Proceeding of Carole FEIL for a Decree Apportioning Estate Taxes with Respect to the Marital Trust Created Under Article Fifth of the Last Will and Testament of Louis Feil, Deceased.
Submitted for decision is the issue of estate tax apportionment in the estate of Gertrude Feil but governed by the terms of the will of her pre-deceased husband, Louis Feil. The issue arises from the interaction of several factors: 1) an apportionment clause in Louis's will that varies EPTL 2-1.8 by requiring estate taxes be paid from the residuary estate; 2) intra-residuary bequests in Louis's will to both charitable and non-charitable beneficiaries; and 3) the nature of charitable bequests and their favored status vis-a-vis tax apportionment. One might also include a fourth issue-the complications that arise when the dispute arises in one spouse's estate but the bequests are governed by the testamentary plan of her pre-deceased spouse. For the reasons that follow, it should become clear that on these facts the “pass through” issue is moot.
Louis Feil died a resident of Nassau County on February 3, 1999. His will, dated November 5, 1996, was admitted to probate by this court on June 10, 1999. Mr. Feil was survived by his wife, Gertrude, and by their four (4) adult children: Marilyn, Judith, Carole, and Jeffrey. Carole and Jeffrey are the co-executors of Louis's estate as well as the co-trustees of the trusts established by Louis's will. Carole is the petitioner and Jeffrey is the respondent in this proceeding to determine the proper way to apportion estate taxes.
The dispute arose when Gertrude Feil died on January 4, 2006, and her will was admitted to probate by this court. Although Gertrude's death triggered the estate tax apportionment dispute, the issue originates and remains in the testamentary plan of Louis, whose estate passed free of estate taxation.1 Because Louis predeceased Gertrude, his entire estate of approximately $250,000,000.00 passed through the residuary clause in his will. The residuary clause created a marital trust for the benefit of Gertrude and upon her death, gave the remainder to two classes of continuing trusts, one set of continuing trusts for the benefit of issue and one set of charitable lead annuity trusts (CLATs). The two co-executors of Louis made a QTIP election on the federal estate tax return and the marital trust was fully funded with the $250,000,000.00, all of which was free of estate taxes in the estate of Louis. However, the QTIP election merely deferred the estate tax until the death of the surviving spouse because the Internal Revenue Code considers a marriage to be a single economic unit. In this regard, the QTIP marital trust provides a temporary safe harbor from the immediate application of the terminable interest rule (cf. IRC § 2056[b] and 2056[b] ) that would otherwise prevent a marital deduction for bequests to a spouse in trust that do not also give the surviving spouse a general power of appointment over the remainder.
For the purposes of this decision, the following provisions in the will of Louis Feil are relevant:
FOURTH: DOLLAR AMOUNT LEGACIES TO INDIVIDUALS.
If Gertrude dies before I do, I give Twenty Million Dollars ($20,000,000) to my issue, subject to the Continuing Trust provisions of Article SEVENTH.
FIFTH: RESIDUARY ESTATE.
A. GERTRUDE SURVIVES. If Gertrude is living, I give my Residuary Estate to my Trustees, IN TRUST, as follows:
NAME OF THE TRUST
The trust shall be known as the “Marital Trust.”
When the Marital Trust ends [upon Gertrude's death], my Trustees shall pay the trust fund as follows:
1. An amount equal to Twenty Million Dollars ($20,000,000) to my issue, subject to the Continuing Trust provisions of Article SEVENTH; and
2. The balance to the Trustees of the Charitable Lead Annuity Trusts established under Article SIXTH.
B. GERTRUDE PREDECEASES. If Gertrude dies before I do, I give my Residuary Estate to the Trustees of the Charitable Lead Annuity Trusts established under Article SIXTH.
SIXTH: CHARITABLE LEAD ANNUITY TRUSTS.
My Trustees shall pay the annuity amount to such one or more Qualified Charities as my Trustees shall select ․ in each taxable year of the trust until the expiration of the Trust Term. The annuity amount is the smallest amount that could be provided under the terms of the trust to produce a Federal estate tax deduction in my estate equal to one hundred percent (100%) of the Federal estate tax value of the assets constituting the trust.
TWELFTH: DEATH TAXES.
A. IN GENERAL. I direct that my Death Taxes with respect to property passing under this Will and property passing under any trust or trusts included in my gross estate under Section 2044 of the Code (i) with respect to which an election under Section 2652(a)(3) of the Code has been made and (ii) that is for the primary benefit of one or more of my issue, shall be charged, without apportionment, entirely against my Residuary Estate.
If Gertrude predeceased Louis, a pre-residuary specific bequest of $20,000,000.00 would pass to the continuing trusts of Article SEVENTH for the benefit of the issue of Louis Feil. That bequest would pass free from estate taxation because Article TWELFTH requires non-apportionment, thereby requiring taxes to be paid from the residuary estate which was the sole remaining beneficiary of the will. If Gertrude survived Louis, as she did, then the entire estate passed to Gertrude in the residuary estate, albeit in a marital trust subject to a QTIP election. However, even in the event that Gertrude survived Louis, the $20,000,000.00 bequest to the continuing trusts from Article FOURTH for the benefit of issue does not disappear. Instead, it survives in the residuary clause, lurking inchoate in the Marital Trust as one of two classes of remainder beneficiaries of the marital trust when Gertrude died. The other class of remainder beneficiaries upon the termination of the Marital Trust are the series of Charitable Lead Annuity Trusts, or CLATS.
Carole Feil (as co-executor and co-trustee) takes the position that the $20,000,000.00 bequest to the continuing trusts retains its tax-favored position regardless of either its status as a pre-residuary bequest (if Gertrude predeceased Louis) or as the remainder of the Marital Trust (if Gertrude survived Louis).
Jeffrey Feil (also as co-executor and co-trustee) disagrees with his sister and takes the position that as the non-charitable portion of the residuary estate of Louis Feil, it must bear the burden of the estate taxation that came due on remainder of the Marital Trust when Gertrude died.
For the reasons that follow, the court finds Carole's position as the correct construction of the intent of Louis Feil.
There are two related rules of testamentary construction that have been developed over the years: one, that a will must be interpreted to reflect the actual intention of the testator; and two, that this intention be ascertained from a sympathetic reading of the document as a whole. (See e.g. Matter of Bieley, 91 N.Y.2d 520, 673 N.Y.S.2d 38, 695 N.E.2d 1119 ; Matter of Dammann, 12 N.Y.2d 500, 504-505, 240 N.Y.S.2d 968, 191 N.E.2d 452 ; Matter of Fabbri, 2 N.Y.2d 236, 240, 159 N.Y.S.2d 184, 140 N.E.2d 269 ; Williams v. Jones, 166 N.Y. 522, 532-533, 60 N.E. 240  ). If a “general scheme” can be found within the four corners of the document itself, then it is the duty of the courts to carry out the testator's purpose, notwithstanding that “general rules of interpretation” might point to a different result (Williams v. Jones, 166 N.Y. 522, 60 N.E. 240  ). If this process were as simple as described, there would be no occasion for the many cases illustrating these principles. Because each will is a unique document there is a corollary to these broad principles. A court may “give effect to an intention or purpose, indicated by implication, where the express language of the entire will manifests such an intention or purpose” and the testator has simply neglected to provide for the exact contingency which occurred or thought that he or she had made such intention clear in the context (Matter of Selner, 261 A.D. 618, 620, 26 N.Y.S.2d 783 [2d Dept. 1941], affd. 287 N.Y. 664, 39 N.E.2d 287 ; see also Matter of Gulbenkian, 9 N.Y.2d 363, 370, 214 N.Y.S.2d 379, 174 N.E.2d 481  ). Hence, “[i]ntent is not to be gleaned by focusing upon any one particular word, sentence, or provision; rather, it must be ascertained from a perusal of the entire will by a reader mindful of the particular facts and circumstances under which the provisions of the instrument were framed” (Matter of Bellows, 103 A.D.2d 594, 597, 480 N.Y.S.2d 925 [2d Dept. 1984] ). Added on to this common-law edifice is the strong policy in favor of statutory apportionment and the requirement that those who would seek to stray from such policy must produce a clear and unambiguous direction to the contrary in the will (Matter of Mann, 186 A.D.2d 500, 589 N.Y.S.2d 416 [1st Dept. 1992] ).
The issue of estate tax apportionment is an issue that is governed by the intent of Louis Feil and based upon a fair reading of his will as a whole it is clear to the court that he intended the $20,000,000.00 to survive intact both his death and his wife's death.
EPTL 2-1.8 governs issues related to the apportionment of estate taxes. It is a default statute and provides that unless the testator has expressed an intent to the contrary, the estate tax is to be paid by all beneficiaries according to their interest in the gross tax estate-unless the beneficiary is a qualified charity. The deduction that the estate receives for charitable gifts must benefit the charity and therefore the charity is generally not liable for tax on the amount it receives. Therefore, charitable dispositions are “not taxable and in consequence may not be burdened with any part of the estate tax deficit” (Matter of Volckening, 70 Misc.2d 129, 332 N.Y.S.2d 538 [Sur. Ct., Kings County 1972]; see EPTL 2-1.8[c] ). These rules do not apply if the testator directs otherwise in his or her will. Moreover, construction proceedings of unique instruments are sui generis and rules of interpretation are subordinated to the requirement that the actual intent of the testator be sought and given effect (Matter of Fabbri, 2 N.Y.2d 236, 159 N.Y.S.2d 184, 140 N.E.2d 269  ).
Before proceeding with the analysis, it might be instructive to highlight the effect of a decision either way and to describe the purpose of charitable lead annuity trusts. As to the stakes involved here, the figures used are approximate and meant for purposes of illustration only.
It is readily apparent that Carole's interpretation preserving the “full value” of the continuing trusts results is more money going to the IRS than does the interpretation favored by Jeffrey. The court notes, however, that any rules of construction that generally favor tax savings must still give way to the intent of the testator. In some respects, one could conclude that the difference between Carole and Jeffrey is between short-term gain (Carole) for the continuing trusts and the potential for long-term gain (Jeffrey) because the continuing trusts for the benefit of issue are also the remainder beneficiaries when the CLATs terminate. Of course, the court notes the possibility that the remainder of the CLATs may be zero, after all they are not called “zeroed-out charitable lead annuity trusts” without reason. At this juncture, it might be useful to expand on these concepts and to explain how properly structured annuity payments of a CLAT can result in zero tax exposure at inception and tax-free distributions of a remainder at the termination of the trust.
A CLAT is a split-interest trust that pays an annuity to a charity for the life of some person or for a term of years, with the remainder interest payable to a noncharitable beneficiary (typically, the testator's family). Both the charitable lead portion and the remainder portion can be readily calculated. The charity receives annual payments from the CLAT for a period of time and what is remaining in the CLAT at the end of the term belongs to the decedent's family outright or through a device like the continuing trusts here and passes to them with no further tax consequences because all estate tax consequences are fixed at the time the CLAT is created. The decedent receives an estate tax charitable deduction for the present value of the lead interest while the present value of the remainder interest is includible in the gross estate. It is therefore possible to set the value of the lead interest equal to the full value of the property transferred to the CLAT, making the value of the remainder interest zero. These are in effect estate freeze techniques that capitalize on the mismatch between the “locked-in” interest rates used to value transfers by the IRS and the actual anticipated performance of the transferred assets. If the assets can be managed to produce a rate of appreciation that exceeds the “locked-in” rate applied by the IRS, then the appreciated sum will pass tax free to the remainder beneficiaries. This is the reason a CLAT is a valuable estate planning tool in a low interest rate environment. CLATs are particularly suited for hard-to-value assets (such as real estate) and assets which are expected to grow rapidly in value.
Based on the foregoing, it is clear that the charitable lead annuity trust is an estate freeze plan for large estates (see Whitty, Effects of Low Interest Rates on Investment-Driven Estate Planning Techniques, 30 Est. Plan. 587 [Dec. 2003] and Freeman Rapkin, Planning for Large Estates, Matthew Bender & Company, Inc., 2007). The intent behind a “zeroed-out charitable lead annuity trust” like these is to maximize a charitable deduction so as to produce a tax neutral event because the present value of the lead charitable portion of the trust cancels out the presumptive remainder value of said trust. But this is an actuarial estimation. It preserves the possibility that there will be an actual remainder to pass on tax free. The value of the lead interest is set at the date of Gertrude's death using the percentages set under IRC § 7520. In a low-interest environment, a relatively low IRC § 7520 rate coupled with a favorable (i.e., low) valuation of the assets funding the CLAT means that the actual remainder of the Feil CLATs will exceed the initially presumed remainder and would pass tax free to the continuing trusts. Of course, it is also possible that the rate of return on the trust assets does not exceed the IRC § 7520 rate and that the assets were initially fully or even overly valued. This would make the CLAT a sinking fund resulting in an actual remainder of zero. The court also notes that we are currently in a low-interest rate environment, thereby enhancing the viability of these CLATs. However, whatever long-term possibilities exist with regard to these CLATs, those possibilities cannot defeat the intent of Louis Feil.2 Therefore, while one cannot minimize the charitable intent possessed by Louis Feil in granting such a large sum to a trust for undesignated charities, it must also be recognized there are significant planning advantages behind the charitable intent.
The intent of Louis Feil is established clearly and unambiguously in his will by the entirety of the circumstances-the use of a fixed sum in funding the continuing trusts, i.e., $20,000,000.00, and the repeated use of that fixed sum both inside and outside the residuary as the intended amount should Louis have died before or after Gertrude, and the corresponding lack of logic that results in reading Louis's use of the pronoun “my” in his will in a narrow way to apply only to his estate taxation. To come to the conclusion advanced by Jeffrey would require the court to find that Louis intended $20,000,000.00 to pass tax free to the continuing trusts if Gertrude died before he did but not if he died first. This strikes the court as most unlikely and not supported by the language chosen by Louis to make these decisions. After all, and as pointed out above, there exists a non-trivial chance that there may be no remainder to the CLATs at all. This is not a case where the issue of Louis and the charities were to each receive a fractional share of the residue. Instead, Louis made a specific bequest of a fixed dollar amount to continuing trusts for his issue with the “balance” (in the words of Louis's will) going to the CLATs, or as Louis expressed it, “(pay an amount equal to Twenty Million Dollars ($20,000,000.00)” to the continuing trusts. It is this intent that precludes the application of IRC § 2207A 3 as argued by the Attorney General. Likewise, Jeffrey's reliance on Matter of Shubert, 10 N.Y.2d 461, 225 N.Y.S.2d 13, 180 N.E.2d 410 , is similarly unpersuasive. Shubert did not involve a specific bequest operative both outside the residuary estate (if Gertrude predeceased) or inside the residuary (if Gertrude survived Louis). Moreover, and in contrast to Louis's will, which clearly specified that taxes are to be charged “without apportionment,” the tax clauses in Shubert did not contain any directions about apportionment of the taxes, merely directing taxes to be paid from the residue. The court agrees with Carole and her assessment that Matter of Kindermann, 21 N.Y.2d 790, 288 N.Y.S.2d 480, 235 N.E.2d 452 , is more analogous to these facts than is Matter of McKinney, 101 A.D.2d 477, 477 N.Y.S.2d 367 [2d Dept. 1984]. In sum, to accept Jeffrey's argument is to accept an intent on the part of Louis that conceivably would result in none of a $250,000,000.00 estate going to his issue but being instead used to produce a double tax free estate. It is possible that Louis Feil disliked the IRS more than he loved his children, but that result does not seem likely under the circumstances presented.
Finally, Carole's reliance on “true residuary” jurisprudence is appropriate and the court considers it to be an extension of her other arguments. In this line of cases, the distinguishing factor in determining when courts should parse a residuary clause for apportionment purposes is when there is a bequest of a specific dollar amount contained within a portion of the will which is ostensibly the residuary clause. Where a residuary distribution is divided between fractional or percentage shares (see Matter of McKinney, 101 A.D.2d 477, 477 N.Y.S.2d 367 [2d Dept. 1984] ), courts typically conclude that intra-residuary apportionment applied and that, absent an unequivocal exoneration from statutory apportionment within the residue, all residuary beneficiaries bear the taxes attributable to their share of the residue, and all exempt beneficiaries are entitled to the benefit of the charitable (or marital for that matter) deduction. Therefore, the non-charitable portion of the residuary assumes the full burden. However, when a residuary distribution is divided between specific dollar amounts and a further distribution of the “the balance” or the “amount remaining” (see Matter of Kindermann, 21 N.Y.2d 790, 288 N.Y.S.2d 480, 235 N.E.2d 452  ), then the specific bequests are exonerated from paying any portion of the estate taxes, and the estate taxes are charged entirely against the “true residuary,” even if the true residuary is charitable.
In conclusion, Carol's construction of the will is the correct one. Her petition is granted. Settle decree
1. EPTL 2-1.8(a) gave Louis the right to control how the estate taxes with respect to his property are allocated among the recipients of the property, regardless of when such taxes are payable. EPTL 2-1.8(d) gave Gertrude the limited power to exonerate the marital trust from any tax burden and to use her own separate property to pay all the taxes due. This was not done. Gertrude did not have the power to determine how taxes that were left to be paid from the trust would be apportioned among the trust beneficiaries; only Louis could do that.
2. The court further notes that the IRS applied a § 7520 rate of 5.4% to the Feil CLATs. The current § 7520 rate is 3.2%.
3. IRC § 2207A requires specific direction by the surviving spouse to reallocate the taxes from the beneficiaries of the QTIP property. The issue here is the intent of Louis, as expressed in his will, not the intent of Gertrude. It is true that Gertrude could have used her own separate property to free the marital trust property from bearing all or part of the trust tax burden at her death. (See EPTL 2-1.8[d] ). However, she did not have the power to determine how taxes that were left to be paid from the marital trust would be allocated among the trust beneficiaries, only Louis could do that. To have it otherwise would possibly defeat the purpose of the QTIP altogether.
JOHN B. RIORDAN, J.