• Private letter ruling confirms trust settlement doesn’t create gift or generation-skipping transfer (GST) tax issues—In PLR 202343005 (Oct. 27, 2023), a family sought confirmation that its settlement agreement regarding several family trusts wouldn’t cause adverse GST or gift tax consequences.
A married couple created a series of testamentary trusts for their children under their wills. The trusts became irrevocable before Sept. 25, 1985 and, as a result, were grandfathered for GST tax purposes. Over the years, after one child died without children and pursuant to state court orders, the trusts for the children divided into further trusts for grandchildren.
The trust company serving as trustee of each of the trusts filed a petition with the state court to construe the definition of the term “children” and “descendants” because two of the eight grandchildren had adopted individuals who were older than 18. The issue at hand was whether those adopted individuals qualified as descendants of the original settlors and beneficiaries of the trust. A state law answered this question, but the law was enacted after the date of the settlors’ deaths, so it wasn’t clear if it was applicable to the trusts established under the settlors’ wills.
After years of litigation, the family members and trustee entered into a settlement agreement that the state court approved. The agreement provided that certain cash payments would be made to the adopted individuals and to separate trusts for their benefit.
The Internal Revenue Service ruled that the lengthy litigation clearly showed that the parties had adverse interests, the issue was bona fide and the settlement agreement was the product of an arm’s length negotiation. Further, the settlement was within the range of reasonable outcomes under the wills and state law. As a result, the various distributions and trust severances under the settlement didn’t interfere or affect the GST tax status of any of the trusts. In addition, none of the family members were treated as making taxable gifts.
• Successor trustees are liable for unpaid taxes—In May 2023, the U.S. Court of Appeals for the Ninth Circuit issued its opinion in U.S. v. Paulson (May 17, 2023) in favor of the government. The estate has filed a petition for writ of certiorari at the U.S. Supreme Court.
Alan Paulson, a Gulfstream Aerospace executive, died in 2000. He was survived by his third wife and three children from a prior marriage, as well as grandchildren. His son John Michael was appointed a co-executor and co-trustee of Alan’s living trust. The estate filed an estate tax return showing a gross estate of over $187 million. After deductions, Alan’s net estate was about $9.2 million, and estate tax of $4.4 million was due. About one-sixth of the estate tax was paid with the return that was filed on time. An election under Internal Revenue Code
Section 6166 was made to pay the remaining estate tax in installments. Most of the estate was comprised of real estate, stocks, bonds, cash and receivables, all held in Alan’s living trust.
While disputes were ongoing and tax payments were due, the trustee made significant distributions from the trust. For example, in 2003, John Michael made distributions to Alan’s wife, which the children allege were valued at more than $42 million.
In 2005, the Tax Court affirmed the IRS’ notice of deficiency that an extra $6.6 million in estate taxes was due. The estate elected to pay the additional amount in installments under IRC Section 6166, timely paid the installments in 2006 and 2007 and received a 1-year extension for the 2008 payment. But due to disputes among the family members and beneficiaries, John Michael was removed for misconduct as trustee in March 2009, and no further tax payments were ever made.
Vikki and James Paulson were appointed as John Michael’s successor trustee. A year later, the IRS terminated the Section 6166 election and issued a notice of final determination for all the overdue taxes. James was removed as trustee in 2010 and replaced by Crystal Christenson.
Further disputes arose among the family and, ultimately, were settled by the family with court approval. In 2015, the United States sued the estate and trust for over $10 million in unpaid estate tax, as well as John Michael, Alan’s wife, James, Vikki and Crystal to impose a judgment against them as individuals under IRC Section 6324(a)(2).
Section 6324(a)(2) imposes personal liability for unpaid estate tax on:
the spouse, transferee, trustee . . . , surviving tenant, person in possession of the property by reason of the exercise, non-exercised or release of a power of appointment, or beneficiary who receives, or has on the date of the decedent’s death, property included in the gross estate under section 2034 to 2042.
James, Vikki and Crystal asserted the living trust was insolvent when they accepted their trusteeship years after Alan had died. They argued that Section 6324(a)(2) imposes personal liability on those individuals who receive or have property on the date of decedent’s death. Those who receive property from the estate later, after the decedent’s death, should have no personal liability for the estate tax. They cited to significant case law support.
However, the Ninth Circuit held for the IRS, basing its opinion on a close reading of the grammatical text and broader reading of the estate tax sections of IRC Sections 2034 to 2042. It noted that most of the cases relied on by the defendants predated Section 6324. This case makes it clear that successor trustees (reasonably so) take on the liability of their predecessors when it comes to unpaid taxes.