Opinion ID: 2595160
Heading Depth: 1
Heading Rank: 3

Heading: The First Change: Limitation of Discretionary Powers over Distribution of Trust Corpus to an Ascertainable Standard

Text: The testator's son, John G. Harris, is a beneficiary as well as a trustee of the Trust. The trustees allege that discretionary powers regarding the distribution of the corpus may cause an estate tax problem for trustee John G. Harris. According to their argument, the entire corpus of the Trust may be included in his estate upon his death unless the trustees' discretionary powers under Paragraph (e) are limited by an ascertainable standard pursuant to Internal Revenue Code (IRC) provision, 26 U.S.C. § 2041(b)(1)(A) (2000). Paragraph (e) is as follows: (e) Notwithstanding anything hereinabove contained to the contrary, if at any time while the trust herein created is in force, any financial emergency arises in the affairs of any of the primary beneficiaries of such trust, or if the independent income of any of such beneficiaries and all other means of support are insufficient for the support of such beneficiary, in the judgment of the Trustees, the Trustees shall pay over to such beneficiary out of the corpus of the trust, at any time and from time to time, such sum or sums as the Trustees shall deem necessary or appropriate in their sole discretion. In order to establish the need for such a change, the trustees point out that a decedent's gross estate includes the value of property subject to a general power of appointment. 26 U.S.C. § 2041(a)(2). Section 2041(b)(1)(A) defines a general power of appointment by excluding the following: (A) A power to consume, invade, or appropriate property for the benefit of the decedent which is limited by an ascertainable standard relating to the health, education, support, or maintenance of the decedent shall not be deemed a general power of appointment. If it is determined that the power given is not a general power of appointment, the corpus would be excluded from John G. Harris' estate consistent with his father's intent. However, according to the powers in Paragraph (e) of the Trust, John G. Harris possesses the power to distribute the corpus in the event of a financial emergency of a beneficiary or if the financial means of a beneficiary are insufficient to support such beneficiary. Thus, the trustees argue that without an ascertainable standard governing the distribution of the corpus, there is a risk that the entire corpus will be included in John G. Harris' estate upon his death contrary to the intent of the testator. In order to insure favorable tax treatment, the trustees seek to reform the power in Paragraph (e) by expressly bringing the discretionary powers within the safe harbor of 26 U.S.C. § 2041(b)(1)(A). In support of the first change, the trustees contend that Harris intended that the Trust assets not be taxed by inclusion in the estate of his son. Instead, Harris sought by his will to avoid such taxes and that the remaining assets of the Trust upon termination be paid to the charitable organization of Kansas Philanthropies, Inc. The trustees argued before the district court and now before this court that a typographical error occurred during the drafting of the will that caused Paragraph (e) not to be limited to an ascertainable standard to avoid inclusion of the corpus in John G. Harris' estate. The proposed modified version of Paragraph (e) of the Trust is set forth in full below, which accomplishes Harris' intent and thereby avoids adverse tax consequences: (e) Notwithstanding anything hereinabove contained to the contrary, if at any time while the trust herein created is in force, any financial emergency arises in the affairs of any of the primary beneficiaries of such trust, or and if the independent income of any of such beneficiaries and all other means of support are insufficient for the support of such beneficiary, in the judgment of the Trustees, the Trustees may shall pay over to such beneficiary out of the corpus of the trust, at any time and from time to time, such sum or sums as the Trustees shall deem necessary or appropriate in their sole discretion; provided, however, any distributions made pursuant to this provision can only be made for the support of such beneficiaries as such term is defined in Section 2041 of the Internal Revenue Code of 1986, as amended.  (Emphasis added.) The trustees point to the language in John P. Harris' will as evidence that he intended to maximize existing tax advantages by providing for a significant bequest to his surviving spouse thereby freeing the remainder for funding the Trust. Harris left property to his surviving spouse all of which qualifies for the marital deduction as an outright bequest. However, he expressly limited any powers granted to his trustees in order to maximize tax benefits: Any power, duty or discretionary authority granted to my executors or the Trustees of the trust created hereunder shall be void to the extent that their actions shall cause my estate to lose all or any part of the tax benefit afforded by the marital deduction under the Federal Estate Tax Laws. The trustees argue that the self-imposed limitations to maximize benefits available under the IRC applies with equal force to the discretionary powers granted his trustees with reference to his son and grandchildren, especially where the ultimate disposition upon termination of the Trust is a charitable organization. The trustees also rely upon evidence from the scrivner of Harris' last will and testament. In an affidavit dated March 29, 2002, attorney William Chalfant states that he first became acquainted with Harris in 1933 or 1934. Chalfant did legal work for Harris' corporation beginning in 1956, and began doing personal legal work for Harris in 1964. The personal work included drafting Harris' will. According to Chalfant, Harris' primary goal was to provide for his spouse and dependents while minimizing the estate taxes for him and his family. Chalfant addresses powers granted to the trustees in Paragraph (e) of the Trust: 7. Affiant knows, based on his conversations with John P. Harris, that it was not his intention that the assets held in the trust be included in the Estate of his son, John G. Harris, as it would result in a significant estate tax liability. Such a result is contrary to the clear intention of John P. Harris to minimize and/or eliminate any potential estate tax liability. Chalfant says that the phrase, any financial emergency arises in the affairs of any of the primary beneficiaries of such trust should be limited by the phrase, for the support of such beneficiary. In order to effect such a limitation, Chalfant suggested that and should have followed the or and the or should be deleted as reflected in the above proposed changes to Paragraph (e). Chalfant concludes by saying that he believes that modification of the phrase shown above to limit the authority of the Trustees to make distributions under said provision to `support,' or other ascertainable standard, is what was intended by John P. Harris and would be appropriate. Trustee John G. Harris suggests that the Trust Paragraph (e) should be reformed by not only changing the or to and, but also by adding language to insure the limitation of powers is consistent with the provisions of the 1986 Internal Revenue Code as reflected in the above proposed changes to Paragraph (e). According to John P. Harris' estate plan as evidenced by his last will, he was aware of and sought to avoid excessive estate taxes through planning. He provided for his wife by outright devises and bequests that would qualify for the marital deduction then available under the IRC. He devised real estate as well as household goods and automobiles to his wife. He then devised $400,000 in cash or securities reduced by any sums of any gifts of cash or securities made by him to his wife subsequent to their marriage. By these provisions, Harris sought to maximize the available marital deduction as evidenced by the partial federal tax return in the record. The remainder of his estate, reduced by specific bequests to named beneficiaries and further reduced by payment of all estate and inheritance taxes chargeable against the estate, make up the Trust we now consider. As indicated above, Harris expressed his intent to favor his wife with one-half of the income from the Trust for her life and provided for distribution of corpus to his wife in the following paragraph (d): (d) Notwithstanding anything hereinabove contained to the contrary, if at any time while the trust herein created is in force, any financial emergency arises in the affairs of my said wife, Rosalie Harris, of if the independent income of my said wife and all other means of support available to her, including her share of the trust income hereunder, are insufficient for her support in the manner to which she was accustomed during our married life, in the sole judgment of the Trustees, the Trustees shall pay or use, for my said wife's support and reasonable comfort, and for her care, including hospital, medical and nursing expenses, such part of the trust principal as shall be reasonably required for such purposes. At all times I desire that the trustees be liberal with the encroachment upon the principal or corpus of the trust for the purposes hereof. In Paragraph (e), Harris provided for other beneficiaries (son and grandchildren) with almost identical language. Paragraphs (d) and (e) make it apparent that Harris attempted to limit the discretion of the trustees with regard to the invasion of the corpus. The purpose of the limitation is evidenced by two other provisions of the trust. The first is contained in paragraph 10: Any power, duty or discretionary authority granted to my executors or the Trustees of the trust created hereunder shall be void to the extent that their actions shall cause my estate to lose all or any part of the tax benefit afforded by the marital deduction under the Federal Estate Tax Laws. The second is contained in Paragraph (c) which provides that upon termination the property and share and interest in property which constitutes the corpus of the trust shall be paid and distributed to the Kansas Philanthropies, Inc., Hutchinson, Kansas, said property and money to be expended, spent and used as may be determined by the governing body of such charitable corporation. The clauses of Harris' will establish that Harris was acutely aware of the tax consequences in adopting his estate plan. The clauses also establish that Harris intended that the corpus be preserved for final distribution to charity, subject to the limited powers to invade the corpus for the beneficiaries. These clauses as well as the entire will support the conclusion that his intent was not only to exclude the corpus from his wife's estate upon her death but also to exclude the corpus from his son's estate upon his son's death. Inclusion of the corpus in his wife's estate upon her death deprives him of the marital deduction and fails to preserve a large portion of the remainder of his estate for his ultimate charitable distribution. Inclusion of the corpus in his son's estate upon his son's death frustrates his tax plan by diminishing his estate through payment of substantial estate taxes upon his son's death, thereby, failing to preserve the bulk of the remainder of his estate for charitable purposes. Moreover, the scrivener's affidavit establishes that a paramount consideration for Harris in devising his estate plan was to achieve tax savings. Under these circumstances, we conclude that there is clear and convincing evidence supporting the trial court's reformation of Paragraph (e) of Harris' trust. K.S.A. 2002 Supp. 58a-415 provides the basis for affirming the district court's reformation of Paragraph (e). It provides: The court may reform the terms of a trust, even if unambiguous, to conform the terms to the settlor's intention if it is proved by clear and convincing evidence that both the settlor's intent and the terms of the trust were affected by a mistake of fact or law, whether in expression or inducement. The trustees allege that a mistake was made in Paragraph (e). They proved before the district court by clear and convincing evidence that Harris' intent was to limit the invasion of the corpus to an ascertainable standard with reference to all beneficiaries of the Trust. The Trustees have demonstrated the need under existing tax law for the changes proposed in Paragraph (e). The proposed changes do not interfere with the effective conduct of the judicial proceedings or prejudice the rights of the parties. See K.S.A. 2002 Supp. 58a-1106(a)(3). All beneficiaries have agreed with the proposed changes. We, therefore, affirm the reformation of Paragraph (e) entered by the district court. Two additional points must be noted. First, the same result may be reached by the following provisions of K.S.A. 2002 Supp. 58a-416 regarding the Trust modification to achieve Harris' tax objectives: To achieve the settlor's tax objectives, the court may modify the terms of a trust in a manner that is not contrary to the settlor's probable intention. The court may provide that the modification has retroactive effect. Second, the precise situation present in Paragraph (e) of the Trust was anticipated by the UTC in § 814. However, in adopting the UTC § 814, Kansas omitted the tax-curative provision of the UTC that imposes an ascertainable standard on language that might otherwise constitute a general power of appointment. See English, 51 Kan. L. Rev. at 321 n.80; compare K.S.A. 2002 Supp. 58a-814 with UTC § 814. According to the official Kansas Comment to the KUTC under this section, the Kansas drafting committee struck the tax-curative provision of the UTC because there was a difference of views among the committee members on its inclusion.