Income beneficiary liable for gift taxes owed by terminated GRIT.

As a result of her divorce from J. Howard Marshall, II, Eleanor Stevens received stock in a company called MPI. In 1989, she transferred MPI stock to a Grantor Retained Income Trust (GRIT) with a 10-year term. During the term, the GRIT paid all of its income to her. At the end of the term the trust would terminate and the trust assets would be distributed to Pierce Marshall. During the GRIT term and shortly before his death, Marshall sold his MPI stock back to MPI at a below market price, thereby increasing the ownership interest of the other MPI shareholders. The IRS audited the transaction and assessed gift taxes against Marshall’s estate for the indirect gifts to the other MPI shareholders. The United States Tax Court found deficiencies in gift taxes against the Marshall estate, but the Marshall estate failed to fully pay the gift taxes due.

Thereafter, Stevens died and the United States sued her estate in federal court for the gift taxes owed by Marshall’s estate, arguing that Stevens was liable for the unpaid gift taxes as the donee of the indirect gift. The estate argued that (1) at the time of the indirect gift the MPI stock had been transferred to the GRIT and therefore Stevens could not be the donee of the gift, (2) because the GRIT had terminated at the time of the suit, the remainder beneficiary, and Stevens, as income beneficiary, should be liable for the taxes due on a gift that enlarged the trust principal.

The court rejected the estate’s arguments and held that Stevens was the donee of the gift on the grounds that: (1) a donee for gift tax liability purposes follows the Supreme Court’s definition of a donee for purposes of determining whether a gift is eligible for the gift tax exclusion; (2) because gift tax exclusions apply only to present interest gifts and do not apply with respect to future interests, the current beneficiaries and not the remainder beneficiaries constituted the donees of a gift to the trust; (3) at the time of the gift, Stevens was the sole current beneficiary of the GRIT; (4) the gift taxes should have been paid out of the principal of the GRIT; (5) the remainder beneficiary’s interest in the GRIT was an uncertain future interest; (6) the principal of the trust could have been depleted before the termination of the trust by its terms; (7) the gift tax liability should be paid from a known present source of funds; and (8) therefore, the current beneficiary, even though she was only an income beneficiary, was determined to be the donee of the gift and liable for the tax.

Lifetime beneficiary of ILIT not entitled to death benefit proceeds – Leventhal v. Montelione, 2012 Cal. App. Unpub. LEXIS 2964 (Cal. App. 2d Dist., 2012)

In 1996, Frank Montelione created an ILIT for the benefit of his daughter, Michelle, and his stepson, Shaun. The trust terms granted Crummey withdrawal rights during Frank’s lifetime to Michelle, Shaun, and any child subsequently born to or adopted by Frank. Upon Frank’s death, the proceeds of the life insurance policy and any other trust assets were to be held in separate trusts for Michelle and Shaun, with Michelle’s trust receiving an 80% share and Shaun’s trust receiving a 20% share. In 2003, Frank and his wife had another child named Gianfranco.

Frank made periodic gifts to the trust to pay the insurance premiums. Under the trust terms, written Crummey notices were not required because the beneficiaries were minors and the trustee was only required to inform the beneficiaries’ legal and natural guardians of the gifts. The lifetime beneficiaries never exercised their withdrawal rights.

Frank died in 2007 and the life insurance proceeds were paid to the trust. The trustee divided the trust assets to separate trusts for the benefit of Michelle and Shaun. In 2009, Gianfranco, through his guardian ad litem, brought a suit seeking to declare that as a lifetime beneficiary of the trust he was entitled to an interest in the life insurance proceeds. The trial court determined that Gianfranco’s interest was limited to his Crummey withdrawal rights and that he had no interest in the life insurance proceeds. Gianfranco appealed.

On appeal, Gianfranco argued that he is entitled to a pro rata share of the life insurance proceeds because: (1) the trustee failed to provide written notice of his withdrawal rights so the withdrawal rights did not lapse; (2) Frank could not waive Gianfranco’s withdrawal rights because he had a conflict of interest; and (3) the trustee misappropriated trust funds by not maintaining the funds that Gianfranco had a right to withdraw in a separate trust for Gianfranco’s benefit and instead investing those assets in an insurance policy for the benefit of other beneficiaries.

The California Court of Appeals rejected Gianfranco’s arguments and held that Gianfranco has no interest in the life insurance proceeds on the grounds that: (1) the trust terms did not require written notice of withdrawal rights to minor beneficiaries; (2) Frank, as legal and natural guardian, had actual notice of the gifts because he made the gifts; (3) Frank, as the settlor of the trust, was also aware of the beneficiaries’ withdrawal rights; (4) the trust terms authorized Frank to waive the withdrawal rights on behalf of the minor beneficiaries so any alleged conflict of interest was contemplated by the settlor; (5) the trust terms and Frank’s intent were clear that all of Frank’s children had Crummey withdrawal rights but only Michelle and Shaun were to be beneficiaries of the life insurance proceeds.