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Sunday, May 11, 2014

FAILURE TO DIVIDE ESTATE INTO MARITAL AND NONMARITAL TRUST–WHAT HAPPENS AT DEATH OF SURVIVING SPOUSE

Upon the death of wife, wife’s assets were supposed to be divided into two marital deduction trusts and a bypass family trust. An estate tax return was filed, and an estate tax deduction was taken for the transfer that was supposed to be made to the marital trusts.

No division was ever made during husband’s remaining lifetime after wife’s death. Instead, the combined assets were reported for income tax purposes as one trust. When husband died, the issue arose as to how much of the remaining assets should be included in husband’s gross estate per being held in marital trusts under §2044, and how much was not to be included as being held in the family trust.

Not surprisingly, the husband’s estate argued that none of the trust assets were includible. Its theory was that $393,978 that had been withdrawn and put in the account of the husband after the death of the wife had come from the marital trust assets, and that a similar depletion of the marital trust assets occurred for $1,080,802 that had been withdrawn and paid to charity. With those withdrawals, and working backwards from what should have been used to fund the marital trust, in their estimation there was nothing left in the marital trust.

The IRS took the opposite tack and asserted that ALL of the remaining assets were in the marital trusts.

The Tax Court took a facts and circumstances approach, and did its best to determine which trusts should be charged with the withdrawals that had occurred. It found that the $393,978 that was paid to the husband’s account must have come from the marital trusts under the HEMS provision of those trusts, since the family trust provisions did not allow for distributions to the husband of principal. It then charged the charitable contributions to the family trust, again seeking which trust should be deemed to have paid out its assets based on the authorized distributions in each. After accounting for those distributions, it then provided what portion of the total remaining assets were allocable to the marital trusts and thus includible in the husband’s gross estate.

The fact that the division of assets did not occur at the death of the first spouse should not come as a surprise. Oftentimes, the proper professionals are not involved at the time of the first death, or the family or trustees do not follow their instructions, and thus the proper division does not occur. The problem is often not uncovered until the death of the surviving spouse.

The case confirms that the parties will not be “punished” for failing to make the division. Instead, the proper course of action is to make a constructive division as if the proper division occurred, and then attempt to deal with intervening occurrences prior to the death of the second spouse in a reasonable manner (such as the substantial distributions made in the subject case).

Estate of Elwood H. Olsen, et al., TC Memo 2014-58

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