HOW NOT TO DESIGNATE A REVOCABLE TRUST AS AN INSURANCE POLICY BENEFICIARY

In a recent Florida case that likely has relevance to other states, a decedent established a revocable trust for the benefit of his heirs. The trust had typical language that directed that the after the death of the settlor, the trust should be used to pay death obligations of the decedent and his estate. After such payment, the remaining trust proceeds would be used to fund residuary trusts for the decedent’s children.

The decedent named the revocable trust as beneficiary of two life insurance policies on his life. Due to financial reversals during his lifetime, at the time of his death the insurance proceeds were needed by his estate to pay the decedent’s death obligations, and thus would not pass to the trusts for the children.

The decedent’s personal representative and the trustee of his revocable trust (who was the same individual) asserted that Fla.Stats. §222.13(1) exempted the insurance proceeds from the claims of the decedent’s creditors.  Fla.Stats. §222.13(1) reads:

Whenever any person residing in the state shall die leaving insurance on his or her life, the said insurance shall inure exclusively to the benefit of the person for whose use and benefit such insurance is designated in the policy, and the proceeds thereof shall be exempt from the claims of creditors of the insured unless the insurance policy or a valid assignment thereof provides otherwise.

The decedent’s creditors claimed that Fla.Stats. §222.13(1) didn’t apply to protect the insurance benefits because the proceeds were payable to the revocable trust, and the revocable trust expressly provided for the payment of the decedent’s death obligations. The trial court agreed with the creditors, and on appeal, the appellate court concurred.

The court noted that a payment of insurance proceeds to a trust does not void the statutory exemption under Fla.Stats. §222.13(1). However, Fla.Stats. §733808(1) makes it clear that life insurance payable to a trust “shall be held and disposed of by the trustee in accordance with the terms of the trust as they appear in writing on the date of the death of the insured.” Since the terms of the trust directed payment of the decedent’s death obligations, then those terms would be given effect. Pursuant to the court’s reference in footnote 4 to  Fla.Stats. §733.808(4) which addresses payments to a revocable trust and the statutory direction for the payment of death obligations from a revocable trust, the court did not appear to believe that provision changed the analysis.

The case is relevant since oftentimes insurance, annuities, and other plan assets designate a trust to be established under a will or trust at the death of a decedent as the beneficiary. This allows the proceeds to pass into trust for the beneficiary and not outright to him or her, without the establishment of a separate trust for that purpose. Clearly, as this case confirms, a designation directly to the revocable trust which bears death obligation payment provisions will open such payments up to estate creditors.

While not addressed by the court, the better course of action would have been beneficiary designations directly to the testamentary subtrusts established under the revocable trust agreement, and not the revocable trust itself. Such subtrusts will usually themselves not be subject to the reach of the reimbursement obligation to the decedent’s estate as to assets flowing into them from assets situated outside of the revocable trust. Nonetheless, an express provision to that effect in the trust agreement  (i.e., that testamentary funding of a subtrust from insurance proceeds or other beneficiary designations is not intended to subject the funding assets to the  death obligation payment provisions of the revocable trust) would be helpful to avoid the interpretative issue whether it is intended that such fundings are subject to the death obligation payment provisions. Presumably, the statutory death obligation payment provisions (which exist outside of the payment provisions which are in the trust) will likely not be operable against such proceeds either, per the provisions of Fla.Stats. §733.808(4) which reads that a beneficiary designation to a trust “shall not be subject to any obligation to pay the expenses of the administration and obligations of the decedent’s estate or for contribution required from a trust under s. 733.607(2) to any greater extent than if the proceeds were payable directly to the beneficiaries named in the trust.”

While the above analysis does turn in part on Florida statutory law, it was the combination of the payment of the insurance proceeds directly to the revocable trust (and not a testamentary subtrust) and the express payment language in that trust, that created the problem. Therefore, the concept of choosing the right trust as beneficiary likewise should also have application in other states where the proceeds of life insurance payable directly to a beneficiary are not subject to the claims of a decedent’s creditor.

As an aside, the trial court and appellate court also turned down an attempt to reform the the trust to not have the death obligation payment provisions apply to the insurance, citing a lack of proof of intent that this is what the settlor intended.

Morey v. Everbank, 2012 WL 3000608 (1st DCA July 24, 2012)

IRS VICTORY IN FBAR WILFULNESS PENALTY CASE

[This entry was prepared by Mitchell Goldberg of our office]

In an unpublished opinion, the Fourth Circuit Court of Appeals in U.S. v. Williams, reversed the district court’s holding that the taxpayer’s failure to file Form TD F 90-22.1 (“FBAR”) was not willful and in so holding, gave the IRS a boost in its efforts to combat offshore noncompliance.  A case out of the District Court of the Eastern District of Virginia, Williams had been one of the few sources of precedent for how willful FBAR penalties will be enforced.  The District Court held in favor of the taxpayer, finding, in part, that mere failure to check “yes” as to whether the filer held an interest in a foreign account on Schedule B of Form 1040 was insufficient, alone, to prove willfulness, and the facts and circumstances had to be examined to determine willfulness.  The Fourth Circuit reversed the lower court’s holding as being clearly erroneous.  Significantly, without examining the facts and circumstances, the Fourth Circuit found that the taxpayer’s signature on his return was “prima facie evidence that he knew the contents of the return.”  Moreover, the Second Circuit found that the instructions to line 7a of Form 1040, which cross referenced the FBAR requirement, put the taxpayer on “inquiry notice” of the FBAR filing requirement.  Such notice, combined with the taxpayer’s admission that he never read his tax return nor consulted the FBAR form, resulted in a “conscious effort to avoiding learning about reporting requirements... meant to conceal or mislead sources of income or other financial information... that constitutes willful blindness to the FBAR requirements.”  (emphasis added).  The Fourth Circuit therefore held that the taxpayer willfully failed to file FBARs and found him liable for willful penalties under 31 USC § 5314.

U.S. v. Williams (4th Circuit, unpublished)

APPLICABLE FEDERAL RATES–AUGUST 2012