An IRS ruling released last month presented some encouraging news for estate planners and their clients, regarding drafting errors made by attorneys. Despite the IRS’ reputation as a ruthless, unforgiving agency, it actually allowed someone a bit of leeway for a trust that was constructed incorrectly but in good faith. The case serves as a useful guide to how mistakes in an estate plan can be lawfully corrected.
The case involved a business owner with four adult children, who wanted a way to transfer property to his children with minimal gift taxes and avoiding estate tax. An attorney persuaded the businessman to establish two grantor retained annuity trusts, funded with stock from the company he owned.
The first GRAT was set up so that the businessman would retain the right to receive an annuity for four years, after which the remaining trust assets, if any, would pass to the children’s trust. The second GRAT was similar to the first one, but with a fifteen-year term.
The problem, though, was that the children’s trust was structured as revocable. The businessman’s accountant, preparing the gift tax returns, noticed that the nature of the children’s trust meant that the remainder interest being transferred to it from the GRATs would be both included in the businessman’s estate as well as be susceptible to gift taxes – exactly what the original estate plan was hoping to avoid.
The accountant mentioned this to the estate attorney, only to be told that – according to the IRS ruling – “Accountant, not being an attorney, did not understand the State law governing the trust.” Nevertheless, the accountant made a note of the exchange and filed it away.
In year three of the GRAT, the businessman brought in a financial planner to deal with estate issues related to the business’ shareholders. That financial planner also thought the original GRATs were constructed improperly, that the revocability of the children’s trust negated its tax advantages. He brought in another attorney, who agreed with him on the flaws.