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Court Listens to Construction Proceeding Regarding Tax Returns


The executors have instituted this construction proceeding, prior to the filing of Federal and New York estate tax returns, to determine the effect of a tax exoneration clause, paragraph second and request a reformation or interpretation of paragraph eleventh, which creates a pre 1969 residuary, multiple, split-income, charitable remainder trust so as to qualify it for a charitable deduction under U.S.Code, tit. 26, § 2055 as amended by the Tax Reform Act of 1969 (TRA).

The testator died on September 9, 1973, age 92, leaving a daughter, age 64, as his sole distributee, and a granddaughter and three great-grandsons. His will, executed on December 19, 1967 was admitted to probate and letters testamentary issued to petitioners on October 1, 1973.

Paragraph second of the will provides: I direct that all my funeral, administration expenses, just debts, and all estate and inheritance or succession taxes be paid as soon after my death as may be practicable. After several outright and in trust cash bequests to his daughter, granddaughter, great-grandsons and friends totalling $38,050, testator gave his residuary estate to his trustees in trust.

The income of any part which shall remain undisposed because of the death prior to the termination of the trust of the persons hereinabove named to receive the same shall be distributed ratably among the beneficiaries of the remaining parts in the proportion that their respective income interests bear to the aggregate of the income interests of all the remaining parts.

Upon the death of the testator’s daughter the trust remainder is payable in the same proportions as the excess income. Though the petition does not set forth the assets comprising the testator’s estate, petitioners’ attorney has informed the court that the assets and deductions for estate tax purposes

The residuary probate estate, after deducting the preresiduary outright and in trust bequests, but before estate taxes, is $845,580. Petitioners allege that the loss of the charitable deduction because the trust is not a charitable annuity trust under TRA would increase the estate tax by $163,000. It should be noted that prior to December 31, 1969, the estate would be entitled to a charitable deduction since the amounts payable to the charities could be readily determined.

Before proceeding with the construction of paragraphs second and eleventh of the will, the court is called upon to determine a question of jurisdiction, which appears to be of first impression.

Petitioners named and cited as interested parties, in addition to the charitable and noncharitable residuary legatees, the Attorney General of the State of New York (AG), the United States Treasury Department–Internal Revenue Service (IRS), and the New York State Tax Commission (Commission). With the exception of the IRS all of the cited parties have duly filed notices of appearances.

The decedent’s daughter Mary Simms denies any consent to acceleration of the charities’ remainder interests and filed an answer opposing the relief requested by the petition.

Both the United States Department of Justice and the United States Attorney for the Eastern District filed written objections to the IRS being made a party. They contend that IRS is not a legal entity which can be sued; that if the real party in interest is the United States, it has not waived its sovereign immunity. Because of the opposition of the United States, the IRS cannot be deemed a party.

As a result of the answer, court personnel have had several conferences with the attorneys for all of the parties in an attempt to dispose of the issues amicably. The Commission’s attorney participated in such conferences. While the petitioners and all the residuary legatees have filed memoranda of law in support of their respective positions, neither the attorney for the Commission nor AG has submitted a memoranda of law. Following the submission of the proceeding for decision, the Commission moved for an order dismissing the proceeding as to it, or in the alternative, dropping it as a party.

In his supporting affidavit the attorney for the Commission alleges that the allowance of the charitable deduction is a matter for the IRS, which determination, under Article 26 of the Tax Law is binding upon the Commission in the absence of fraud or palpable error. Since the IRS is not a party to this proceeding and in any event would not be bound by any determination of this court under Commissioner v. Estate of Bosch, supra, the Commission contends that it should not be bound by this court’s determination, but only by the determination of the IRS.

As to the tax exoneration clause, the Commission admits that under SCPA 1420(4) all parties to the proceeding are bound by the decree of a court unless modified or reversed on appeal. Nevertheless, the Commission argues that an interpretation of the exoneration clause can affect the extent of the charitable deduction, if any, for estate tax purposes, which would not be binding upon the IRS under Bosch, supra, and likewise would not be binding upon the Commission.

No claim is made that the Commission is not a proper party to this proceeding, nor that the appearance by its attorney was in any way unauthorized or improper. Research by the court fails to reveal any reported case in which the Commission has sought relief similar to that requested here.

In the Estate of Ella M. Stalp a recent case involving a will construction under TRA similar to the instant case the court has been advised that the Commission was cited, appeared but did not file a brief or otherwise participate in the proceeding. Discussing the problems resulting from the judicial construction of the will under TRA and the estate tax implications of his determination, Surrogate Sobel said: In the light of local law, as discussed earlier in this decision, and without regard to present or future transitional provisions, this Court is satisfied that the Treasury will accept the ruling of this Court directing minor reformation of the trust in issue. The section 664 Regulations do not require a ruling of the State’s highest court in such circumstances

TRA as originally enacted provided for a saving or transitional period (IRC 2055(4)(B)(i)(ii)(iii); Reg. 3664–1(g)(1)(i)(ii)(iii)) which is inapplicable to testator, who, petitioners allege at all times was under no mental disability. In his learned analysis of the TRA as it affects charitable trusts under both the old and new law, Surrogate Sobel in the Stalp case, supra, called attention to the need for statutory relief by Congress. Prophetically, on October 26, 1974, Congress amended section 2055(e) of the IRC by the addition of subparagraph (3), Public Law 93–483, 93rd Congress, H.R. 12035, effective as to the estates of decedents dying after December 31, 1969.

This amendment permits estates of decedents dying after December 31, 1969, with wills executed prior to September 31, 1974, creating old law charitable remainder trusts, which do not qualify as a charitable remainder annuity or unitrust to qualify for a charitable deduction in the following language: if the governing instrument is amended or conformed on or before December 31, 1975, or, if later, on or before the 30th day after the date on which judicial proceedings begun on or before December 31, 1975, become final, so that the interest is in a trust which is a charitable remainder annuity trust, or a charitable remainder unitrust, or a pooled income fund, a deduction shall nevertheless be allowed.

In the case of wills of decedents which come within the purview of the 1974 amendment to IRC § 2055, it is obvious that they can only be amended or conformed by a local court such as this court. Any other interpretation of the new transitional amendment would render it meaningless. This has been the interpretation given by the courts to the original saving provisions contained in the TRA and the administrative provisions in income tax Regs. 1–664. The Legislature enacted EPTL 8–1.8 which the Practice Commentary in McKinney’s indicates was passed to conform New York law with the restrictions imposed upon charitable trusts by the TRA.

All of the above cited cases involved post TRA executed wills. The courts have uniformly permitted a construction or reformation of wills to enable estates to claim a charitable deduction pursuant to section 2055 IRC as amended by the Tax Reform Act of 1969. An appearance once served can only be withdrawn with the permission of the court. Accordingly, in light of the 1974 amendment to IRC § 2055 and in the exercise of its discretion, the motion of the State Tax Commission to dismiss the proceeding as to it, or in the alternative, to withdraw its appearance, is denied. Testator, by grouping the payment of taxes with the payment of debts, funeral and administration expenses in paragraph second, indicated an intent to pay estate taxes on the gifts passing under his will as an expense of administration.

Accordingly, pursuant to the provisions of EPTL 2–1.8 estate taxes will be apportioned against non-testamentary gifts and the taxes attributable to gifts passing under the will are to be paid as an expense of administration to be deducted before division of the residuary estate. Lastly, the court is called upon to determine testator’s intent with regard to paragraph eleventh of his will so that, if it is at all possible, the estate will be entitled to a deduction for the gifts to charity.

That testator intended to benefit the three charitable remaindermen named in his will is obvious. As Surrogate Sobel stated in Matter of Stalp, supra, This court finds that Miss Stalp’s honest and straightforward charitable motive, one devoid of any purpose of tax avoidance has been frustrated by an unintended mistake in will draftsmanship, justifying the Court in allowing reformation of Article 32 of her will by minor judicial surgery as hereinafter directed.

The sum of $8,000 which decedent directed to be paid in quarterly instalments to his daughter for life, first from income and so much of the principal as may be necessary created an annuity.

The court has computed the present value of the annuity, based upon a female age 64, as of the date of the decedent’s death to be $79,318.42. After inquiry, the court has been informed that petitioners can purchase a similar commercial annuity from an insurance company for $86,811.93 without any refund, and with a refund feature for $91,463.40. Under the 1974 amendment to the TRA, the court will amend or conform the decedent’s will by the use of the doctrine of segregation as did Surrogate Sobel in the Stalp case, supra, so that the indefeasibly vested income and principal payable to the charities qualifies as a deduction under IRC § 2055.

Rather than create six separate trusts as requested by petitioners in their brief and accelerate payment of one-half of the residue to the charities, which is opposed by decedent’s daughter, the court will create four separate trusts as set forth below.

The residuary estate will be ascertained after deducting from the gross probate estate, debts, funeral, administration expenses, estate taxes, and the cash bequests, both outright and in trust pursuant to paragraphs third through tenth inclusive, from which a charitable annuity remainder trust of $80,000 will be created. Pursuant to EPTL 8–1.8 this trust will be held by the trustees pursuant to all the income and estate provisions of the Internal Revernue Code and regulations relating to charitable annuity trusts from which an annuity of $4,000 per annum (5% Of the principal), will be paid in quarterly instalments first from income and then from principal to the decedent’s daughter for life. The annual excess income, if any, and principal upon death to be paid to the three designated charities in accordance with the proportions designated in paragraph eleventh (a) 4, 5 and 6 of the decedent’s will.

A second private non-charitable remainder trust found of $80,000 is to be created to be held by the trustees from which an annuity of $4,000 per annum (5% Of the principal in quarterly instalments, is to be paid to the decendent’s daughter for life, first from income and then from principal, excess annual income and the principal upon her death to be paid to the persons designated in the proportions set forth in paragraph eleventh (a) 1, 2 and 3 of the provisions of the decedent’s will.

The balance of the residuary estate after the funding of the two $80,000 trust funds to be divided into two equal trusts both to be held during the life of the decedent’s daughter, one for the benefit of the charitable remaindermen and the other for the other noncharitable remaindermen pursuant to the provisions of subparagraph (b) 1, 2, 3, 4, 5 and 6 of paragraph eleventh of the decedent’s will. The charitable trust in accordance with the provisions of EPTL 8–1.8 shall be held by the trustees subject to all of the income and estate tax provisions of the IRC and regulations relating to charitable foundations.

Since the noncharitable income and remainder interests are not indefeasibly vested, the court cannot commute the annuity payable to the decedent’s daughter without affecting the rights of the noncharitable remaindermen who can only be ascertained upon the death of the annuitant.

The aggregate value of the charitable annuity and noncharitable trusts ($160,000) will fully assure the payment of the $8,000 annuity payable to the decedent’s daughter during her life.

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