Navigating the minefield of settlements: a primer on tax issues for the probate and trust litigator.

• Author: Griffin, Linda S.
• Position: Real Property, Probate and Trust Law

In these economic times, probate and trust litigators have a growing practice. Litigation results not only from clients who are more knowledgeable in pursuing their rights, but also from the proliferation and increasing complexity of trust documents, together with the demographics of baby boomers and their parents reaching middle and old age. This author has worked with many excellent litigators and has had the opportunity to advise them on various tax issues in resolving disputes and documenting the resolutions in settlement agreements. This article is intended to help litigators spot various tax issues and assist in properly documenting the resolution in an agreement.

Background

Florida law permits settlements in disputed will matters (1) and trust matters. (2) Agreements avoid the unnecessary expense of a trial and may resolve issues between family members that have been brewing for many years. Agreements can be as creative as the litigators who draft them. Unfortunately, while an agreement may resolve family issues and address the equitable distribution of the assets, tax consequences to the beneficiaries may not be considered until well after the agreement is finalized by the court. These tax issues can expose litigators to unforeseen liability because the parties assume (perhaps incorrectly so) that the litigators have addressed all the tax issues in an agreement.

One beneficial way to analyze tax issues in the negotiation of an agree ment is to realize that every transaction, change, or addition affecting a disputed will or trust can have a tax consequence. The tax consequence may be favorable, unfavorable, or neutral to any one or more of the parties to the agreement. Obvious tax areas that must be addressed are income tax, gift tax, estate tax, and generation skipping transfer tax (GSTT) matters, and the not-so-obvious taxes include (but are not limited to) foreign tax, employment tax, excise tax, return filing, collection, penalties, criminal tax misconduct, corporate tax, deferred compensation, UBTI, partnership tax, capital gains tax, and special valuation rules. While a discussion of all these taxes is beyond the scope of this article, the author believes that litigators should be aware of the "ticking time bomb" of undisclosed and unknown tax effects to the parties to the agreement.

Some litigators may assume that the certified public accountant (CPA) or tax attorney (collectively the "tax professionals") will cover the litigator's exposure. However, if the facts, details, and the background of an agreement are not adequately communicated to the tax professionals, then tax advice will not be comprehensive. Tax advice is extremely detail-driven, and it is this author's experience that in the rush to sign an agreement, details may be overlooked. Litigators should involve tax professionals as early as possible. In many cases, "the tax tail cannot wag the dog," but adverse tax consequences found after entering into an agreement will surprise the parties who will look to the attorneys who negotiated the agreement for satisfaction.

The purpose of this article is to focus on identifying issues, not resolving them. The author wants to help litigators spot issues so that they will know when it is appropriate to contact the tax professionals to clarify the outcome of the desired transaction. Litigators often provide their expertise and creativity to alternatives not considered by the tax professional because the litigators generally understand the controversy and the family dynamics much better than the outside tax professionals. Working with the litigator and the tax professional in unison is a win-win situation.

Fact Pattern

The following fact pattern will be analyzed throughout this article. Assume Duke, age 87, a Florida resident, dies in 2009 with a $10 million estate, $1 million passing through probate to his trust, $7 million already funded in his revocable trust, and $2 million in joint names with his surviving spouse, Daisy. Duke and Daisy, age 98, have each been married several times, and each has adult children from prior marriages. Duke's children are Jim, Fred, and Charles and his grandchildren are Fred's children, Mindy and Mark. Daisy's only child is a daughter, Samantha. Duke leaves via a pecuniary formula his maximum exemption amount (the exemption assets) outright in equal shares to his children and his grandchildren. The balance is left to a qualified terminal interest property (QTIP) trust for Daisy's benefit and...