In 2010, Warren Buffett and Bill Gates made their Giving Pledge campaign public. The Giving Pledge asks some of the wealthiest people in the world to donate at least half of their wealth to charity during lifetime or at their death. As of last year, 168 billionaires have signed the pledge. The fine print of the campaign, however, makes clear that “the pledge is a moral commitment to give, not a legal contract.”

It is not unusual for donors to sign a charitable pledge when committing to make a charitable contribution.  While many think of a charitable pledge as a promise, it can be a legally enforceable contract between a donor and a charity.  Whether a charitable pledge is a legally enforceable contract depends on the specific language in the pledge document and on applicable state contract law.

In recent years, courts have shown more willingness to enforce charitable pledges than has generally been the case in the past.  In an opinion rendered last month in Appalachian Bible College v. Foremost Industries, a federal district court in Pennsylvania followed the recent trend and enforced a charitable pledge by a corporate donor.

THE FACTS

In 2015, Foremost Industries signed a charitable gift agreement promising to pay Appalachian Bible College $4 million in five equal annual installments.  The agreement provided that in entering into the gift agreement, Appalachian Bible College was relying to its detriment on satisfaction of the pledge in full.

Foremost never made any of the payments called for under the gift agreement, and Appalachian Bible College filed suit in federal district court in Pennsylvania.  The College alleged breach of contract, anticipatory breach of contract and unjust enrichment.

THE RULING

In its ruling issued April 17, 2018, the United States District Court for the Middle District of Pennsylvania analyzed the facts of the case just as it would any other contract dispute.  The Court held that Foremost is liable for damages in the amount of $4 million for both breaching the contract and anticipatorily breaching the contract.

THE TAKE AWAY

Not all charitable pledges are enforceable contracts.  In order to determine whether the pledge is enforceable, attention needs to be paid to the particular language of the written instrument.  If the charitable pledge is an enforceable contract, it is binding on the donor and, if the donor is an individual, the pledge is enforceable on the donor’s estate.

Around The Water Cooler we typically do not dive into discussions about law review articles.  However, several outstanding law review articles have been published in the past year which deserve the attention of trustees, trust beneficiaries and others involved in the administration of trusts.

  • For the past few years, Adam Hofri-Winogradow has conducted an exhaustive survey of professional trust service providers.  After receiving over 400 responses from professional service providers all over the world (full disclaimer: I was one of the respondents), he has now published his findings in The Demand for Fiduciary Services: Evidence from the Market in Private Donative Trusts.  Hofri-Winogradow focuses his analysis and conclusions on (1) perpetual trusts, (2) trustee exculpatory terms, (3) asset protection, and (4) settlor control of trusts.
  • Decanting has become increasingly prevalent in the trust world.  Trust decanting is the process of distributing assets from one trust to a new trust with different terms.  As Steve Oshins describes the process, “Just as one can decant wine by pouring it from its original bottle into a new bottle, leaving the unwanted sediment in the original bottle, one can pour the assets from one trust into a new trust, leaving the unwanted terms in the original trust.”  Despite its attractions, trust decanting has serious policy implications.  In his new article in the Cardozo Law Review, Stewart Sterk examines these policy implications and the social costs and benefits of decanting in Trust Decanting: A Critical Perspective.
  • In Probate Lending in the Yale Law Journal, David Horton and Andrea Chandrasekher fix their focus on the probate loan industry.  One of the most controversial trends in the American legal system in recent years has been the practice of litigation lending whereby companies pay plaintiffs a lump sum in return for a stake in a pending lawsuit.  As the authors detail, a similar phenomenon has quietly emerged in the probate system.  Companies are advancing funds to heirs in probate proceedings.  The authors determined that during the course of one year in one county in California, probate lending companies loaned $808,500 in exchange for $1,378,786, a return of 69%.

Around The Water Cooler this morning, we’re talking about impact investing, family business succession planning, and estate tax liens.

  • The rise of impact investing poses unique concerns for trustees.  Impact investments are designed to align environmental, social, governance and faith-based goals with an investment portfolio.  Casey Clark and Andy Kirkpatrick examine whether impact investing is compatible with the Uniform Prudent Investor Act in Impact Investing Under the Uniform Prudent Investor Act.
  • The succession of a family business can often be akin to Odysseus’ passage through Charybdis, a treacherous whirlpool, and Scylla, a man-eating, cliff-dwelling monster in Homer’s Odyssey.  Approximately 70% of family businesses fail to successfully transition to the second generation, and 90% fail to successfully transition to the third generation.  In Advising Family Businesses in the Twenty-First Century, Scott Friedman, Andrea HusVar, and Eliza Friedman apply new insights from the fields of social neuroscience and positive psychology and offer a new approach to the succession of family businesses.
  • The IRS has issued Interim Guidance which clarifies the process for obtaining a Release of an Estate Tax Lien.  At the moment of death, an automatic estate tax lien is imposed on a decedent’s property, and the lien attaches to all property of the estate.  If an estate wishes to sell property before receiving closing letters from the IRS, the estate would prepare and file IRS Form 4422, “Application for Certificate Discharging Property Subject to Estate Tax Lien.”  In the summer of 2016, the IRS began requesting additional documentation and requiring that the net proceeds of the sale be paid over to the IRS or held in escrow until IRS closing letters are issued.  In Update on New IRS Release of Estate Tax Lien Requirements, Shaina Kamen and Michael Schwartz detail the Interim Guidance and new requirements.

Around The Water Cooler this morning, we’re talking about investing trust assets, trust distributions for health and education, generation skipping transfer taxes, and the Uniform Fiduciary Principal and Income Act.

  • Emily Bruner offers considerations for investing assets of Grantor Trusts, Non-Grantor Trusts, Insurance Trusts and Charitable Trusts in Investing for Trusts.
  • Griffin Bridgers and Christopher Harrison provide practical insights on trust distributions for the purposes of health and education in Health and Education in Trust Administration.
  • In Diagnosing the GST Tax Status of a Trust, Nathan Brown and Brandon Ross offer an outstanding analysis at the intersection of trusts and generation skipping transfer taxes.
  • A drafting committee of the Uniform Law Commission has been hard at work on the Uniform Fiduciary Principal and Income Act (“UFIPA”), a revised act to the Uniform Principal and Income Act (“UPIA”).  UFIPA retains the power to adjust and the default income and principal allocation rules in UPIA, and UFIPA includes a broad unitrust provision.  The drafting committee should complete its work this summer.

 

 

Around The Water Cooler this morning, we’re talking about trust investments, the importance of updating retirement account beneficiaries, and “directed trusts.”

Around The Water Cooler this morning, we’re talking about “Generative Trusts” and taxes.

  • Many in the trust field have long known of the work of “John A.” Warnick at The Purposeful Planning Institute.  His has long been a wise voice in the field.  If you are not aware of John A.’s work or The Purposeful Planning Institute, I encourage you to check it out.  John A. recently published an excellent piece on Generative Trusts and Trustees as a guest blogger on Holland and Hart’s Fiduciary Law Blog.  As John A. writes, a generative trust is one that could start out with, in the words of Jay Hughes, “This trust is a gift inspired by love, faith and hope.  The paramount purpose of this trust is to nurture the growth and well-being of the beneficiaries.”
  • And now, taxes:

The Act provides unique planning opportunities, but it also presents potential pitfalls for estate plans drafted before 2018.  It is critical that clients review current plans to ensure that they meet tax and non-tax objectives and determine if they want to take advantage of the increased exemptions.  

ESTATE TAX CHANGES ARE UPON US

The tax bill commonly referred to as the Tax Cuts and Jobs Act (the “Act”) was signed into law by the President on December 22, 2017 and provides unique opportunities and challenges for estate planning clients.  The changes are the broadest rewrite of the U.S. tax code since 1986 and will have widespread impact on both individuals and businesses.  With few exceptions, the provisions of the Act are effective for tax years beginning on or after January 1, 2018, and most of the provisions pertaining to non-corporate taxpayers will expire on December 31, 2025.  The provisions of the Act relating to estate, gift, and generations skipping transfer (“GST”) taxes are not permanent and will expire on December 31, 2025.  No one knows what will happen between now and December 31, 2025.  However, considering the fact that the legislation was passed along party lines, the provisions of the Act could be substantially altered before December 31, 2025 if the political pendulum swings in the other direction in coming election cycles.

WHAT DOES NOT CHANGE

Before diving into how the Act changes estate, gift, and GST taxes, it is helpful to consider what the Act does not change.  During his campaign, then candidate Trump pledged to repeal the estate tax.  The House version of tax reform proposed full repeal of the estate tax.

The Act does not repeal the estate tax or alter its fundamental structure.  The Act does not change the unlimited marital deduction or the unlimited charitable deduction, and the Act does not change estate tax rates.  The Act retains “portability” of estate tax exemption between spouses, which provides that the amount of federal estate tax exemption that a deceased spouse does not use can be transferred to the surviving spouse.

Likewise, the Act does not fundamentally alter the federal gift tax or the federal generation skipping transfer tax. There is still an unlimited gift tax exclusion for payments of tuition and medical expenses; there is an “annual exclusion” that allows for tax-free gifts (increased to $15,000 per person and $30,000 per couple for 2018); and there is an unlimited marital deduction for gifts to spouses who are U.S. citizens.

Also of note, the Act does not change the basis rules for assets received by gift or for assets received at death.  Assets received by gift take a carryover basis; that is, the basis in the hands of the donee is the same as the basis in the hands of the donor.  Assets received at death receive a step-up in basis to the fair market value of the property generally on the donor’s date of death.

WHAT DOES CHANGE

The Act doubles the amount an individual may transfer free of tax either by gift during lifetime or at death.  Before the Act was enacted into law, the exemption amounts in 2018 would have been $5.6 million per individual and $11.2 million per couple.  Under the Act, in 2018, the exemption amounts in 2018 will now be $11.2 million per individual and $22.4 million per couple (these are approximate figures and the final figures may vary slightly since the method for making annual inflation adjustments will change).  For years 2019 through 2025, the exemption amounts will be adjusted for inflation.  Since the estate, gift and GST provisions of the Act sunset after December 31, 2025, the exemption amount in 2026 will revert to pre-Act levels ($5.6 million per individual and $11.2 million per couple, as adjusted for inflation).

Given the increase in the exemption amounts, as a practical matter the Act renders federal transfer taxes irrelevant for all but the wealthiest, and only a small amount of estates will be subject to the estate tax.  In 2000, 52,000 estates paid estate tax.  The Joint Committee on Taxation estimates that the number of estates which will pay any estate tax will drop from 5,000 in 2017 to 1,800 under the new law.

Also included in the Act are various income tax provisions which affect trusts and which provide potential planning opportunities for minimizing trust income taxes.  Trusts should benefit from lower income tax rates (including a top income tax rate of 37%, decreased from 39.6%), and may also be able to take advantage of a new 20% deduction for qualified business income.

A new limitation on the deductibility of state and local income taxes will also apply to trusts and may increase the importance of strategies designed to reduce those taxes. These strategies include changing the income tax residence of existing trusts, the use of grantor trusts, converting existing grantor trusts to separate taxpayers, and making distributions to beneficiaries who may have lower tax burdens.

Also of note to many estate planning clients is the change with respect to Section 529 plans.  Section 529 plans are designed to allow tax-free accumulation of education savings. Under current law, funds in these plans may be distributed income tax free for qualified higher education expenses. The new law allows distributions to be made on the same basis to elementary or secondary schools as well, subject to a limit of $10,000 per plan beneficiary per year.

POTENTIAL PLANNING OPPORTUNITIES

The increased federal estate, gift and generation-skipping transfer tax exemptions will present significant planning opportunities and may also have unintended, and potentially negative, consequences for existing estate planning documents.  Given the significant changes to the federal estate, gift and generation skipping transfer taxes effective on January 1, 2018, clients should consider the following:

Review and Revision of Existing Estate Plans

Your current estate plan reflects the transfer taxes in effect at the time your documents were executed.  In light of the current changes to those transfer taxes, your estate plan should be reviewed to ensure that it still accomplishes your estate planning objectives.  All clients that have previously engaged in tax planning should revisit their estate plans, including the dispositive provisions of all testamentary and non-testamentary trusts. These plans should be evaluated both for tax and non-tax purposes.

Of critical importance, the increase in the exemption has immediate implications for estate plans which use formula clauses.  A formula clause is a provision which allocates assets by reference to the exemption amount, the marital deduction, the GST exemption, or the charitable deduction.  For example, many estate plans allocate estate assets to a marital trust held for the sole benefit of the surviving spouse and a credit shelter trust (also referred to as a family trust or a bypass trust) held for the benefit of the surviving spouse and/or the decedent’s descendants.  Many estate plans fund the trusts using a formula clause which allocates the maximum exemption amount to the credit shelter trust and the rest and remainder to the marital trust.  For all but the wealthiest of individuals, a formula clause may result in all of a decedent’s assets (other than those passing by beneficiary designation or joint ownership) passing to the credit shelter trust; that is, the increased exemption amount may result in only the credit shelter trust being funded and nothing will pass to the marital trust for the sole benefit of the surviving spouse.  This may be a disastrous result given the client’s intentions.

There may also be opportunities to remove limitations in existing trusts. For example, mandatory income distribution standards designed to qualify a trust as a qualified terminable interest property (QTIP) trust may no longer be needed. The trust could be amended to replace the mandatory distribution standards with discretionary distribution standards to provide more flexibility.

Those clients for whom federal transfer taxes are no longer relevant should consider reworking tax and trust planning to eliminate unnecessary complexity or consider moving assets back into their estates to take advantage of the step-up in basis at death.

Build Flexibility into Plans

Considering the fact that the Federal tax law changes are scheduled to sunset after December 31, 2025 and the possibility that changes in Congress and the White House may bring about change to the Act, flexibility is critical for clients with potentially taxable estates. Tools and techniques for building in flexibility to an estate plan include powers of appointment, disclaimers, alternate distribution provisions that change depending on the exemption amount, and trust protectors.

Lifetime Gifting

For those clients who are facing the prospect of paying estate tax, the increase in the gift tax exemption to $11.2 million per individual and $22.4 million per couple may present an exceptional opportunity for lifetime planning through significant gifts made between January 1, 2018 and the sunset of the increased exemptions on December 31, 2025.

For many clients, this will mean adding property to trusts that they have already created.  For others, this will mean establishing new trusts to which to contribute assets.  Other uses of the increased exemption amount include forgiving family indebtedness and unwinding installment sales.

By gifting property during life, donors may successfully avoid transfer taxes on post-gift appreciation.  Further, property gifted to a trust is protected from the creditors of a beneficiary.  Given that the increase in exemption is scheduled to expire or may be reduced by a future Congress, there is an added incentive to accelerate lifetime gifting.  If the client is considering gifts for non-tax reasons (such as asset protection), the increased exemption amount may be enough to tip the scales in favor of a lifetime gift.

Note that one trade-off for making a lifetime gift with appreciated property is that the opportunity for a basis step-up at death is lost.

Opportunities for Generation Skipping Transfer Tax Planning

The benefits of funding dynasty trusts that last for generations will be amplified with the increased GST exemption amount.  Instead of making outright gifts to skip persons, clients can establish a GST trust and allocate the increased exemption amount to such trust, rendering it fully exempt from GST tax.  For clients with existing trusts to which no GST tax exemption was allocated, 2018 (until the sunset) may be the time to make a late allocation. For clients with existing GST tax exempt and non-exempt trusts, the period of increased exemption could be the ideal time to make distributions out of the non-exempt trusts either directly to skip person beneficiaries or to a GST tax exempt trust.

Domestic Asset Protection Trusts

Now may be an ideal time to establish and contribute assets to a self-settled domestic asset protection trust (DAPT).  Establishing and funding a DAPT may not only remove assets (including future appreciation) from a client’s estate but also provide ongoing asset protection for the term of the trust.

Re-Inclusion of Assets

Clients that have made previous lifetime transfers should revisit those transfers in light of the new law to ensure they still meet the client’s planning objectives.  For example, assume that a client transferred family limited partnership or family limited liability company interests to a trust.  Depending on the life expectancy of the client and the extent of the client’s estate, the client should consider techniques to re-include the partnership interests in the client’s estate to take advantage of the basis step-up.  One technique to consider is to give the client sufficient incidents of ownership to trigger inclusion of the assets in his or her estate.

SUMMARY

The Act provides unique planning opportunities, but it also presents potential pitfalls for estate plans drafted before 2018.  It is critical that clients review current plans to ensure that they meet tax and non-tax objectives and determine if they want to take advantage of the increased exemptions.  Looking ahead to the sunset of the Act on December 31, 2025, the challenge is to plan for where we are now taking full advantage of the increased exemptions and build in flexibility for where we may be in the future.

 

* Please note: This advisory should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your situation and any specific legal questions you may have. Readers should not act upon this information without seeking professional counsel.  Please be advised that, this communication is not intended to be, was not written to be and cannot be used by any taxpayer for the purpose of (i) avoiding penalties under U.S. federal tax law or (ii) promoting, marketing or recommending to another taxpayer any transaction or matter addressed herein.

 

In a highly anticipated opinion, the Pennsylvania Supreme Court has prevented an end around the no fault removal provision of Uniform Trust Code (“UTC”) Section 706.  As we discussed in “An ‘End Around’ Trustee Removal,” UTC Section 706 provides that a court may remove a trustee if removal is requested by all of the qualified beneficiaries and the court finds that removal “best serves the interests of all of the beneficiaries and is not inconsistent with a material purpose of the trust.”  In Edward Winslow Taylor, Irrevocable Trust, only three of the four beneficiaries wanted to remove the Trustee, Wells Fargo.  Since all of the beneficiaries did not agree to remove Wells Fargo as the Trustee, they could not use the no fault removal provision of UTC Section 706.  So, the beneficiaries came up with an end around.  They filed a petition in the Court of Common Pleas of Philadelphia County to modify the trust agreement using Pennsylvania’s version of UTC Section 411 in order to add a provision to the trust agreement which would permit a simple majority of the beneficiaries to remove the Trustee.  Their petition to modify the trust agreement was denied by the Court of Common Pleas, and the beneficiaries appealed to the Superior Court of Pennsylvania, an intermediate appellate court, which sided with the beneficiaries and blessed the modification.  Wells Fargo then appealed to the Pennsylvania Supreme Court, and, not surprisingly, the Pennsylvania Bankers Association filed an Amicus Curiae brief in support of reversal of the Superior Court’s decision.

A Win for the Trustees

On appeal, in a unanimous decision, the Pennsylvania Supreme Court reversed the decision of the Pennsylvania Superior Court and set aside the trust modification.  The Court held that allowing the beneficiaries, through modification of the trust, to do something which UTC Section 706 expressly prohibits (that is, removal of a trustee without court approval and unanimous consent of all beneficiaries) would circumvent the very purpose of UTC Section 706 and render it useless.  The Court ruled that UTC Section 706 is the exclusive provision for removal of a trustee and that beneficiaries cannot use the modification statute to add a provision to a trust agreement which would permit the removal of a trustee.

The Problem

A significant number of trust documents which were drafted and executed before the 1990’s do not include a “portability provision” which gives the beneficiaries the power to remove and replace a trustee.  Portability provisions only became widely prevalent in the past few decades.  Many older trust agreements were actually prepared by the very banks which were named as the Trustee, or the banks provided specific language to the grantor’s attorney to include in the trust agreement.  The banks obviously had no incentive to include a clause which would provide the beneficiaries with the power to remove and replace the bank.  Likewise, many grantors, those who established trusts, typically had no incentive to include a clause providing the beneficiaries with the power to remove and replace the trustee.  When these trusts were drafted decades ago, many banks were small businesses which delivered a high level of customer service.  The grantors typically had personal relationships with the bank employees in the trust department and other bank staff.  As the banking industry has experienced a tidal wave of mergers and acquisitions over the past few decades, the grantor’s small bank has long since been gobbled up, and trust beneficiaries find themselves frustrated with the lack of attention and personal service.  Indeed, as the Pennsylvania Supreme Court itself noted in its opinion, the original trustee of the Edward Winslow Taylor Trust, the Colonial Trust Company in Philadelphia, through a series of mergers became Wells Fargo, the 3rd largest bank in the United States headquartered in San Francisco.

A Way Forward?

So, does this court opinion mean that beneficiaries are helpless in the face of a trustee which is not responsive or meeting expectations?  No.  Can the trustee hold the trust at ransom?  No.  There are alternatives to free a trust from an indifferent or incompetent trustee.  If you have questions or concerns about your Trustee, an attorney with deep experience in trust law may be able to help.

A. M. Publishing recently released its 2017 Trust Performance Report.  The Trust Performance Report is based on an annual survey of financial institutions which offer trust administration services.

The aggregate data in the 2017 Trust Performance Report and its sister publication, Fiduciary Earnings and Expenses, reveals, in general, two conclusions: (1) the market rewards those trust service providers which have a tightly focused service offering and (2) the independent trust company model is more successful than the bank trust department model.  The following data points back up the conclusion:

  • The survey data demonstrates that the highest profit margin institutions limit operations, typically focusing on three or fewer service offerings.  Of those that specialize, the overwhelming majority focus on a combination of personal trusts, employee benefits, and investment management services.  Bank trust divisions continue to favor a full-service model.  92% of high profit margin independent trust companies specialize; only 57% of high profit margin bank trust departments specialize.
  • The only institutions which are contemplating selling or outsourcing their trust operations were bank trust divisions.  No independent trust company reported that they are contemplating selling its trust operations.
  • Executives at independent trust companies consistently and by a wide margin report lower stress and concern than do bank trust division or national trust company executives, especially when it comes to meeting account, revenue, and net income targets.

Other interesting data points:

  • P. I. E. assets (personal trust, investment management, and employee benefits assets) account for only 14% of industry assets but generate a whopping 50% of industry gross revenue.
  • To generate $1 of revenue requires $753 of P. I. E. assets.
  • Traditional P. I. E. assets grew overall by 7%.
  • 15% of bank trust departments reported one or more fee increases in 2016.
  • Growing new business is more important to bank trust executives than meeting revenue and net income targets (81% of executives surveyed responded that meeting new accounts was an important concern).

Traditionally, each party to a lawsuit must pay their own fees and expenses, including attorney fees.  Courts typically award litigation fees and expenses against another party only in cases where the other party engaged in egregious conduct such as bad faith or fraud.  Not so in trust litigation.  Section 1004 of the Uniform Trust Code provides a fee-shifting mechanism where litigation fees and expenses may be charged against another party even in the absence of egregious conduct.

Section 1004 of the Uniform Trust Code provides that “in a judicial proceeding involving the administration of a trust, the court, as justice and equity may require, may award costs and expenses, including reasonable attorney’s fees, to any party, to be paid by another party or from the trust that is the subject of the controversy.”  The fee shifting statute’s standard  for awarding costs and expenses is “as justice and equity may require;” certainly a different standard than the traditional standard of egregious conduct like bad faith or fraud.  “As justice and equity may require” is a standard that gives broad discretion to a court to award fees and expenses against another party.  Often times, a court will make a determination on whether to award a beneficiary’s litigation costs against the trustee based on a determination of whether the litigation has been beneficial to the trust.  This is the standard that an Ohio court recently used.

In McHenry vs. McHenry, 2017-Ohio-1534, the Ohio Fifth Appellate District awarded fees and expenses to the beneficiary of the trust.  In McHenry, the plaintiff beneficiary claimed that the trustee breached its fiduciary duty.  The Court agreed and awarded $13,364 to the beneficiary for damages and awarded the beneficiary $49,444 in attorney fees.  On appeal the defendant trustee argued that the attorney fee award was excessive given the relatively small damage award.  In essence, the defendant trustee argued that the Court should apply a rule of proportionality when awarding attorney fees.  The Court rejected the defendant trustee’s argument and held that “a rule of proportionality in trust cases would make it difficult for beneficiaries with meritorious claims against the trustee, but with relatively small potential damage claims, to seek redress in the court.”

Parties to trust litigation should be acutely mindful of the fee shifting statute.  If they are not, they may have to pay not only their attorney’s fee but the other side’s attorney’s fee as well.