Monthly Archives: March 2012

Protecting the True Objects of Decedent’s Bounty—Pets Included

Mar 28, 2012 Solangel Maldonado

I have never had a pet (yes, very sad), so I must admit that in my Estates & Trusts course, I covered the cases involving gifts to pets with some amusement.  After reading Frances Foster’s provocative article, Should Pets Inherit?, I will never teach those cases in quite the same way again.  Building on many scholars’ (including her own) critiques of U.S. inheritance law’s focus on relationships based on blood, adoption, or marriage to the exclusion on those based on caregiving and affection, Professor Foster expands the universe of beings who should inherit to include non-human family members—pets.

Professor Foster briefly summarizes the rich literature showing that U.S. inheritance law excludes many people Americans consider nearest and dearest to them, including nonmarital partners, friends, and individuals with whom they share a de facto parent-child relationship.  As a result, inheritance law often conflicts with and defeats decedents’ wishes to provide for individuals with whom they shared affectionate and supportive relationships.  She points out that the law’s exaltation of family status over affection and support is so entrenched that attempts to give property to persons the law does not consider “family” are deemed “unnatural.”  In my opinion, many would find few bequests more “unnatural” than dispositions to a pet, which the law deems to be property and as such, cannot inherit under the common law.  As Professor Foster points out, bequests to a pet may be used as evidence of testamentary incapacity. After all, who in their right mind would leave property to a pet?  However, Professor Foster persuasively demonstrates that given the vast majority of pet owners’ inclusion of their pets in their definition of family and their desire to provide for their pets after they pass, the law should allow and facilitate inheritance by pets.

I will admit that I approached the article with some skepticism.  It is one thing to enforce provisions in wills leaving money for the care of a pet as some courts have done, or to eliminate obstacles to enforcement of pet trusts as forty-six jurisdictions have done.  As Professor Foster concedes, as a result of legislative reforms, revocable trusts, pet retirement homes, and other mechanisms, Americans (at least those who have the foresight and resources to consult lawyers) are increasingly able to protect their pets through careful estate planning.  Although these reforms are not perfect and their lack of uniformity leaves many legal questions unanswered and many pets unprotected, it is quite radical, many would say, to address the law’s shortcomings by granting pets the right to inherit.  This is exactly what the law must do according to Professor Foster because, as the article demonstrates, current inheritance law does not only harm pets.  Rather, the law’s failure to recognize Americans’ wishes to provide for their loved ones affects both the human and non-human objects of their bounty.

Professor Foster argues that the law should look to the decedent’s intent to provide for her pets as evidenced in a will or other written instrument (whether validly executed or not), oral statements, and the decedent’s “acts, state of mind … and intensity of feelings.”  Courts would be guided by the decedent’s intent to provide for her pets, even at the expense of human family members, and the court would be bound by the amount devised for the care of pets even if it exceeds the amount needed for their care.  In other words, Leona Helmsley’s dog Trouble would be entitled to enjoy the standard of living that a $12M inheritance can buy.

Under Professor Foster’s proposal, pets would inherit even in cases where there is no clear evidence of decedent’s intent to provide for them.  In determining whether a pet will inherit, courts would focus on the relationship between a particular decedent and the pet “claimant,” including its duration, frequency of contact, interaction, emotional bond, and decedent’s care of the pet.  Was the pet well-fed, groomed, and housed?  Did it enjoy quality medical care, exercise, and luxuries not available to most pets?  Courts would also look at what the pet provided to decedent—companionship, affection, better health, and service.

Given that only one-third of American households have children living with them but two-thirds have pets, I am persuaded that the law should honor decedent’s wishes to care for their animals.  However (as all Jotwell articles must), the article raised a host of questions that I hope Professor Foster will address in future work.  First, should pets inherit when decedent had a will but failed to provide for the pet?  Should an elective share or omitted pet provision apply?  Second, is it wasteful to honor decedent’s wishes to leave excessive amounts (see Trouble example, above) to their pets?   The law will not enforce decedent’s wishes for her executor to burn her cash because it is wasteful.  Isn’t $12M for a pet its equivalent?  Third, is it efficient from a judicial resources standpoint for pets to inherit when a decedent died intestate and there is no clear evidence of intent to provide for them?  One reason the family paradigm is so entrenched is its ease of administration.  One simply looks at the intestacy statute and determines who inherits without any need for individualized determinations in most cases.  Should we expect judges to examine how close decedent was to his pet and how much the pet enriched his life when there are many other pending cases on her docket?  I agree that an individualized approach “would align inheritance law with current societal views or family and pets.”  Nonetheless, I am afraid that given the law’s continued focus on family status rather than actual relationships even in cases where the claimant is a person, invoking Americans’ close relationships with their pets may do little to challenge the family paradigm.

Repeal the Grantor Trust Rules

Mar 14, 2012 Kerry Ryan1 comment

“It is not a matter of the cure being worse than the disease.  It is rather, that the cure has become the disease.”¹  This line, written by Leo Schmolka, is quoted in Mark Ascher’s recently published article calling for repeal of (most of) the grantor trust rules.  I quote Schmolka here too because he so pithily captures “the irony of using anti-abuse rules to abuse the tax system.”  The tax avoidance vehicle of choice is known as an “intentionally defective grantor trust” or “IDGT” (sardonically pronounced “I dig it”).  As noted by Ascher, “even their name seethes with irony.”

Ascher’s article makes three main points:  1) the grantor trust rules are obsolete; 2) their continued existence leads to significant erosion of our income and transfer tax bases; and 3) as a result the grantor trust rules (or at least most of them) should be repealed.  To be sure, most of these points are not new, and indeed, two other recent articles cover similar ground.²  However, Ascher’s is by far the most comprehensive and, in my opinion, persuasive of the three.

Trust income is normally taxable either to the trust or its beneficiaries, unless the settlor (aka “grantor”) retains too much “dominion and control” over the trust — in which case items of trust income, deductions and credits are attributed to the settlor and reportable on his or her own tax return.  The statutory grantor trust rules (aka “subpart E”) identify which interests or powers retained by or on behalf of a trust’s settlor will cause a trust to be ignored for income tax purposes.  The reader of Part I of Mark Ascher’s article will understand that the statutory grantor trust rules were a codification of Treasury regulations designed to supplant the vague and ultimately unworkable “dominion and control” standard articulated by the Supreme Court in the Clifford case.

Part I of Ascher’s article also describes the original purpose of the grantor rules (“to prevent high-income taxpayers from avoiding the impact of the progressive nature of the federal income tax by creating certain types of inter vivos trusts with which to splinter income”) and then persuasively argues that these rules are no longer needed for this purpose.  Why?  According to Ascher, the tax world is significantly different now than it was in 1954 when the bulk of subpart E was enacted.  Ascher cites compression of the tax brackets applicable to trusts as the single most important change making subpart E obsolete.  Since 1986, trusts hit the maximum marginal tax rate at extremely low levels of income, as compared to individual taxpayers.  Thus, there is little to no tax benefit in shifting income to an inter vivos trust when that income would be taxed at the trust level.

Part II of Ascher’s article discusses how taxpayers are taking advantage of the grantor trust rules to achieve spectacular tax savings.  The game, so to speak, is to create an inter vivos trust (IDGT) that is ignored for income tax purposes, but respected for transfer tax purposes.  Taxpayers can achieve this incongruous tax result by exploiting the difference between the transfer and income tax definitions of “dominion and control.”  The transfer tax benefits include those associated with most estate freeze techniques.  For little to no gift tax cost, a settlor can remove the transferred property and all subsequent appreciation from the gross estate.  The IDGT kicker, however, is that for as long as the trust remains a grantor trust, the settlor is able to make an additional annual tax-free gift to the trust beneficiaries in the amount of the income tax paid.

Ascher’s discussion of the ostensible income tax benefits of using an IDGT is particularly insightful.  He first observes that the income tax regime applied to any inter vivos trust is implicitly elective.  The problem for Ascher is not electivity per se, but that the grantor trust rules “regularly produce diametrically different results based on truly trivial differences.”  Next, Ascher highlights how subpart E fails to deal with all of the collateral tax consequences of grantor trust status.  In particular, it is virtually silent on how to account for transactions between the settlor and his or her grantor trust.

Out of this statutory void grew a popular estate planning technique wherein a settlor sells appreciated property to his or her grantor trust in return for an installment note.  While the astonishing transfer tax savings garner most of the press, Ascher distinguishes himself by engaging in a thoughtful and thorough discussion of the transaction’s uncertain income tax consequences.  As he points out, for income tax purposes, the most important question may be what is the trust’s basis in the “purchased” assets?  As long as we get that answer right, any untaxed gain will eventually be accounted for.  However, by Ascher’s account, some practitioners are taking the questionable (although not entirely unsupportable) position that under certain circumstances nobody has to “pay the piper.”

After requesting more administrative guidance (and expressing doubt that it will be forthcoming), Ascher calls for repeal of most of the grantor trust rules.  Under his proposal, revocable trusts would be the only domestic trusts subject to the grantor trust regime.  All other domestic irrevocable trusts would be treated as separate taxpayers.  He argues that revocable and irrevocable trusts are sufficiently different to justify different tax treatment.  I prefer Ascher’s proposal to those calling for wholesale repeal of subpart E because it preserves the statutory overrule of the Clifford case.  Ascher’s case is so persuasive and the number of calls for reform so numerous, one wonders in this fiscal environment how much longer policymakers can continue to ignore such low-hanging revenue fruit?