One of the issues in drafting estate planning documents is that if there is a mistake in the will or the trust, it is often not discovered until many years later after the testator or grantor has passed away. Sometimes these errors are glaring, such as naming the wrong person in the will.
But ofttimes, the mistake is subtle and ambiguous, and might not even be a mistake at all. However, due to the massive amount of estate and generation skipping transfer tax that could be imposed if there is a mistake, it’s best to get it correct the first time.
Luckily, mistakes can often be corrected, both under state law and through the Internal Revenue Service (IRS) through a process known as reformation. In Florida, the Florida Trust Code provides for Trust modification. This can be done with our without judicial approval depending upon when the Trust was executed, whether the Grantor is still living, whether the Qualified Beneficiaries consent and other factors. See Florida Trust Code Section 736.0410 – 736.04113 for more information.
Even though a mistake can be modified for state law purposes, there is often the concern as to what the Federal Estate and Generation Skipping Transfer Tax consequences will be. In many estates, the tax consequences are irrelevant because the amount of money is too small. But Private Letter Ruling (PLR) 200910003 (text not yet available online), which was issued by the IRS on November 17, 2008, and per their records policy released approximately four months later is a good example of the interplay between state law modification and the tax results thereof.
In PLR 200910003, the Grantor established a Trust that provided upon her death, the trust assets would be split into a Trust that was exempt from the Generation Skipping Transfer Tax or GST (Exempt Trust) and Trust that was not exempt from the GST (Non-Exempt Trust).
The Exempt Trust was for the benefit of the Grantor’s Daughter’s descendants. The Non-Exempt Trust was for the benefit of the Grantor’s Son and Daughter if living, and if not then their issue per stirpes. The Non-Exempt Trust allowed the Grantor’s children to withdraw all of the Trust property at any time, which both of them did (in a future post, I’ll talk about why that was a horrible decision by the Grantor’s children).
According to the PLR, the Exempt Trust provided that upon the death of a Primary Beneficiary (which was initially a child of the Grantor’s Daughter):
The Trustee shall distribute the principal. . . of any Exempt Trust and any part of the principal of the Non-Exempt trust not otherwise subject to appointment to or in trust for the benefit of such of my descendants as the Primary Beneficiary may appoint under Will bey specific reference to this power. (Emphasis Added)
The “mistake” if there even is one is subtle. Because the Primary Beneficiary is one of the Grantor’s descendants, then this paragraph may be interpreted as giving the Beneficiary a General Power of Appointment (which would cause estate tax inclusion) as opposed to a Limited Power of Appointment.
The PLR stated that the Trustee would petition a local court to modify the Trust to clear up this ambiguity. The Trustee also asked the IRS for a ruling stating that as a result of the reformation, the Primary Beneficiaries will not possess nor will have ever possessed a general power of appointment with respect to the Exempt Trusts, and that as a result of the judicial reformation the exempt status of the Exempt Trusts for GST purposes will not be affected.
The IRS ruled favorably.
While that is all well and good, note that the user fee for a private letter ruling is $10,000; plus the costs involved paying the attorneys to prepare the PLR and petition the court for modification. The lesson is that it is important to make sure the documents are correct the first time; and to be careful, because even innocent “mistakes” could result in serious consequences.