Bandy v. Clancy

• Decision Date: 24 August 2016
• Docket Number: Sept. Term, 2015,No. 93,93
• Citation: 144 A.3d 802,449 Md. 577
• Parties: Michelle Bandy et al. v. Alexandra Clancy
• Court: Court of Special Appeals of Maryland

449 Md. 577

144 A.3d 802

Michelle Bandy et al.

v.Alexandra Clancy

No. 93

Sept. Term, 2015

Court of Appeals of Maryland.

August 24, 2016

Argued by Jerrold A. Thrope (Sheila K. Sachs, Gordon Feinblatt, LLC of Baltimore, MD; Robert S. Brennen, Jennifer J. Coyne, Menachem Lanner, Miles & Stockbridge, P.C. of Baltimore, MD) on brief, for Appellants.

Norman L. Smith (Jeffrey E. Nusinov, Nusinov Smith, LLP of Baltimore, MD; Lansing R. Palmer, Akerman, LLP of New York, NY) on brief, for Appellee.

Barbera, C.J., Greene, Adkins, McDonald, Watts, Hotten, Lynne A. Battaglia, (Retired, Specially Assigned), JJ.

Battaglia

, J.

“The avoidance of taxes is the only intellectual pursuit that still carries any reward.”—John Maynard Keynes

“The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.”¹ —Justice George SutherlandAcclaimed author Thomas L. Clancy, Jr., (“Decedent” and “Testator”) died in October of 2013, survived by his second wife, Alexandra M. Clancy (“Mrs. Clancy”) and a minor child by that marriage, as well as four adult children (“The Older Children”) from Mr. Clancy's first marriage. Mr. Clancy died, leaving a will, as well as various amendments; the issue before us involves the interpretation of Mr. Clancy's Will, as amended by a Second Codicil, with respect to not only the payment of federal estate taxes, but also to the question of upon which beneficiaries the burden of such taxes should be placed at the time of Mr. Clancy's death.²

Federal estate taxes may be imposed on a decedent's real and personal property and any property interests³ in excess of five million dollars, an amount adjusted annually since 2011 for the “cost of living”,⁴ 26 U.S.C. § 2010(c)(3)

; the threshold for the imposition of Federal estate taxes in 2015 was $5,430,000.⁵ Federal estate tax is calculated on a graduated basis, on the value of the estate above the threshold, starting at 18% for the first ten thousand dollars.⁶ Which beneficiaries, if any, are obligated to pay a portion or all of the federal estate taxes is a matter of State law, Riggs v. Del Drago et al. , 317 U.S. 95, 97–98, 63 S.Ct. 109, 110, 87 L.Ed. 106, 110–11 (1942)

, and, in Maryland, may be provided for under the Will.⁷ Md. Code Tax Gen. § 7–308(k).

Deductions available to reduce the federal estate tax burden include expenses and indebtedness,⁸ certain uncompensated losses,⁹ transfers of property for public, charitable and religious uses¹⁰ and the marital deduction,¹¹ all of which reduce the taxable estate by the value of the property allocated to the deduction.¹² With respect to the marital deduction, Congress in 1948 enacted a mechanism to reduce taxes on property transferred upon death to a surviving spouse. Revenue Act of 1948, Pub. L. No. 80–471, 62 Stat. 110, 117 (1948). At its inception, the marital deduction essentially excluded the lesser of the value of property transferred to the surviving spouse from the taxable estate or one half of the adjusted gross estate.¹³ Changes to the computation of the marital deduction occurred over the years but the most significant for our purposes occurred in 1981 through the Economic Recovery Tax Act, under which the marital deduction was increased by enabling the total value of an estate to be transferred to a surviving spouse without adverse federal estate tax consequences. Economic Recovery Tax Act of 1981, Pub. L. 97–34, 95 Stat. 172 1981). See also George M. Schain, Marital Trust v. QTIP: Advice for Estate Planners , 49 Mo. L. Rev. 741 (1984).

Essentially, then, an estate can avoid adverse tax consequences upon the death of the testator through the use of the marital deduction, because the marital deduction “reflects a strongly held policy that it is inappropriate to assess transfer taxes on transfers of property between spouses.” William M. McGovern, et al., Wills, Trusts and Estates Including Taxation and Future Interests 719 (4th ed. 2010). Federal estate taxes may be reduced when property is transferred to the surviving spouse upon the death of the decedent, but the value of the property conveyed that remains at the time of the death of the surviving spouse is subject to federal estate tax.¹⁴ 26 U.S.C. § 2044

. See also Angela M. Vallario, The Fundamentals of Estate Planning 251 (2012).

To qualify for the marital deduction, the property must be that which would have been includable in the gross estate of the decedent and which passes, or has passed, to the surviving spouse by operation of law or otherwise.¹⁵ 26 U.S.C. § 2056(a)

.

“Terminable” property interests, interests given to a surviving spouse for a limited time, however, do not qualify for the marital deduction, unless the interest qualifies as one of the exceptions provided in Section 2056 of the Internal Revenue Code

,¹⁶ including the Qualified Terminable Interest Property (QTIP), 26 U.S.C. § 2056(b)(7), or that property:

(I) which passes from the decedent,

(II) in which the surviving spouse has a qualifying income interest for life, and

(III) to which an election¹⁷ under this paragraph applies.

26 U.S.C. § 2056(b)(7)(B)(i)

. To constitute a “qualifying income interest for life” the terms of the property transfer must provide that:

(I) the surviving spouse is entitled to all the income from the property, payable annually or at more frequent intervals, or has a usufruct¹⁸ interest for life in the property, and

(II) no person has a power to appoint any part of the property to any person other than the surviving spouse.

Subclause (II) shall not apply to a power exercisable only at or after the death of the surviving spouse. To the extent provided in regulations, an annuity shall be treated in a manner similar to an income interest in property (regardless of whether the property from which the annuity is payable can be separately identified).

26 U.S.C. § 2056(b)(7)(B)(ii)

. Treatment of property as QTIP property requires that the executor elect the property for treatment as QTIP property on the federal tax return for the estate, a decision that is irrevocable. 26 U.S.C. § 2056(b)(7)(B)(v).

Property elected for QTIP treatment may qualify for the marital deduction, whether it is transferred outright or placed in a trust. Tax Reg. § 20.2056(a)–1. A properly structured QTIP trust, one that meets the requirements of Section 2056(b)(7)(B)

, qualifies the property in trust for inclusion in the marital deduction, yet allows the testator to specify a different beneficiary for the remainder of the QTIP trust assets upon the death of the surviving spouse. 26 U.S.C § 2056(b)(7)(B)(i)–(ii). See also Vallario, supra , at 261. The QTIP Trust qualifies for the marital deduction when the surviving spouse is entitled to all of the income of the trust for life, the income is paid to the surviving spouse at least annually and no one has the power to appoint any part of the property to any person other than the surviving spouse.

In addition, unlike a traditional life estate, the surviving spouse, who is the beneficiary of a QTIP Trust, not only receives the income from the Trust but also may request that the trustee disburse principal from the Trust to meet the surviving spouse's needs.¹⁹ Tax Reg. § 20.2056(b)–7(d)(6). It is possible, therefore, that distributions of principal for the benefit of the surviving spouse could have depleted the Trust such that only minimal assets are left for the remainderman identified by the testator.²⁰

Any property used to pay federal estate taxes, however, will not qualify for the marital deduction. 26 U.S.C. § 2056(b)(4)(A)

. If property allocated to the marital deduction is used to pay federal estate tax, the marital deduction is reduced by the amount of the payment made, thereby increasing the federal estate tax imposed on the estate. Id. See also Jerome A. Manning, Manning on Estate Planning 14-18 (7th ed. 2015).

One way to protect the marital deduction from adverse tax consequences and receive the full federal estate tax benefit for property transferred to the surviving spouse is to use a “savings clause” in the will. That type of savings clause, often referred to as an “interpretive aide savings clause”, restricts actions taken by the personal representative that could reduce the tax benefit of the marital deduction and assists with the interpretation and explanation of the testator's intent with respect to preventing adverse tax consequences. See Eugene Lyle Stoler, Savings Clauses , The CPA Journal, 25 (April 1999); Charles A. Redd, What Types of Savings Clauses will Preserve the Marital Deduction? , 14 Est. Plan. 72 (1987)

. The interpretive aide savings clause “attempts to elucidate the testator's or grantor's prevailing intentions with regard to securing the marital deduction,” Redd at 72, and is “a provision that takes away a power or changes a provision that is expressly given elsewhere in the instrument and is, therefore, in direct conflict with that other express power or provision.” Stoler at 25; see also William Parsons, Lifetime and Testamentary Estate Planning , 74 (9th ed. 1983). The interpretive aide savings clause, therefore, can express the testator's intent that any authority granted to the personal representative is void should it reduce the efficacy of the marital deduction.

The Internal Revenue Service has recognized the validity of an interpretive aide savings clause in Rev. Rul. 75–440 (1975)

. Addressed in Revenue Ruling 75–440 was a situation in which a will provided for both a marital trust and a residuary trust and granted authority to the trustees to invest trust principal in non-income producing life insurance. The will also included a savings clause that stated:

Notwithstanding anything herein contained to the contrary, any power, duty, or discretionary authority granted to my Fiduciary hereunder shall be absolutely void to the extent that either the right to exercise or the exercise thereof, shall in any way affect, jeopardize or cause

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