The Will & The Way, November 2013 – a publication of the Estate Planning & Fiduciary Law Section of the North Carolina Bar Association (NCBA)
Federal Case Law Developments
No Loss of Exempt Status When IRA Funds Withdrawn and Re-deposited Within 60 Days. In re: Rudd, 2013 Bankr. LEXIS 2387 (Bankr. E.D.N.C. June 12, 2013), the Bankruptcy Court determined that $25,000 withdrawn from debtor’s Simple IRA for personal living expenses and re-deposited within a 60-day period thereafter was not a prohibited transaction under Code Section 4975, nor did it cause the entire $246,973.91 IRA balance to lose its exempt status.
Claim for Refund Filed One Day Late Was Barred. In Estate of Langan v. United States, 111 Fed. Cl. 654 (Fed. Cl. 2013), the taxpayer’s counsel did not mail the estate tax refund complaint until Thursday at 11 p.m., which was the day before the expiration date of the statute of limitations. The complaint arrived on the following Monday. Taxpayer claimed that the complaint was properly placed in the mail but later admitted that the complaint arrived late. The Court granted the government’s motion to dismiss.
Same-Sex Marriage Valid in State of Marriage and Recognized in State of Domicile Upon Death Qualifies Surviving Spouse for Estate Tax Marital Deduction in Estate Tax Refund Claim. In United States v. Windsor, 133 S. Ct. 2675 (2013), a same-sex couple married in Canada resided in New York at the time of the decedent’s death. The decedent left her entire estate to her surviving same-sex spouse (Windsor). Upon filing IRS Form 706 Windsor, as Executor, paid $363,053 in federal estate taxes and sought a refund. The IRS denied the refund, concluding that under the Defense of Marriage Act (DOMA) the marriage of decedent and Windsor did not qualify as a “marriage” for purposes of federal law, nor did Windsor qualify as a “spouse” as used in the term “surviving spouse” under the marital deduction rules of Code Section 2056(a). The United States Supreme Court upheld the findings of the District Court and Second Circuit Court of Appeals that the DOMA definition of marriage as “only a legal union between one man and one woman as husband and wife” and definition of “spouse” as “a person of the opposite sex who is a husband or a wife” were unconstitutional deprivations of the equal liberty of persons protected under the Constitution’s Fifth Amendment. Accordingly, Windsor, as a surviving spouse in a lawful marriage, became entitled to the refund.
Executor Who Relied on CPA’s Erroneous Advice that Estate Tax Return Extended for One Year Did Not Show Reasonable Cause In Filing Return Three Months Late. In Knappe v. U.S., 713 F.3d 1164 (9th Cir. Cal. 2013), cert denied Oct. 15, 2013, the decedent named a longtime friend and successful businessperson as her executor. The executor had no prior experience serving as an executor, so he hired a CPA who had worked as a corporate tax accountant for the executor’s company for many years. At the executor’s request, the CPA completed and filed IRS Form 4768, an “Application for Extension of Time to File a Return and/or Pay US Estate (and Generation-Skipping Transfer) Taxes”. Form 4768 gives taxpayers the option of seeking an extension of time to file the estate tax return, an extension of time to pay estate taxes, or both. Part II of the instructions provides that the executor may apply for an automatic extension of time to file the return. An executor who is out of the country may apply for an additional six-month extension. Part III, Extension of Time to Pay, provides that an extension of time to pay of up to twelve months may be granted in the Service’s discretion. The CPA filed for a 12-month extension of time to pay estate taxes and for an automatic six-month extension of time to file but incorrectly advised the executor that both extensions were for one year (not six months). The executor reviewed the IRS-approved extension request but only noted the due date for the extension of time for payment (twelve months), and filed the estate tax return within that period, but several months late. The IRS assessed penalties against the estate. The executor requested an abatement of the penalty asserting that his reliance on the CPA’s erroneous advice was reasonable cause for the late filing. The IRS denied the request. The executor’s administrative appeal of the decision was also denied. The executor paid the full penalty amount and filed a claim for refund which was denied. The executor filed a refund action alleging that his reliance on CPA was reasonable cause to excuse the penalty. The Court distinguished between substantive and non-substantive tax matters in considering whether the executor had reasonable cause to rely upon the CPA’s advice. The Court reasoned that because the instructions and governing statute on the time to file an estate tax return were clear, the matter is a non-substantive matter. The Court held that the executor failed to exercise ordinary business care and prudence by relying on the CPA’s erroneous advice on a “non-substantive” matter. Furthermore, it was the executor’s non-delegable duty to ascertain the correct extended filing deadline.
Assumption of Potential Code Section 2035(b) Estate Tax Liability is Calculable for Purposes of Reducing Value of Net Gift. In Steinberg v. Commissioner, 141 T.C. 8 (Sept. 30, 2013), an 89 year-old taxpayer made gifts of cash and marketable securities to her four daughters, subject to an agreement whereby the daughters agreed to pay any Federal gift taxes imposed on the value of the gifts. The donees also agreed to pay any Federal or State estate taxes imposed on the value of the gift taxes paid on the gifts within three years preceding death under Code Section 2035(b). The taxpayer and her daughters executed the net gift agreement after several months of negotiation using separate counsel. The taxpayer hired an appraiser to calculate the fair market value of the property transferred to the daughters. The appraiser calculated the fair market value of the gifts first, and then reduced that value by (1) the value of the gift taxes paid by the daughters, and (2) the actuarial value of the assumption of potential Code Section 2035(b) liability if taxpayer died within three years (based, in part, upon annual mortality rates in each of the three years following the gift). The appraiser determined that the aggregate fair market value of the net gift was $71,598,056 (including a discount of $5,838,540 for the value of assumed potential Code Section 2035(b) estate tax liability). The taxpayer timely filed IRS Form 709 (with a copy of the net gift agreement) reporting the $71,598,058 value of the gift and total gift tax of $32,034,311. The Service mailed a notice of deficiency, which disallowed the discount for the assumption of potential estate tax liability. The taxpayer filed a petition in Tax Court and the Service filed a motion for summary judgment.
The sole issue asserted by the Service was that the daughters’ assumption of potential Code Section 2035(b) estate tax liability did not increase the value of the petitioner’s estate and therefore did not constitute consideration in money or money’s worth (under Code Section 2512(b)) in exchange for the gifts. The opinion contains a comprehensive history of net gifts and Code Section 2035(b). The Tax Court rejected its own analysis in McCord that the value of the contingency was “too speculative” to be determined. While the Tax Court in McCord was later reversed by the 5th Circuit Court of Appeals, the case at hand was not within the 5th Circuit, and therefore not bound by that reversal. Consistent with the appellate McCord decision, the Tax Court found as a matter of law that the actuarial value of the assumption of estate tax liability was not precluded from treatment as consideration in money or money’s worth for purposes of determining the value of the “net net” gift.
IRS Terminates Estate Tax Payment Plan Under Code Section 6166 for Missed Installment Payments While Valuation of Estate Asset is Pending. In Estate of Adell v. Commissioner, T.C. Memo. 2013-228 (Sept. 30, 2013), the Tax Court upheld the IRS’s decision to terminate a Code Section 6166 estate tax installment payment plan on account of the estate’s failure to make two required annual payments. The estate had applied for an extension to make the interest payments in two of the first five years of the estate’s fifteen-year estate tax payment plan. Successive personal representatives had been replaced during that time and were involved in a number of actions involving recovery of estate assets from predecessors. In addition, one of the estate’s assets reported as $9.3 million on the IRS Form 706 was subject to a proposed adjustment to $92 million by the Appeals officer. The estate tax installment payments were not made when due, and the Service issued a final notice and demand for estate tax installment payments. The Service then issued a preliminary determination letter terminating within 30 days the Code Section 6166 election. During discussions relating to the estate’s protest to the proposed adjustment, no attempt by estate’s counsel was made to address the termination of the Section 6166 election. After receiving notification that the Code Section 6166 election had been terminated, the estate filed a petition claiming that the termination of the Code Section 6166 election was an abuse of discretion given the uncertainty of the amount of estate tax owed by the estate. The estate took the position that the case should not be tried until the valuation matters had been resolved. Finding that the disputed value of the estate asset was not material to the abuse of discretion analysis, the Tax Court upheld the IRS’s termination of the estate tax installment payment plan.
Federal Administrative Developments
IRS Releases Interest Rates to be Used By Estates For Special Use Farm Real Property Under Code Section 2032. In Revenue Ruling 2013-19 (Sept. 23, 2013), the Service issued the 2013 interest rates to be used in computing the special use value of farm real property under Code Section 2032A. The rates range from 4.99% to 5.49% depending upon the state in which the property is located.
Windsor Extended to Recognize Valid Same-Sex Marriages in Every State for All Federal Tax Purposes as of September 16, 2013 and Retroactively for Open Tax Years. In Revenue Ruling 2013-17 (Aug. 29, 2013), two months after Windsor, the Department of Treasury and the Internal Revenue Service issued Revenue Ruling 2013-17 extending the application of Windsor to apply “spouse” and “marriage” to same-sex spouses for all federal tax purposes and in all states, not just those states such as New York that recognize same-sex marriage. The marriage must have been valid in the state, territory, or foreign country where the couple was married. Specifically, the ruling held that Internal Revenue Code terms “spouse” and “marriage” include, respectively, “an individual married to a person of the same sex if the couple is lawfully married under state law” and “a marriage between individuals of the same sex.” Consistent with Windsor, where taxpayer sought a refund based on application of the marital deduction to a same-sex spouse, the Service’s ruling further addressed Code references to “husband and wife” found no evidence that Congress intended to exclude any couple legally married under state law. The Service pointed out that individuals of the same sex are lawfully married for Code purposes as long as they were married in a state authorizing same-sex marriages without regard to domicile or subsequent changes thereto. A significant consideration is the need for uniformity, stability, and efficiency in the application of the Code. Otherwise taxpayers, the Service, and third parties such as employers and plan administrators would risk costly errors and delay. The Service clarified that marriage does not extend to “registered domestic partnerships, civil unions, or other similar formal relationships recognized under state law that are not denominated as a marriage under that state’s law.” Furthermore, parties to such non-marriage designations regardless of sex thereof do not fall within the Code’s terms “spouse”, “husband and wife”, “husband”, and “wife”. The prospective effective date is September 16, 2013. On or after that date same-sex legally married same-sex couples must file “married filing jointly” or “married filing separately,” and may file refunds claim for all open tax years (2010, 2011, 2012) for any taxes paid (income, gift, estate, etc.). This specifically includes income tax with respect to employer-provided health coverage benefits or fringe benefits provided by the employer and excludable from income based on marital status. The Service expects to provide further guidance on application of Windsor to employee benefit plans and similar arrangements.
IRS Consolidates Revenue Procedures To Provide Exclusive Relief Method For Late S Corporation, ESBT, QSST, QSub, and Entity Classification Elections. In Revenue Procedure 2013-30, 2013-36 IRB 173 (Aug. 14, 2013), the IRS consolidated several revenue procedures into one that sets forth the exclusive method for taxpayers to request relief for late S Corporation elections, electing small business trust (ESBT) elections, Qualified Subchapter S Trust (QSST) elections, Qualified Subchapter S Subsidiary (QSub) elections, and late entity classification elections intended to have the same effective date as that for an S corporation election. The Service included a helpful flowchart for application of the new procedures.
Property Transferred to Revocable Trust is Subject to Federal Tax Lien.
In Chief Counsel Advice 201324017 (June 14, 2013) the IRS addressed whether a federal tax lien (FTL) attaches to property held in the name of a revocable trust. Taxpayer transferred property to a revocable trust. Under Code Section 6321 the FTL attaches to all the taxpayer’s property and rights to property. Under Code Section 676 the grantor of a trust is treated as the owner of the trust when the power to re-vest in the grantor is exercisable by the grantor or a non-adverse party, or both. The Service also cited the trust law principle that revocable trust assets are treated as property of the settlor of the trust. Accordingly, the property transferred by the taxpayer to his revocable trust is treated as the taxpayer’s property for lien attachment under Code Section 6321.
Policy Dividends Alone are Not Incidents of Ownership in Life Insurance Policies.
In Chief Counsel Advice 201328030 (July 12, 2013) the IRS addressed whether at death a decedent insured possessed an incident of ownership in life insurance policies such that the proceeds are includible in the decedent’s gross estate under Code Section 2042. Decedent and former spouse had executed a property settlement agreement that required decedent to maintain life insurance policies for the sole benefit of the former spouse. Decedent paid premiums but could not borrow against or pledge the policies.
Policy dividends belonged exclusively to decedent. Upon decedent’s death the insurance company paid the policies’ proceeds to former spouse, and the executor included the proceeds as part of decedent’s gross estate on Form 706. Under Code Section 2042(2) the gross estate includes property received by all beneficiaries (other than decedent’s estate) as insurance under life insurance policies with the decedent as insured and in which decedent at death possessed any incidents of ownership. The Treasury Regulations provide that the term “incidents of ownership” refers to the rights of the insured or the insured’s estate to the economic benefits of the policy. The Service cited the Tax Court’s previous holdings that the right to dividends that may be applied against current premiums is a mere reduction in the amount of premiums paid, not a right to a policy’s income. Decedent had agreed to maintain the policies solely for the spouse’s benefit. Furthermore, according to the Service, even though the policies’ dividends technically “belonged” to decedent, the right to dividends, by itself, was not an incident of ownership that would cause inclusion under Code Section 2042(2).
Service Addresses Estate and Gift Tax Consequences of Sale of Stock in Exchange for Notes Including SCINs. In Chief Counsel Advice 2013300033 (July 26, 2013) decedent updated his estate plan in the year before the year of his death. In a series of transactions he sold and made gifts of stock to several newly established grantor trusts for family members (“new trusts”). At some point over the period of the sale and gift transactions he became ill and died less than six months after the diagnosis. In the first set of transactions decedent funded grantor trusts with common voting and preferred non-voting stock. Before the funding he substituted common and preferred shares for preferred shares held by existing grantor trusts (“old trusts”). Appraisers valued the stock for purposes of the substitutions and transfers to the new trusts. In the second set of transactions the decedent substituted common and preferred shares for other shares held in the old trusts for the benefit of family members. At the same time, after completing the substitutions, he made a gift of shares to a grantor-retained annuity trust (“GRAT”). Decedent died before the end of the GRAT term, and the GRAT assets that were part of the gross estate passed to charity. On the same date as the second set of transactions decedent entered into a third set of transactions. He transferred stock to the “new trusts” in exchange for promissory notes with a term based on the Code Section 7520 life expectancy tables. Some notes had face amounts equal to the appraised value of the transferred stock to the grantor trusts, with interest payable annually and principal payable at the end of the term. Other notes were self-canceling installment notes (“SCINs”), i.e., the grantor trust, as maker, was relieved from making payments on the note if the holder (decedent) dies before all payments come due. The face value of the SCINs were roughly double the value of the stock to reflect the risk that principal and interest would not be paid to decedent upon death before the end of the note term. The fourth set of transactions entailed decedent’s transfer of stock to the old trusts. In exchange he received notes with a face value equal to the appraised value of the stock. The term was based on the Code Section 7520 life expectancy tables, with interest payable annually and principal payable at the end of the term. Instead of the higher face value these notes had a higher interest rate. Decedent died before receiving any principal or interest on these notes. At the same time as the fourth set of transactions, decedent entered into a fifth set of transactions that created another GRAT and funded it with stock and promissory notes received from the previous sales. Shortly after the fourth and fifth set of transactions decedent was diagnosed with an illness and died less than six months thereafter.
The decedent’s estate filed IRS Form 709 (gift tax return) setting forth the GRAT-related taxable gifts and corresponding gift tax, some non-taxable gifts, and the SCIN transactions with no gift taxable gift reported. The estate also filed IRS Form 706 (estate tax return), which set forth on Schedule G (i) the non-self-cancelling promissory notes at face values plus accrued interest, and (ii) the value of the GRATs, but not the SCINs.
The issues were (i) whether decedent’s transfers of stock to grantor trusts in exchange for SCINs constituted a gift; (ii) how to determine the fair market value of the SCINs; and (iii) if the transfers did not constitute a gift, the estate tax consequences of the cancellation of the SCINs upon the decedent’s death.
With respect to the first issue, whether the transfer of stock in exchange for SCINs constitutes a gift, the Service looked to whether the value of the notes is equal to the value of the stock. If the FMV of the promissory notes is less than the FMV of the property transferred to the grantor trusts, then the difference is a deemed gift under Code Section 2512(b). Treasury Regulations Section 25.2512-4 provides that the FMV of secured or unsecured notes is presumed to be the unpaid principal plus accrued interest to date of the gift unless the donor establishes a lower value by satisfactory evidence (e.g., interest rate, maturity date, uncollectible, insufficient security). Treasury Regulations Section 25.2512-8 provides that a sale or exchange in the ordinary course of business will be considered as made for adequate and full consideration in money or money’s worth. In this case, the Service noted that the face value and length of payment must be reasonable based on the circumstances. The total face value of the notes was almost twice the amount of the stock to take into consideration the self-cancelling nature of the notes. The notes called for interest-only payment until a balloon payment at the end of the term. The decedent died less than six months after the transfer and did not receive interest or principal payments prior to death. The Service distinguished the facts from those in Estate of Costanza v. Comm’r, 320 F.3d 595 (6th Cir. 2003) where a business was sold to a taxpayer’s son for a SCIN which called for regular payments of interest and principal necessary to provide a steady stream of income to the taxpayer. In that case there was a bone fide arrangement because the decedent expected repayment and intended to enforce the collection. In this case, the Service noted that a steady stream of income was not contemplated, the decedent had substantial assets, and that the decedent did not require income from the notes to cover his living expenses. The Service concluded that the arrangement was nothing more than a device to transfer the stock to other family members at a lower value than the fair market value of the stock.
With respect to the second issue, how to determine the fair market value of notes with a self-cancelling feature, the reported value of the notes was based on a term chosen within the decedent’s life expectancy and then either the face amount or interest rate was adjusted to account for the value of the self-cancelling feature. The Service noted that unlike annuities, life estates, term or remainder interests, where is it appropriate to base valuation on the decedent’s life expectancy, the FMV of promissory notes is based on a willing-buyer willing-seller standard and should take into consideration decedent’s medical history on the date of the gift.
With respect to the third issue, the consequences of the self-cancelling feature upon death, Code Section 2033 includes the value of all property to the extent of the decedent’s interest at the time of death and Code Section 2038 includes the value of any interest which the decedent has transferred (except in the case of a bone fide sale for an adequate and full consideration) the enjoyment of which is subject to change through the exercise of a power by decedent. The Service compared the facts to a case where the decedent made a loan to his son a month before his death for the stated purpose of satisfying a debt of his sister’s estate. Estate of Musgrove v. United States, 33 Fed. Cl. 657 (1995). In Musgrove the court concluded that the property was includible in the decedent’s estate because he had retained the note at his death, never demanded repayment, and controlled the son’s use of the money (to pay the debt on the sister’s estate). In the ruling, the Service noted the similarities – the use of a SCIN by a person in poor health, right before death. The Service concluded without analysis that there were no estate tax consequences associated with the cancellation of the notes upon the decedent’s death.
Fractional Funding of Charities’ Share of Residuary with IRAs Naming Estate as Beneficiary is not a Transfer of IRD Taxable to Estate. In PLR 201330011 (July 26, 2013), the IRS addressed the distribution of several IRAs in fractional shares between charitable residuary beneficiaries of a decedent’s revocable trust. The estate was the beneficiary of each IRA. The terms of the decedent’s will provided for distribution of assets to the decedent’s revocable trust. The decedent’s revocable trust provided that two charities receive fractional shares of the residue of the decedent’s estate. Code Section 691(a)(2) provides the general rule that when the right to receive IRD is transferred by an estate, the full fair market value of the right to receive IRD is included in the estate’s income. Treasury Regulations Section 1.691(a)-4(b) provides an exception for transfers of the right to receive IRD to a specific or residuary legatee, in which case the recipient, not the estate, includes items of IRD in income only in the tax year in which the income is received. The transfer of the IRAs to the charities will not result in IRD taxable to the estate; rather, the charities will include IRD in their gross income when distributions actually received.
Trust Transfer of Policy on Husband and Wife is Not a Transfer for Valuable Consideration.
In PLR 201332001 (Aug. 9, 2013), the Service addressed the transfer of a life insurance policy insuring the lives of husband and wife from a trust for the benefit of children distributable outright at the death of the surviving spouse to a perpetual trust for the benefit of the children with special needs provisions for one of the children. Husband and wife were partners of a partnership. The transfer was for consideration equal to the interpolated terminal reserve value of the policy. The latter trust, a grantor trust for income tax purposes, will own the policy that, in turn, will be treated as owned by the Grantor husband. The portion of the life insurance policy insuring the life of the wife will be treated as transferred to the husband as a partner in the partnership with the wife as partner. Accordingly, the transfer was excepted from the transfer for value rule of Code Section 101(a) because it was a transfer to an insured and to the partner of the insured for income tax purposes.
Valid Disclaimer of pre-1977 Trusts Within Nine Months of Learning of Transfers.
In PLR 201334001 (Aug. 23, 2013), the Service addressed a disclaimer of a remainder interest in each of four trusts created before the Jan. 1, 1977, the effective date of Code Section 2518. Taxpayer proposed to execute the disclaimers within nine months after learning of the transfers creating the interests. The Service cited Regulation Section 25.2511-1(c)(2) and case law, which for pre-1977 interests generally requires that the refusal to accept ownership be made within a reasonable time after knowledge of the existence of the transfer, not after distribution or vesting of the interest. As long as the disclaimers complied with the applicable regulation and were valid under state law, the taxpayer’s disclaimers of interests in the trusts would not be taxable gifts under Code Section 2501.
QTIP Election Not Necessary to Reduce Estate Taxes to Zero is Void.
In PLR 201338003 (Sept. 20, 2013), the Service addressed a QTIP election that was not necessary to reduce estate taxes to zero. The decedent left his residuary estate to a revocable trust that became irrevocable upon his death. Pursuant to trust terms the Trustee was directed to fund a marital trust and a credit shelter trust. Under the terms of the credit shelter trust, the Trustee was directed to distribute income and principal to the surviving spouse and children. Spouse, as executrix of the estate, allocated the residuary estate to the credit shelter trust (not enough to fund marital trust) and filed IRS Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return listing the credit shelter trust as QTIP property. Code Section 2044 provides the value of the gross estate includes the surviving spouse’s QTIP property. Code Section 2519(a) and (b) provides that disposition of all or part of the QTIP property is treated as a transfer of all interests in the property other than the qualifying income interest. Code Section 2652(a) provides that the surviving spouse will be treated as the transferor of the QTIP property for generation-skipping transfer (GST) tax purposes in the absence of a “reverse QTIP” election under Code Section 2652(a)(3). Under Rev. Proc. 2001-38, 2001-1 C.B. 1335, the Service will treat a QTIP election as null and void for purposes of Code Sections 2044(a), 2056(b)(7), 2519(a), and 2652 where the election was not necessary to reduce estate tax liability to zero. In this ruling the estate tax liability would have been zero without the QTIP election, so the Service ruled that the election was null and void for estate, gift, and GST purposes.
Division of IRA into Three sub-IRAs for Intestate Beneficiaries Is Not a Transfer of IRD Taxable to Estate; 5-Year Rule Applies. In PLR 201338028 (Sept. 20, 2013), the Service addressed the death of a 68 year-old IRA owner whose failure to name beneficiaries resulted in the (intestate) estate as beneficiary. The IRA owner died before reaching his required beginning date, and the IRA did not have a designated beneficiary, so the five-year rule applied to distributions from the IRA as later divided. The division into separate IRAs for each heir was not a “transfer” of IRD for income tax purposes, so amounts were taxable only as distributed from each separate IRA to the corresponding heir. The Service also noted that nothing in the Code Section 401(a)(9) or the corresponding Treasury Regulations precluded posthumous division of an IRA into more than one IRA.
North Carolina Case Law Developments
Court of Appeals Affirmed Order to Disqualify Counsel from Representing Fiduciary in Individual Capacity. In Williams v. Williams, 746 S.E.2d 319 (N.C. Ct. App. Aug. 6, 2013), heirs sought damages and declaratory relief against Defendant in both individual and fiduciary capacities. Plaintiff heirs were decedent’s siblings, and Defendant (Amber) had represented to the Clerk that she was decedent’s daughter and sole heir-at-law. Amber had bank add her name as a co-owner of a survivorship account, and she retained counsel to prepare a durable power of attorney naming her as decedent’s attorney-in-fact. The Clerk appointed Amber as administratrix; thereafter the siblings petitioned for Amber’s removal. The Clerk determined that Amber was not an heir but allowed her to continue serving as administratrix.
Thereafter the siblings filed suit asserting claims against Amber in both individual and fiduciary capacities. On behalf of Amber in fiduciary capacity, law firm moved to dismiss, then siblings moved to disqualify law firm from the fiduciary representation. The trial court found that law firm had represented Amber in both capacities and disqualified it from individual representation. The Court of Appeals found no abuse of discretion and noted as persuasive N.C. St. B. Ethics Op. RPC 137 (Oct. 23, 1992) (lawyer who formerly represented estate cannot later defend the former PR against estate’s claim) and N.C. St. B. Ethics Op. RPC 22 (Apr. 17, 1987) (in absence of heirs’ consent lawyer cannot represent administratrix in both fiduciary and individual capacities where interests in the two roles conflict).
Civil Cause of Action for Perjury Not Available in Fraudulent Will Matter.
In Gilmore v. Gilmore, 748 S.E.2d 42 (N.C. Ct. App. Sept. 17, 2013), three defendants (Sherrie, Deana, and Milton) conspired to create a fraudulent will for Sherrie’s husband, Jackie. Deana and Milton signed the paper as witnesses knowing that Jackie did not sign the paper, did not ask them to sign as witnesses, and did not indicate that he intended the paper to be his will. After Jackie died Sherrie submitted it for probate falsely stating that it was Jackie’s will and that under oath and penalties of perjury she believed that the paper was Jackie’s will. Deana and Milton further signed the affidavit of subscribing witnesses under penalties of perjury. Plaintiffs moved to revoke probate, and defendants gave false testimony at the hearing. Plaintiffs filed an amended complaint asserting claims for fraud, conspiracy to commit fraud, a pattern of racketeering activity in violation of N.C. RICO, and obstruction of justice. The court denied judicial notice of the criminal charges and the trial court’s revocation of probate of the purported will. The court granted defendants’ 12(b)(6) motion to dismiss for failure to state a claim. It reaffirmed the well-established principle that perjury and subornation of perjury, though indictable criminal offenses, do not give rise to a civil cause of action in North Carolina.
Three-Year Statute of Limitations Barred Claim for Fraud; Existence of Fiduciary Relationship Alone Was Not Sufficient to Extend Statute of Limitations to Ten Years for Constructive Fraud; Modification of Testamentary Trust Action was Impermissible Because Not Filed as a Caveat.
In James v. Schoonderwoerd, 2013 N.C. App. LEXIS 943 (N.C. Ct. App. Sept. 17, 2013), the Court of Appeals addressed whether the three-year statute of limitations was appropriately applied to bar claims for constructive fraud and trust termination and modification in a case against an attorney-in-fact and trustee acting under documents prepared by and executed with an attorney. The clients, a husband and wife, had a daughter with two children and a son with no children. The daughter contacted an attorney about meeting with her parents to prepare and execute estate planning documents. The attorney met with the couple and daughter (separately) over the course of several months in 2001. During that time the attorney met with and discussed credit shelter planning with the clients and explained that they would have to execute deeds dissolving tenancy by the entirety ownership of their four tracts of real property. The daughter, and later the daughter’s son, were named as sole attorneys-in-fact. The wills named the daughter, her children, and the son as beneficiaries of a testamentary trust with the surviving spouse and grandson named as co-trustees. The clients also executed deeds changing the ownership of the properties to tenants-in-common. The wills were subsequently amended two months later by codicil to change the beneficiaries of the testamentary trust to only the clients’ children. The husband died in 2003, and while the estate was open, the wife sold one of the properties, signing the deed both in her individual capacity and as co-trustee of the trust. She received one-half of the sale proceeds in her individual capacity. In 2004, one year after her husband’s death, the wife met with a new attorney to understand the will and trust. As a result of the meeting, she asked the new attorney to prepare a new will leaving all her property to her son. She signed the new will in 2004 and then tried several times from 2005 to 2008 to gain control of the trust assets until filing an action in 2010, almost six years after her meeting with the new attorney to explain the terms of the will and trust. Upon deposition, she testified that she did not remember meeting with the attorney and was on seventeen medications during the time. Her husband’s neurologist testified that the husband suffered from vascular dementia and that he expected him to have “significant cognitive impairment” that would not allow him to execute legal documents. The wife testified that neither she nor her husband understood the wills and deeds that they executed in 2001. The attorney testified that their daughter told him in 2001 that her parents were “very competent” and he testified that he found the wife to be very competent when she executed the will in 2001. The elements of a constructive fraud claim necessary to extend the statute of limitations to 10 years are (1) a relationship of trust and confidence, (2) the defendant took advantage of that position to better himself, and (3) injury to the plaintiff. The court noted that the only transactions in question were the power of attorney naming daughter in 2001, power of attorney naming daughter’s son later in 2001, and deeds terminating tenancies by the entirety in 2001. The constructive fraud claim surrounding the execution of the 2001 will could not be brought because this action can only be brought by caveat. The court noted that the mere existence of the fiduciary relationship evidenced by the powers of attorney was not enough when the individuals named never acted under the power of attorney to transfer the principal’s property. Finally, the court did not find that execution of the deeds benefited the daughter or her son. The court found it clear that husband intended to benefit both of his children by executing the will, and that to the extent the wife wanted to revise her documents to change the disposition of her assets, she may do so, but the court would not allow the transfer of assets in trust that would be to the detriment of the husband’s trust beneficiaries. With respect to the modification and termination of trust claim, the Court supported the finding of summary judgment, citing cases supporting the proposition that the action was an impermissible collateral attack of the terms of a will and should have been brought as a caveat action. Finally, the court affirms the dismissal of the fraud action by finding that the wife had reason to discover the alleged fraud when she met with the new attorney in 2004. She did not file a complaint until 2010, which was after the three-year statute of limitations had run.
The Statute of Limitations Barred Actions for Fraud and Breach of Fiduciary Duty.
In Robert K. Ward Living Trust v. Peck, 2013 N.C. App. LEXIS 961 (N.C. Ct. App. Sept. 17, 2013), the successor trustee of a trust brought an action for fraud and breach of fiduciary duty against the former trustee (the attorney who drafted the trust) more than six years after the trustee resigned as trustee. The actions were barred by the expiration of the five-year statute of limitations.
North Carolina Administrative Developments
Application of Windsor and Revenue Ruling 2013-17 in North Carolina Prohibits Same-Sex Couples from Filing as Married and Will Require Separate Calculation and Reporting for State Income Tax Purposes. In NCDOR Directive PD-13-1 (Oct. 18, 2013), the NCDOR addressed the impact of IRS Revenue Ruling 2013-17 on filings for North Carolina individual income and withholding tax purposes. NCDOR will not follow the new definitions in Rev. Rul. 2013-17 because North Carolina does not recognize same-sex marriages as valid. Individuals who enter into a same-sex marriage in another state cannot file as married filing jointly or married filing separately, but must file as single or head of household or qualifying widower. Such individuals must prepare a pro forma federal return to determine each individual’s adjusted gross income, deductions, and tax credits allowed under the Code for the filing status used for North Carolina purposes and then attach a copy of the pro forma return to the North Carolina return.
North Carolina Legislative Developments
Session Law 2013-81 (increasing year’s allowance for a surviving spouse) | N.C.G.S. § 30-15, -29. Effective for estates of persons dying on or after January 1, 2014, the surviving spouse’s year’s allowance increases from $20,000 to $30,000.
Session Law 2013-91 (updating and clarifying provisions of laws governing estates, trusts, guardianships, powers of attorney, and other fiduciaries) | N.C.G.S. § 28A-18-2(a). The wrongful death recovery provisions were amended to correct the reference to the State Health Plan subrogation rights and to clarify that claims for the decedent’s burial expenses and reasonable hospital and medical expenses are subject to the approval of Clerk of Superior Court.
N.C.G.S. § 28A-29-1, -2(a). The relatively new provisions on notice to creditors without estate administration were amended to describe in more detail when the procedure can be used. Generally speaking, if no application or petition for appointment of a personal representative is pending or has been granted, a qualified person or trustee of decedent’s revocable trust can invoke the procedure in one of five situations: (i) the decedent died testate or intestate and left no personal property subject to probate and no real property devised to the personal representative; (ii) administration by collection by affidavit; (iii) administration by summary administration; (iv) estate consisting solely of a motor vehicle transferable under N.C.G.S. § 20-77(b); or (v) the decedent left assets that may be treated as assets of an estate for limited purposes under N.C.G.S. § 28A-15-10.
N.C.G.S. § 30-3.1. The elective share provisions were amended to determine the surviving spouse’s share based simply on the length of the marriage, not on the existence or number of lineal descendants and whether the spouse is a second or successive spouse. Effective for estates of decedents dying on or after Oct. 1, 2013, the applicable share of the Total Net Assets is as follows:
N.C.G.S. § 30-31. The Year’s Allowance provision was amended to clarify that the Clerk of Superior Court may order the estate to pay the surviving spouse’s attorney’s fees and costs and that such amounts are paid as administrative expenses of the estate.
N.C.G.S. § 31-11.6. The provisions setting forth how attested wills may be made self-proved were amended to expand as self-proving those wills shown by the propounder as self-proving under the laws of another state. Furthermore, military testamentary instruments executed in accordance with 10 U.S.C. § 1044d(d) are considered self-proved.
N.C.G.S. § 31-46. The will validity provisions were expanded to include as valid wills executed in compliance with the laws of the place where executed at the time of execution, wills executed in compliance with the laws of the decedent’s domicile at execution or at death, or military testamentary instruments executed in accordance with 10 U.S.C. § 1044d(d). The provisions on non-resident decedent wills also were updated to include the additional executed wills considered valid under N.C.G.S. § 31-46.
N.C.G.S. § 36C-1-114. This is a new section of the trust code that codifies a trustee’s insurable interest in a person insured under a trust-owned life insurance policy. On the date the policy is issued, the insured must be either the settlor or a person in whom the settlor has an insurable interest upon issuance of the policy. In addition, the policy proceeds must be primarily for the benefit of one or more trust beneficiaries that have an insurable interest in the insured’s life. This new provision does not limit any existing common law or statutory right to insure, and it must be construed liberally to sustain insurable interest.
N.C.G.S. § 36C-5-505(c). This provision was amended to clarify that the settlor’s spouse is a person to whom the settlor was married at the time the irrevocable intervivos trust was created, notwithstanding a subsequent dissolution of the marriage.
N.C.G.S. § 36C-8-816. Among the trustee powers is the power to exercise federal, state, and local tax elections. This provision was expanded to include consideration of discretionary distributions to a beneficiary as made from capital gains realized during the year.
N.C.G.S. § 36C-8-816.1(c)(3). The decanting statute was further clarified. With respect to the trustee’s power to appoint to a second trust, the existing provision prohibiting the second trust terms from reducing a beneficiary’s fixed income, annuity, or unitrust interest in the original trust was amended to require that such interest actually have come into effect with respect to such beneficiary.
N.C.G.S. § 36C-8-816.1(c)(8), -(e)(2). With respect to the exercise of the power to appoint principal or income to a second trust, the references to N.C.G.S. § 41-23 (Perpetuities and Suspension of Power of Alienation for Trusts) were updated such that the limitation specifies the permissible period allowed for the suspension of the power of alienation of the original trust and the time from which the permissible period is computed.
N.C.G.S. § 1C-1601(a). The provisions exempting IRAs from creditor claims were amended to clarify that after the IRA owner’s death IRA assets remain exempt if held by one or more subsequent beneficiaries via direct transfer or eligible rollover excluded from gross income. The new provision specifically includes direct transfers or eligible rollovers to “inherited” or “beneficiary” IRAs.
N.C.G.S. § 32-72(d). The provisions addressing directed fiduciaries other than trustees were expanded beyond the power to direct or consent to a fiduciary’s actions to include all powers with respect to actions of a fiduciary. An additional exception to the rule that persons who hold such powers are fiduciaries was added to beneficiaries who hold such powers was added to provide that the beneficiary who has the power to remove and appoint a fiduciary is not a fiduciary.
N.C.G.S. § 35A-1251, -1336.1, -1341.1. With respect to gifts by incompetents that require judicial approval, the prerequisite that the gift not exceed the federal gift tax annual exclusion was expanded to provide that the gift may qualify either for the federal annual gift tax exclusion under Code Section 2503(b) or is a qualified transfer for tuition or medical expenses under Code Section 2503(e). The general provision that a guardian of the estate of an incompetent ward not alter the ward’s estate plan was expanded to allow the guardian to incorporate tax planning or public benefits planning into the existing estate plan, which may include leaving assets in trust.
N.C.G.S. § 78C-2, -8. The Dodd-Frank Act replaced the “private adviser” exemption for individuals with fewer than fifteen clients with a rule that now gives the SEC the ability to define “family offices.” The provisions that incorporated the (now repealed) federal law were revised to preserve the exemption at the state level for private advisers who had fewer than fifteen clients during the preceding 12 months.
Session Law 2013-132 (amending laws governing credit unions)
N.C.G.S. § 54-109.58(e)-(h). A credit union is not liable for complying with a writ of execution, garnishment, attachment, levy, or other court-ordered process to seek funds held in the name of any joint tenant. A joint account with right of survivorship at a credit union may be established by election by the joint tenants on a signature card or explanation in a separate document. Any joint tenant may terminate the account, and where an account is held by two or more individuals, the account will remain in the name of the remaining tenants, but the removed joint tenant will remain liable for any debts incurred in connection with the joint account during the period in which named as a joint tenant.
N.C.G.S. § 109.60A, -B. These provisions govern the administration of share, deposit, and custodial share accounts opened by or on behalf of minors.
N.C.G.S. § 109.62, -62A. These new provisions govern the administration and disposition of an account for a principal, decedent, or incompetent by the respective agent or duly qualified representative.
N.C.G.S. § 109.82. The investment of funds is expanded beyond the form of investment allowed by the State Treasurer to include investment in corporate bonds with an A+ rating.
Session Law 2013-157 (amending and restating the North Carolina Limited Liability Company Act) | Chapter 57D of the North Carolina General Statutes contains the restated North Carolina Limited Liability Company Act.
Session Law 2013-198 (modernizing provisions relating to children born out of wedlock) | N.C.G.S. § 29-19. The existing requirements for a child born out of wedlock to inherit from the child’s father are expanded to also allow a child born out of wedlock to inherit from such child’s father if the father died within one year of the child’s birth and who is established to be the father by DNA testing.
Session Law 2013-316 (simplifying North Carolina tax structure including elimination of North Carolina estate tax).
Session Law 2013-378 (clarifying notice requirements and creditor status relating to Department of Health and Human Services, Division of Medical Assistance (Medicaid)) | N.C.G.S. § 108A-70.5(b)(2). DHHS has all rights as an estate creditor, including the right to be appointed as collector.
N.C.G.S. § 28A-14-1(b). This provision requires that a copy of notice to creditors be delivered or mailed to DHHS if decedent was receiving medical assistance at the time of death.
N.C.G.S. § 28A-19-6(a). DHHS is a 6th class creditor for purposes of determining claims against an estate.
N.C.G.S. § 36C-8-818. The trustee of a revocable trust established by a person who is receiving medical assistance (to the trustee’s knowledge) at time of death is required to provide notice to DHHS within 90 days of such person’s death. •
Mr. and Mrs. Cella are shareholders of Manning, Fulton & Skinner, P.A., Raleigh, N.C.