423 Mass. 683 | Mass. | 1996
In this action the settlor and sole trustee of an irrevocable trust instrument seeks to reform the instrument by changing the remaindermen so as to accord with the settlor’s intentions and thus avoid tax consequences that were neither foreseen nor intended when the trust was created. The single justice reserved and reported this case without decision to us.
I
In 1992, the plaintiff established a qualified personal resi
The sole purpose of the QPR trust was to transfer the Osterville property to the plaintiff’s issue in such a way as to reduce the resulting tax liability by creating a QPR trust pursuant to § 2702, as amended, while allowing the plaintiff to remain in possession of the residence for the term of the trust. Title 26 C.F.R. § 25.2702-5 (1996) was adopted by the Internal Revenue Service to permit the transfer of family homes with reduced tax liability. Under 26 C.F.R. § 25.2702-5, the residence must be transferred irrevocably to a QPR trust for a fixed term. The settlor is permitted to remain in possession during that term and only at its expiration does the property pass to the beneficiary. At the time the trust is settled, the settlor must pay gift taxes on the value of the transfer to the QPR trust. This means of transferring the property has three principal advantages. The gift tax is paid on the value of the property at the time of the transfer to the trust, thus avoiding tax based on a subsequent higher value if the property appreciates. Second, the value of the transfer for tax purposes is discounted insofar as the intended beneficiaries’ receipt of the property is delayed for the term of the trust during which time the settlor retains a possessory interest. Third, the value of the transfer is discounted based on the probability that the settlor will not survive the term of the trust in which case the property reverts to the settlor’s estate. In this case, the value of the transfer for gift tax purposes was only $968,275, despite the fact that the property was valued at $2.5 million and would likely appreciate in value over the ten-year trust term. I.R.C. § 2702. 26 C.F.R. § 25.2702-5. See Pless, PRTs and QPRTs: Shelter from Taxation, 7 Probate & Property 13 (1993).
The QPR trust has certain drawbacks as well. The transfer
In creating this trust to minimize the tax burden on the transfer of this property, the plaintiff overlooked the fact that the generation-skipping transfer tax (GST tax) would apply to the transfer from the QPR trust to the nominee trust at the end of the trust term. I.R.C. § 2601. The GST tax generally applies whenever a gift or bequest skips one or more generations, such as a gift from grandparents to grandchildren.
The reformation of the trust will not, of course, avoid all tax liability because the children of the settlor will be liable for transfer taxes when the residence is eventually handed
After discovering the potential GST tax liability, the plaintiff filed suit to have this court reform the trust instrument by substituting the plaintiff’s children for the nominee trust as beneficiaries of the QPR trust pursuant to our equity powers under G. L. c. 215, § 6 (1994 ed.).
II
Although the reformation of the QPR trust has Federal tax
“It is settled that a written instrument, including a trust, will be reformed on the grounds of mistake upon ‘full, clear, and decisive proof of the mistake.” Berman v. Sandler, supra at 509, quoting Richardson v. Adams, 171 Mass. 447, 449 (1898). Unlike the law of contracts, a mistake is generally made out by a unilateral mistake by the settlor since the settlor typically receives no consideration. Berman, supra at 510. 4 A. Scott, Trusts § 333.4 (4th ed. 1989). A mistake by the settlor concerning the Federal estate and gift tax consequences of a provision of the trust justifies reformation. 4 A. Scott, supra. See First Agrie. Bank v. Coxe, 406 Mass. 879, 883 n.6 (1990) (“fine tuning of the administration of the trusts ... in order to reduce, if not eliminate, the application of the GST tax”).
The plaintiff provides ample proof that a mistake was made as to the tax consequences of naming the nominee trust as the sole beneficiary of the QPR trust and that she would have named her children beneficiaries had she understood the implications of her choice. In determining whether a mistake has been made, we must determine the settlor’s intent and
So ordered.
The GST tax makes an exception where the parents of the grandchild are deceased, but that provision is not applicable here. I.R.C. § 2612 (c) (2).
If the plaintiff does not survive the trust term, then the property reverts back to the plaintiff’s estate. Estate tax would then be assessed ágainst the property, but no GST tax would be due since no transfer to the grandchildren would take place (unless the plaintiff has made separate arrangements under her will to make bequests to the grandchildren).
There is an exemption of $1 million which may be allocated to any property subject to the GST tax. I.R.C. § 2631. The plaintiff seeks to avoid using this exemption because she has made other gifts to the grandchildren to which she wants to apply this exemption.
In addition, the middle generation could create deferral of taxes by holding the property for some time before transferring it. The I.R.C. contains numerous exemptions and other methods of tax reduction that the middle generation might be able to take advantage of that the settlor may have already used or may not be able to use. See, e.g., I.R.C. § 2010 (grants a $192,800 credit against taxes incurred to every estate).
To have effect, such a reformation should be done in this court as the Internal Revenue Service need not accept decisions other than those of a State’s highest court. Commissioner of Internal Revenue v. Estate of Bosch, 387 U.S. 456, 465 (1967). See Shawmut Bank, N.A. v. Buckley, 422 Mass. 706, 710 (1996).
The doctrine of frustration of purpose would also justify reformation in these circumstances. Clymer v. Mayo, 393 Mass. 754, 763-764 (1985) (courts “are empowered to terminate or reform a trust . . . where its purposes have become impossible to achieve”). There is ample evidence that the sole purpose of the QPR trust was to minimize taxes as the property passed from the settlor to the next generations in the plaintiffs family, and the Federal tax law authorizing the QPR trust was written to facilitate this purpose. Because of the GST tax, this purpose cannot be fully realized by the QPR trust without reformation. Because of the nature of the mistake made here, the analysis of mistake and frustration of purpose are virtually identical. The mistake made relates directly to the primary purpose of the trust — transferring the property to the plaintiffs issue with the least possible tax liability. Thus, the relevant intent for purposes of mistake analysis is the same as the over-all purpose for frustration of purpose analysis.
We find it persuasive that the trustees of all four trusts for the benefit of the grandchildren as well as the guardian ad litem agree that the reformation is in the best interests of the grandchildren even though they will no longer be the beneficiaries of the QPR trust.
Even assuming that the overriding purpose was to ensure that the grandchildren in particular were given the opportunity to possess and enjoy the property, reformation would be proper because the GST tax would defeat this intent as well. The trust would be liable for the over $1 million in taxes. The trust could not satisfy that liability without selling the property that the settlor has gone to such lengths to convey intact.
On transferring the property to the trust, the plaintiff became liable for gift taxes on the discounted value of the property.
Lora S. Owades and Sherri A. Mahne.