In Uncategorized on 03/13/2023 at 18:58

Unlike O. Henry’s 1903 short story that became the Broadway classic, the reformation here wasn’t the result of a judicial proceeding commenced within 90 (count ’em, 90) days after the due date of the estate tax return, so the attempted reformation of the Katz Trust, a subtrust of the late Susan R. Block’s own revocable trust, costs the late Susan’s estate the charitable deduction for the remainder of the Katz Trust. The case is Estate of Susan R. Block, Deceased, Julie B. Saffir and Peter A. Block, Executors, T. C. Memo. 2023-30, filed 3/13/23.

The late Susan, before she became the late Susan, wanted to provide for her sister and sister’s spouse, so she put $761K in the Katz Trust. Sister, and sister’s spouse if he survived sister, was to get the greater of all net income or $50K annually, remainder to a 501(c)(3). The co-trustees of the Katz Trust, who were also the late Susan’s co-ex’rs, had power to amend the Katz Trust to maintain compliance with Section 664(d)(1) and Rev. Proc. 2003-57.

And they did amend to reform, but only after IRS was auditing the estate tax return. And more than a year after the estate tax return was due. And they never started a judicial proceeding.

Problem: Section 2055(e)(2)(A) requires the income beneficiaries to get annual distributions of a fixed dollar amount or fixed percentage of net asset value, and Katz Trust did neither. Prior to enactment of Section 2055, settlors and income beneficiaries were playing games, by whacking up income distributions so as to shortchange charitable remainderguys after claiming big charitable deductions based upon cooked numbers. So whether the reformation might be made pursuant to State law (CT) is irrelevant.

Judge Elizabeth A. (“Tex”) Copeland finds substantial compliance doesn’t rescue the Katz Trust.

“Petitioners ask us to deem the Estate to have substantially complied with the exception. We decline to do so. As we have previously observed, Congress made clear that the rules for qualified reformations are to be construed strictly, in order to prevent abuse of the charitable deduction. Specifically, Congress was concerned that if the reformation regime were overly lenient, taxpayers would not reform trusts to comply with the split-interest rules unless and until the IRS discovered defects upon audit.” T. C. Memo. 2023-30, at p. 8. (Citation omitted).

I don’t mean to suggest that the ex’rs here, or their trusty attorney, were playing games, although this error was expensive.

I would suggest to my estate planning brethren and sistern that the kind of free-riding the statute means to prevent is a dangerous game. If you’re reforming a CRAT, make it a proper reformation.


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