Estate of Tamulis v. Comm'r , 92 T.C.M. 189 ( 2006 )


Menu:
  •                         T.C. Memo. 2006-183
    UNITED STATES TAX COURT
    ESTATE OF ANTHONY J. TAMULIS, DECEASED, WANDA RODGERSON, EXECUTOR
    AND TRUSTEE, Petitioner v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent
    Docket No. 20721-03.                Filed August 29, 2006.
    Hugh J. Graham III, for petitioner.
    Thomas C. Pliske, for respondent.
    MEMORANDUM FINDINGS OF FACT AND OPINION
    GALE, Judge:   Respondent determined a deficiency in Federal
    estate tax of $745,177 for the Estate of Anthony J. Tamulis (the
    estate).   The sole issue for decision is whether the estate is
    - 2 -
    entitled to a deduction under section 20551 for the remainder
    interest of the Anthony J. Tamulis Trust (the trust).    We hold
    that the estate is not.
    FINDINGS OF FACT
    Most of the facts have been stipulated and are so found.
    The stipulation of facts and the attached exhibits are
    incorporated by this reference.
    Anthony J. Tamulis (decedent), a Roman Catholic priest, died
    testate on November 23, 2000, in Sandwich, Massachusetts.2
    Dennis Carlile was named executor of the estate and trustee of
    the trust.   The estate was administered in Illinois, where Mr.
    Carlile resided at the time the petition was filed.3
    Decedent executed a will on February 18, 2000, that was in
    effect at the time of his death.   On the same day, decedent also
    executed a Third Restatement and Revision of Living Trust
    Instrument, governing the terms of the trust.   The parties have
    1
    All section references, unless otherwise noted, are to the
    Internal Revenue Code of 1986, as in effect for the time of
    decedent's death.
    2
    Decedent was a resident of Mt. Olive, Ill., for most of
    his life, but following a stroke several years before his death
    had been living in Massachusetts so that he could be cared for by
    his niece, Wanda Rodgerson.
    3
    Mr. Carlile died on Apr. 7, 2005, and Wanda Rodgerson was
    substituted as executor for the estate and successor trustee for
    the trust.
    - 3 -
    stipulated that decedent amended the trust by means of a letter
    dated February 26, 2000 (discussed infra).    This Third
    Restatement and Revision of Living Trust Instrument, as amended
    by the letter, was in effect at the time of decedent's death.     As
    settlor, decedent directed that the trust be governed by Illinois
    law.
    The will directed that all of decedent's property, after the
    payment of debts, expenses, and taxes, pass to the trust.   The
    trust's governing instrument provided for specific bequests to
    various charitable and noncharitable recipients.   Following the
    satisfaction of these specific bequests, the trust's governing
    instrument provided for annual payments during the term of the
    trust of specific amounts to several of decedent's relatives,
    provided certain conditions were met, as well as the transfer of
    certain real property and payment of the real estate taxes on
    that property during the lives of its life tenants, with the
    remainder of the trust's "net income" each year to be divided
    equally between two of decedent's grandnieces.   More
    specifically, paragraphs 7(B) and (C) of the trust provided that
    B. The trustee is to convey my property at No. 2
    Surrey Lane, Sandwich, Massachusetts 02563 with a life
    estate therein to be held by my brother, John Tamulis and
    his wife, Mary or the survivor of them, with the remainder
    therein to my grandniece[s], Erica Rodgerson and Melissa
    Rodgerson share and share alike.
    - 4 -
    During the period of the lives of John and Mary
    Tamulis, the trust shall pay all real estate taxes on said
    real estate; however, utilities and all other costs shall be
    borne by the life tenants, yet as supplemented with the
    contribution from the trust as provided in 7(C)i below.
    C. During the term of the trust, the trustee is to pay
    the following amounts to the following individuals:
    i. $5,000 per year to John Tamulis and if he
    should predecease his wife Mary Tamulis, then
    $5,000 per year to her, said money is for the
    purposes of defraying the utilities and cost of
    repair and maintenance of the house in Sandwich,
    Massachusetts;
    ii. $5,000 per year to Wanda Rodgerson so long as
    she is making reasonable progress in pursuit of a
    Ph.D. in education;
    iii. $1,000 per year to Erica Rodgerson;
    iv. $1,000 per year to Melissa Rodgerson;
    v. The trustee is to pay the balance of the trust
    net income as that is determined in accordance
    with normal accounting principles to Melissa
    Rodgerson and Erica Rodgerson, my grandnieces,
    share and share alike.
    The amendment to the trust by letter of February 26, 2000,
    provided that the trust would pay $10,000 per year to Migle
    Francaite, another of decedent's grandnieces, "until she
    graduates from medical school.    I gave same to Melissa and
    Erica."   Decedent, as settlor, gave the trustee
    authority to act with regard to the trust and the assets
    making up the trust in all manners consistent with the laws
    of the States of Illinois and Massachusetts provided,
    however, the trustee is authorized to sell or exchange
    shares of stock making up the trust account only upon first
    - 5 -
    having received the prior written approval of the intended
    sale from my niece, WANDA RODGERSON.
    The trust was to operate for the longer of 10 years or the joint
    lives of John and Mary Tamulis,4 and upon termination, the
    remainder of the trust's assets was to pass to the Roman Catholic
    Diocese of Fall River, Massachusetts (diocese).
    After obtaining an extension for filing, the estate timely
    filed its Federal estate tax return on November 30, 2001.    The
    estate claimed a charitable contribution deduction of $1,495,526
    representing the claimed value of a charitable remainder interest
    given to the diocese.   On Schedule O of the estate's Form 706,
    United States Estate (and Generation-Skipping Transfer) Tax
    Return, the following statement (return statement) was made:
    Charitable Remainder
    Roman Catholic Diocese of Fall River, Mass.
    Balance that is residue following 10 year term certain
    charitable remainder unitrust at 5% quarterly payments to
    two grand nieces Erica and Melissa Rodgerson, where during
    the term, the Trustee holds and operates pursuant to the
    terms and conditions of I.R.C. Sec. 664 and related
    provisions with balance at end of 10 year term to the Roman
    Catholic Diocese of Fall River, Mass. a 501(c)3 organization
    See attached calculations of Charitable Remainder
    Deductible.
    4
    The estate states on brief that John and Mary Tamulis were
    in their eighties when the trust was created, although there is
    no direct evidence of their age in the record.
    - 6 -
    In each of the years 2001 through 2004, the trust distributed 5
    percent of the fair market value of the trust assets, valued as
    of January 2 of each year, to the trust's beneficiaries.
    An examination of the estate's return commenced sometime
    before February 25, 2002, the date of a letter from respondent to
    Mr. Carlile seeking additional information in connection with the
    examination.   A notice of deficiency was issued on September 18,
    2003, in which respondent determined that the charitable
    contribution deduction claimed by the estate for the remainder
    interest should be disallowed because the trust did not satisfy
    the requirements of section 2055.
    During August 2002, certain of the interested parties made
    various efforts to reform the trust.    Mr. Carlile and the diocese
    each prepared revised versions of the trust's governing
    instrument, but neither version was ever executed by the trustee
    or any of the beneficiaries.   Mr. Carlile also prepared a draft
    of a "Complaint for Restatement of Trust" for filing in State
    court, which was circulated to the beneficiaries but never filed
    with any court.
    In August 2003, Mr. Carlile executed a document, also titled
    "Third Restatement and Revision of Living Trust Instrument",
    which by its terms revised the trust's governing instrument (2003
    amendment).    All of the beneficiaries of the trust, except Migle
    - 7 -
    Francaite, provided written consent to the 2003 amendment.     Under
    the 2003 amendment, the trustee was required to pay, in the
    aggregate, 5 percent of the net fair market value of the trust
    assets each year to the same noncharitable beneficiaries
    designated in the original instrument, with payment to be
    allocated among them so as generally to equal the annual payments
    specified for each in the original instrument, with any remaining
    balance paid in equal shares to Erica and Melissa Rodgerson.5
    OPINION
    In general, for purposes of determining the estate tax
    imposed by section 2001, a deduction is allowed from a decedent's
    gross estate for transfers for public, charitable, or religious
    uses.    Sec. 2055(a).   However, this general rule is restricted
    for so-called split-interest transfers, wherein an interest in
    property passes from the decedent to a charitable beneficiary
    while an interest in the same property passes to a noncharitable
    beneficiary (for less than adequate and full consideration).     See
    sec. 2055(e)(2).    Where the interest passing to the charitable
    beneficiary is a remainder interest, no deduction is allowed
    unless the interest is in a trust which is a charitable remainder
    5
    The 2003 amendment's terms further provided that, in the
    event 5 percent of the annual fair market value was insufficient
    to satisfy all of the allocations, the allocated payments would
    be satisfied according to a designated order until the 5 percent
    was exhausted.
    - 8 -
    unitrust (CRUT) or charitable remainder annuity trust (CRAT)
    (described in section 664), or a pooled income fund (PIF)
    (described in section 642(c)(5)).   Sec. 2055(e)(2)(A);6 Estate of
    Edgar v. Commissioner, 
    74 T.C. 983
    , 986 (1980), affd. without
    published opinion 
    676 F.2d 685
    (3d Cir. 1982).
    Congress imposed the section 2055(e)(2)(A) requirement that
    a CRAT, CRUT, or PIF be used where there is a bequest of a
    charitable remainder interest to remove the "incentive to favor
    the income beneficiary over the remainder beneficiary by means of
    manipulating the trust's investments."   H. Rept. 91-413 (Part 1),
    at 59 (1969), 1969-3 C.B. 200, 238; S. Rept. 91-552, at 88
    (1969), 1969-3 C.B. 423, 480.   It had come to Congress's
    attention that taxpayers were claiming charitable deductions for
    bequests of remainder interests in trusts based upon valuation
    assumptions for the remainder interests that were inconsistent
    with the manner in which the trusts assets were in fact managed.
    Where trust assets were invested so as to maximize the income
    interest, the value eventually passing to charity through the
    remainder interest might bear little relationship to the
    deduction previously taken.   Therefore, Congress mandated a trust
    6
    Sec. 2055(e)(2) was enacted as part of the Tax Reform Act
    of 1969 (the 1969 Act), Pub. L. 91-172, sec. 201(d)(1), 83 Stat.
    560, and its requirements for split interests are often referred
    to as the "1969 Act rules."
    - 9 -
    mechanism that set the annual payout to the noncharitable income
    beneficiaries as a fixed dollar amount (a CRAT) or fixed
    percentage of the value of the trust assets (a CRUT), thereby
    minimizing the incentive to skew investment strategy to favor the
    noncharitable income beneficiaries.7   Estate of Gillespie v.
    Commissioner, 
    75 T.C. 374
    , 376-378 (1980); H. Rept. 91-413 (Part
    1), supra at 58-60, 1969-3 C.B. at 237-238; S. Rept. 91-552,
    supra at 86-87, 1969-3 C.B. at 479.
    To mitigate the reduction in amounts going to charity that
    the imposition of this stringent framework could engender,
    Congress provided a statutory mechanism in 1984 by which a trust
    that failed to satisfy the CRAT, CRUT, or PIF regime of section
    2055(e)(2)(A) might nonetheless be modified by means of a
    "qualified reformation" so that a deduction under section 2055(a)
    would be allowed.   Sec. 2055(e)(3)(A).8   A "qualified
    7
    The third option Congress provided, a PIF, is an
    irrevocable trust in which the property of the trust is managed
    by the charitable organization to which the remainder interest is
    contributed and for which the donor retains an income interest
    for the life of one or more beneficiaries. Sec. 642(c)(5).
    Since the assets in a PIF are managed by a charitable
    organization, the incentive to favor the noncharitable income
    beneficiaries is presumed eliminated.
    8
    Sec. 2055(e)(3), enacted by the Deficit Reduction Act of
    1984, Pub. L. 98-369, sec. 1022(a), 98 Stat. 1026, was a
    permanent rule to replace various temporary reformation
    provisions that preceded it and is effective for reformations
    made after Dec. 31, 1978.
    - 10 -
    reformation" for this purpose "means a change of a governing
    instrument by reformation, amendment, construction, or otherwise
    which changes a reformable interest into a qualified interest",
    subject to certain conditions.   Sec. 2055(e)(3)(B).
    A "reformable interest" for this purpose is defined as an
    interest that would qualify for a deduction under section 2055(a)
    but for the CRAT, CRUT, or PIF requirement of section 2055(e)(2),
    sec. 2055(e)(3)(C)(i),9 but only if all payments to be made to
    noncharitable beneficiaries before the remainder interest vests
    are expressed either in "specified dollar amounts" or as a "fixed
    percentage of the fair market value of the [trust] property",
    sec. 2055(e)(3)(C)(ii).   The requirement that all such payments
    be expressed as specified dollar amounts or a fixed percentage of
    the fair market value of the trust property does not apply,
    however, "if a judicial proceeding is commenced to change such
    interest into a qualified interest not later than the 90th day
    after the last date (including extensions) for filing the estate
    tax return."   Sec. 2055(e)(3)(C)(iii)(I).
    9
    The sec. 2055(e)(3)(C)(i) prong is intended to incorporate
    the requirements of prior law, such as that the charitable
    remainder interest in a split-interest trust be "ascertainable";
    i.e., severable from the noncharitable interest. H. Rept. 98-432
    (Part 2), at 1518 (1984); see also Ithaca Trust Co. v. United
    States, 
    279 U.S. 151
    , 154 (1929); sec. 20.2055-2(a), Estate Tax
    Regs.
    - 11 -
    The legislative history of section 2055(e)(3) indicates that
    Congress intended a more liberal reformation rule for trusts
    where the creator had made a bona fide attempt to comply with the
    provisions of the 1969 Act (i.e., the requirements of section
    2055(e)(2)), and a more exacting rule (namely, commencement of a
    judicial proceeding within 90 days after the due date of the
    estate tax return) for trusts where the creator had not evidenced
    any intent to comply with the 1969 Act.
    The committee believes that these [reformation] rules will
    permit the correction of major, obvious defects (such as
    where the "income" interest is not expressed as an annuity
    interest or a unitrust interest) so long as the taxpayer
    initiates reformation proceedings before audit, while
    allowing the correction of minor defects (such as defects in
    determining the correct payout in short taxable years, in
    years of additional contributions, etc.) upon audit so long
    as there was a good faith attempt to comply with the 1969
    Act rules (i.e., the payout is basically expressed as an
    annuity interest or a unitrust interest). * * * [H. Rept.
    98-432 (Part 2), at 1517 (1984); S. Rept. 98-169 (Vol. 1),
    at 732 (1984).]
    Thus, where the payout to the noncharitable beneficiaries has
    been "basically expressed as an annuity interest or a unitrust
    interest"–-that is, as specified dollar amounts or as a fixed
    percentage of the fair market value of the trust property, in
    accordance with section 2055(e)(3)(C)(ii)–-then a reformation may
    be effected even after an audit has commenced.   H. Rept. 98-432
    (Part 2), supra at 1517; S. Rept. 98-169 (Vol. 1), supra at 732;
    see also Estate of Hall v. Commissioner, 
    93 T.C. 745
    , 753-754
    (1989), affd. without published opinion 
    941 F.2d 1209
    (6th Cir.
    - 12 -
    1991).    But where the payouts have not been expressed in the
    trust's governing instrument in conformity with section
    2055(e)(3)(C)(ii), reformation is permitted only if a judicial
    proceeding to make the appropriate changes to the trust is
    commenced within 90 days after the due date of the estate tax
    return.
    The estate has stipulated that the trust, as in effect at
    the time of decedent's death, did not qualify as either a CRAT or
    a CRUT.10   Consequently, the bequest of the remainder interest to
    the diocese will qualify as a deduction under section 2055(a)
    only if the remainder interest was a "reformable interest" that
    underwent a "qualified reformation".    Sec. 2055(e)(3).
    The remainder interest to the diocese cannot qualify as a
    "reformable interest" because certain payments to be made to the
    noncharitable beneficiaries before the remainder vests are not
    expressed as either a specified dollar amount or a fixed
    percentage of the fair market value of the trust property, as
    required by section 2055(e)(3)(C)(ii).11   The provision for the
    10
    Similarly, because the trust at issue was not maintained
    by the diocese, it cannot qualify as a PIF. See sec.
    642(c)(5)(E).
    11
    Respondent also argues that, because the trust instrument
    provides for payments to Wanda Rodgerson for "so long as she is
    making reasonable progress in pursuit of a Ph.D. in education"
    and to Migle Francaite "until she graduates from medical school",
    the remainder interest also does not satisfy sec.
    (continued...)
    - 13 -
    payment of the real estate taxes on decedent's Sandwich,
    Massachusetts, residence is not expressed as a specified dollar
    amount (or calculable as such) or as a fixed percentage of fair
    market value; thus, the payment for taxes is not fixed as
    required under section 2055(e)(3)(C)(ii).   More significantly,
    the provision for payment to Melissa and Erica Rodgerson of the
    balance of the trust's "net income" (after satisfaction of the
    payments directed for other noncharitable beneficiaries) is
    neither a specified dollar amount nor a fixed percentage of fair
    market value.   Indeed, by providing for a payout of net income to
    a noncharitable beneficiary, the trust's terms would enable the
    specific abuse to which the 1969 Act rules (i.e., the provisions
    of section 2055(e)(2)) were addressed; namely, the reduction of
    the value of the remainder interest actually passing to charity
    below the amount of the deduction claimed, because of the
    11
    (...continued)
    2055(e)(3)(C)(i); i.e., the remainder interest would not be an
    allowable deduction under pre-1969-Act law because the payments
    are not "ascertainable". We note that the trust instrument
    provides, immediately after directing the foregoing payments,
    that "the balance of the trust net income" is to be paid to two
    other beneficiaries. This juxtaposition gives rise to a possible
    interpretation that the payments to Wanda Rodgerson and Migle
    Francaite are limited to the trust's net income, and the estate
    makes an argument on similar grounds that the remainder interest
    was ascertainable. However, we find it unnecessary to decide
    whether the remainder interest satisfies sec. 2055(e)(3)(C)(i),
    as the remainder interest's failure to satisfy sec.
    2055(e)(3)(C)(ii) precludes a finding that it is a "reformable
    interest" in any event.
    - 14 -
    trustee's ability to favor a noncharitable "income" beneficiary
    through his management of the trust assets during the period
    before the remainder vests.12   See Estate of Gillespie v.
    Commissioner, 
    75 T.C. 376-378
    ; H. Rept. 91-413 (Part 1), supra
    at 58-60, 1969-3 C.B. at 237-238; S. Rept. 91-552, supra at 86-
    87, 1969-3 C.B. at 479.
    Because the noncharitable beneficiaries' interests were not
    fixed as required in section 2055(e)(3)(C)(ii), the only
    remaining option for reformation was commencement of a judicial
    proceeding to reform the trust within 90 days after the estate's
    tax return was due.   See sec. 2055(e)(3)(C)(iii).   Since no such
    proceeding was ever commenced, the estate has failed to satisfy
    the requirements of section 2055(e)(3)(C)(iii).   As a result, the
    remainder interest at issue is not a "reformable interest", which
    precludes any reformation whereby it could meet the requirements
    for a deduction under section 2055(e)(2).
    While this result may seem harsh, the legislative history
    makes clear that Congress intended a tightly circumscribed
    reformation rule.   Congress was concerned that an overly liberal
    rule would permit abuse; namely, that taxpayers would not reform
    12
    In this regard, we note that although the governing
    instrument gave the trustee authority to act with respect to the
    trust assets "in all manners consistent with the laws of the
    States of Illinois and Massachusetts", the trustee could sell
    stock held by the trust only upon the approval of Wanda
    Rodgerson, one of the noncharitable beneficiaries.
    - 15 -
    trusts to comply with the 1969 Act rules unless and until defects
    were discovered by the Commissioner upon audit.   The committee
    reports accompanying Congress's enactment of the reformation
    provisions of section 2055(e)(3) state as follows:
    Congress first permitted reformation of charitable
    remainder trusts in 1974 and since that time, the
    Congress has extended the period for reformations
    several times * * * . Even so, it has come to the
    attention of the committee that there are still many
    instruments providing for split-interest charitable
    contributions which do not meet the requirements for
    qualification under the rules of the Tax Reform Act of
    1969. * * * In light of the repeated need to extend
    the period to reform such governing instruments and the
    fact that failure to meet the 1969 Act rules often
    results in reduced amounts passing to charity, the
    committee believes that a permanent rule permitting
    reformation of split-interest charitable contributions
    should be permitted as long as there are adequate
    safeguards to avoid abuse.
    Specifically, the committee is concerned that
    governing instruments of charitable split-interest
    trusts which evidenced no attempt to comply with the
    1969 Act rules would be reformed only if the defects
    are found upon audit by the Internal Revenue Service.
    In order to prevent this from occurring, the committee
    believes that, in order for a governing instrument of a
    charitable split-interest contribution to be
    reformable, either (1) the creator had to make a bona
    fide attempt to comply with the 1969 Act rules or (2)
    the taxpayer must initiate reformation proceedings
    before the Internal Revenue Service could reasonably be
    expected to begin an audit. * * * [H. Rept. 98-432
    (Part 2), supra at 1516-1517; S. Rept. 98-169 (Vol. 1),
    supra at 731-732.]
    The committee reports go on to clarify what constitutes the
    creator's "bona fide attempt to comply with the 1969 Act rules"
    (as codified in section 2055(e)(3)(C)(ii)):   "The governing
    instrument evidences an intent to comply with the 1969 Act rules
    - 16 -
    if all current payouts from the trust are expressed solely[13] as
    a fixed dollar amount or a fixed percentage of the value of the
    trust's assets."
    Id. at 1518;
    S. Rept. 98-169 (Vol. 1), supra at
    733.
    Congress thus intended reformation to be available only if
    the "creator" of the trust had made a bona fide attempt to comply
    with the 1969 Act rules (i.e., the governing instrument as
    established by the trust's settlor expressed noncharitable
    payouts solely as fixed dollar amounts or a fixed percentage of
    the value of the trust's assets) or a judicial proceeding to
    reform the trust was commenced within 90 days after the return's
    filing.
    The estate cobbles together several arguments in an effort
    to show that a "qualified reformation" occurred.   The estate
    argues that the return statement served either to amend the trust
    into a CRUT or to signify the trustee's intent to operate the
    trust as a CRUT.    Furthermore, the estate contends, the trust was
    in fact managed in accordance with the requirements for a CRUT,
    as the total annual distributions to the noncharitable
    beneficiaries were equal to 5 percent of the fair market value of
    the trust's assets in each of the years 2001 through 2004.
    13
    The excerpts from the House and Senate committee reports
    are identical, except that the word "solely" does not appear in
    the House version.
    - 17 -
    We reject the estate's contention that the return statement
    amended the trust into a CRUT.   Even if we accept the dubious
    proposition that a statement on a Federal estate tax return could
    operate to amend a trust created under State law, the return
    statement nowhere contains the words "amend" or "amendment" or
    otherwise suggests this purpose in any way.   Moreover, there is
    no evidence that, as of the return's filing, either the
    charitable or the noncharitable beneficiaries consented to the
    amendment purportedly manifested on the estate's return, as
    required by Illinois law.14
    The estate also contends in the alternative that the return
    statement was equivalent to the commencement of a judicial
    14
    Decedent as settlor directed that the trust be governed
    by Illinois law, and the estate on brief takes the position that
    Illinois law governs. Illinois law requires the consent of all
    charitable and noncharitable beneficiaries (whose interests have
    not expired) before a trustee may amend a charitable trust
    instrument to bring it into conformity with the CRUT requirements
    of sec. 664. See 760 Ill. Comp. Stat. Ann. 60/1(2) (West 1992).
    Notwithstanding the foregoing provision of Illinois law, the
    estate argues that the trustee was authorized, acting alone, to
    amend the trust instrument, citing as authority Rev. Proc. 89-20,
    1989-1 C.B. 841. Rev. Proc. 
    89-20, supra
    , provides a sample form
    of a declaration of trust that, if followed by a taxpayer, the
    Commissioner agrees to treat as satisfying the requirements for a
    CRUT. The sample form contains a provision authorizing the
    trustee, acting alone, to amend the trust in any manner required
    for the sole purpose of ensuring that the trust qualifies as a
    CRUT. Rev. Proc. 
    89-20, supra
    , is conditioned, however, upon a
    taxpayer's trust's being "a valid trust under applicable local
    law." We conclude that Rev. Proc. 
    89-20, supra
    , is neither
    intended to, nor does it, abrogate the requirements of Illinois
    law for amending a charitable trust.
    - 18 -
    proceeding within the meaning of section 2055(e)(3)(C)(iii),
    which ultimately culminated in the 2003 amendment that amended
    the payment terms for the noncharitable beneficiaries so that a
    qualified interest was created.15   We disagree.   Filing a Federal
    estate tax return in no way commences a judicial proceeding.      The
    commencement date for a judicial proceeding for purposes of
    section 2055(e)(3)(C)(iii) has been strictly construed.    See
    Estate of Hall v. Commissioner, 
    93 T.C. 745
    (1989) (State court's
    nunc pro tunc effective date for trust reformation disregarded in
    determining date of commencement of judicial proceeding under
    section 2055(e)(3)(C)(iii)).   In sum, the claim that the trust
    was amended by virtue of the return statement does not withstand
    scrutiny.
    The estate's argument that the section 2055(e)(3)
    reformation provisions were satisfied because the trust was
    managed by the trustee in conformance with the requirements of a
    CRUT, since the payments to noncharitable beneficiaries were in
    fact equal to 5 percent of the fair market value of the trust's
    assets, is similarly unavailing.    The claim that it should be
    15
    The 2003 amendment fixed the annual payments to the
    noncharitable beneficiaries (in the aggregate) at 5 percent of
    the net fair market value of the trust's assets (allocated among
    those beneficiaries generally according to the payments specified
    in the original trust instrument). However, the 2003 amendment
    was not executed, or consented to by any beneficiaries, until
    August 2003.
    - 19 -
    sufficient if a trustee chooses to manage a trust so that the
    payouts to noncharitable beneficiaries conform to the
    requirements of a CRUT, even where the governing instrument does
    not require this result, conflicts with the explicit terms of
    both the 1969 Act rules, sec. 2055(e)(2), and the reformation
    provisions of section 2055(e)(3).   Section 2055(e)(2) provides
    that "no deduction shall be allowed" for the charitable remainder
    interest in a split-interest trust "unless * * * such interest is
    in a trust which is a charitable remainder annuity trust or a
    charitable remainder unitrust (described in section 664) or a
    pooled income fund (described in section 642(c)(5))".
    Reformation under section 2055(e)(3) is not available unless the
    governing instrument contains specified terms, sec.
    2055(e)(3)(C)(ii), or is promptly amended, sec.
    2055(e)(3)(C)(iii).   Thus, in both the "substantive" deduction
    requirements of section 2055(e)(2) and the reformation provisions
    of section 2055(e)(3), the terms of the governing instrument are
    paramount.   As the legislative history explains, the requirement
    in section 2055(e)(2) that certain trust forms be used was
    designed in large part to eliminate a trustee's discretion, which
    might be used to favor noncharitable income beneficiaries.   See
    Estate of Gillespie v. Commissioner, supra at 376-377; H. Rept.
    91-413 (Part 1), supra at 58-60, 1969-3 C.B. at 237-238; S. Rept.
    91-552, supra at 86-87, 1969-3 C.B. at 479.   The fact that the
    - 20 -
    trustee here was not required by the governing instrument to make
    payouts conforming to those of a CRUT--at least not until the
    untimely 2003 amendment--is fatal to the estate's position.
    The estate also appears at times to suggest that we should
    treat the 2003 amendment as a qualified reformation under section
    2055(e)(3), since it limited payments to the noncharitable
    beneficiaries to amounts that could be satisfied annually by 5
    percent of the fair market value of the trust property.   We
    disagree.   Since the payments to noncharitable beneficiaries in
    the original governing instrument were not expressed as specified
    dollar amounts or a fixed percentage of the fair market value of
    the trust's assets as required by section 2055(e)(3)(C)(ii), the
    only remaining option for reforming the trust was a judicial
    proceeding commenced within 90 days after the return's filing,
    pursuant to section 2055(e)(3)(C)(iii).   The 2003 amendment was
    executed beyond that deadline--indeed, well after respondent had
    contacted the estate for purposes of an examination.16
    Finally, the estate argues that the actions of the trustee
    should satisfy section 2055(e)(3) under the doctrine of
    16
    We also note that the 2003 amendment appears ineffective
    under Illinois law, insofar as the record discloses. As
    discussed supra note 14, under Illinois law, amendment of the
    trust required the consent of all noncharitable beneficiaries
    with unexpired interests. There is no evidence that Migle
    Francaite consented to the 2003 amendment or that her interest in
    the trust had expired at the time the amendment was purportedly
    made.
    - 21 -
    substantial compliance.   According to the estate, the trustee
    disclosed in the return statement his intention to follow and be
    bound by the requirements of a CRUT in operating the trust, the
    payments to the noncharitable beneficiaries in fact conformed
    with CRUT requirements, and the 2003 amendment modified the trust
    so that it complied with CRUT requirements.   Thus, the estate
    argues, the essential purpose of the 90-day rule in section
    2055(e)(3)(C)(iii)--which is to require taxpayers to initiate
    reformation before being contacted by the Commissioner--has been
    satisfied by the return statement, and the eventual amendment of
    the trust in 2003 should be treated as timely, especially given
    the fact that the trustee in fact adhered to CRUT payout
    requirements in the interim.   The foregoing should therefore be
    treated as satisfying section 2055(e)(3) under the doctrine of
    substantial compliance, in the estate's view.
    We disagree.   This Court's application of the substantial
    compliance doctrine has been summarized as follows:
    The test for determining the applicability of the
    substantial compliance doctrine has been the subject of
    a myriad of cases. The critical question to be
    answered is whether the requirements relate "to the
    substance or essence of the statute." If so, strict
    adherence to all statutory and regulatory requirements
    is a precondition to an effective election. On the
    other hand, if the requirements are procedural or
    directory in that they are not of the essence of the
    thing to be done but are given with a view to the
    orderly conduct of business, they may be fulfilled by
    - 22 -
    substantial, if not strict compliance. * * * [Taylor v.
    Commissioner, 
    67 T.C. 1071
    , 1077-1078 (1977); citations
    omitted.]
    Given the antiabuse rationale behind section 2055(e)(3) (as
    explained in the legislative history previously discussed), we
    conclude that Congress intended compliance with either section
    2055(e)(3)(c)(ii) or (iii) as a precondition to effecting a
    reformation of a trust to satisfy section 2055(e)(2).    Thus, the
    foregoing requirements relate to the substance or essence of the
    statute.   We accordingly conclude that section 2055(e)(3)
    requires strict, not merely substantial, compliance.
    There was no strict compliance here.    Moreover, we are not
    persuaded that even substantial compliance occurred.    The
    estate's contention that the return statement should
    substantially satisfy the requirement for prompt initiation of
    reformation proceedings is unpersuasive.    While the
    executor/trustee may have acted in good faith, the return
    statement did not put respondent on notice of the trust's defects
    before audit.   The return statement is fairly read as asserting
    that the trust at issue was a CRUT, as it described the
    charitable remainder as the "Balance that is residue following 10
    year term certain charitable remainder unitrust * * * where * * *
    the Trustee holds * * * pursuant to the terms and conditions of
    I.R.C. Sec. 664 and related provisions".    (Emphasis added.)   None
    of the efforts to amend the trust, either the unexecuted attempts
    - 23 -
    in August 2002 or the 2003 amendment in August 2003, was
    commenced before respondent contacted the estate for an audit--
    precisely the circumstances where Congress intended that
    reformation could not be initiated.    If the estate's position
    regarding substantial compliance were accepted, then the
    reformation requirements of section 2055(e)(3) could be
    circumvented by means of a simple disclosure on the return that a
    CRUT (or CRAT) was intended, without regard to the actual terms
    of the trust's governing instrument.
    We have considered the estate's remaining arguments and
    conclude they are without merit or relevance.
    For the foregoing reasons,
    Decision will be entered
    for respondent.
    

Document Info

Docket Number: No. 20721-03

Citation Numbers: 2006 T.C. Memo. 183, 92 T.C.M. 189, 2006 Tax Ct. Memo LEXIS 182

Judges: \"Gale, Joseph H.\"

Filed Date: 8/29/2006

Precedential Status: Non-Precedential

Modified Date: 4/18/2021