One of the major issues for keeping wealth in the family has long been the federal estate and gift tax. The tax rate today is 40%, but historically has been as high as 70%. The exemption amounts were far lower in the past than they are today. To gain control over this tax exposure, some families have created irrevocable trusts for the younger generation. Funding such a trust will trigger federal gift tax exposure, but it freezes the value of family wealth for these tax purposes. Subsequent asset appreciation may pass to beneficiaries without additional transfer taxes.
If an irrevocable trust has been established, there is another strategy to be considered. The trust may be designed so that the grantor of the trust remains responsible for the trust’s income taxes. Why do this? Because the IRS has held that even though the payment of the trust’s income tax obligation will enrich the trust beneficiaries, it will not be a taxable gift to them. In effect, millions more may be transferred to beneficiaries tax free.
This strategy appealed to Norman Millstein. He created two irrevocable trusts for his children, the Kevan Millstein trust in 1988 and the Al-Jo trust in 1987. Kevan was the trustee of both trusts. Perhaps to maximize the amount passing to the children free of federal estate and gift taxes, these were designed as grantor trusts, which meant that Norman remained responsible for paying the income taxes associated with them.
All was well until 2010, when Norman’s wealth was diminished to the point that he could no longer pay the income taxes. He asked Kevan for reimbursement of the tax payments, which was refused. Kevan did arrange for a modification of the Kevan Millstein trust to relieve his father of future income taxes, but the beneficiaries of the Al-Jo trust were not similarly generous.
Norman filed suit, asking for equitable reimbursement of federal and state income taxes. He had paid over $5.2 million in income taxes for the Kevan trust in 2013, and $1.2 million for the Al-Jo trust in 2013-2015.
The lawsuit was dismissed for failure to state a cause of action upon which relief could be granted. Ohio trust law is clear that such relief is not permitted without the cooperation of the beneficiaries or the trustee. What’s more, said the Court, “Even if we were to allow appellant to use equity to circumvent the clear intent of the legislature, it is well established that
equity will not aid a volunteer.” Norman brought this on himself.
It’s important in estate planning to remember that “irrevocable” means “forever.” Perhaps in 1987 Norman thought he would never run out of money. But 22 years later he did just that.
We specialize in estate planning and settlement and are advocates for trust-based wealth management services. If you have questions about how wills and trusts work or where to begin, ask us. The officers at The Trust Company of Kansas are always willing to discuss your financial goals with you and help you to create a plan which is well-aligned with your wishes.