Opinion ID: 2512045
Heading Depth: 1
Heading Rank: 7

Heading: did the district court err in approving the modification granting a limited testamentary power to alford?

Text: Alford contends on appeal that the second modification to the trust (Article VII, paragraph B) achieves favorable tax treatment consistent with Senator Darby's intent. See K.S.A. 58a-416. By granting Alford a limited testamentary power of appointment, the apparent intent of this modification was to vest the assets of the trust in Alford's taxable estate, thus subjecting them to federal estate tax rather than federal generation-skipping transfer tax (GSTT). Because the exemption for federal estate taxation exceeds the value of the trust assets, the modification was apparently intended to minimize federal tax liability. At the outset, we note the curious nature of the power granted in this proposed modification. The language requires that the assets of the trust shall be distributed to such federal or state taxing authorities for payment of estate taxes as [Alford] may appoint by a will [or otherwise]. The language then states that in default of such appointment (or if ineffective), the trust shall be divided into equal shares for each of the second generation beneficiaries. Although Alford claims on appeal that this language creates a general testamentary power of appointment, we disagree. Instead, Alford would be granted only a limited power to appoint federal or state taxing authorities to receive a distribution for payment of estate taxes. The taxes to be paid are not limited only to Alford's estate taxes, but rather could include generically any and all federal and state estate taxes of anyone. We also fail to see any logical nexus whatsoever between the limited power granted and the specified consequences of default of such appointment division of the trust into shares for each of the second generation beneficiaries. Finally, we find it curious that Alford seeks avoidance of the federal GSTT, which has been eliminated effective December 31, 2010. Pub.L. No. 107-16 § 501, 115 Stat. 38, 69 (2001); see 26 U.S.C. § 2601(2006) et seq. Notwithstanding these curiosities, we analyze the validity of the proposed modification. The tax problem addressed by the proposed modification is exposure to the GSTT. As described by Alford's brief on appeal: As drafted, the Will failed to account for the generation-skipping transfer tax ('GSTT'). See 26 U.S.C. § 2601, et seq. As a general rule (which applies here), the federal transfer tax system subjects assets to estate tax in every generation. Otherwise, assets fall under the GSTT. Id. `The generation-skipping transfer tax is designed to tax these transfers of accumulated wealth to successive generations in much the same way that a gift or estate tax would have done if the property had been transferred outright by gift or inheritance.' In re Estate of Tubbs, 21 Kan. App.2d 395, 399, 900 P.2d 865[, rev. denied 258 Kan. 858] (1995).... As such, the GSTT `impos[es] a [45%] tax on transfers which skip generations.' Id. See also 26 U.S.C. § 2641(a).... At the time of Senator Darby's death, the GSTT was subject to a $1 million exemption for the entirety of his estate. [Citation omitted.] Under the Will, Mr. Darby left over $7 million in separate trusts for his children and, upon their deaths, for their children. All of these trusts including Trust D, were designed to `skip' estate taxation in the child's generation. Id. The GSTT is triggered, therefore, when the trust funds pass to the second generation of beneficiaries (in the case of Trust D, Ms. Alford's children). Id. See also 26 U.S.C. § 2623 (same). Thus, under the Will as originally drafted, a 45% GSTT would apply to the remaining value of Trust D upon Ms. Alford's death, with only minimal set off for its pro rata portion of the $1 million GSTT exemption. [Citation omitted.] In other words, Alford argues that when the Darby Trust D was created, generation skipping may have been a vehicle to avoid federal estate taxation on the trust assets passed to each generation, but changes to both the federal GSTT and the federal estate tax exemption have now turned the table and optimal tax minimization would avoid the generation skip and expose the assets to estate taxation because they do not exceed the increased exemption. Applying K.S.A. 58a-416, would such a change achieve the settlor's tax objectives in a manner that is not contrary to the settlor's probable intent? Questions of this nature have puzzled courts across the nation. Treatise law acknowledges that some courts have been sympathetic to a postmortem request to a modification that achieves more favorable tax treatment, but to say that such a request achieves the settlor's objectives in a way that is not contrary to probable intent can be a stretch. Indeed, many of the cases pretty plainly boil down to nothing more than an attempt to obtain, through post-mortem litigation, the benefits of better, or more sophisticated, estate planning than the settler was able or willing to procure while alive. So, though it is possible to rationalize each of these cases as merely correcting `mistakes,' in many, the petitioner is plainly asking the court to rewrite a document whose dispositive terms are exactly the way the settler intended them to be, simply to improve its tax efficiency. It is hardly surprising, then, that the courts sometimes balk at tax-driven reformations. . . . . ... Proof that there was a more tax-efficient way to dispose of the settlor's property, therefore, is and should be far short of what is necessary to justify reformation of a governing instrument, even if there is also proof that the settler wanted to `minimize taxes.' Under current law, it is always possible not just to `minimize' the federal estate tax, but to eliminate it altogether, by leaving everything, in appropriate ways, to either a surviving spouse or a charity. Yet a great many people, who may well think of themselves as wanting to `minimize taxes,' do not do so; they deliberately dispose of their property in ways that will not `zero out' their taxes. When the claim is later made that the arrangement was not tax-efficient, it may be that the only way to make it more tax-efficient would have involved different dispositive provisions. The courts are quite naturally less inclined to do this. 5 Scott and Ascher on Trusts § 33.5, pp. 2193-95 (5th ed. 2008). See Bogert and Radford, Trusts & Trustees § 994, pp. 196-205 (3d ed. 2006) (and cases collected therein). Here, Alford does not point us to any specific provision of the trust that indicates Darby's tax objectives or probable intent relative thereto. Alford argues on appeal only that [c]onsistent with Senator Darby's intent, the district court's restatement of the will would also lower Trust D's future tax burden. It may be difficult to divine Darby's objectives, but it is not difficult to see that the requested modification could seriously jeopardize his overall intent manifested within the instrument, and this boundary may not be crossed. See Bogert and Radford, Trusts & Trustees § 994, pp. 197-98 (power to modify the tax related provisions ... is limited by the requirement that the settlor's overall intent, especially the dispositive provisions, not be disturbed by the modification). Regarding Darby's tax objectives, we perceive within the four corners of the will nothing more than an oblique idea that taxes should be minimized or avoided by restricting or directing certain investment practices by the trustee as a part of Article IX. As to Trust D, however, there is merely a straightforward generation skipping bequest subject to a spendthrift clause. The generation skipping design may have been intended to minimize federal estate taxes, but we decline to believe that Darby failed to understand it would expose the trust to the GSTT. When Darby designed and executed his original will, the 1976 Tax Reform Act imposed the GSTT on trusts or similar arrangements having beneficiaries in more than one generation below that of the transferor, subject only to a $250,000 grandchild exclusion. Pub. L. No. 94-455 §§ 2006-2622, 90 Stat. 1520, 1879 (1976); grandchild exclusion at I.R.C. § 2613(b)(6) (repealed 1986). The Tax Reform Act of 1986, effective in October 1986, retroactively repealed the original GSTT and substituted a flat tax rate on such transfers, subject to a new exemption of $1 million per transferor. Pub. L. No. 99-514 §§ 1431-33, 100 Stat. 2085, 2717 (1986) exemption at I.R.C. § 2631; see 26 U.S.C. § 2601 (2006) et seq. As recognized by most commentators at the time of the 1986 enactment, there appear to be several methods by which one can avoid the full impact of the new [GSTT]. See, e.g., Plant and Wintriss, Generation Skipping Transfer Tax, 17 U. Balt. L. Rev. 271, 272 (Winter 1988). Whether we examine Darby's original will or his codicil, it is clear that he could have done a far better job of tax planning had he desired to avoid the GSTT implications for Trust D. This is especially true of his later testamentary device, the codicil, which ratified his depository scheme despite the changes to the GSTT effective months prior to his execution of the codicil and which created an even more burdensome tax impact for his grandchildren. Because it is just as likely that Darby intended exposure to the GSTT for his grandchildren and avoidance of federal estate tax on the death of Alford as that he more generally sought to avoid or minimize overall taxation, there is no reason to believe that the requested modification somehow achieves his tax objectives. In fact, it is just as likely that the proposed modification defeats his precise tax objective for Trust D. An easier call, however, is that the proposed modification would seriously jeopardize Darby's overall intent for Trust D. In distributing all assets at Alford's death to whichever taxing authority she may appoint to pay anyone's federal or state estate taxes is not only directly contrary to the spendthrift clause prohibiting such powers in beneficiaries, but it must be seen as completely destroying his intent to preserve assets for the second and third generations. Moreover, if the grant is construed as a general power of appointment as characterized by Alford in her appellate brief, the proposed modification may expose the trust assets to the claims of Alford's creditors in direct contravention to the express terms of the trust. See Restatement (First) of Property § 329 (1940). In either event, we stand with a majority of courts in holding that a modification of trust provisions to achieve tax benefits cannot be validated when it would alter the dispositive provisions of the trust. See, e.g., Matter of Estate of Branigan, 129 N.J. 324, 336-37, 609 A.2d 431 (1992) (court prohibited modification to power of appointment because it would alter the dispositive provisions and grandchildren would face possibility of losing inheritance); Bogert and Radford, Trusts & Trustees § 994, pp. 197-98. Finally, we note that the limited power of appointment granted to Alford in the proposed modification may not have succeeded in achieving the desired tax result. We express no opinion in the matter but note in passing that the curious attempt to vest the assets in Alford for payment of estate taxes may not have satisfied the IRS that vesting sufficiently occurred to avoid the GSTT. Moreover, we note that the entire GSTT scheme is currently in a state of uncertainty, given scheduled expiration and unknown reinstatement. See, e.g., McCouch, The Empty Promise of Estate Tax Repeal, 28 Va. Tax Rev. 369 (Fall 2008). In summary, we conclude that the proposed modifications to the Darby Trust D would contravene applicable Kansas law. The district court must be reversed and this matter remanded with directions to invalidate the modifications. Reversed and remanded with directions. DAVIS, C.J., not participating. GREENE, J., assigned. [1]