxpayer. As a result, $33,125 was taxable income. In light of the taxpayer’s reliance in good faith on the agent’s advice, the court relieved taxpayer of liability for the Code Section 6662 accuracy-related penalty assessed on the deficiency.

Federal District Court Forces Deposit of Irrevocable Trust Income and Prohibits Liquidation of Trust Principal Pending Determination on Use of Trust Assets for Partial Satisfaction of Grantor’s $330 Million Debt to IRS.

In Acheff v. Lazare, 2013 U.S. Dist. LEXIS 160026, 2013-2 U.S. Tax Cas. (CCH) P50,553 (Oct. 15, 2013)the United States District Court for the District of New Mexico ordered an injunction on Trust assets requiring the Trustee to deposit all trust income into the court’s registry for possible payment of a $330 million tax bill. The order further enjoined the Trustee from liquidating or distributing any part of the trust principal pending a decision as to whether the Trust represented the grantor’s mere nominee and whether the trust assets could be used to satisfy the grantor’s tax liability. In so ruling, the court found (i) that the grantor of the trust had in excess of $330 million in tax liability, (ii) that the trust was the only known source for the United States to recoup what was owed by the grantor of the trust, and (iii) that there was no credible evidence that any trust beneficiaries could not support themselves with other means until the trial court could reach a decision on the merits. In ordering the preliminary injunction, the court ruled that the United States had demonstrated a likelihood of success on the merits through the denial of the trustee’s summary judgment motion. The United States had the potential to suffer irreparable harm on account of a tax debt of over $330 million, and, moreover, because there was no testimony that any beneficiaries were solely dependent on the trust funds, the balance of equities tipped in favor of the United States.

Federal Administrative Developments

IRS Treats Grantor Trusts As Disregarded Entities and Disallows Short-Term Capital Loss to Grantor Trusts on Sale of Partnership Property Under Code Sections 267 and 707(b)(1)(A) But Not Code Section 165.

In CCA 201343021 (Nov. 1, 2013), the Service reviewed the treatment of grantor trusts under Revenue Ruling 85-13, 1985-7 I.R.B. 28 (Feb. 19, 1985) and confirmed that such trusts are disregarded for all federal income tax purposes. The Service addressed a transaction involving the purchase of two LLC-owned partnerships by three grantor trusts, of which B, C, and D were grantors, respectively. The LLC was owned by (i) an S Corporation (owned by a foundation and a grantor trust of which A was grantor); (ii) a partnership (owned by three non-grantor trusts each for the benefit of A and one of his three children, B, C, and D (and their respective spouses and children)); and (iii) a partnership (owned by four grantor trusts, the grantor of each was A’s father, Z, and the beneficiaries of which were A and one of B, C, and D, respectively, and A and A’s grandchildren but not spouses).

The Service addressed three issues: (i) whether grantor trusts are disregarded as separate entities from their owners for all federal income tax purposes including Code Sections 267 and 707(b)(1)(A); (ii) whether a short-term capital loss recognized upon the sale of LLC-owned partnerships to certain grantor trusts may be disallowed under Code Sections 267 and 707(b)(1)(A); and (iii) whether a short-term capital loss recognized upon the sale of LLC-owned partnerships to certain grantor trusts may be disallowed under Code Section 165.

With respect to the first issue, the Service explained that Rev. Rul. 85-13 should be read broadly. It states that the owner of a grantor trust is not merely taxable on the trust’s income but is treated as the owner of the trust’s assets for federal income tax purposes. Therefore, the purchasing grantor trusts are ignored entities apart from their respective grantors for all federal income tax purposes, including Code Sections 267 and 707(b)(1)(A).

With respect to the second issue, the Service explained that a short-term capital loss recognized upon the sale of LLC-owned partnerships to certain grantor trusts may be disallowed un­der Code Sections 267 and 707(b)(1)(A). Under Code Section 267(c), stocks owned directly or indirectly by a trust, corpora­tion, or partnership shall be treated as owned “proportionately” by its beneficiaries, shareholders, or partners. Under Code Sec­tion 267(c), it is necessary to determine (i) the total capital or profits interest owned by each selling trust, (ii) the specific bene­ficiaries of each selling trust that should be treated as proportion­ately owning a capital or profits interest in taxpayer, and (iii) each beneficiary’s ownership portion of the capital or profits interest in taxpayer that is owned by the respective selling trust in compari­son to all other beneficiaries’ proper ownership interest or total capital or profits interest. Once the beneficiary’s proportionate capital or profits interest in taxpayer is established under Code Section 267(c)(1), the constructive ownership rules must be ap­plied to attribute ownership to other specified persons (e.g., fam­ily members) to determine a person’s direct and indirect owner­ship of the capital or profits interest of taxpayer. Acknowledging minimal authority on the methodology used in calculating the proportionate interest owned by each beneficiary in trust, the Service used two methodologies. The first methodology allocated the interests proportionately among all the named beneficiaries. The second methodology considered the seven-year history of distributions to A and allocated the interests to A. Under either methodology the family attribution rules resulted in more than 50% of the LLC being owned by B, C, and D, so the Service disal­lowed the loss.

With respect to the third issue, the Service explained that un­der these facts the sale eliminated A’s interest and increased A’s grandchildren’s interests. The Service concluded that loss may not be disallowed under Code Section 165 because the sale was bona fide and not merely a transfer “from one pocket to the other.”

Service States Inflation-Adjusted Items for 2014.

Rev. Proc. 2013-35, 2013-47 I.R.B. 537 (Nov. 18, 2013) updates for inflation the income and transfer tax dollar limitations appli­cable in 2014.

Description Internal Revenue Code Amount
(.32) – Unified Credit Against Estate Tax – Basic Exclusion Amount for Determining Amount of Unified Credit Against Estate Tax IRC § 2010 $5,340,000
(.33) – Valuation of Qualified Real Property (QRP) in Decedent’s Gross Estate (Special Use Valuation) – Limitation on Decrease in Value of QRP IRC § 2032A Aggregate Decrease Cannot Exceed $1,090,000
(.34) – Annual Exclusion for Present Interest Gifts IRC § 2503 $14,000
(.34) – Annual Exclusion for Present Interest Gifts to Non-US Citizen Spouses IRC §§ 2503 and 2523(i)(2) $145,000
(.41) – Dollar Amount Used to Determine “2% Portion” Used For Calculation of Interest on Installment Payment of Portion of Estate Tax Where Estate Consists Largely of Closely-Held Business IRC § 6166 $1,450,000

Treasury Issues Final Regulations on 3.8% Medicare Tax on Cer­tain Net Investment Income, Including That of Trusts and Estates.

In T.D. 9622, 78 Fed. Reg. 72394-01 (Nov. 26, 2013), the Depart­ment of the Treasury issued final regulations under Code Section 1411 on the 3.8% tax on net investment income of certain individ­uals, estates, and trusts. Generally speaking, for estates and trusts, Code Section 1411(a)(2) imposes a tax equal to 3.8% of the lesser of the estate’s or trust’s undistributed net investment income (NII), or the excess of (i) the estate’s or trust’s adjusted gross income for the taxable year, over (ii) the dollar amount at which the highest tax bracket in Code Section 1(e) begins for such taxable year. Ef­fective for taxable years beginning after December 31, 2012, the Final Regulations include guidance on computation of NII tax for individuals (1.1411-2) and estates and trusts (1.1411-3); applica­tion to trade or business income (or not) (1.1411-4, -5, -6, and -10); application to dispositions of partnership or S corporation interests (part of contemporaneous Proposed Regulations; Final Regulations Section 1.1411-7 reserved for future guidance); the general exception for qualified retirement plan and IRA distribu­tions (1.1411-8); and provisions relating to self-employment in­come (1.1411-9).

IRS Releases Form 5227 (2013), Split-Interest Trust Information Return and Instructions, for Net Investment Income (NII) Reporting.

All charitable remainder trusts described in Code Section 664 must file IRS Form 5227 (2013), Split-Interest Trust Information Return and Instructions. In addition, and unless an exception applies, all Code Section 642(c)(5) pooled income funds and all other trusts such as charitable lead trusts that are Code Section 4947(a)(2) split-interest trusts must file the return. The form replaces IRS Forms 1041-A and 1041-B, which are mentioned in the Treasury Regulations. The Service’s objective is to track net investment income received and distributed. Generally speaking, the form subdivides tiers of income (ordinary income, capital gains (losses), and nontaxable income) as either “excluded [from NII] income” or “accumulated NII.”

IRS Issues Procedures for Reinstatement of Tax-Exempt Status of Organizations That Failed to File for Three Years.

In Rev. Proc. 2014-11, 2014-3 I.R.B. 411 (Jan. 13, 2014), the Service released procedures for retroactively reinstating tax-exempt status of organizations that had such status automatically revoked for failure to file required annual returns or notices for three consecutive years.

Treasury Issues Proposed Regulations on CRT Taxable Beneficiary’s Basis Upon Disposition of CRT Income Interest.

In REG-154890-03, 79 Fed. Reg. 3142-01 (Jan. 16, 2014), the Department of the Treasury issued proposed regulations that affect taxable beneficiaries of charitable remainder trusts (CRTs). Generally speaking, the proposed regulations address the situation where a taxable CRT beneficiary sells all its interest in a CRT following the CRT’s sale of CRT assets and reinvestment of proceeds from such sale. Corresponding to Code Section 1014, the proposed regulations set forth guidance for determining a taxable beneficiary’s basis in a CRT term interest upon a sale or other disposition of all interests in the trust to the extent such basis is a share of adjusted uniform basis. These regulations are intended to address transactions of interest described in IRS Notice 2008-99, 2008-47 I.R.B. 1194, including sales of CRT interests to third parties where the taxable CRT beneficiary attempts to use a uniform basis that is derived from basis of new CRT assets as opposed to grantor’s basis in assets contributed to the CRT. In general, the taxable CRT beneficiary’s adjusted uniform basis would be reduced by undistributed ordinary net income and undistributed net capital gain. The treatment of participating charitable remaindermen remains under consideration by Treasury.

IRS Allows for Extension of Time for Non-Taxable Estate to File Estate Tax Return with Portability Election.

In Rev. Proc. 2014-18, 2014-7 I.R.B. 513 (Feb. 10, 2014), the Service issued simplified procedures for seeking “9100 relief” to file a late estate tax return in cases where the taxpayer did not file an estate tax return, which is required to elect portability of the deceased spouse’s unused exclusion amount. The revenue procedure applies only if the executor has not already filed an estate tax return for a nontaxable estate of a decedent who (i) had a surviving spouse (including a same-sex spouse); (ii) died in 2011, 2012, or 2013; and (iii) was a U.S. citizen or resident. If these requirements are met, then the deadline to file the estate tax return to elect portability is December 31, 2014. For deaths after 2013, the due date for filing an estate tax return solely to elect portability is the same as the due date for filing an estate tax return required for a gross estate in excess of the basic exclusion amount. If a surviving spouse also died during the applicable period then that surviving spouse’s executor may file a protective claim for a refund warranted by portability.

North Carolina Case Law Developments

N.C. Court of Appeals Upholds Summary Judgment Rejecting Undue Influence and Lack of Testamentary Capacity When Will Prepared by and Executed in Presence of Attorney Two Weeks Before Death.

In In re Will of McNeil, 749 S.E.2d 499 (Nov. 5, 2013), three of Elzie Rogers McNeil’s descendants filed a caveat to a 2010 will. The caveators alleged that Mrs. McNeil lacked the capacity to make the will, that the will was procured by undue influence and duress, and that a fiduciary relationship existed between one of the propounders and Mrs. McNeil. Mrs. McNeil executed a will in 2008. In 2010 she met with an attorney and executed a new will in the attorney’s presence. The latter will removed as a beneficiary her grandson (not a caveator), who was a beneficiary under the 2008 will. During the execution of the 2010 will, Mrs. McNeil had breast cancer, coronary artery disease, and diabetes. After lengthy discovery, propounders moved for summary judgment, which the trial court granted. Caveators appealed. The Court of Appeals held that caveators did not present sufficient evidence to create a genuine issue of material fact regarding undue influence. The court considered relevant factors, including (i) the person’s old age and physical and mental weakness; (ii) whether the person signed the paper in beneficiary’s home and was subject to beneficiary’s constant association and supervision; (iii) whether others had little or no opportunity to see the person; (iv) whether the will is different from and revokes a prior will; (v) whether it is in favor of one with whom there are no blood ties; (vi) whether it disinherits the natural objects of the person’s bounty; and (vii) whether the beneficiary procured its execution. The court found no specific instances of mental infirmity, nor was there any evidence that Mrs. McNeil was subject to propounders’ constant association and supervision. Moreover, there was no evidence of others’ inability to interact with Mrs. McNeil, who was related by blood to all the beneficiaries. The 2010 will did not further benefit any propounder or result in any caveator’s loss. One of propounders helped procure the 2010 will by contacting the attorney and delivering documents between Mrs. McNeil and the attorney, but she received no greater benefit under the 2010 will. Furthermore, the court found no issue as to testamentary capacity because Mrs. McNeil had only a few signs of confusion and was able to recall family member’s names and to understand what was going on around her. Her attempt to bequeath non-existent shares in a non-profit corporation merely reflected a misunderstanding of corporate law and did not show testamentary incapacity.

N.C. Court of Appeals Upholds Superior Court’s Ruling that Decedent’s Ambiguous Residuary Bequest Disposed of All Testator’s Assets.

In Halstead v. Plymale, 750 S.E.2d 894 (Dec. 3, 2013), Ms. Halstead executed a will in which she disinherited her estranged husband on account of adultery and abandonment. After her death, he sought declaration that the residuary clause of her will failed to devise her intangible personal property and real property and therefore such property should pass by intestacy. The trial court found that despite patently ambiguous language in the residuary clause (“My residuary estate, being all my real and personal property… I give all such tangible personal property to my relative, Jennifer Plymale, if she survives me.”), Ms. Halstead expressly intended to disinherit and disqualify her husband. The Court of Appeals affirmed the trial court’s decision concluding that the testatrix’s intent is the “polar star that must guide the courts in the interpretation of a will.” The court noted that such intent must be ascertained from consideration of the will as a whole and not merely from consideration of specific items or phrases of the will taken in isolation. Furthermore, according to the court, there is a general presumption that a testator does not intend to die intestate. The court concluded that despite some ambiguity and conflicting language, Ms. Halstead clearly meant to disinherit her husband and leave the residuary to Ms. Plymale.

Transfer of Trust Assets by Grantor/Trustee to Himself is Voidable as Violation of Duty of Loyalty to Beneficiaries.

In THZ Holdings, LLC v. McCrea, 2013 N.C. App. LEXIS 1345 (Dec. 17, 2013), Richard McCrea, as a condition of separation, agreed to provide housing for his former wife and their children. Richard created a trust in April 2008 and designated the children as beneficiaries. Initially the trustee was North Star Trust Company (North Star). Richard lent funds to the trust for the purchase of a home, which was intended to satisfy the housing obligation. There was no loan agreement or any other legal documentation reflecting his intent to satisfy such obligation. Later in 2008 Richard lost his job and could no longer contribute to the trust. He was advised to liquidate it. North Star resigned as trustee, and Richard was appointed as successor trustee. He then transferred title to the property from the trust to himself individually in exchange for forgiveness of the purchase-money debt. He alleged that his attempt to contact his former wife and children was unsuccessful, so he filed an action for summary ejectment to remove them from the house. His former wife filed a third-party complaint against him seeking to void all conveyances of the property to him, return title to the trust, and remove him as trustee. The trial court entered a judgment granting her relief on all claims. The Court of Appeals affirmed the trial court’s conclusion that Richard breached his duty of loyalty to the trust beneficiaries. The court concluded that discharging the debt owed by the trust to him personally in exchange for trust property was clearly a transaction “entered into by the trustee for the trustee’s own personal account.” The court also concluded that Richard’s actions contravened a long-standing common law rule that prohibit trustees from self-serving actions. The court ruled that the transfer from the trust to Richard and then subsequently to Richard and his second wife was void because North Carolina law treats transfers resulting in a breach of a trustee’s duty of loyalty as voidable by the beneficiaries affected. The court also held that Richard was properly removed as trustee because he breached his duty of loyalty. However, it reversed the trial court’s appointment of a successor trustee without following trust terms (as required under N.C. Gen. Stat. § 36C-7-704(b)) and remanded for appointment of a successor trustee in accordance with such terms.

North Carolina Administrative Developments

NCDOR Directive Addresses Income Taxation of Rolled Over Retirement Benefits Paid to Certain Former Government Employees.

In NCDOR Directive PD-14-1 (Feb. 26, 2014), the N.C. Department of Revenue supplemented an earlier directive (PD-04-1) and further addressed the consequences of rollover distributions from a qualifying tax-exempt retirement account described in Bailey v. State of North Carolina to a 401(k) or 457 Roth account or to a Roth IRA. The directive also includes guidance on filing amended 2010 – 2013 returns requesting refund of taxes paid on rollover distributions from a qualifying tax-exempt Bailey retirement account into a Roth account.

John R. Cella, Jr. and Ansley Chapman Cella are shareholders of Manning, Fulton & Skinner, P.A., in Raleigh, North Carolina.

– To view the April 2014 edition of The Will & The Way in its entirety, click here.


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