In 1994, Elwood Olsen created a revocable living trust to hold his separate property and his half of the joint property. That same year his wife, Grace Olsen, created a revocable living trust to hold her separate property and her half of the joint property. At death, Elwood and Grace’s trusts were to divide into three sub-trusts, Marital Trust A, Marital Trust B, and a Family Trust. The Family Trust was to contain the amount of trust assets that could pass free of estate tax at death. The Marital Trust A was to hold any excess amount over the amount distributed to the Family Trust, but not to exceed $1 million reduced by the amount of generation skipping trust exemption used by Elwood or Grace during their lifetimes, as applicable. The Marital Trust B was to hold any remaining excess over the amount allocated to the Family Trust and Marital Trust A.
The terms of Marital Trusts A and B provide the surviving spouse was to receive all income and principal, as determined at the discretion of the trustee, for the surviving spouse’s health, education, support, and maintenance. The terms of the Family Trust provide the surviving spouse was to receive income and principal, as determined at the discretion of the trustee, for the surviving spouse’s health, education, support, and maintenance. At the death of the surviving spouse, the Family Trust and Marital Trust A were to be combined and then split into as many shares as there were children of the couple then living, plus one additional share for any deceased child who left descendants who were living at the death of the surviving spouse. The assets of Marital Trust B were to be divided into shares for Elwood’s and Grace’s grandchildren.
Both Elwood and Grace received degrees from Morningside College. Elwood worked for the college after his graduation, first as the manager of its business operations and then as vice president of business operations until his retirement in 1978. During life, Mr. and Mrs. Olsen had a history of making donations, some sizable, to the college.
Elwood and Grace amended their respective trusts in 1995. The amendment made by Elwood reduced a testamentary gift to Morningside by the amount the college was to receive from annuities and retirement plans of which Morningside College was named as beneficiary. Elwood and Grace also amended their respective trusts to eliminate a provision relating to equalization of gifts made to members of their family during their lifetimes.
Grace passed away in 1998. Elwood did not split Grace’s trust into three shares as required under the terms of her trust. Elwood passed away in 2008. Elwood’s executor filed a late estate tax return for Grace, showing values at Grace’s date of death of $1 million in Marital Trust A, $504,695 in Marital Trust B, and $600,000 in the Family Trust. The estate tax return showed a zero estate tax because the executor used the unlimited marital deduction to shelter the assets allocated to the Marital Trusts.
By the end of 2000, the assets in Grace’s Trust had increased to $2,664,584. Elwood, as trustee of Grace’s trust, made three significant withdrawals from Grace’s trust – first, a charitable gift in 2002 to Morningside College in the amount of $249,550, second, a charitable gift in 2004 to Morningside College in the amount of $831,252, and, third, a withdrawal of $393,978 in 2006 that Elwood deposited into one of his bank accounts.
In 2007, Elwood amended his revocable trust to eliminate all gifts to Morningside College (because he had taken care of the college with his lifetime gifts) and he increased the amount of the generation skipping trust exemption to be allocated under the terms of his trust to $2 million (to reflect the increased limit in 2007).
After Elwood’s death, the executor of his estate informed the beneficiaries of Grace’s Trust that he was allocating all the remaining assets in Grace’s trust (remember it had never been divided at Grace’s death as required under the terms of the trust) to the Family Trust because he was taking the position that the charitable gifts and withdrawal made by Elwood from Grace’s Trust came from the Marital Trusts.
The executor then filed an estate tax return for Elwood. Elwood’s estate tax return contained none of the assets in Grace’s trust, as the executor was taking the position all the assets had been allocated to the Family Trust, which should pass free of estate tax to the couple’s children. The IRS audited Elwood’s estate tax return and issued a notice of deficiency, taking the position that Elwood’s estate was undervalued by $1,071,224 because of the exclusion of all assets from Grace’s Trust on his estate tax return. The IRS took the position that Elwood was not authorized under the terms of Grace’s trust to make withdrawals from the Marital Trusts to make charitable contributions or for deposit into his personal account. As such, these withdrawals could have only come from the Family Trust. Thus, the assets remaining in Grace’s trust must all be assets that should be allocated to the Marital Trusts, and under Internal Revenue Code §2044, Grace’s Marital Trust assets would be includible in Elwood’s estate.
The Tax Court, in Estate of Olsen v. Commissioner, T.C. memo 2014-58, held that the IRS’ position was correct and the amount of Elwood’s estate should be increased by the assets in Grace’s trust.
Had Elwood properly divided Grace’s trust into the three sub-trusts called for at Grace’s death and made the charitable gifts to Morningside College from his assets during his lifetime, it is very possible that the consequences of this adverse ruling could have been avoided or significantly reduced. At a minimum, the interest and penalties would have been eliminated.
Our office focuses on trust administration and methods to reduce estate taxes, including charitable giving strategies. We work with clients of all ages and income and wealth levels. As a member of the American Academy of Estate Planning Attorneys, our firm is kept up to date with information about recent developments, such as the Estate of Olsen case. You can get more information about scheduling a complimentary estate planning or trust administration appointment and the services offered by calling our firm at (408) 356-9200 or (831) 476-2400.