• Trust with HEMS standard held to be grantor trust under Internal Revenue Code Section 678—In United Food and Commercial Workers Unions v. Magruder Holdings, Inc. (U.S. Dist. Ct. Maryland (March 27, 2019)), Magruder Holdings, Inc. (Magruders) was a grocery chain that, before it went out of business, was a contributing employer to the United Food and Commercial Workers Pension Fund (the Fund). Because Magruders had no assets to cover its withdrawal liability pursuant to the Multiemployer Pension Plan Amendments Act, the Fund sought to recover from Fanaroff & Steppa, LLC (F&S) and Bedrock Asset Management, LLC, two real estate investment companies that allegedly share ownership interests with Magruders.
The parties had to ascertain the owners of F&S as part of the proceedings. F&S was owned by several grantor trusts of the Steppa and Fanaroff families, totaling 51%. But, for purposes of the claims, they needed to determine whether the Fanaroff Family Trust (Family Trust), which owned 49%, could be attributed to the family to constitute an 80% controlling interest.
IRC Section 678(a) states:
A person other than the grantor shall be treated as the owner of any portion of a trust with respect to which:
(1) such person has a power exercisable solely by himself to vest the corpus or the income therefrom in himself, or
(2) such person has previously partially released or otherwise modified such a power and after the release or modification retains such control as would, within the principles of sections 671 to 677, inclusive, subject a grantor of a trust to treatment as the owner thereof.
Four siblings serve as the trustees of the Family Trust. The beneficiaries of the trust are four separate special trusts (the Special Trusts) for the respective benefit of each of the siblings. The Family Trust Agreement provides that the siblings, as trustees of the Special Trusts, can freely distribute the Family Trust’s principal interest in F&S to each of the Special Trusts, as long as the distributions amount to equal portions, and, in their individual capacities, the siblings may each withdraw as much of the net income and principal of their respective special trusts as they deem necessary for their own health, education, maintenance and support (HEMS).
In fact, the siblings took monthly payments directly from the Family Trust from Jan. 16, 2011 through Dec. 16, 2015. The Fund contended that the actual usage of the trusts is evidence that the siblings have “a power exercisable solely by [themselves] to vest the corpus or the income of any portion of the trust in [themselves],” and the court agreed.
The defendants countered that the HEMS limitation on the distribution of principal or income necessarily precludes the application of Section 678, as it prevents the siblings from having a power exercisable solely by themselves to vest the corpus or the income therefrom in themselves. But, they didn’t introduce evidence that the HEMS limitation was dutifully followed. To the contrary, the accountant for the company explained that HEMS wasn’t taken into consideration when payments were distributed to the siblings and that none of the siblings had ever discussed with him whether a payment complied with HEMS requirements.
Without concluding whether a HEMS provision nullifies the application of Section 678 as a matter of law, the court held that “a HEMS provision that exists only on paper cannot be said to restrict the power exercisable by the Siblings as to the Family Trust.” As a result, Section 678 applied, and the ownership attribution rules resulted in a controlling interest of 100%, making the Magruders and F&S in common control and jointly and severally liable for Magruders’ withdrawal liability.
This case doesn’t open the door for all trusts with a HEMS standard controlled by the beneficiaries to be grantor trusts under Section 678. In this case, the court found the HEMS limitations were disregarded and therefore didn’t limit the ability of the beneficiaries to vest the trust property in themselves. Other courts have held that distributions limited by HEMS or other standards aren’t sufficient to tax a trust to the beneficiary under Section 678. See United States v. De Bonchamps, 278 F.2d 127 (9th Cir. 1960) and Funk v. Commissioner, 185 F.2d 127 (3rd Cir. 1950), rev’d, 14 T.C. 198 (1950). Private Letter Ruling 8211057 (Dec. 16, 1981) ruled that a beneficiary’s power to invade corpus for her “support, welfare and maintenance” would be taxable under
Section 678(a), but “welfare” isn’t an ascertainable standard and therefore isn’t subject to review by a state court.
• Beneficiary decant attempt triggered no-contest clause—In Gowdy v. Cook, 2020 WY 3 (Jan. 8, 2020), the Wyoming Supreme Court held that a beneficiary’s attempt to decant a trust triggered a no-contest clause. Dennis and Craig Cook were law partners who prepared the trust for Marian Louise Jackson. Dennis was trustee, and Craig was the trust protector (who could replace trustees).
Gerald Gowdy, as a beneficiary of the trust, sued the Cooks for malpractice, breach of fiduciary duties, breach of the duty of good faith and fair dealing, negligence and conflict of interest, among other things. Gerald asked the court to: remove Dennis as trustee; award monetary damages, including attorney’s fees, to him and the trust; require the Cooks to provide a trust accounting; enter the declaratory judgment referenced above; and enter a “decanted trust,” which he attached to the complaint, to “repair issues” due to Dennis’ drafting errors. (This wasn’t a trust decanting under Wyoming statute, but a request to the court to amend the trust.)
The trust contained the following no-contest clause:
The right of a beneficiary to take any interest given to him or her under this trust or any trust created under this trust instrument will be determined as if the beneficiary predeceased [Ms. Jackson] without leaving any surviving descendants if that beneficiary, alone or in conjunction with any other person, engages in any of these actions:
seeks to obtain adjudication in any court proceeding that [the trust] or any of its provisions is void, or otherwise seeks to void, nullify, or set aside [the trust] or any of its provisions[.]
My [t]rustee may defend any violation of this [s]ection at the expense of the trust estate.
Dennis asserted Gerald’s proposed change was an attempt to void, nullify or set aside a provision of the trust. The district court agreed and ruled Gerald had forfeited his interest under the trust. The Supreme Court of Wyoming agreed, stating, “The no-contest provision of Ms. Jackson’s trust is clear and unambiguous. She plainly intended that any beneficiary who attempts to obtain a court ruling voiding, nullifying or setting aside any of the trust provisions forfeits his rights under the trust.”
The court also granted the Cooks’ motion for summary judgment on the claims. The district court grouped the causes of action into two categories: malpractice/professional negligence and breach of fiduciary duties/breach of the duty of good faith and fair dealing. On the malpractice claim, the district court concluded Dennis didn’t owe Gerald a duty when drafting Marian’s trust. It also ruled Gerald hadn’t presented evidence supporting his claim that Dennis breached the standard of care in drafting the estate-planning documents. The district court ruled there was no evidence the Cooks breached any fiduciary duties owed to Gerald, and if they had, he failed to present any evidence showing he was damaged by their actions. The Supreme Court affirmed all of these findings.
Even if Gerald had presented sufficient evidence to support his claims, his attempt to modify the trust eliminated his beneficial interest, shooting himself in the foot.