Tax and State Law Planning Options in a Post-Windsor and Perry World, Including Potential Fiduciary Issues. Broward County Bar Association

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1 Tax and State Law Planning Options in a Post-Windsor and Perry World, Including Potential Fiduciary Issues As presented to the Broward County Bar Association February 18, 2015 Ft. Lauderdale, Florida George D. Karibjanian, Esq. Proskauer Rose LLP 2255 Glades Road, Suite 421 Atrium Boca Raton, Florida Telephone: Fax: gkaribjanian@proskauer.com (materials current through January 8, 2015)

2 George D. Karibjanian George D. Karibjanian Senior Counsel, Personal Planning Department Fellow, American College of Trust and Estate Counsel Board Certified By The Florida Bar in Wills, Trusts and Estates 2255 Glades Road Suite 421 A Boca Raton, FL d f gkaribjanian@proskauer.com George D. Karibjanian is a Senior Counsel in the Personal Planning Department of Proskauer Rose LLP and practices in Proskauer's Boca Raton office. George is Board Certified by the Florida Bar in Wills, Trusts & Estates and is a Fellow in the American College of Trust and Estate Counsel. He earned his B.B.A. in Accounting from the University of Notre Dame in 1984, his J.D. from the Villanova University School of Law in 1987, and his LL.M. in Taxation from the University of Florida in George has practiced his entire legal career in South Florida (over 26 years), practicing exclusively in the areas of estate planning and probate and trust administration, and also represents numerous clients with respect to nuptial agreements. George lectures to national, state-wide and local groups and has been published in national and local periodicals and journals. Born and raised in Vineland, New Jersey (in the heart of South Jersey), George has called Boca Raton home since When not attending Miami (nee Florida) Marlins home games, George is either locked to his desk for the better part of the daytime and early evening hours by security at the One Boca Place office building or is keeping current with television programming that skews way below his supposed demographic. On January 15, 2014, George was presenter at the prestigious 48 th Annual Heckerling Institute on Estate Planning in Orlando, Florida, speaking on a panel discussion titled, Living and Working with the Uniform Principal and Income Act, focusing on the tax effects on the power to adjust trust principal to income, the power to convert an income trust to a unitrust, comparing the various unitrust statues and focusing on potential litigation facing fiduciaries in this area. On the topic of same-sex estate planning, George has lectured at various conferences and estate planning councils throughout the United States and has published numerous articles in publications such as Steve Leimberg s LISI Estate Planning Newsletters, Trusts & Estates Magazine and the Florida Bar Journal. George has also been quoted by several publications and websites. George s other lectures to national organizations have included topics such as Prenuptial Agreements for the Estate Planner, Portability, the Principal and Income Act, Representing a Client with Potential Capacity Issues and Whether a Supplemental 706 is Required. George s national, state and local association activities include: with respect to the ABA, he is currently serving as the Second Vice- Chair of the Estate and Gift Tax Committee of the ABA Tax Section; the current Vice-Chair of the Estate and Gift Tax Committee of ABA s RPTE Section, the Chairperson for a ABA Tax Section Task Force Subcommittee Advocating Changes to the Portability Provisions Added by the 2010 Tax Act and a contributing draftsman to the ABA Tax Section s 2012 comments to the IRS on decanting; with respect to RPPTL, he is current Vice-Chair for the RPPTL s Asset Protection Committee, the RPPTL ActionLine publication s Co-Vice Chair Probate & Trust and National Events Editor since 2012, the co-chairperson of the RPPTL Ad Hoc Committee regarding potential statutory changes in light of a change in Florida s DOMA laws, a committee member of an Ad Hoc Committee to study changes to Florida s decanting statutes; the Chairperson and primary draftsman of the RPPTL s 2012 comments to the IRS on decanting, a member of the RPPTL Ad Hoc Committee that drafted a statutory change in response to Florida s Morey v. Everbank decision, and a current At-Large Member to RPPTL s Executive Council; he is also active committee member for the Advanced Association of Life Underwriters Business Insurance in Estate Planning and Charitable Planning Committees, and an active member of the Greater Boca Raton Estate Planning Council and the South Palm Beach County Bar Association. George is currently on the Professional Advisory Committee for the Boca Raton Museum of Art. Previously, George served as President and a member of the Board of Directors of the Notre Dame Alumni Club of Boca Raton ( ), a member of the St. Jude's Church (Boca Raton) Financial Education Council ( ), and Vice President and a member of the Board of Directors of the Boca Raton Girls Fastpitch Softball Association ( ) i

3 Tax and State Law Planning Options in a Post-Windsor and Perry World, Including Potential Fiduciary Issues 1 Table of Contents A. DOMA and Unconstitutionality Tax Status of Prior Years... 1 (1) Introduction... 1 (2) Open Years... 1 (3) Closed Years... 1 B. Asset Protection, Windsor and IRA s What to Do?... 9 (1) Introduction... 9 (2) Example... 9 C. What If State Law DOMA is Rendered Unconstitutional (1) Introduction (2) What s Good for the Goose is Good for the Gander Void Ab Initio (3) Examples of Potential Problems (a) Tenancy-by-the-Entirety (b) Homestead (c) Elective Share Pretermitted Spouse (4) Will this Really Happen? Maybe not There May Be Some Protection of Rights D. Potential Issues When a Beneficiary is a Party to a Same-Sex Marriage (1) (2) Example (3) Variation #1 Trust Remainder (4) Variation #2 Limited Power of Appointment (5) Variation #3 Discretionary Distributions to Spouse (6) Variation #4 Who are the Descendants? (7) Variation #5 Spousal Support Obligations (8) Can Some of the Results Be Changed? (a) Change of Governing Law (b) What if the Trustee had a Power to Modify? (c) Drafting Solution: should terms be defined? (9) Beware of Older Documents (10) Conclusion as to Fiduciary Duties by George D. Karibjanian. i

4 Tax and State Law Planning Options in a Post-Windsor and Perry World, Including Potential Fiduciary Issues A. DOMA and Unconstitutionality Tax Status of Prior Years 2 (1) Introduction Pursuant to the decision of the United States Supreme Court in Windsor v. United States, 3 Section 3 of the Federal Defense of Marriage Act ( DOMA ) was held to be unconstitutional as a violation of the Due Process and Equal Protection Clauses of the Fifth Amendment to the United States Constitution. Given this unconstitutionality, what does this do for taxpayers who may have been prevented from filing joint tax returns, claiming the federal gift tax or estate tax marital deduction? Can they now file for refunds? (2) Open Years (a) for open years. According to I.R.S. Notice (August 29, 2013), clearly they can (b) Individuals who were in same-sex marriages may, but are not required to, file original or amended returns choosing to be treated as married for federal tax purposes for one or more prior tax years still open under the statute of limitations. (c) Generally, the statute of limitations for filing a refund claim is three years from the date the return was filed or two years from the date the tax was paid, whichever is later. (d) As a result, as of the time of the issuance of IR , refund claims could still have been filed for tax years 2010, 2011 and Some taxpayers may have special circumstances, such as signing an agreement with the IRS to keep the statute of limitations open, that permit them to file refund claims for tax years 2009 and earlier. (3) Closed Years (a) Example After the 2004 change in the law in Massachusetts, Liberace and Scott decide to marry in Wealth-wise, Liberace is the bread-winner in the family with a large estate, whereas Scott has little or no assets. 2 Note that the Constitutional analysis is not intended to be a detailed Law Review-style dissection of the issues and arguments resulting from the DOMA s unconstitutionality, but rather, is intended to present a general overview of potential Constitutional arguments and analysis should the situations discussed below arise in a particular setting. The author readily admits that when it comes to Constitutional Law, he slept in that day during Law School. The author wishes to thank Proskauer New York partner Mark D. Harris for reviewing the general Constitutional analysis presented herein. The provisions of this part of these materials were codified in George D. Karibjanian, DOMA: What If Unconstitutionality Becomes a Reality?, LISI ESTATE PLANNING NEWSLETTER #1986 (July 16, 2012) at S.Ct. 786 (2013). 1

5 Liberace dies suddenly on March 31, 2006, leaving entire estate, valued at $10,000,000, in a trust, under which, (a) Scott receives all of the income therefrom, (b) the Trustees have the discretion to pay to Scott as much principal as Scott needs for his health, support and maintenance, and, (c) upon Scott's death, the remainder is paid among Liberace's blood heirs. Absent DOMA, the trust for Scott would qualify for QTIP treatment. As a result of DOMA, however, Liberace's executors cannot elect QTIP treatment because Scott, even though he was legally married to Liberace in Massachusetts, is not married for Federal tax purposes, and, as a result, on December 31, 2006, Liberace's executors file Liberace's Federal estate tax return (the "706") and, ignoring deductions and applying the rates and exemptions applicable in 2006, pay $3,680,000 in Federal estate taxes. With the Windsor opinion, the definition of marriage under DOMA is unconstitutional. However, as of June 26, 2013, which is the date of the Windsor opinion, the statute of limitations for amending the 706 has passed - pursuant to 6501(a) of the Code, the statute of limitations for adjustments to Liberace's 706 and estate tax liability (absent fraud) expired three years from the filing/payment date. Upon reading the decision, Scott visits his attorney and asks, "hey...if 'unconstitutional' means that the statute was void ab initio, i.e., void from the outset so it should be treated as if it never existed, shouldn't Liberace's trust for me have qualified for the marital deduction?" His lawyer responds by saying, "Sure, but the statute of limitations for amending the 706 and seeking a refund of taxes paid long ago expired." From a constitutional standpoint, does the unconstitutionality of the statute trump the statute of limitations? Should Scott be able to apply for a refund of Federal estate taxes paid? In addition, what about the filing of joint income tax returns...can Scott reopen income tax years 2005 and 2006 and amend his and Liberace's income tax returns to file as married persons, thus potentially generating a refund for Federal income taxes paid? Doing your best Neo impersonation, enter and experience "The Matrix" by considering if, at the time of Liberace's death, Scott and Liberace had children, both of whom were legally adopted by the couple. Suppose that part of Liberace's estate consisted of an individual retirement account (an "IRA") with a value of $5 million, the beneficiary of which was Scott. Noting that same-sex spouses cannot elect to rollover IRA benefits and the IRA therefore becomes an "Inherited IRA." If DOMA is deemed to be unconstitutional, and if at all times Scott is under age 70 1/2, is it possible for him to retroactively deem the IRA to have been rolled over into his own IRA and then apply for income tax refunds in all years where distributions were taken and thereafter declare that there were no distributions from the IRA? 2

6 (b) Effect of Unconstitutionality When a statute is declared to be "unconstitutional," the general rule is that the statute, though having the form and name of law, is in reality no law but is wholly void and ineffective for any purpose; further, since unconstitutionality dates from the time of its enactment and not merely from the date of the decision so branding it, an unconstitutional law, in legal contemplation, is as inoperative as if it had never been passed and never existed so as to be void ab initio. 4 (c) Distinguishing from Common Constitutionality Arguments. (i) With respect to taxes and assessments, like a same-sex marriage is the inverse of a traditional, opposite-sex marriage, so too is the effect of a DOMA constitutionality determination. More often than not, constitutionality is determined as to the retroactivity of a tax or assessment. (ii) For example, tax literature was wrought with articles and discussions in 2010 on the constitutionality of potential legislation that would retroactivity impose the Federal estate tax. 5 (iii) The difference between such discussions and the DOMA constitutionality issue is that all such discussions focused on the retroactive impact of an additional tax or new legislation; what has not been discussed is the effect of a statute's determination of unconstitutionality on a prior tax liability, the effect of which would not be detrimental to the taxpayer, but actually beneficial to the taxpayer. (d) Supreme Court Chimes in as to State Tax Issues 6 While there do not appear to be any U.S. Supreme Court decisions affecting a Federal statute on this topic, the Supreme Court has discussed the issue of unconstitutionality as to state tax statutes. Dept. of Business 7 (i) McKesson Corp. v. Division of Alcoholic Beverages and Tobacco, (A) Wholesale liquor distributors in Florida filed suit, challenging the Florida excise tax that gave preferential treatment to beverages that were manufactured from Florida-grown citrus and other agricultural crops and then bottled in state. The Florida lower courts invalidated the tax scheme under the Commerce Clause. Upon appeal to the Florida Supreme Court, the lower court decisions were upheld, but the Florida Supreme 4 16A AM. JUR. 2D Constitutional Law 195 (updated May 2012). 5 For example, see Pratt and Bowman, Retroactive Transfer Tax Legislation: Constitutional or Unconstitutional?, LISI ESTATE PLANNING NEWSLETTER #1573 (January 6, 2010) leimbergservices.com; Beth Shapiro Kaufman, 2010: The Anatomy of a Train Wreck, 37 ESTATE PLANNING JOURNAL NO. 05, p.42 (May 2010) 6 A portion of this analysis is derived from Siske, Maryn & Smith, What's New In Employee Benefits: A Summary Of Current Case And Other Developments, AMERICAN LAW INSTITUTE - AMERICAN BAR ASSOCIATION CONTINUING LEGAL EDUCATION, ALI-ABA COURSE OF STUDY - PENSION, PROFIT-SHARING, WELFARE, AND OTHER COMPENSATION PLANS (October 12, 1995). In addition, special thanks to (then) Proskauer Summer Associate Intern Alexander Birkenfeld for his assistance with the cite-checking of the Supreme Court cases U.S. 18, 110 S.Ct (June 4, 1990). 3

7 Court did not provide any post-tax payment refunds, so the liquor distributors appealed to the U.S. Supreme Court. 8 included the following: (B) In its decision, the U.S. Supreme Court's conclusions (C) If a state penalizes taxpayers for failure to remit their taxes in a timely fashion, thus requiring them to pay first and obtain review later, the Due Process Clause of the Fourteenth Amendment requires that the state afford a meaningful post-payment remedy for taxes paid pursuant to an unconstitutional tax scheme. (I) The remedy to a distributor for having paid taxes higher than those paid by favored competitors would require a refund of the excess tax or a partial retroactive assessment of tax increases on the favored competitors. (II) In describing the available remedies for the state in this instance, the Court stated that, "And in the future, States may avail themselves of a variety of procedural protections against any disruptive effects of a tax scheme's invalidation, such as providing by statute that refunds will be available to only those taxpayers paying under protest, or enforcing relatively short statutes of limitation applicable to refund actions Such procedural measures would sufficiently protect States' fiscal security when weighed against their obligation to provide meaningful relief for their unconstitutional taxation." (emphasis added) 9 1) By the emphasized statement, the Supreme Court is seemingly stating that for "closed" tax years, the applicable statute of limitation trumps an unconstitutionality decision. 2) Query whether this is a conclusion as part of the Supreme Court's holding or dicta used to illustrate a point, subject to its own interpretation. (D) Subsequent decisions citing McKeeson include Newsweek, Inc. v. Florida Dept. of Revenue, 522 U.S. 442, 118 S. Ct. 904 (1998) (wherein a magazine publisher sought a refund of sales taxes following a determination that a tax exemption available for newspapers, but not magazines, was unconstitutional); Stone Container Corp. v. United States, 229 F.3d 1345 (Fed. Cir. 2000) (see Section A(3)(g), below); and Venture Coal Sales Co. v. United States, 370 F.3d 1102 (Fed. Cir. 2004) (wherein the taxpayer argued that the accrual of a cause of action under the Tucker Act for refund of coal sales taxes when such taxes were paid, and not when the statute required payment of those taxes, was unconstitutional under Export Clause). (ii) Davis v. Michigan Dept. of Treasury 10 (A) Paul Davis, a Michigan resident and former Federal employee, paid state income tax on his Federal retirement benefits in accordance with the Michigan Income Tax Act, which exempts from taxation all retirement benefits paid by the State So.2d 1000 (1988). 9 McKeeson at 50, U.S. 803, 109 S.Ct (1989). 4

8 of Michigan or its political subdivisions, but taxes retirement benefits paid by other employers, including the Federal government. (B) Mr. Davis filed for a refund, claiming that the taxation of Michigan employees vs. Federal employees was discriminatory. (C) The Supreme Court held that Michigan's tax scheme violates principles of intergovernmental tax immunity by favoring retired state and local government employees over retired federal employees. (iii) Harper v. Virginia Dept. of Taxation 11 (A) Henry Harper and his fellow plaintiffs, all of whom were Federal civil service and military retirees residing in Virginia, challenged a Virginia tax statute similar to that found in the Davis decision and brought an action seeking a refund, citing Davis. (B) The Supreme Court concluded that its decision in Davis must be applied retroactively to the petitioner's claims for refunds; however, it ruled that its decision in Davis does not necessarily entitle the petitioners to a refund; rather, the Constitution requires Virginia to fashion relief consistent with the demands of constitutional due process. (iv) Reich v. Collins 12 (A) The taxpayer, Charles Reich, a Federal retiree, commenced an action under Georgia's tax refund statute, seeking recovery of state income taxes unconstitutionally assessed against Federal retirement benefits when state retirement benefits were exempt from taxation. Georgia had taxed retirement benefits paid by the Federal government, but exempted those paid by the State of Georgia, until the Supreme Court issued its decision in Davis. (B) In response to the unconstitutionality of its statute, Georgia had repealed its state retiree tax exemption, but did not offer Federal retirees refunds for the unconstitutional taxes they had paid prior to the Davis decision. (C) The Georgia Superior Court denied the refund request, and Mr. Reich appealed. The Georgia Supreme Court determined that the refund statute did not apply when law under which taxes were assessed and collected was itself subsequently declared to be invalid. 13 Mr. Reich then petitioned for certiorari, and the U.S. Supreme Court remanded for further consideration, 14 after which the refund claim was again denied by the Georgia Supreme Court, which claimed that Georgia provided an adequate pre-deprivation remedy and thus due process did not require Georgia to provide refunds to the Federal retirees. 15 (D) Upon the second certiorari, the Supreme Court, in a unanimous opinion, rejected the Georgia Supreme Court's analysis, concluding that a state may U.S. 86, 113 S.Ct (1993) U.S. 106, 115 S.Ct. 547 (Dec. 6, 1994) Ga. 625, 422 S.E.2d 846 (Ga. 1993) U.S. 918, 113 S.Ct (1993) S.E.2d 320 (Ga. 1993). 5

9 not reconfigure its remedy scheme in mid-course to avoid paying refunds. Terming the Georgia Supreme Court's analysis in the second Reich opinion as a "bait and switch," the Supreme Court held that a state may not hold out a "clear and certain" post-deprivation remedy, in the form of its tax refund statute, and then declare, only after Reich and others had paid the disputed taxes, that no such remedy exists. 16 (e) Although the above-referenced cases refer to state statutes, can the same arguments be applied at the Federal level? (i) Perhaps so it is not outside the realm of possibility that the same "Due Process" arguments challenging state statutes based on the Fourteenth Amendment could also be presented challenging Federal tax statutes based on the Fifth Amendment Due Process Clause. (ii) In other words, it may be possible that a same-sex surviving spouse would argue that the unconstitutionality of DOMA deprived him or her (or his or her spouse's estate) of property (i.e., tax dollars paid as a result of a void ab initio statute) without due process. (iii) If successful, the next question is whether the Code s postdeprivation remedy (i.e., the ability to claim a refund), can block a claim for refund in years beyond the applicable statute of limitations. (f) Post-Deprivation Remedy: Protective Claim for Refund (i) In the event that a case applies the Fourteenth Amendment arguments to the Fifth Amendment, taxpayers may be entitled to refunds for improperly paid taxes. However, don't expect the Service to concede that all taxes should be refunded - the Reich opinion discussed a remedy and how the states can avoid liability (i.e., presumably refunds beyond the applicable statute of limitations) if their remedy is adequate it could be argued that the Code contains such a post-deprivation remedy in the form of a "protective claim" for refund. (ii) Procedures for filing a protective claim for refund as to the Federal estate tax are found in Rev. Proc (October 14, 2011). (iii) Application of Protective Claim for Refund. (A) An executor of a deceased same-sex spouse could file for a protective marital deduction election in order to stay the statute of limitations for filing for refunds in accordance with 6511(a) of the Code. (B) The same logic would apply to a same-sex married couple in seeking a refund by filing a joint income tax return for a prior year. 16 Reich at 111,

10 (C) If the Service advocates that the protective election approach as a "post-deprivation" remedy, this would seemingly negate any refund claims that are barred by the applicable statute of limitations. (g) The Federal Circuit Court of Appeals may have already resolved these issues in Stone Container Corp. v. U.S. 17 (i) In the Stone Container decision, the Federal Circuit applied Fourteenth Amendment reasoning on this issue to a Fifth Amendment claim and ultimately rejected the taxpayer's argument that it is unconstitutional to apply a statute of limitations to an unconstitutional tax. (ii) Summary (A) Stone Container Corp. ("Stone"), along with other corporations, brought an action to recover harbor maintenance taxes ("HMT") which they had paid to the Federal government and which were deemed to have been unconstitutional, to which the government's actions were defended on theory that corporations' lawsuit was filed outside two-year statute of limitations on such suits. (B) Stone argued that it is unconstitutional to apply any statute of limitations to refund claims with respect to an unconstitutional tax, although, the Court noted, Stone did not explain why unconstitutional taxes, unlike other constitutional violations, should be free of statutes of limitations. (C) In its analysis, the Court cited McKesson's Fourteenth Amendment Due Process analysis and stated that, although McKesson is based on the Due Process Clause of the Fourteenth Amendment, its principles are equally applicable to the Federal government through the Due Process Clause of the Fifth Amendment. (D) Further applying McKeeson, the Court denied Stone's argument, stating that in McKeeson, the Supreme Court stated that a state was free to impose various procedural requirements on actions for post-deprivation relief, including enforcing relatively short statutes of limitations applicable to such actions. (E) When discussing Stone's argument concerning the statute of limitations, the Court acknowledged Stone's claim that the language from McKeeson was "mere dicta" and that the Court is free to disregard it, but rejected the notion and failed to engage in the discussion, instead stating that as "a subordinate Federal court, we do not share the Supreme Court's latitude in disregarding the language in its own prior opinions." (h) Although Stone is a Federal Circuit Court opinion, it seemingly addresses the refund issues that would be presented should DOMA fall as a result of an unconstitutional determination. As a result, taxpayers would seemingly have two lines of attack: F.3d 1345 (Fed. Cir. 2000). 7

11 dicta. (i) (ii) First: The "statute of limitations" discussion in McKeeson mere Second: Remoteness (A) Given the application of the law at the time of enactment and considering that challenges have only recently gained ground. (B) Even as recently as 2006 the likelihood of the nonapplicability of DOMA was infinitesimal consider that the Middle District of Florida opinion in Wilson v. Ake 18 held that DOMA did not violate the Full, Faith and Credit Clause and that there is no Due Process violation. (C) Thus, would it be reasonable to bar a taxpayer the right to challenge closed tax years because they failed to file a protective claim for refund under which the taxpayer had no reasonable belief that the refund would someday become payable. (D) In other words, is there a "remoteness" test that can somehow supersede reliance on a statute of limitations as an available governmental remedy, and, if not, does this mean that protective refunds should be filed in all matters on account of the uncertainty of all future laws? (i) If the situation arises whereas the harmed taxpayers are harmed to the degree where total "improper" taxes enter the seven or eight figures, it is not unreasonable to presume that this matter would ultimately find its way back to the Supreme Court. (j) With respect to the estate tax issues, is this even necessary? (i) Conventional wisdom is that it may be more beneficial to have paid the taxes rather than defer until the future. (A) (B) Hedge against higher taxes. Potential use of the 2013 credit for tax on prior transfers. beneficial: (ii) Reasons why retroactive marital deduction may be more inclusion. (A) (B) If trust value has depreciated, less of a gross estate If transfer tax rates are lower than when the decedent died. (C) If property passed outright to the spouse rather than in trust, the property would be subject to a double estate tax, so qualification for the marital deduction eliminates one such tax F.Supp (M.D. Fla. 2005). 8

12 (k) Portability (i) If the trust value has decreased, and if the surviving spouse has significant assets of his or her own, the use of portability may enhance the surviving spouse's estate planning alternatives. (ii) If the value of the trust for the benefit of the surviving spouse has fallen since the date of death, consider the advantage of retroactively electing the marital deduction for the entire estate, which would then allow the decedent's estate to elect portability and thus increase the surviving spouse's applicable exclusion amount as a result of the DSUE Amount under 2010(c)(4). B. Asset Protection, Windsor and IRA s What to Do? (1) Introduction (a) Since the Windsor opinion, the Service has issued certain notices and rulings regarding retirement accounts and retroactive application in the form of I.R.S. Notice (b) However, such guidance relates to employers and conforming employer plans with respect to the Windsor opinion and the findings under Rev. Rul What about the effects of Windsor from the beneficiary standpoint? (2) Example In 2005, April and Leslie, each of whom are 48 years old, are married and reside in Massachusetts. April dies in 2007, naming Leslie, who is then age 50, as the primary beneficiary of her $10,000,000 individual retirement account ( IRA ). Because Leslie was not recognized as April s spouse under federal law, Leslie receives the IRA as an Inherited IRA, meaning that she must start receiving her required minimum distributions ( RMD s ) based on her life expectancy beginning in If Leslie were deemed to be April s spouse, then Leslie could have qualified the IRA as a spousal rollover IRA, meaning that the IRA would have become her personal IRA and not be required to take RMD s until the year in which she attains age 70 ½. As Leslie was born on January 1, 1957, she would not attain age 70 ½ until Assume that the IRA has a 5% average annual yield. Leslie s RMD s from 2008 through 2014, which she withdraws on December 1 of each year, are as follows: Year Age Divisor Balance Withdrawal IRB 979 (April 4, 2014). 9

13 $10,500,000 $315, $10,693,918 $331, $10,880,979 $347, $11,060,011 $365, $11,229,744 $383, $11,388,800 $402, $11,535,688 $422, Leslie s total withdrawals through December 2012 are $1,742,316. Leslie s total withdrawals through December 2014 are $2,567,300. On December 2, 2014, Leslie is found liable in a civil action to Ron and is required to pay to Ron $5,000,000 in damages. Leslie s only assets are the IRA and a personal investment account into which she has deposited the RMD s (the Investment Account ), which has a balance of $2,750,000. (a) General Analysis (i) Based on the facts as stated above, Ron would be able to recover Leslie s Investment Account because that is Leslie s personal account. Deducting the Investment Account from the balance due, and Leslie still owes Ron another $2,250,000. (ii) What about the Inherited IRA? Remember that Leslie and April resided in Massachusetts. The question of whether an Inherited IRA (as opposed to a regular IRA) was available for creditors is not resolved, although without a statutory exemption, recent developments seemingly indicate that a creditor could recover against an Inherited IRA. (A) Insight can be garnered from the United States Supreme Court decision of Clark et. ux. v. Rameker, 20 which held that an Inherited IRA was not exempt from federal bankruptcy matters. (B) The Supreme Court cited three distinctions between an Inherited IRA and a regular IRA that justifies creditor attachment: 21 (I) additional contributions to the account. The beneficiary of an Inherited IRA cannot make (II) The beneficiary of an Inherited IRA must take required minimum distributions from the account regardless of age, while an IRA owner can defer distributions at least until age 70 ½ U.S. (2014). 21 See generally, Id. 10

14 (III) The beneficiary of an Inherited IRA can withdraw all of the funds at any time and for any purpose without a penalty, while an IRA owner must generally wait until age 59 1/2 to take penalty-free distributions. (IV) Had they resided in certain states, for example, Florida, a specific state statutory exemption would protect the Inherited IRA. In Florida, Fla. Stat (2)(c) provides as follows: (c) Any money or other assets or any interest in any fund or account that is exempt from claims of creditors of the owner, beneficiary, or participant under paragraph (a) does not cease to be exempt after the owner s death by reason of a direct transfer or eligible rollover that is excluded from gross income under the Internal Revenue Code of 1986, including, but not limited to, a direct transfer or eligible rollover to an inherited individual retirement account as defined in s. 408(d)(3) of the Internal Revenue Code of 1986, as amended. This paragraph is intended to clarify existing law, is remedial in nature, and shall have retroactive application to all inherited individual retirement accounts without regard to the date an account was created. (Emphasis added.) (iii) If Massachusetts applies the logic from the Clark case, then Ron can attach $2,250,000 of Leslie s Inherited IRA to satisfy the balance of the judgment. (iv) Query whether, when using an Inherited IRA to satisfy a judgment, should income taxes be taken into consideration? If the judgment is for personal injury or sickness, which are excludable under 104(a)(2), perhaps Ron should receive an additional portion of Leslie s Inherited IRA so that he is not penalized for having to pay income taxes on the portion of the Inherited IRA that he received. (b) Does Windsor s Retroactivity Change This Result? Until guidance is issued by the Service, the answer is unclear. The following is a logical, step-by-step what if analysis that suggests a course of action for such guidance. (i) As stated above, due to the void ab initio concept of unconstitutionality, 3 of DOMA is deemed never to have existed. (ii) Had Leslie actually been recognized as April s spouse back in 2007, the IRA would have been a spousal rollover IRA as to Leslie, which would have been an exempt asset under Massachusetts law. 22 (iii) Since 3 of DOMA is deemed never to have existed, then Leslie, who is now recognized as April s spouse, is retroactively recognized as her spouse in Therefore, Leslie has an strong argument that she should be able to reclassify the IRA as a spousal rollover IRA and therefore protected from her creditors. (iv) What about the RMD s? 22 MASS. GEN. L. CH A. 11

15 (A) If the Inherited IRA were instead a spousal rollover IRA, Leslie would not be required to take any distributions until she attained age 70 1/2. Because, as previously stated, unconstitutionality can be considered to be a form of mistake of law, the RMD s that Leslie received can be considered to have been paid as a mistake of law. (B) This would lead to two possible avenues of recourse, both of which should allow such RMD s to have exempt status as an extension of the IRA: (I) Leslie should be able to recontribute any or all of her RMD s that she received back into the IRA without penalty. The theory is that if such payments were made under a mistake of law, then they should never have left the account so she should be able to make the account whole as best she can. (II) The account holding the RMD s, if segregated in a separate account, plus any earnings thereon, should be able to be reclassified retroactively as an IRA. (C) What if the RMD s are commingled with other funds? (I) Through the annual cost of living, it would appear possible to determine what portion of the account or accounts holding the RMD s represents the RMD s, plus interest. (II) Leslie should be given a fixed period of time in which to either segregate such assets into a separate account or move them back into the IRA. (III) If distributions were made, perhaps the Service could adopt a method under which the RMD s or growth thereon would either be treated as the First Out or Last Out : First Out would be more beneficial to the Service, whereas Last Out is more beneficial to Leslie. (D) Should pre-windsor and post-windsor distributions matter? Probably not mainly because Leslie must withdraw her RMD s in accordance with applicable federal law, so the 2013 and 2014 RMD s should be treated the same way as the pre- Windsor RMD s. (v) Wait isn t this like the tax refund argument from earlier? Doesn t the statute of limitations bar any argument? NO! (A) Under the McKeeson analysis, when a tax statute was held to be unconstitutional, the Supreme Court held that the situation must be remedied and that the governing body (there, the particular state) was required to provide a post-deprivation remedy. 23 (B) In the analysis that followed, it was concluded that as to tax refunds, the statute of limitations would trump an unconstitutionality unless an exception could 23 See Section A(3)(d), above. 12

16 be found to the post-deprivation remedy of a protective claim for refund (which, as stated earlier, is a remoteness test). 24 (C) However, applying this analysis to the IRA issue, the Code does not contain any type of post-deprivation remedy, so it would appear that the unconstitutionality would trump the statute of limitations. C. What If State Law DOMA is Rendered Unconstitutional 25 (1) Introduction. (a) Given the volume upon which cases are proceeding through the Federal court system, it would appear that a case involving state law DOMA issues ( State Law DOMA ) could reach the Supreme Court during the Term. (b) On October 6, 2014, the Supreme Court denied certiorari to four cases: (i) From the 10 th Circuit Court of Appeals, Kitchen et. al. v. Herbert et. al. - No , --- S.Ct. ---, 2014 WL (U.S.), 83 USLW 3102 (October 6, 2014) (Utah). (ii) From the 4 th Circuit Court of Appeals, Bostic et. al. v. Rainey et. al. - No , --- S.Ct. ----, 2014 WL (U.S.), 83 USLW 3102 (Virginia). (iii) From the 7 th Circuit Court of Appeals (A) Indiana - Baskin et. al. v. Bogan et. al. - No , --- S.Ct. ----, 2014 WL (U.S.), 83 USLW 3127 (B) Wisconsin - Wolf. et. al. v. Walker et. al. - No , --- S.Ct. ----, 2014 WL (U.S.), 83 USLW 3127 (c) The effect of the certiorari denial is that the decision of the applicable Circuit Court of Appeals became the law within the particular Circuit, meaning that same-sex marriage became legal in states such as Virginia, North Carolina, South Carolina, West Virginia and Missouri. The belief was that the Supreme Court did not accept certiorari because there had been near uniformity among the lower courts as to State Law DOMA s unconstitutionality and that Supreme Court intervention would only be required if and when a split developed in the Circuits. (d) And then the split occurs on November 6, 2014, a decision was issued by the 6 th Circuit Court of Appeals overturning district court decisions from Michigan, Ohio, 24 See Section A(3)(h)(ii), above. 25 This section is based on the three-part series by George D. Karibjanian, State Law DOMA: What if Unconstitutionality Becomes a Reality? Part I, LISI ESTATE PLANNING NEWSLETTER #2205 (March 20, 2014); Part II, LISI ESTATE PLANNING NEWSLETTER #2219 (March 26, 2014); and Part III, LISI ESTATE PLANNING NEWSLETTER #2205 (April 29, 2014). 13

17 Kentucky and Tennessee, each of which had held that the particular State Law DOMA provisions were unconstitutional: (i) Michigan - DeBoer et al. v. Snyder et al., 6 th Cir., Case No (November 6, 2014). (ii) Ohio (November 6, 2014). (November 6, 2014). (A) Obergefell et. al. v. Hodges, 6 th Cir., Case No (B) Henry et. al. v. Hodges, 6 th Cir., Case No (iii) Kentucky (November 6, 2014). (November 6, 2014). (A) Bourke et. al. v. Beshear, 6 th Cir., Case No (B) Love et. al. v. Beshear, 6 th Cir., Case No (iv) Tennessee - Tanco et. al. v. Haslam et. al., 6 th Cir., Case No (November 6, 2014). (e) Certiorari may be granted to such decisions sometime in January 2015 with a decision due in June (f) However, The question then becomes what next? What happens to state particular rights that had been denied to same-sex married couples living in those states where same-sex marriage is not recognized (each a Non-Recognition State )? (2) What s Good for the Goose is Good for the Gander Void Ab Initio (a) As stated above, when a statute is declared to be "unconstitutional," the general rule is that the statute, though having the form and name of law, is in reality no law but is wholly void and ineffective for any purpose; further, since unconstitutionality dates from the time of its enactment and not merely from the date of the decision so branding it, an unconstitutional law, in legal contemplation, is as inoperative as if it had never been passed and never existed so as to be void ab initio. 26 (b) The same rule that applies to Federal statutes would also apply to state law statutes and provisions, meaning that upon a determination of unconstitutionality, such state provisions must be interpreted as if they never existed (3) Examples of Potential Problems. 26 See Footnote 4. 14

18 (a) Tenancy-by-the-Entirety (i) Recall that if property is owned as tenancy-by-the-entirety, a spouse s creditors cannot attach a lien against the property unless the creditor is a creditor of both spouses. (ii) Under Florida law, property acquired jointly by the spouses is presumed to be held as tenants-by-the-entirety. 27 (iii) Example Mac and Dennis are married in New York in In October 2013, they move to Florida and purchase a residence in Boca Raton for $6,000,000 in their joint names (the Boca Residence ). Even though Mac contributes all of the proceeds, courtesy of the Windsor opinion, Mac s titling of the Boca Residence in his and Dennis s names qualifies for the Federal gift tax unlimited marital deduction. If Mac and Dennis were an opposite sex married couple, pursuant to Florida law, title to the Boca Residence would have been presumed to be held as tenants-bythe-entireties; however, because they are an same-sex married couple and because Florida is a Non-Recognition State, if they wish for survivorship (and they do), they are required to take title as joint tenants with right of survivorship. In January 2014, a prior joint venture in which Mac partnered with Charlie goes bad; Charlie thereafter sues Mac and is victorious. The verdict in Charlie s favor is reduced to a judgment. Because the Boca Residence is not owned as tenants-by-the-entirety, Charlie is permitted to attach the judgment against the Boca Residence, thus forcing a severance of the property and eventual liquidation. Mac dies in January In June 2015, State Law DOMA is determined to be unconstitutional. What effect does such unconstitutionality have on the Boca Residence? (A) Courtesy of the void ab initio theory, Florida s DOMA laws are deemed to have never existed. (B) If they never existed, then the titling of the Boca Residence by Mac and Dennis should have been deemed to have been held as tenants-by-the-entirety. (C) If the property is held as tenants-by-the-entirety, then Charlie s judgment could not have been attached to the Boca Residence. (D) If Charlie s judgment would not have been attached to the Boca Residence, then the property would not have been sold and would have remained held by 27 FLA. STAT

19 Mac and Dennis at the time of Mac s death, which, upon Mac s death, would then have passed title to the Boca Residence outright to Dennis. (E) Query: as a result, can Dennis commence an action against Charlie to recover the value of his interest? After all, if State Law DOMA is deemed never to have existed, Charlie s lien against the Boca Residence was improper and deprived Dennis of his entitlement to the property. (F) What about the statute of limitations? Is this a bar to the action? Maybe or, maybe not. The same analysis in Part IV, Section A(3) of this Outline regarding opening the statute of limitations with respect to Federal tax refunds would seemingly apply to the opening of any statute of limitations. (iv) Variation on Example 28 Mac and Dennis are married in New York in In October 2013, they move to Florida and purchase large tract of undeveloped land in Boca Raton for $20,000,000 in their joint names (the Boca Property ). Mac and Dennis hope to one day construct a large house on the Boca Property. Even though Mac contributes all of the proceeds, courtesy of the Windsor opinion, Mac s titling of the Boca Property in his and Dennis s names qualifies for the Federal gift tax unlimited marital deduction. As in Example 8, Mac and Dennis cannot take title as tenants-by-the-entireties, so they list married on the deed and insert, in the event tenants-by-the-entireties is not recognized, that they wish for property to be held as joint tenants with right of survivorship. In October 2014, Mac and Dennis separate, but job constraints keep both in Florida so they are unable to be divorced. Mac is later approached by Liam McPoyle, a developer who wishes to purchase Mac s undivided one-half interest in the Boca Property. McPoyle believes that the property can be subdivided for a huge profit, so he is purchasing Mac s interest, hoping subsequently to force Dennis to sell. Mac agrees to sell his interest for $15,000,000. In June 2015, State Law DOMA is determined to be unconstitutional. What effect does such unconstitutionality have on the Boca Residence? (A) Because title is not held as tenants-by-the-entireties, property is severable by either party (recall that with property owned as tenants-by-the-entirety, unilateral severance cannot occur), so Mac is free to convey his undivided one-half interest. (B) However, once unconstitutionality occurs, Mac and Dennis are deemed to be married and therefore property is owned as tenants-by-the-entireties, for which Mac s conveyance would require a joinder by Dennis in order to convey legal title. 28 The author greatly acknowledges the work of Jeffrey Dollinger of Gainesville, Florida and the University of Florida Levin College of Law, as this is his example and he has consented to allow the author to use it as part of these materials. 16

20 (C) As a result, the deed out from Mac is void; legal title is still owned by Mac and Dennis as tenants-by-the-entireties, and McPoyle probably has a recovery action against Mac for the $15,000,000. (D) for Mac s conveyance of void title. Query whether any damages or interest are due McPoyle (v) Planning Option: to potentially preserve any rights associated with tenancy-by-the-entireties, the spouses may wish to specifically state in the deed that they are married to each other; this will help buttress the argument upon unconstitutionality that title was always held as tenants-by-the-entirety. (b) Homestead (i) In many states, homestead rights are granted to a surviving spouse, and some states, such as Florida, restrict the ability to devise the homestead depending on whether the spouse and minor children survive the decedent. (ii) For example, in Florida, if a decedent is survived by a spouse and minor child, no devise of the homestead is permitted; rather, the surviving spouse receives a life estate and the children receive a vested remainder interest. If all of the children are adults, the only permissible devise is a fee simple interest to the spouse. (iii) Example Mac and Dennis are married in New York in At the time of the wedding, Mac has two minor children, Frank and Deandra, that he previously adopted. In October 2012, they move to Florida and Mac purchases a residence in Boca Raton for $6,000,000, taking title in his sole name (the Boca Residence ). Mac dies in February 2013 without changing his Will, and nor did he have any form of nuptial agreement with Dennis. At the time of Mac s death, the Boca Residence is valued at $6,500,000, and Dennis is 50 years old. In July 2014, when the 7520 Rate is 2.2% and Dennis is 51 years old, the Boca Residence is sold for $7,000,000. In June 2015, State Law DOMA is determined to be unconstitutional. (A) Based on these facts, upon Mac s death in 2014, under applicable Florida law, Mac is survived by only minor children Dennis is not recognized as his spouse. Thus, pursuant to Florida homestead laws, Frank and Deandra each receive a 50% fee simple interest in the Boca Residence and Dennis receives nothing. (B) As a result of DOMA s unconstitutionality, Mac and Dennis should have been deemed to have been spouses in Florida from the moment that they moved to Florida. 17

21 (C) As a surviving spouse, Dennis should have had homestead rights at the time of Mac s death in the form of a life estate. (D) Does Dennis have a right of recovery against Frank and Deandra? At the time of the sale of the property in July 2014, Frank and Deandra split $7,000,000; at this time, Dennis s life estate comprised a % share of the property. Therefore, Dennis should have been entitled to $3,159,030 of the $7,000,000 proceeds. (iv) Variation on Example: Suppose that Frank and Deandra were adults at the time of Mac s death and that Mac had revised his will to provide for an outright devise of the Boca Residence to my spouse without naming Dennis, with the remainder of his estate divided equally between Frank and Deandra. (A) At the time of Mac s death, Dennis would not have been deemed to have been Mac s spouse so therefore, the devise would have failed because there was no spouse under Florida law; therefore, the property passed equally to Frank and Deandra. (B) However, as a result of State Law DOMA s unconstitutionality, the devise should have been effective because Dennis was Mac s spouse; therefore, query whether Dennis has a claim against Frank and Deandra for the entire proceeds from the sale of the Boca Residence. (c) Elective Share Pretermitted Spouse (i) All states provide a spouse with a forced or marital or elective share intended to preclude a decedent from disinheriting a spouse. (ii) Most states range from 30% to 33 1/3%. (iii) Example Mac and Dennis are married in New York and subsequently move to Florida in Mac has two children, Frank and Deandra, that he adopted prior to his marriage to Dennis. No nuptial agreement exists. Mac s total estate is $10,000,000, comprised of property either in his outright name or in the name of his Revocable Trust and which would comprise the Florida elective estate pursuant to Fla. Stat (i.e., no homestead property). Pursuant to Fla. Stat , if Dennis survives Mac and they were considered to be married, the amount of the elective share payable to Dennis would be 30% of $10,000,000, or $3,000,000. In 2012, Mac executes an amendment and restatement to his Revocable Trust leaving Dennis a total of $1,000,000 while leaving the balance of his estate in equal shares to Frank and Deandra. 18