Florida Bar Journal

The Robertson Case: A Beneficiary by Any Other Name is Still a Beneficiary

By Kristen M. Lynch and Linda Suzzanne Griffin

When does the term “beneficiary” not mean “beneficiary”? In the recent case of Robertson v. Deeb, the court determined that an interest of a beneficiary of an inherited individual retirement account (“IRA”) was not an exempt asset protected from creditors under the terms of Section 222.21 of the Florida Statutes (“Fla. Stat.”), even though the statute has, by its terms, protected the interests of a “beneficiary” in an IRA since the statute was originally enacted in 1987. The authors of this article respectfully disagree with the decision in this case. As Robertson is a case of first impression in Florida, the authors believe this case addresses an issue of great importance, potentially affecting thousands of non-spouse beneficiaries of IRAs and other types of tax-qualified plans or accounts in the State of Florida.

The Name of the IRA Game

IRAs are a form of a retirement account established in accordance with Section 408 or 408A of the Internal Revenue Code (the “Code”). Although IRAs and other types of qualified or tax-deferred plans are creatures of the Code, state laws may impact these accounts. Examples of state laws that could impact retirement accounts are guardianship and intestacy laws, principal and income act provisions, elective share statutes, trust statutes, real estate statutes, and bankruptcy exemption statutes, such as those relied upon in the Robertson case. Every state has a different statutory scheme, and the decision as to which state’s law applies depends on the issue at hand and whether the issue is based upon the domicile of the IRA owner, the IRA beneficiary, or the state law specified in the IRA agreement.

Qualified plans and IRAs present an estate and asset protection planning challenge because they cannot (except in the case of divorce) be transferred from the IRA owner to anyone else during lifetime without losing tax-deferred status. The primary goal of most clients is to preserve and maximize the tax-deferred growth opportunities provided by these types of accounts. In fact, many clients choose to leave this type of asset to children or grandchildren for the enhanced tax-deferral opportunities. This appears to be one of the reasons that the Pension Protection Act of 2006 includes provisions for non-spouse beneficiaries of qualified plans to roll those assets into “inherited” IRAs after the death of the plan participant. Under federal bankruptcy law, assets that a beneficiary elects to leave in a qualified plan would be protected from the beneficiary’s creditors, whereas the protected status of those assets transferred into an “inherited” IRA in Florida has now been called into question.

The Robertson Case

In Robertson v.Deeb, 16 So.3d. 936 (Fla. 2d D.C.A. 2009), Kevin J. Deeb (“Deeb”) sued Richard A. Robertson (“Robertson”) on a promissory note. Deeb obtained a judgment of $188,000 against Robertson and served a writ of garnishment against RBC Wealth Management (“RBC”), the custodian of an IRA which Robertson had inherited from his father, Harold Robertson.

Under federal law, if an IRA owner dies and has named a beneficiary of the IRA which is either an individual or a trust that meets certain requirements, then the beneficiary of that IRA is allowed, under federal law, to transfer the IRA from the name of the deceased IRA owner into an IRA titled in the decedent’s name as owner (deceased) for benefit of the beneficiary. This is commonly referred to as an “inherited IRA”. The advantage of creating an inherited IRA is that, if done properly, the Code provides the required minimum distributions from the IRA may be spread out over the life expectancy of the beneficiary, as opposed to a presumably older IRA owner and. no premature distribution penalties are assessed against the beneficiary, regardless of his or her age. This is true whether the beneficiary is a spouse or a non-spouse, unless the spouse rolls it into their own name, at which point the spouse becomes the owner.

In Robertson, RBC, the custodian of the IRA, informed Robertson that he had two options with respect to the distribution of his father’s IRA. The first option would be to transfer his father’s IRA into an “inherited IRA”, which would require that he take minimum distributions based on his remaining life expectancy, with the ability to withdraw more than the minimum distributions without a penalty. The second option would be to keep the IRA in his father’s titled account and take distributions over 5 years without penalty. Robertson chose the first option. The funds were transferred from his father’s IRA into an inherited IRA, properly titled “Richard Robertson, Beneficiary, Harold Robertson, Decedent RBC Capital Markets, Custodial IRA”.

The issue before the court was whether Robertson’s interest in the inherited IRA, was exempt from garnishment. The lower court held that it was not exempt because the “account became Robertson’s property and no longer qualified for the same exemptions from taxation.” Further, the lower court determined that Robertson’s inherited IRA was “not like an IRA in terms of taxing and penalty tax for early withdrawal and things of that nature so I don’t think that’s what (the legislature) meant”. (emphasis added).

Robertson argued – correctly, in the authors’ opinion – that under Fla. Stat. § 222.21(2)(a) he was a “beneficiary” of a “fund or account” and therefore his beneficial interest in the inherited IRA was exempt. However, the appellate court agreed with the lower court and determined that the inherited IRA was not exempt.

The appellate court determined that the statute did not “exempt the money or assets at issue” unless such amounts were maintained in the original “fund or account”. The court determined that the inherited IRA was a different fund or account which was “created when the original fund or account passes to a beneficiary upon the death of the participant.” The court also conditioned the exemption as “identified by its tax exempt status.” Therefore, once the IRA was distributed upon the death of the original owner, the inherited IRA’s tax-exempt status changed. The court stated that, while inherited IRAs are exempt from taxes until distributions are made to the beneficiary, beneficiaries of inherited IRAs are required to take distributions. The court did not note that, generally, the original owner is also required to take minimum distributions upon reaching age 70 ½. Furthermore, a spouse who inherits an IRA is ultimately required to take distributions either by stepping into the shoes of the owner by rolling it over, or by taking distributions as a beneficiary.

Additionally, the court seemed to make a distinction between leaving the IRA in the name of the decedent and withdrawing the funds over five years, and transferring the original IRA into an “inherited IRA”. There is no basis for such a distinction under state law, in the Code, or under federal bankruptcy law.

The court then analyzed cases from other states, and relied on an Oklahoma bankruptcy case which denied an exemption for a beneficiary of an inherited IRA based on an Oklahoma statute. The Oklahoma law exempts assets “only to the extent that contributions by or on behalf of a participant were not subject to federal income taxation to such participant at the time of such contribution.” The language in the Oklahoma statute is not in the Florida statute. The court then noted that in the Oklahoma case “(t)he purpose of the Legislature in exempting individual retirement accounts is to allow debtors to preserve assets which have been earmarked for retirement in the ordinary course of the debtor’s affairs. Such a purpose would not be served by upholding the (beneficiary’s) request to keep his interest in the IRA as exempt.”

A recent decision from Minnesota illuminates the issue in Robertson quite well. In re: Nessa (105 AFTR 2010-XXXX, 01/11/2010) is a Minnesota bankruptcy case with a fact pattern similar to Robertson, except that the debtor in this case claimed an exemption for the IRA inherited from her father under the federal statute, 11 U.S.C. § 522(d)(12). The trustee objected to the exemption, arguing that inherited IRAs do not qualify under the statute. The Court disagreed and overruled the objection. The Court in Nessa cited language contained in IRS Publication 590, Individual Retirement Arrangements, which states in part: “If you inherit a traditional IRA from anyone other than your deceased spouse, you cannot treat the inherited IRA as your own. This means that you cannot make any contributions to the IRA. It also means you cannot roll over any amounts into or out of the inherited IRA.”

The IRA beneficiary in Nessa had properly transferred the funds into an inherited IRA, much as Richard Robertson did in the case at hand. The Court in Nessa then stated that the tax-deferred character of the IRA did not change because the IRA was transferred into an inherited IRA. Further the trustee did not claim that the IRA was not in compliance or that the funds in the inherited IRA were not exempt from taxation until they were distributed.

The History of the Statute

Fla. Stat. § 222.21 was enacted in 1987, with amendments in 1998, 1999, 2005 and 2007 that do not affect the provisions of the statute discussed in the Robertson case. The applicable portions of the statute currently provide as follows: “(2)(a) Except as provided in paragraph (d), any money or other assets payable to an owner, a participant, or a beneficiary from, or any interest of any owner, participant, or beneficiary in, a fund or account is exempt from all claims of creditors of the owner, beneficiary, or participant if the fund or account is:” (emphasis added) . . . [Provisions in the statute, providing that the creditor protection inures to the benefit of the persons described above as long as the fund or account is tax-qualified, are omitted. (c) Any money or other assets that are exempt from claims of creditors under paragraph (a) do not cease to qualify for exemption by reason of a direct transfer or eligible rollover that is excluded from gross income under s. 402(c) of the Internal Revenue Code of 1986. (emphasis added) The original statute was intended to insure that the creditor protection of a qualified plan created under the Code which contains a spendthrift clause to implement the anti-alienation rules of Section 401(a)(13) of the Code also applied to single owner/participant plans. There was a concern that Bankruptcy Courts were permitting creditors to attach single owner/participant plans on the theory that the plan which was required to have a spendthrift provision was a self-settled trust which, then and now, does not defeat claims of the settlor’s creditors. This statute was enacted to make clear that all plans would be exempt even if there was a single owner/participant.

Further, one of the original drafters, who testified before the Florida House and Senate, has confirmed to the authors that the intent of the word “beneficiary” under the statute was to mean any beneficiary, including, not only the beneficiary of the original IRA, but also a beneficiary of an inherited IRA. Further, a Florida Bar Journal article co-authored by the same drafter soon after the statute was enacted indicates that the legislation “should protect from creditors(sic) interests in all types of tax qualified retirement plans (including….. individual retirement accounts)” emphasis added. This legislation used the word “beneficiary” with no qualifiers. The drafters and the legislature could certainly have denied or limited protection afforded to beneficiaries. Neither did so.

In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) became effective, and the Florida statute was amended to mirror the changes in BAPCPA. Paragraph 2(c) was added to Fla. Stat.§ 222.21(2) , stating, in part, “Any money or other assets that are exempt from claims of creditors under paragraph (a) do not cease to qualify for exemption by reason of a direct transfer or eligible rollover that is excluded from gross income ….” This language was added to clarify those tax-qualified funds could be rolled over or transferred between accounts without losing the protection intended to be afforded by the statute. The provisions of EGTRRA were intended to create more flexibility in tax-qualified accounts, allowing IRA owners to roll IRA funds into qualified plans, qualified plan funds into other qualified plans, and attempting to make tax-qualified funds more manageable.

No change was made to the language regarding beneficiaries, owners or participants. In fact, the Florida Session Law analysis states that the change “is made because technically the owner of an IRA is neither a beneficiary nor a participant in the account.” It is therefore clear that the term, “beneficiary”, is not the same as the term, “owner”, of an IRA.

The Clear Meaning of the Statute

The well-reasoned brief by Robertson’s attorney, James Byrne, Esquire, points out that Robertson was listed by RBC as a beneficiary of the account. Survivor beneficiaries should be provided the same protection under the statute as that afforded to the actual contributors because no distinction has been made between the two in the statute. The language as to whose interests are protected is clear and unambiguous. When the language of a statute is clear and unambiguous and conveys clear meaning, the statute must be given its plain and ordinary meaning. In such instances, courts will not go behind the plain and ordinary meaning of the words used in the statute unless an unreasonable or ridiculous conclusion would result from a failure to do so.

In LeCroy v. McCallum, 612 So. 2d 572 (Fla. 1992), the Supreme Court considered whether a structured settlement in a wrongful death claim constituted an annuity under Fla. Stat. § 222.14, and therefore exempt from creditor claims. The Legislature has not defined the term, “annuity contracts” in Chapter 222. Thus, the court looked to other chapters of the Florida Statutes for guidance as to the meaning of the word. Similarly the term “beneficiary” is not defined in Chapter 222, but Fla. Stat. § 736.0103 provides that the term “beneficiary” includes a person who has a present or future beneficial interest in a trust, vested or contingent and Fla. Stat. § 736.1106 defines a “beneficiary” as the beneficiary of a future interest and includes a class member if the future interest is in the form of a class gift.

Robertson’s status with regard to the IRA in question is fairly described by any one of the foregoing definitions, and there is no differentiation in Fla. Stat. §222.21(2)(a) between survivor beneficiaries and owner beneficiaries. Moreover, Florida has a longstanding policy that favors liberal construction of exemption statutes so as to prevent debtors from becoming public charges.

Some may argue even though the language may be clear, it is not the intent of the Legislature to protect the beneficiaries of an account because the beneficiary did not “earn” or contribute to the account. The Legislature has not enacted any such policy. When a beneficiary receives proceeds from annuities, those proceeds are exempt from the beneficiary’s creditors. To find that an inherited IRA beneficiary would not be protected would encourage IRA holders to purchase so-called “individual retirement annuities” within an IRA to qualify under the exemption statute for annuities. It is the authors’ opinion that the Legislature would not want to unduly encourage IRA holders to purchase retirement annuities. Qualified or retirement annuity sales are an area rife with abuse and are currently the subject of several national class action suits.

Further Reading of the Statute Confirms Exempt Treatment

Fla. Stat. § 222.21(2)(c) specifically states that assets that are exempt from claims of creditors under paragraph (a) do not cease to qualify for exemption “by reason of a direct transfer or eligible rollover that is excluded from gross income under s. 402(c) of the Code. Section 402(c)(11) of the Code specifically addresses distributions to inherited IRAs of non-spouse beneficiaries from qualified plans. The Code states that if “a direct trustee-to-trustee transfer is made to an individual retirement plan”…from a qualified trust under § 401(a) of the Code “for the purposes of receiving the distribution on behalf of an individual who is a designated beneficiary”…“the transfer shall be treated as an eligible rollover distribution.”

The Robertson court provided that an IRA which is owned by the original owner is exempt from creditor’s claims under Fla. Stat. § 222.21(2)(a). The court reasoned that “the plain language of that section references only the original “fund or account” Section 402(c)(11) of the Code provides that the transfer to an inherited IRA is an eligible rollover. Fla. Stat. § 222.21(2)(c) provides that the exemption does not cease as to eligible rollovers or transfers (which are non-taxable events). Therefore, the statute clearly provides that Robertson’s interest in the inherited IRA was exempt from creditor claims.

The term “IRA owner” is a term of art used in the Code. Under Section 408 of the Code, the inherited IRA continues the tax-exempt status afforded to the original IRA owner. When the beneficiary establishes the inherited IRA, the beneficiary becomes the beneficial or equitable owner of that inherited IRA. Fla. Stat. § 222.21 (2)(a) confers an exemption on “owners” if the plan is maintained in accordance with a plan or governing instrument that has been determined by the Internal Revenue Service to be exempt from taxation under the relevant provisions of the Code. Nothing in the statute states that the word “owner” must be the original IRA owner. Thus, it can be argued that the inherited IRA, which is owned in equity by the beneficiary, is exempt from claims of creditors under the protection the statute affords to “owners.”

Planning With a Modicum of Caution

Simple steps can be taken in order to protect IRA funds in light of this errant decision. If the IRA owner is concerned about the vulnerability of the IRA to creditors when the IRA reaches the hands of the beneficiary, then, instead of naming the beneficiary directly, the IRA owner may wish to create a spendthrift trust specifically for that beneficiary. Finally, while the purchase of an annuity may have disadvantages in certain circumstances, if an IRA owner has reason to believe that the beneficiary could have creditor issues or is at risk for bankruptcy under current Florida law, apart from the Robertson case, an annuity would seem to provide the protection sought.

CONCLUSION

The statutory treatment of exemptions for all forms of IRAs is a very hot topic in the current economic environment and no doubt will continue to be a hot topic for years ahead, as it is estimated that over $14 trillion dollars are either currently held in IRAs or are held in qualified plans that will eventually roll over into IRAs. Creditors are becoming more aggressive and more creative in their attempts to attack these types of accounts. As such, it is extremely important that the law is clearly interpreted. It is not the intent of the authors to change existing policy, but rather to confirm the intent of the original drafters, as well as the drafters of subsequent amendments to Fla. Stat. § 222.21 of the Florida Statutes, that the interests of beneficiaries of IRAs, in whatever form, are protected. While the case of Robertson is the law in the Second District Court of Appeals this will not be the final answer to this timely issue.


Views From a Former Member of a Grievance Committee: Hot Buttons For the Estate Planning, Probate and Trust Attorney

I have had the great opportunity to be on three Grievance Committees (the “Committee”) for a total of nine years. I would like to say my participation on the Committee has been purely altruistic but my experience has taught me I am not often “purely altruistic”. I realized that when I opened my own practice in 1990 I needed to understand how The Florida Bar ethics rules practically affected my practice. I have had the good fortune to interact with attorneys in different areas of practice, such as criminal defense (most interesting), personal injury (most entertaining), civil litigation (sometime complicated), securities (always complicated), family (most drama), prosecuting attorneys and public members from air conditioning company owners to real estate developers, to certified public accountants and to trust officers. My relationships with these fine individuals developed through discussions in the Committee meetings and have enhanced my practice, not only through referrals, but also in educating me in other areas of practice and helping me become a true “counselor” to my clients.

I have had the opportunity to review situations where I think to myself in total indignation “I can’t believe he or she did that” (usually stealing) to “I have to go back and check my files to be sure I did not do that” to everything in between. I have had the privilege to act as a chairperson of a Committee and presided over evidentiary trials with the accused attorney represented by excellent attorneys. This article is written to share my thoughts and experiences as to certain “hot buttons” applicable to estate planning, probate and trust attorneys, suggestions on how to avoid having a complaint filed and the general procedures of the grievance process if a complaint is filed against you. I have obviously omitted names and exact circumstances because of confidentiality of the proceedings. Certain cases are public record. I also want to reiterate these are only the opinions of the author. Ethics opinions should be reviewed and specific questions directed to the ethics hotline at 1-800-235-8619.

Estate Planning

In my experience clients do not generally file complaints in the drafting of the estate planning documents as most complaints generally arise after the death of the client. Nevertheless, complaints in this area are primarily communication, competence, fees, and conflict of interest.

Communication. Committee members (remember at least one–third of the members are public members) are generally amazed when attorneys do not return phone calls, sometimes for weeks. This complaint is easily avoided by having an office policy that every phone call must be returned by you or your assistant within 24 hours of the call. Documentation of your return phone calls also provides the Committee objective evidence that you or your staff actually called the complainant particularly when the complainant states they have not heard from you in weeks or months. Sometimes clients will get mad at the attorney because they do not get the response they want and may file a complaint that you have not returned their calls when they are calling you 10 times a day. Documentation refutes those false complaints. If you are in trial then you should train your assistant to return those phone calls. Some clients prefer e-mails rather than phone calls. When you respond to a client via e-mail, print and file the e-mail or save it to the file on the computer. Software programs, such as Amicus, automatically assign e-mails and telephone calls to the appropriate file. Some practitioners avoid the use of e-mails because e-mails are discoverable and often language in an e-mail is not carefully thought out as in written correspondence.

Competence. Clients complain when an attorney advises the client that he or she can provide certain estate planning techniques, for example a qualified domestic trust, for which the attorney is not currently qualified to handle. Instead of turning down the client and referring to a qualified attorney, the attorney signs a fee agreement with the client. The comment to the applicable rule provides that an attorney can perform legal work for which the attorney does not have experience but the attorney must research and become qualified to handle such a matter. If the attorney realizes that he or she can not adequately handle the matter, then he or she may avoid the client ( see communication above) because they have already spent the money advanced by the client (which is another issue). Unfortunately, the incompetence is often not discovered until after the death of the client. If an attorney finds that he or she can not handle a matter, then the attorney should either advise the client and refund the client’s advance payment or consult with a more experienced attorney and be willing to pay the experienced attorney for their time.

Excessive Fees. Estate planners often charge fixed fees for wills and trusts and the client agrees and willingly signs the fee agreement. Such a fee agreement does not prevent the client from filing a grievance against an attorney for excessive fees. Committee members will review the fee agreement but if, for example, an attorney counsels a client and determines the client needs a simple will and the attorney charges and collects an exorbitant fee (many times a family member reviews the fee agreement and complains), the Committee members will not look favorably upon such an fee agreement unless there is a valid explanation, not “the client signed the fee agreement and therefore the fee is not excessive. ” If, however, the simple will is not “simple” and involves complex provisions, those factors will influence the outcome. Generally Committee members request time records even if a fixed fee agreement is signed. Committee members, especially public members, understand time records. Committee members will want to know how many hours the attorney spent on the matter. While time records generally do not apply to criminal, personal injury matters and certain probate matters, the hourly rate is still what Committee members understand. Remember you, the attorney, have to defend your fee and your time records are the best defense.

Conflict of Interest. A complaint alleging conflict of interest in the planning context usually arises in the representation of multiple parties in an estate planning vehicle such as a family limited partnership or limited liability company. When representing multiple family members it is critical that an attorney have the clients sign conflict letters and the attorney must advise the clients of the potential conflicts.

The Florida Supreme Court amended the conflict rules in 2006 and added, among other definitions, definitions of “informed consent “ to mean “the agreement by a person to a proposed course of conduct after the lawyer has communicated adequate information and explanation about the material risks of and reasonably available alternative to the propose course of conduct”; “writing” to mean ”tangible or electronic record of a communication or representation, including handwriting, typewriting, printing, photostating, photography, audio or video recording, and email”; and “signed” writing to mean an electronic sound, symbol or process attached to or logically associated with a writing and executed or adopted by a person with the intent to sign the writing.”

An attorney can represent a client if there is a conflict of interest IF the lawyer believes that he or she can represent the client competently and diligently, the representation is not prohibited by law and each affected client gives informed consent, confirmed in writing or on the record at a hearing.

Determining Competence of the Client. This area is definitely a current hot button. While a lawyer is not a doctor certain indicators of undue influence (i. e. the Carpenter case ) may be apparent. This complaint arises when the attorney drafts the estate planning documents, perhaps omitting a natural beneficiary and replacing the natural beneficiary with someone else. In my experience the complaint arises in that the attorney “should have known” that the client was not able to understand and change their documents because of diagnosed Alzheimer’s or some other dementia. If the attorney can document any doubtful cases and more importantly be cognizant of the facts at the time of the drafting, such as the beneficiary driving the client to the attorney, the beneficiary retaining the attorney, the client not willing to talk to the attorney without the beneficiary present, then such documentation may alleviate the problem. On your initial questionnaire you may ask about recent diagnosis and document their appearance and demeanor.

Some attorneys videotape the signing of estate planning documents to evidence the competency of the client. Videotapes have been shown to the Committee members. If an attorney videotapes, then open ended questions should be asked. When Committee members hear only yes or no answers, an argument can be made that the client is being instructed off camera as to what to say. Just be aware that a videotape can work against you if not done properly.

I watched a video where the testator obviously looked coached and answered only yes or no to questions for about a half hour. It was not convincing to the Committee members that the testator was competent and the Committee found probable cause as the client had been diagnosed with Alzheimer’s at the time the disputed will was prepared.

Powers of Attorney

Conflict of interest. Conflicts of interest issues arise while advising clients in the drafting of durable powers of attorney and durable health care powers of attorney. When the client names as attorney-in-fact the lawyer drafting the document, unless good reason exists, such documents are closely scrutinized by the Committee. The fastest way to antagonize children and siblings is to draft such powers of attorney taking the children and siblings out as attorney-in-fact and drafting yourself in the document as attorney-in-fact. While such actions seem obvious, attorneys still do it. Just do not put yourself in as attorney in fact unless there is no other way to help your client and you have documented in the file the reasons together with a conflict of interest letter. Better yet, just avoid it.

Further an attorney should not make provisions for the attorney or any one related to the attorney in such documents. If that situation arises and the attorney believes that the client really wants to draft that language refer them to another independent attorney. Do not get involved in that situation. My experience is that, no matter the reason, Committee members have a great distaste for attorneys who are appointing themselves.

Probate and Trust Administration

In my experience most complaints arise in probate and trust administration proceedings because beneficiaries find out how much and when they are receiving money and/or tangible possessions. Do not always believe your client when they say “my kids would never fight”. After parents die sibling “issues” arise more often than not. Thus, it is important to document, document, document your clients’ wishes. The dynamics in a family go much further than money and many times siblings have deep seated resentments that have been avoided while the parents are alive but become obvious when dividing money and especially sentimental tangible property.

Diligence. This complaint frequently arises against probate attorneys. It appears that some probate attorneys take their time proceeding with probate and what makes the matter worse is that the client is not informed of the status of the proceedings. Accordingly every attorney who practices in this area should have a “tickler” system to remind the attorney or paralegal to advise the client of the status of the probate and document these reminders. Many attorneys who do not normally practice probate may probate a will for a relative or friend because it is “only a form”. Unfortunately, too late the attorneys find out that these ”forms” are just forms and the statutes and rules can be just as complicated as the original drafting. Children and heirs will file a complaint against you even if you are a “nice person”. Further, while paralegals often prepare many, if not all, the probate pleadings (under the supervision of the attorney), an attorney’s phone call to a client will work wonders in deferring a complaint in this area. Keep the client informed. Even if you are delayed then let your client know so the client is not calling you first.

In one proceeding a complaint was filed in which beneficiaries were litigating over the value of assets and to whom the assets should be distributed. One of the beneficiaries complained because they wanted a partial distribution from the trust and the litigation took a long time – three years. Fortunately, the attorney had documentation regarding the litigation and documentation advising the personal representative/trustee. The attorney presented the documentation to the Committee and the complaint was dismissed. To protect the personal representative and trustee the assets had to be held in the estate and trust until the litigation was resolved. Further many attorneys and complainants appear to not understand that the client is the personal representative, not the beneficiaries. While there may be duties to protect the estate for the beneficiaries the client is still the personal representative.

Competence. As discussed above attorneys who do not practice probate often will do a probate for a friend or relative because the attorney believes it is only a form and the attorney does not know the probate rules or the applicable statutes.

During my most recent time on the Committee, several attorneys have had a misunderstanding of homestead. The homestead has been called a “legal chameleon” and is extremely complicated. A recent court referred to homestead as “the leading cause of cerebral herniation” for probate lawyers and judges. Any time homestead is part of an estate or trust administration a “red alert” should sound in your head and particular attention should be made as to whether the homestead can be validly devised and to whom. Again document your discussions with your clients.

In one situation the personal representative sold the homestead, made specific bequests from the proceeds of the sale of the homestead and then distributed the balance of the proceeds to a relative, who was an heir pursuant to the intestacy statute. The attorney never advised the personal representative that the homestead vested immediately in the beneficiary heir and that the specific bequests did not have to be satisfied. Recent case law has clarified that finding. Even if the law is ambiguous an attorney should advise their clients as to the risks of such actions. In this case luckily no claims were filed by creditors and the heir did not want the money returned from the specific devisees so there was no harm. The Committee members, however, recommended that the attorney take continuing education classes regarding homestead and such education classes were at the attorney’s expense. The original complaint was forwarded to the Committee as a diligence complaint, but led to a competence rule. Once the Committee has a complaint and starts the investigation if the investigating member (or any other Committee member) finds another violation of the ethics rule that violation can be added to the original violation.

Another homestead issue created problems for the drafting attorney after the death of the decedent. Boyfriend and girlfriend were represented by the same attorney. Attorney drafted a revocable trust for boyfriend, and boyfriend transferred his homestead into such trust. The trust provided that the homestead would be distributed to his girlfriend at a certain age. The girlfriend had creditors that boyfriend wanted to avoid. Boyfriend and girlfriend later married and returned to the same attorney and inquired whether any documents needed to be changed or amended in light of the marriage. Attorney said no. Unfortunately, when husband died, the probate attorney discovered that the homestead distribution in trust was invalid. Pursuant to Florida law spouse (former girlfriend) received a life estate in the homestead with the remainder distributed to husband’s daughter, the stepdaughter of wife. Wife obviously was very upset and intended on filing an ethical complaint against the attorney. Remember even if the issue can be resolved (such as purchasing stepdaughter’s interest) the complainant can always file a complaint.

Excessive fees. Fees are another hot topic in this area. Percentage fees are presumed reasonable and allowable under Florida law. It is important to understand that even if the client and the beneficiaries sign such a percentage fee agreement, it does not mean the client and the beneficiaries can not complain. For example, assume you are representing a personal representative of an estate worth a million dollars. The statutory rate allowed is $ 30,000 and you spend 20 hours on the matter and your paralegal spends 50 hours on the matter. The client complains because the estate consisted of a homestead and one stock account. Client talks to another attorney who said that it should cost at the most $10,000 – $15,000. The client then files a complaint. Even thought the statute permits the statutory percentage as a presumptively reasonable amount, you should have time records to show the Committee. The attorney must remember that Committee members are not always probate attorneys and even though the statute provides a statutory rate the fee must be reasonable under the rules. The fee agreement signed by the client and the beneficiaries’ will weigh in the attorney’s favor; however you do need to have sound reasoning to avoid an excessive fee argument.

In one complaint an attorney completed a summary administration and the fees were calculated on the total amount of the probate estate including homestead. Of course the attorney can get compensated for work on homestead issues but homestead is not an asset of the probate estate. The provisions for fees for homestead should be clearly documented.

A proposal to amend the Rules Regulating The Florida Bar regarding fees and costs (Rule 4-1. 5) has been approved by the Board of Governors and is pending approval of The Supreme Court of Florida. Apparently there has been much confusion between the term “advance fees”, “flat fees” and “retainers”. The comments to the proposed amendment to the rule state that an “advanced fee” is a sum of money paid to the lawyer against which the lawyer bills the client as legal services are provided and such fee is the client’s property and must be placed in the lawyer’s trust account. A “flat fee” is a sum of money paid to a lawyer for all legal services to be provided in the representation and such fee is the property of the lawyer and the funds should be placed in the lawyer’s account and not in a trust account. A “retainer” is a sum of money paid to a lawyer to guarantee the lawyer’s future availability and is neither a payment for past legal services nor for future services. A retainer is property of the lawyer and the funds should be placed in the lawyer’s account and not in a trust account. This amendment also clarifies that the test of reasonableness applies to ALL fees and that a nonrefundable fee must be clarified in writing, together with the intent of the parties as to the nature and amount of the nonrefundable fee. This amendment is NOT in effect as of the time of the writing of this article.

Conflict of Interest. In another interesting case that arose after the death of the decedent the attorney previously drafted a pour over will and joint revocable trust for a husband and wife with the wife being the sole beneficiary of the joint trust during her lifetime. The attorney represented both husband and wife who both had children from prior marriages. After both parties’ death the assets were to be distributed to all children (his and hers). Upon husband’s death, the surviving spouse went to the same attorney, withdrew all of the assets from the joint trust (the joint trust was revocable until both spouses’ deaths) and placed all the proceeds into her own revocable trust (which the same attorney drafted) with her own children as beneficiaries to the exclusion of her stepchildren. Stepchildren filed a complaint against the attorney indicating that the attorney knew the father wanted those assets to be distributed to the stepchildren upon wife’s death and nevertheless represented the surviving spouse in transferring the assets into her own account. The attorney had neither documented his advice nor the issues to the decedent’s beneficiaries. The Committee evaluated the competence and conflict of interest rule and had an evidentiary hearing.

Responsibilities of Supervisory Attorney. To handle probate cases which an attorney may not otherwise be able to handle, either because of time or competence, he or she may hire an outside attorney to help them prepare the probate pleadings. In a recent case the estate of the deceased brought a personal injury action and a personal representative had to be appointed for the estate. Instead of referring the matter, the personal injury attorney hired an attorney who had worked periodically with other probate attorneys. While the client believed that the personal injury attorney was handling everything, the “outside” attorney was handling the probate, ostensibly under the supervision of the primary attorney. In a hearing related to the personal injury case the primary attorney opined to the judge that the personal representative had been appointed. Unfortunately, because of lack of communication between the primary attorney and the hired attorney, the primary attorney did not know that letters of administration had not been issued to the personal representative. Opposing counsel filed a grievance that the primary attorney had misled the court and therefore violated the rule against candor toward a tribunal. While the issue was legally resolved, the Committee member investigated the relationship between the primary attorney and the subordinate attorney and found that the ethics rule applying to supervising attorneys had been violated.

Trust Account Violations

Without a doubt these complaints are the most egregious of the complaints filed with the Committee. Members do NOT tolerate stealing from trust accounts no matter how the attorney attempts to define his or her conduct. It is critical to remember that any money placed in a trust account on behalf of a client is the money of the client and writing a check for the attorney’s personal expense or for another client is stealing their money. A refusal to account for and deliver trust fund money upon demand shall be deemed a conversion. The Florida Supreme Court generally imposes the harshest discipline for conversion and theft of trust funds.

Cases have appeared before the Committee where attorneys basically use the trust account as their own checkbook. The reason one attorney stated was that he or she did not have time or did not want to open another account. Further when a trust account check bounces bankers automatically notify The Florida Bar. Sometimes recognition of trust account violations arise from the investigation of other complaints. For example if a fee is excessive and the Committee looks at the invoice and there is payment from a trust account the member may want to see the trust account records. If an attorney does not have those records then an auditor from The Florida Bar may be notified to perform an audit of the trust accounts.

Be careful of what you are safekeeping. A safe deposit box can be maintained but the attorney must notify the bank that third party funds and assets are held. If you have an item of tangible property, then remember you must account for same.

Every attorney must represent by a mark on The Florida Bar dues statement compliance with the trust accounting rules. If you represent that your trust account is maintained in compliance with the ethics rules and the trust records are not in compliance, then that representation is false and is yet another violation of the ethics rules. Committee members look very closely at trust account violations.

Sometimes attorneys hold money on a short term basis for estates or trusts. While the rules recognize such a procedure the attorney must give a full accounting and if funds are not short term or nominal then the attorney can not receive benefit and interest earned. The determination of whether the holding of money is nominal or short term can be made by the attorney. The attorney must exercise good faith judgment and consider the amount, the time period, the likelihood of delay, the cost to attorney for maintaining interest bearing accounts and the minimum balance requirement. The determination of whether the amount is nominal or short term rests with the sound judgment of the attorney and no lawyer shall be charged with an ethical violation based on a good faith judgment.

In my experience attorneys who have trouble with trust accounts have overextended themselves financially and/or may have gambling, drug or alcohol problems. These problems are mitigating factors if the attorney gets help with Florida Lawyers Assistance program. The abuse problem does not excuse the violation but may affect the outcome of the Committee’s decision. Committee members are very open to attorneys who are getting help. Committee members want to prevent an attorney who has an abuse problem from practicing and harming the public but obtaining help is looked upon favorably by the Committee. Obviously, restitution must be made and the ethics violations still must be dealt with.

Procedure

All complaints must be in writing and signed under oath under penalties of perjury. Any calls and initial complaints are screened in Tallahassee and cases that require further investigation or special handling are forwarded to The Florida Bar branch offices. If The Florida Bar Counsel (“Bar Counsel”) determines, after review of the allegations in the complaint, that no violation of the rules has occurred Bar Counsel can dismiss the complaint. If Bar Counsel determines the conduct should be investigated, the Bar Counsel forwards the complaint to both the grievance committee chairperson and the designated reviewer who is a member of the Board of Governors. The chairperson is responsible for reviewing all complaints and assigning those complaints to the appropriate individuals on the Committee. Complaints are often assigned to attorneys who have handled similar matters or to public members, who can use the help of a Committee member attorney familiar with the particular area. The chairperson determines who can best handle the particular matter.

The chairperson then advises the Bar Counsel to whom the complaint is assigned. Bar Counsel then sends correspondence to the “grieved” attorney to respond to the investigating member within 15 days of receipt of the notice. Either the grieved attorney or her/his attorney must contact the investigating member within the 15 days. Failure to do so can cause another complaint. At this time or earlier if you are aware your client is going to file a grievance, then hire a competent attorney to represent you. Committee members do not look unfavorably on the action of hiring an attorney.

The initial written response to the complaint should be thorough and address the specific issues. One attorney representing a “grieved attorney” drafted a response and referred to rules the Committee members had not even mentioned! Once the investigating member receives the response you can expect a phone call to discuss the matter. The grieved attorney or her/his attorney should make every attempt to be prompt and prepared.

Investigation may be complete with the letter response and the investigating member’s investigation. If the Committee members determine no need for an evidentiary hearing, then the grieved attorney or his or her attorney will be given notice of a summary hearing which will provide the grieved attorney with the Committee members’ names and the rules that may have been violated. No attendance is available and the Committee members must have the hearing with a quorum of 3 members; 2 of which must be lawyers. The Committee members can vote either no probable cause (“NPC”), NPC with letter of advice, minor misconduct, recommendation of diversion or probable cause (“PC”). You or your attorney will be advised in writing of the Committee’s decision.

If the Committee determines that an evidentiary hearing is necessary, then the grieved attorney will be noticed and will appear at the appointed hearing with his attorney. The complainant has a right to be at the hearing. A court reporter records the proceeding and the chairperson runs the hearing. No rules of evidence apply. Generally the investigating member (and sometimes an attorney will help a public member) will take testimony of the attorney and the Committee members also have an opportunity to ask questions.

These hearing are taken very seriously by the Committee members and should also be taken seriously by the “grieved” attorney. While most attorneys are professional, candid and honest I have been amazed at the arrogance and total lack of respect a few grieved attorneys give Committee members. Committee members are there to protect the public and no Committee member is “out” to get an attorney. If a Committee member determines he or she cannot be unbiased, then he or she abstain from voting.

Each Committee member comes from a different walk of life but generally he or she is on the Committee because he or she truly wants to uphold and protect the integrity of the law profession. Being respectful and showing up prepared are ways to have the Committee members see you in the best light.

This may sound obvious but do not lie, not even what you think is a white lie. Also fudging, puffing, speculating should be avoided at all costs. Candor is always the best in front of a Committee. Committee members are very astute and there are always a few litigators who have seen everything. As the hearing is recorded Committee members can always look at what you spoke versus what you wrote in your response. If you do not know or remember say so. Committee members’ findings are all reviewed by a designated reviewer.

Once Committee members vote, then Bar Counsel or the chairperson will notify the grieved attorney or his or her attorney. If the Committee members find NPC, then the complaint is dismissed. If NPC with a letter of advice, minor misconduct or diversion, then those proceedings are available for public view. If there is finding of PC, then the designated reviewer reviews the matter. If he or she confirms, then a complaint is filed by The Florida Bar with The Florida Supreme Court. The clerk of The Florida Supreme Court then forwards the matter to the Chief Judge of a circuit near the “grieved” attorney’s circuit. The Chief Judge then appoints a judge in that circuit to act as referee of the complaint.

Cases that are closed without the imposition of discipline are public record and are purged from The Florida Bar’s record one year after the file is closed. Minor misconduct and PC cases become a part of the permanent discipline record.

CONCLUSION

This article has been written to help attorneys identify certain ethical issues particular to the estate planning, probate and trust practice. Obviously, because of limited space, I can only touch upon my most memorable experiences on the Committee regarding the probate and estate planning practice. Hopefully these experiences can benefit attorneys practicing in these areas.

Most attorneys, especially those reading this article, are professional and have the utmost integrity. Unfortunately a few attorneys give our profession a bad name. I strongly recommend that attorneys practicing in these areas volunteer to participate on a Committee. Participation helps The Florida Bar continue its excellence, the attorney learns the ethics rules and the application to “real life” situations, and participation on the Committee helps you become a better attorney and counselor to your clients. If you are interested in volunteering to participate on a Committee or if you know of potential public members, then contact your representative on the Board of Governors in your circuit.

I also suggest that attorneys practicing in these areas become active in The Florida Bar Real Property Probate and Trust Law (“RPPTL”) section (www. rpptl. org). In Committee meetings you will interact with top attorneys across the state, learn about and draft proposed legislation, find a great network of friends and obtain advice about issues that arise in practice. Substantive Committees in the RPPTL section include IRA and Employee Benefits, Estate and Trust Tax, Probate Law and Procedure, Insurance, Asset Preservation, Probate and Trust Litigation, Trust Law, Professionalism and Ethics, Wills, Trust and Estates Certification, Advance Directives and HIPAA, Charitable Organizations and Planning, Guardianship Law and Procedure and Power of Attorney. Committee chairs are always looking for active members.


The Lottery: A Practical Discussion on Advising the Lottery Winner

As lottery winners are becoming more common in Florida, their advisors should understand the particular income, gift, and estate tax issues relevant to lottery winners.

A practical difference between planning for a lottery winner and other planning is that generally lottery winners have not planned for actually winning the lottery. Therefore, when an individual or group of individuals wins millions of dollars, emotional feelings often override financial considerations. This author’s experience is that most lottery winners want to drive to Tallahassee the next day ( and who can blame them?) to establish their winnings, while they actually have 180 days to claim their winnings. For a more complete discussion of lottery state law, see Linda S. Griffin and Richard V. Harrison, Florida State Lottery Tax and Estate Planning Issues, 70 FLA.B.J. 74 (Jan 1996).

This article focuses on advising those clients who retain you prior to their trip to Tallahassee of necessary planning to save as much as possible in income, gift, estate, and generation-skipping taxes.

For purposes of this article assume that Mr. And Mrs. Gotrich excitedly call you and state that they just won $30 million. Your heart starts racing as you have visions in your head of enormous fees. Remember, however, The Florida Bar ethics provisions on reasonable fees.

Your clients must understand that the ticket should not be signed until the determination is made to who or what entity owns the ticket. A ticket signature should not be whited out or defaced, but language can be added to the signature line. If, however, the ticket is lost before it is signed, the $30 million could be a windfall to the one who finds the ticket. Practically, the lottery ticket should be placed in a safe deposit box until travel to Tallahassee. Some winners have actually hired security to move the ticket.

The ownership of the ticket and the facts relating to the purchase of the ticket should be determined at the time of the initial conference. Be wary if two unrelated parties, i.e., girlfriend and boyfriend, claim the ticket. Florida law requires that only one entity or person can be a winner regardless of whether the ticket is jointly owned. If more than one name appears on the back of the ticket, payment is made to the first person.

Mr. and Mrs. Gotrich explain to you that the lottery ticket has not yet been signed and their whole family ( Mr. and Mrs. Gotrich and their five children) participated in the purchase. If all parties actually participate in the purchase of the ticket, planning will be more advantageous because the benefits and corresponding tax liabilities can be distributed among more parties.

Under prior cases the parties intent and evidence of that intent as to ownership of the ticket must be determined. A recent tax court case, Estate of Winkler v. Commissioner of Internal Revenue, TC Memo 1997-4, illustrates the facts that successfully established a partnership between the parents and their children.

The issue facing the court in Winkler was whether Mrs. Winkler purchased the winning ticket on her own behalf or on behalf of a partnership of family members. If Mrs. Winkler had purchased the ticket in her own name, any benefits to Mrs. Winkler’s children would be considered an assignment of income and/or gifts.

Mr. and Mrs. Winkler had been married for over 50 years and had five children. The facts indicate that the Winklers were a close family and the children lived within a short distance of their parents’ home. The children visited their parents every Sunday. Because Mr. Winkler was in poor health, he frequently went to medical clinics in Champagne, Illinois, and Rochester, Minnesota. The clinics were approximately two and eight hours away, respectively.

While the family was traveling to one of the clinics, Mr. and Mrs. Winkler and one or more of their children suggested they purchase lottery tickets for the weekly Lotto. Thereafter, a family routine was established during the trips to and from the clinics that Lotto tickets would be purchased by whoever actually had a dollar bill.

After the tickets were purchased, Mrs. Winkler would place them in a glass bowl in her home where other family documents were kept. The family members referred to the Lotto tickets as family tickets and always regarded them as being owned by the entire family.

Several of the children also purchased tickets for themselves and considered those tickets to be separate property. As one of the family Lotto tickets had the winning numbers, Mrs. Winkler announced to the family that all of them, including the children, had won the Lotto. In the initial meeting with their attorney, the parties agreed ( although the facts are not clear on how the percentages were determined ) that Mr. and Mrs. Winkler should receive 25 percent each and each of the five children would receive 10 percent of the winnings. A partnership agreement for the E & E Family Partnership was prepared to reflect the percentages and memorialize the family’s understanding concerning the purchase of lottery tickets and subsequently the partnership entity claimed the proceeds.

In 1990, Mr. and Mrs. Winkler’s accountant filed a Form 709 for each of them indicating gifts from Mrs. Winkler of $50,000.50 and gifts from Mr. Winkler of $51,861. Both parents consented to split gifts.

Mr. Winkler died in 1992 with a will providing for a marital and residuary trust. The Form 706, U.S. Estate Tax Return, reflected on Schedule F a 25 percent interest in the partnership which was valued at $714,750.55. Mrs. Winkler disclaimed her interest in Mr. Winkler’s partnership interest.

In 1995, the Internal Revenue Service issued a notice of deficiency to Mrs. Winkler and to Mr. Winkler’s estate determining that Mrs. Winkler made gifts to her children of 50 percent of the winning Lotto ticket and that Mr. Winkler consented to split the gifts. The total gift was valued at $1,514,000, and thus resulted in a corresponding gift tax and estate tax deficiency.

The family argued that the ticket was bought on behalf of a preexisting family partnership even though the written partnership was not signed until after the winning numbers were announced. The oral partnership agreement existed prior to the time Mrs. Winkler purchased the ticket.

The court analyzed the case law regarding the validity of a partnership for tax purposes and based upon Commissioner v. Culbertson, 337 U.S. 733 ( 1946 ), considered the following: agreement, conduct of parties, statements, testimony of disinterested persons, relationship of parties, abilities, capital contributions, control of income, and any other facts regarding intent. The absence of a specific agreement was not fatal to the existence of the partnership prior to the purchase of the ticket.

If, upon a consideration of all the facts, it is found that the partners joined together in good faith to conduct a business, having agreed that the services or capital to be contributed presently by each is of such value to the partnership, that the contributor should participate in the distribution of profits, that is sufficient.

The court cited IRC 704(e), which provides that a person is recognized as a partner if capital is a material income-producing factor and the person owns the partnership interest in the enterprise. Because the Lotto ticket was capital in the partnership and not services, and each member of the Winkler family owned a capital interest in the enterprise by contributing capital in the form of dollar bills to purchase the Lotto ticket, each member of the Winkler family would be recognized as a partner.

The court then focused on whether Mrs. Winkler purchased the winning Lotto ticket on behalf of a preexisting family partnership. The court determined that Mrs. Winkler did not normally play games of chance and that she had never purchased Lotto tickets other than the family tickets. In examining all the facts the court determined that Mrs. Winkler purchased the winning ticket on the family partnership’s behalf.

Because no written partnership agreement existed, the court determined that the family members had not agreed to the specific partnership interests. Quoting Treasury Regulation 1.761-1( c ) " (as) to any matter on which (a) partnership agreement, or any modification thereof, is silent, the provisions of local law shall be considered to constitute part of the agreement," the court determined under Illinois law ( the domicile of the Winklers ) if no written partnership agreement existed each partner would have an equal distribution of partnership profits and interest. Because seven individuals participated, each received a 1/7 or 14.29 percent interest. As the Winklers reported a 25 percent interest, the court determined that the Winklers did not make a gift to their children and therefore no gift or estate tax deficiency resulted.

Based upon Winkler, it appears the relevant factors to review for your discussions with the Gotrichs are:

1) Intent of Mr. and Mrs. Gotrich and their children;
2) Actual circumstances surrounding the purchase of the winning ticket;
3) Agreement between Mr. and Mrs. Gotrich and their children;
4) Statements between Mr. and Mrs. Gotrich and their children;
5) Control of income and capital.

Under Florida law a partnership agreement need not be written. Therefore, Mr. and Mrs. Gotrich’s attorney must ascertain whether the intent and factual circumstances would create the partnership agreement prior to the purchase of the lottery ticket and how the partnership interest were held. If the intent and circumstances do not indicate a partnership or if, upon audit, the Internal Revenue Service determines no partnership exists, the gift tax sequences could be disastrous. For example, assume the present value of a $30 million lottery annuity is $21 million and the partnership interest are divided among seven individuals; then a gift of $15 million would be considered made to the Gotrich children resulting in a gift tax, together with interest and penalties.

Probably the only conclusive way to assert a partnership prior to the purchase of the lottery ticket is by executing a written partnership agreement prior to the date of the winning lottery ticket. Because most clients who play the lottery have not even thought of such an agreement, the attorney must advise clients of tax exposure if a partnership is asserted.

Mr. and Mrs. Gotrich advise you that their intent was to form a partnership with all the parties and want you to draft the partnership agreement. The Gotrichs need to be advised clearly of the income, gift, and estate tax consequences if the Tax Court or Internal Revenue Service determines no partnership actually existed prior to the ticket purchase. The conservative approach is to create the partnership, create the children’s interest of a value equal to the gift tax returns for the amounts of the children’s interest in the partnership. Subsequent gifting of partnership interest to the children then could be made. If the value of the gift is fully disclosed on the gift tax return and is adequate to apprise the Internal Revenue Service of the gift and its value, then the three-year statute of limitations will apply and a revaluation of the gift cannot be made on an estate tax return.

The $30 million less income taxes will be payable annually to the partnership over 20 years. You must also advise the Gotrichs that when either of them dies, an estate tax of up to 55 percent may be payable on the value of the partnership interest included in the decedent’s estate. Generally, lottery winnings are treated as an annuity for estate tax purposes. The valuation of the annuity is made using the interest rates under 7520 of the Code. Thus, if the survivor of the Gotrichs dies holding a partnership interest with a value of $10 million, the children could owe approximately $5.5 million in estate taxes with no cash to pay the amount. Fortunately, the IRS can extend the time for the payment of the estate tax for reasonable cause. Furthermore, recent letter rulings have approved the use of marital QTIP trusts in lottery planning. The Gotrichs may also want to consider purchasing a life insurance policy which could be held in an irrevocable trust. The proceeds then could be available to provide liquidity for the payment of the taxes.

Finally, the Gotrichs should be advised of possible generation-skipping transfer tax exposure. Planning for the allocation of each of the Gotrich’s $1 million exemption must be considered, but because the present value of the lottery winnings exceeds the total exemption available, the documents should be carefully drafted to ensure that no generation-skipping transfers occur.

Assuming the partnership agreement is drafted, the Gotrichs and their children will be the partners. Prior to the trip to Tallahassee, the attorney should obtain a federal identification number for the partnership, open a bank account, and obtain wiring instructions for such account.

The Florida statute requires the names, addresses, and Social Security numbers of all of the ultimate beneficiaries. For example, if Mr. and Mrs. Gotrich each had a revocable trust which would be named a partner of the partnership, then the names of the ultimate trust beneficiaries must be given to the state. The names and cities of the winner, i.e., the partnership, is not confidential, but street addresses and telephone numbers are confidential. With the use of the computer and the Internet, however, your clients should be advised that such information probably could be obtained. You may want to advise them to channel all calls through their attorney.

This article addresses only a portion of the planning issues in collecting lottery proceeds. Unfortunately, the individuals who really need assistance usually are the ones who do not consult an attorney. In many ways planning for the lottery winner is no different than planning for any individual except that the numbers ( and, therefore, your exposure ) are multiplied. The winners, however, often have no concept of the taxes that may be incurred and the attorney’s job is to advise them so as to preserve as much of their winnings as possible.


Florida State Lottery Tax and Estate Planning Issues
Navigating the Minefield of Settlements: A Primer on Tax Issues for the Probate and Trust Litigator

In these economic times, probate and trust litigators have a growing practice. Litigation results not only from clients who are more knowledgeable in pursuing their rights, but also from the proliferation and increasing complexity of trust documents, together with the demographics of baby boomers and their parents reaching middle and old age. This author has worked with many excellent litigators and has had the opportunity to advise them on various tax issues in resolving disputes and documenting the resolutions in settlement agreements. This article is intended to help litigators spot various tax issues and assist in properly documenting the resolution in an agreement.

Background

Florida law permits settlements in disputed will matters1 and trust matters.2 Agreements avoid the unnecessary expense of a trial and may resolve issues between family members that have been brewing for many years. Agreements can be as creative as the litigators who draft them. Unfortunately, while an agreement may resolve family issues and address the equitable distribution of the assets, tax consequences to the beneficiaries may not be considered until well after the agreement is finalized by the court. These tax issues can expose litigators to unforeseen liability because the parties assume (perhaps incorrectly so) that the litigators have addressed all the tax issues in an agreement.

One beneficial way to analyze tax issues in the negotiation of an agreement is to realize that every transaction, change, or addition affecting a disputed will or trust can have a tax consequence. The tax consequence may be favorable, unfavorable, or neutral to any one or more of the parties to the agreement. Obvious tax areas that must be addressed are income tax, gift tax, estate tax, and generation skipping transfer tax (GSTT) matters, and the not-so-obvious taxes include (but are not limited to) foreign tax, employment tax, excise tax, return filing, collection, penalties, criminal tax misconduct, corporate tax, deferred compensation, UBTI, partnership tax, capital gains tax, and special valuation rules. While a discussion of all these taxes is beyond the scope of this article, the author believes that litigators should be aware of the “ticking time bomb” of undisclosed and unknown tax effects to the parties to the agreement.

Some litigators may assume that the certified public accountant (CPA) or tax attorney (collectively the “tax professionals”) will cover the litigator’s exposure. However, if the facts, details, and the background of an agreement are not adequately communicated to the tax professionals, then tax advice will not be comprehensive. Tax advice is extremely detail-driven, and it is this author’s experience that in the rush to sign an agreement, details may be overlooked. Litigators should involve tax professionals as early as possible. In many cases, “the tax tail cannot wag the dog,” but adverse tax consequences found after entering into an agreement will surprise the parties who will look to the attorneys who negotiated the agreement for satisfaction.

The purpose of this article is to focus on identifying issues, not resolving them. The author wants to help litigators spot issues so that they will know when it is appropriate to contact the tax professionals to clarify the outcome of the desired transaction. Litigators often provide their expertise and creativity to alternatives not considered by the tax professional because the litigators generally understand the controversy and the family dynamics much better than the outside tax professionals. Working with the litigator and the tax professional in unison is a win-win situation.

Fact Pattern

The following fact pattern will be analyzed throughout this article. Assume Duke, age 87, a Florida resident, dies in 2009 with a $10 million estate, $1 million passing through probate to his trust, $7 million already funded in his revocable trust, and $2 million in joint names with his surviving spouse, Daisy. Duke and Daisy, age 98, have each been married several times, and each has adult children from prior marriages. Duke’s children are Jim, Fred, and Charles and his grandchildren are Fred’s children, Mindy and Mark. Daisy’s only child is a daughter, Samantha. Duke leaves via a pecuniary formula his maximum exemption amount (the exemption assets) outright in equal shares to his children and his grandchildren. The balance is left to a qualified terminal interest property (QTIP) trust for Daisy’s benefit and at her death, the QTIP assets will be distributed in equal shares to Duke’s children, Duke’s grandchildren, and Samantha.

Prior to Duke’s death, Duke’s son, Jim, under a Florida durable power of attorney, made substantial gifts in equal shares to Duke’s children for estate planning purposes. The durable power of attorney does notauthorize any gifts. Samantha has retained counsel to sue Duke’s granddaughter, Mindy, the named personal representative and trustee, because Samantha was omitted as a beneficiary from the exemption assets. Samantha claims that one month before Duke died, Mindy took Duke to Mindy’s favorite attorney to change his documents to remove Samantha as a beneficiary of the exemption assets. Samantha argues that the Carpenter3 factors are present to make a claim for undue influence. Language in prior wills and/or trusts indicates that all assets were to be distributed to Duke’s children, Duke’s grandchildren, and Samantha equally as is evidenced by the residuary disposition of the QTIP trust.

Further, Duke’s children are suing Daisy, arguing that Daisy coerced Duke to leave the $2 million in assets jointly. Duke’s children believe Duke’s intent was that Daisy should not receive any money outright.

Estate Tax Marital Deduction

Upon initial review, no estate tax will be payable at Duke’s death as the exemption assets fully utilize Duke’s exemption amount, and the other assets pass to a QTIP trust or via joint ownership, both of which qualify (subject to the making of a timely election in the case of the QTIP trust) for the unlimited marital deduction.4 However, if the assets did not pass to the spouse in a disposition qualifying for the marital deduction, then the agreement could be structured to save estate taxes. If property passes to a spouse as a result of a will contest, the marital deduction will be preserved if it passes as a result of a “bona fide recognition of enforceable rights of the surviving spouse in a decedent’s estate.”5 The agreement must be entered because of a valid, enforceable claim.6 If the parties agree for an amount to be distributed to a spouse and no claim is established, the Internal Revenue Service will argue that the agreement is not bona fide and the marital deduction will be disallowed.7 One method determining the “bona fides” of a transaction is whether the proceeding is adversarial. If the matter is tied to a construction or reformation, the Tax Court has found the state court decree was not a bona fide controversy and there was no “genuine and active contest.”8

Under this fact pattern, the QTIP deduction is not at issue. Samantha is not requesting that the QTIP trust be terminated. Suppose, however, the litigators propose to resolve the matter by distributing trust assets to Samantha. Of course, before the beneficiaries of the exemption assets agree to relinquish a portion of their share of the exemption assets to satisfy Samantha’s claim, the parties may agree that the QTIP trust assets of $4.5 million plus the joint assets of $2 million may not be necessary for Daisy’s care, as she is now 98 years old. Thus, if a portion of the QTIP trust is terminated under the agreement and distributed to Samantha to resolve the dispute, then the Internal Revenue Code must be reviewed. An early termination of the QTIP trust will trigger gift taxes,9 a discussion of which is provided later in this article. The cost of a private letter ruling from the IRS and the complications of how to determine how much of the QTIP should be terminated may cause litigators to look to the exemption assets as the source of Samantha’s payment. Nevertheless, litigators should consider that any termination of a QTIP trust will result in gift taxes which are tax exclusive (no tax upon a tax) and will not be includable in Daisy’s estate at her death. As the QTIP assets are includable in Daisy’s estate at Daisy’s death, then the estate tax is tax inclusive (a tax that is calculated on the tax that is paid). Thus, the early termination of a portion of the QTIP may be a viable option considering the age of Daisy.

If Duke’s children are successful in arguing that the jointly held assets should be distributed to Duke’s children instead of Daisy, then the transfer will not qualify for the marital deduction because the assets will not pass from Duke to Daisy, as required by the Internal Revenue Code. Because, however, the exemption assets are funded via a pecuniary formula (the maximum amount that could be funded incurring no estate tax), the QTIP trust would actually be funded with more money, and Duke’s children, grandchildren, and Samantha will be beneficiaries at Daisy’s death.

Administration Expenses

Assume the fees and costs for negotiating and implementing the agreement total $200,000. From which assets do the fees and costs get paid? Assume the parties agree that the exemption assets should be distributed equally to all of Duke’s children, Duke’s grandchildren, and Samantha, but they do not want their shares reduced by any administration expenses, i.e., the beneficiaries want as much money as they can have now, and they agree to give Samantha a portion of the exemption assets so the litigation matter will be resolved. Can those fees and costs be deducted from the principal and/or income of the QTIP trust or must expenses be apportioned between the exemption assets and the QTIP trust? Administration expenses can generally be taken either on the estate tax return or the estate’s income return, but not both.10 If deducted from the estate income, then the marital deduction is not reduced. However, if deducted from the estate principal on the estate tax return, then the marital deduction may be reduced. An analysis must further be made as to whether expenses are management expenses or transmission expenses.11 If the expenses are management expenses, then such expenses generally cannot reduce the amount of the principal for purposes of the marital deduction,12 unless the expenses are attributable to and paid from the marital share and are actually claimed on the estate tax return.13 If the expenses are transmission expenses, then such expenses can reduce the principal.14The agreement should reflect from what source attorneys’ fees and other administrative expenses are to be paid, and from which trust the expenses will be distributed. These discussions should be coordinated with the tax professionals preparing the estate tax return and the estate and trust income tax return.

To be deductible on the estate tax return, the administrative expenses must be “actually and necessarily incurred in the administration of the decedent’s estate; that is, in the collection of assets, payments of debts, and distribution of property to the persons entitled to it.”15 Attorneys’ fees incurred by or for the benefit of beneficiaries who are parties to litigation are not deductible “if the litigation is not essential to the proper settlement of the estate.”16 Thus, litigators should carefully negotiate the terms of the agreement to confirm that such fees and costs are deductible.

Generation Skipping Transfer Tax Issues

Duke’s grandchildren will receive a portion of the exemption assets and may receive a portion of the QTIP trust if any portion of the QTIP trust passes to them at Duke’s death. If a transfer is made to a grandchild from either the exemption assets or QTIP trust, then the GSTT17 may apply. Duke’s personal representative can allocate Duke’s unused GST exemption18 to such transfers. If the personal representative properly allocates the GST exemption to the exemption assets on the estate tax return prior to finalization of the agreement, and assuming Duke has his full GST exemption of $3.5 million available, then the GST exemption allocated will be two-fifths of the $3.5 million, or $1.4 million. The balance of the GST exemption will be allocated to the QTIP trust if the personal representative makes a reverse QTIP election and the QTIP trust can be severed,19 thereby creating an exempt QTIP trust and a nonexempt QTIP trust.

Suppose, however, as a result of the agreement, Duke’s grandchildren only receive two-sixths of the exemption assets, or $1,166,667, instead of $1.4 million to which the personal representative allocated GST exemption on the estate tax return. Can the wasted GST exemption allocated on the estate tax return (i.e., $1.4 million of exemption was allocated instead of $1,166,667) be fixed? Once the GST exemption is allocated on a timely filed estate tax return, the allocation may not be reversed.20 Thus, if an agreement is being hammered out, an extension of the estate tax return should be filed, and the GST allocation should be made by a formula.

When an agreement adjusts grandchildren’s interest or those in lower generations from the decedent, defined as “skip persons,”21 GSTT issues must be considered because the GSTT is at the highest estate tax rate. The attorney must consider not only biological grandchildren, or individuals inherently skip persons, but also beneficiaries who are otherwise skip persons because of ages.22 Remember that if a partner is more than 37 and a half years younger and is a beneficiary of an individual’s trust, a GSTT can result.

Further, if litigators are dealing with an exempt GSTT trust in existence prior to September 25, 1985, care must be made as to contributions or dispositions to or from such a trust. If improperly handled, a fully exempt grandfathered GSTT-exempt trust23 could lose its exemption if assets are contributed to or distributed from such a trust.

Income Tax Issues

Suppose, as part of the agreement, Duke’s son, Fred, wants his share comprised of a specific painting which has appreciated from the date of death. Is this in-kind distribution taxed? If so, then who pays the taxes? From what trust do the funds get paid? Generally, a distribution of an in-kind distribution which has appreciated and is distributed pursuant to a pecuniary (a fixed dollar amount) formula will trigger capital gains tax.24 Thus, if the date of death value of the painting is $100,000, and the date of distribution value is $150,000, then the agreement should provide who will be responsible for those taxes, if any. If the agreement ultimately changes the amounts received by each beneficiary, amounts received that would otherwise be exempt from income taxes25 because the amount received is a gift or bequest,26 then the amount received under the agreement should also be exempt from income taxes. If, however, distributions made pursuant to the agreement would otherwise be taxable income (i.e., income in respect of a decedent27), then the beneficiary will be taxed on such income.

Gift Taxes

Suppose, after the estate tax return has been filed, an agreement is negotiated that provides a portion of the QTIP trust is to be terminated and such assets are to be distributed equally to Duke’s children, Duke’s grandchildren, and Samantha. Generally, one can sever a QTIP by making partial elections,28 and Florida law29 permits such elections. Most trust documents are drafted to provide for such elections. If the trustee of a QTIP trust terminates a QTIP trust, then the spouse is deemed to make a gift of all of the interests in that trust except for the qualifying income interests.30 Thus, the spouse will incur gift taxes on that distribution.

A recent article by Charles D. Rubin, “Tax Results of Settling Trust Litigation Involving QTIP Trusts,”31discusses such tax consequences in detail. Mr. Rubin’s article contains an excellent chart that outlines the various issues. To confirm the estate tax, gift tax, and GSTT consequences of a QTIP termination pursuant to agreement, it is the author’s opinion that a private letter ruling should be obtained as the tax exposure can be high if the consequences are not, in fact, those expected by the parties. However, a private letter ruling can only be relied upon by the taxpayer requesting the ruling. Therefore, it is best to carefully review the successful rulings32 and pattern the agreement accordingly.

If the beneficiaries change their relative interests in the will or trust as between themselves, then, provided that the interests are being adjusted in a bona fide controversy, no gift tax issues should result.33 For example, if each child and grandchild is to receive $700,000 of the exemption assets, and instead each child and grandchild receives $585,333, the amount given to Samantha of $116,667 from Duke’s children and grandchildren is not deemed a gift if a valid agreement is entered into by the parties.

Valuation Issue

What if Samantha contests the gifts made by Jim under the durable power of attorney? Do those gifts reflect a “receivable” that should be included on the estate tax return? If so, how is the receivable valued? A decedent’s gross estate is the value of all property owned by a decedent.34 The value is its fair market value35 at the time of the decedents’ death.36 How much would someone pay for this receivable? Any value of that receivable will affect the value of the QTIP trust. Further, if the estate tax return has already been filed, should an amended estate tax return be filed? In “Filing a Supplemental Estate Tax Return After Probate Litigation,”37 David Pratt and George D. Karibjanian provide an excellent discussion on this issue.

CONCLUSION

Tax issues can vary substantially depending on the facts of each situation and how litigators negotiate and resolve the dispute. While the fact pattern discussed in the article may not arise in your practice, the discussion should sensitize you to the different tax areas that can affect the negotiations, and how these issues can best be resolved in a tax-favored way that will be beneficial (or at least not harmful) to all parties to the agreement.


1 Fla. Stat. §733.815 (2009).
2 Fla. Stat. §§736.0412 and 736.0416 (2009).
3 Carpenter v. Carpenter, 253 So. 2d 697 (Fla. 1971).
4 I.R.C. §2056(b)(7).
5 Treas. Reg. §20.2056(c)-2(d)(2).
6 Ahmanson Foundation v. United States, 674 F.2d 761 (1981).
7 TAM 9610004.
8 Estate of Aronson v. C.I.R., T.C. Memo. 2003-189.
9 I.R.C. §2519.
10 I.R.C. §642(g).
11 Treas. Reg. §20.2056(b)-(4)(d).
12 Treas. Reg. §20.2056(b)-(4)(d)(3).
13 Treas. Reg. §20.2056(b)-(4)(d)(5)Ex3.
14 Treas. Reg. §20.2056(b)-(4)(d)(2).
15 Treas. Reg. §20.2053-3(a).
16 Treas. Reg. §20.2053-3(c)(3).
17 See I.R.C. Ch. 13.
18 I.R.C. §2631(a).
19 I.R.C. §§2652(a)(3) and 2642(3).
20 I.R.C. §2631(b), but see I.R.C. §2642(g)(1) for relief for late elections.
21 I.R.C.§2613.
22 I.R.C. §2651(d).
23 Treas. Reg. §26.2601-1.
24 Kenan v. Commissioner of Internal Revenue, 114 F.2d 217 (1940).
25 Lyeth v. Hoey, 305 U.S. 188 (1938).
26 I.R.C. §102.
27 I.R.C. §61(14).
28 Treas. Reg. §20.2056(b)-7(b)(2)(ii).
29 Fla. Stat. §736.0417 (2009).
30 I.R.C. §2519(a).
31 Charles D. Rubin, Tax Results of Settling Trust Litigation Involving QTIP Trusts, 36 Fla. Bar J. 23 (Jan. 2009).
32 See PLRs 200801009, 200717016, 200628007.
33 Treas. Reg. §25.2512-8.
34 I.R.C. §2031.
35 Treas. Reg. §20.2031-1(b).
36 Id.
37 David Pratt & George D. Karibjanian, Filing a Supplemental Estate Tax Return After Probate Litigation, 36 Estate Planning 17 (Sept. 2009).

Linda S. Griffin is a sole practitioner in Clearwater. She is a fellow of the American College of Trust and Estate Counsel and is board certified in wills, trusts, and estates and tax law. She graduated from the University of Florida, received her LL.M. in taxation from the University of Florida, and is a Florida certified public accountant. The author thanks Board of Governors member from the Sixth Circuit Andrew B. Sasso of Clearwater and Simi Bhatia, a graduate of the paralegal program at St. Petersburg College, for their help in preparing this article.
This column is submitted on behalf of the Real Property, Probate and Trust Law Section, Brian J. Felcoski, chair, and William P. Sklar and Kristen Lynch, editors.
[Revised: 12-22-2010 ]


Other Articles

Estate Planning Issues for the Family Lawyer

Every family lawyer must have some knowledge of estate planning issues as you are advising your clients through dissolution of a marriage. Even something as simple as documenting in your file that you have advised the clients that they should consult an estate planning attorney or, better yet, a letter to your client that he or she should consult with an estate planning attorney to review their documents in light of the upcoming dissolution.

While not comprehensive the following highlights important issues.

1. Change beneficiary designations of life insurance and retirement plans. If the participant spouse dies before the dissolution is final and the surviving spouse is still named as the beneficiary, then that surviving spouse will receive those benefits unless the participant spouse has changed the beneficiary designation (but remember that in a certain qualified plans the spouse has to waive the joint and survivor annuity or other spousal rights so the waiver should be signed by the non participant spouse prior to the dissolution of marriage and such waiver should be addressed in the settlement agreement if the participant spouse wants to change the beneficiary prior to the date of the dissolution). The IRA committee of the Florida Real Property Probate and Trust Law Section (“RPPTL”) is proposing a statute that would provide that upon dissolution of marriage the spouse named as beneficiary would be deemed to have predeceased the decedent spouse.

2. Review the Last Will and Testament for changes for personal representative, guardianship and dispositive provisions. Under current law, upon dissolution of marriage, a spouse is deemed to have predeceased the decedent spouse for purposes of the Will unless the Will or dissolution judgment provides otherwise. If, however, a spouse dies before the dissolution proceeding is final and the decedent spouse has not changed the terms of his or her Will, then the dispositive provisions of the Will control.

3. Consider the gift tax exemption and the use of the exemptions of both parties prior to the dissolution.

4. Titling of property. If the title of the property is held as tenants by the entirety, then, upon dissolution of marriage, the property is held as tenants in common. If one of the spouses die shortly after the dissolution but prior to the time the deed is changed an ex spouse could hold real estate with stepchildren, a very unpleasant result in most cases.

5. Homestead. It is extremely important that your client understands that if he or she receives the homestead in the dissolution of marriage and he or she dies survived by a minor child then the ex spouse (unless the spouse is generally “unfit”) will be the guardian of the homestead for the minor child. The minor child MUST receive the homestead upon the parent’s death.

6. Review revocable trusts. Under current law, upon dissolution of marriage, a spouse is deemed to have predeceased the decedent spouse for purposes of the trust unless the trust or dissolution judgment provides otherwise. If, however, a spouse dies before the dissolution proceeding is final and the decedent spouse has not changed the terms of his or her trust, then the dispositive provisions of the trust control.

7. Review the durable powers of attorney, durable health care powers of attorney and living wills. Generally (there are always exceptions) spouses do not want an ex spouse making their health care or financial decisions!!!

8. Irrevocable trusts. These trusts need to be reviewed to be sure that the named spouse in the document is automatically changed upon the dissolution of marriage.

9. Review the family limited partnerships, LLC and other corporate documents. You need to be sure that the provisions you draft in your settlement agreement are permitted under the documents governing such entities.

10. Elective share. If a spouse omits his or her spouse from the terms of his or her will or trust because of an impending dissolution of marriage and dies prior to the date of the dissolution of marriage, then the surviving spouse is entitled to 30 percent of the “elective estate”. Florida law provides for an elective share trust but such a trust needs to be specifically drafted in the document.

11. Review charitable trusts. If your client has established charitable split interest trusts then you need to review the provisions of such trusts to be sure that the spouse is not named as a successor annuity or unitrust beneficiary of such split interest trusts. If a spouse is named as the successor beneficiary then you may be able to split the charitable trust.

12. Tips for a qualified domestic relations order (“QDROS”)

A. Get the exact name of the qualified retirement plan (the “Plan”) in the settlement agreement.

B. Either provide for earnings and losses after the division date or not.

C. Make sure that the division date is one that is authorized by the Plan.

D. Make sure the spouse receiving the Plan benefits properly rolls over the money to his or her IRA or better yet make a trustee to trustee transfer.

E. Obtain all the Plan information, such as the name of the Plan administrator, a copy of the actual Plan, the contact name at the Plan for QDROs and the statements of the participant’s accounts in the Plan DURING the negotiations for the dissolution of marriage. Do not wait until after everything has been signed and then try to obtain the information.

F. Have the participant spouse sign a release permitting the non participant spouse to obtain the information from the company sponsoring the Plan.

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