Are Assets Left to Your Child Via Your Trust Protected from Your Child’s IRS Tax Liens? It Depends…
As discussed in a prior blog, many individuals do not want creditors of their son or daughter to be able to access the benefits that they leave in trust for their son or daughter. Whether a creditor can “attach” a child’s interest in the trust property depends on how the trust is drafted as illustrated in the recent case of Duckett v. Enomoto.
Ms. Enomoto passed away in February 2013 and provided for her three children, Dennis, Nancy and Joanne. Dennis’s share distributed from Ms. Enomoto’s estate would be held in trust (probably because he was a doctor) and the trust provided that the trustee “shall pay to Dennis Masaki Enomoto so much or all of the net income and principal of the trust as in the sole discretion of the Trustee may be required for support in the beneficiary’s accustomed manner of living …..(emphasis added).” The trustee was a corporate trustee but Dennis could request the removal of the trustee and appoint a successor who would have to be an Arizona license private fiduciary and not a member of his family. Nancy was the personal representative of mom’s estate.
Unfortunately, Dennis had outstanding tax obligations of approximately $700,000 for the years 2007-2011. Nancy, as personal representative, in the estate’s accounting, provided that approximately $173,000 would be distributed to Dennis’ trust. However, before Nancy distributed the funds to Dennis’ trust, Nancy received a Notice of Levy from the Internal Revenue Service (the “IRS”) demanding that Nancy pay Dennis’ proposed distribution directly to the IRS.
The court first analyzed whether Dennis had a property right in the trust funds under Arizona law and then, if Dennis did have such a property right, whether such property right was subject to the IRS levy. The court determined that, because the trust distribution language included the word “shall”, such distributions were mandatory. Further, because the trustee had the “the sole discretion” to make the specific determination of how much distribution was required, the trust was considered a “hybrid” or discretionary support trust. Dennis argued that the trust was purely discretionary and thus, he was not absolutely entitled to distributions from the trust. The court disagreed with Dennis and determined that his right was mandatory; subject to the trustee’s discretion.
The court then analyzed whether such right was a property right subject to the tax levy and whether Dennis had enough “control” over funds held in the discretionary support trust to permit the levy to attach to such property. The court analyzed case law and determined that Dennis had a property right under Arizona that could be attached by the IRS. While the court determined that the property right could be attached, the court did not agree that the IRS could receive 100% of the proposed trust distribution. The IRS would have to return to trial court to determine the amount of the trust distribution that could be attached.
ADVICE: Case law once again makes clear that the drafting of a PURELY discretionary trust must be specific and the word “shall” should not be used in authorizing the trustee to make distributions to the beneficiary. Drafting to assure that a spouse, the IRS or any other creditor will not be able to receive your children’s inheritance is very specific and technical. Also be sure to investigate alternative state statutes which may work better for such protection.
WORD OF THE WEEK: LEVY means imposing or collecting an amount due, such as a tax, by authority or force. Section 6331 of the Internal Revenue Code , enables the IRS to collect a tax that a taxpayer neglects or refuses to pay by seizure of property by any means. Prior to the actual levy, there must be a Notice of Levy sent to the person whose property the IRS intends to levy.
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