Ruby executed a document characterized as a renunciation or as a disclaimer over the revocation power on March 21, 1969, to prevent the nonmarital half of George's trust from being included in her taxable estate. Ruby incurred California inheritance taxes as the owner of the nonmarital half of George's trust on his death, and incurred federal gift tax and California gift tax as a result of half of the trust and the life estate. Ruby's family members, including Barbara Bucquet and others, filed the complaint against Livingston on August 10, 1970.
Livingston contended that the trust carried out George's intent, as the nonmarital half of the trust eventually passed to beneficiaries free and clear of federal estate tax and California inheritance tax. Further, the gift tax and the inheritance tax and the attorney fees were imposed on Ruby. These charges were not chargeable to or paid out of the assets of the trust.
In Bucquet v. Livingston, 57 Cal. App. 914, 129 Cal.Rptr. 514 (1976), the California court did not accept Livingston's contention as to George's intent. The nonmarital half of the trust passed to the beneficiaries free and clear, but the steps that Ruby had taken reduced the corpus of the trust. Ruby's power of revocation remaining after George's death would have subjected the nonmarital half of the trust to both federal estate tax and inheritance taxes if Ruby had not taken the remedial steps of renouncing her general power of appointment and assigning her life estate. The beneficiaries argued that these remedial actions reduced the value of the trust.
The California court took judicial notice of Livingston's "outstanding reputation for integrity and competence during the long career of the sole practitioner (now retired)" and that the complaint alleges no conduct to which any moral blame can be attached. The court went to great length to hold that the potential tax problem of general powers of appointment in inter vivos or testamentary marital deduction trusts were within the ambit of a reasonably competent and diligent practitioner from 1961 to the present, and therefore held for Bucquet. "[U]nless the beneficiaries can recover against the attorney, no one could do so and the social policy of preventing harm would be frustrated."
2. Levin v. Berley. Irving M. Levin hired attorney David R. Berley to prepare the will of Levin's wife, Evelyn, in 1972. Levin instructed Berley to take full advantage of the marital deduction in drafting this will. Evelyn had a New York stock account that was subject to a trust rather than having the stock pass outright to Irving. Evelyn died in 1975 and Irving became the executor. Irving filed the federal estate tax return on October 4, 1976, claiming the marital deduction.
The IRS contacted Levin in 1978 questioning the amount of the marital deduction. The IRS disallowed the marital deduction on Evelyn Levin's New York stock account pursuant to section 2056(b) and the IRS sent Levin a notice of its $60,000 estate tax deficiency on March 9, 1979. The Tax Court decided this issue in favor of the IRS on April 9, 1981, and this court affirmed the decision.
Levin brought suit against Berley on October 12, 1982, suing both in his individual capacity and as executor of his wife's will. Levin asserted malpractice and alleged Berley's violation of the Massachusetts Unfair Trade Practices Act. In Levin v. Berley, 728 F.2d. 551 (1st Cir. 1984), the Court of Appeals ruled against Berley, holding that while Levin was not a purchaser of services within the scope of this provision, Evelyn Levin was a purchaser of services under the Massachusetts Unfair Trade Practices Act. Levin's claim as executor of Evelyn's estate "clearly had standing" and this case was allowed to proceed.
B. Claiming the alternative valuation date
Property in an estate can be valued at date of death, but section 2032 permits the estate to use an alternative valuation date. This alternative valuation date is one year from the date of death unless the property is distributed within one year from the date of death. In that event, the alternative valuation date is the date that property is distributed. Smith v. St. Paul Fire & Marine Insurance Company, 344 F.Supp. 555, (M.D.La. 1972), reversed and remanded 471 F.2d. 840, 366 F.Supp.1283 (M.D.La. 1973), addresses this distribution process. The alternative valuation date is available only if the federal estate tax is filed in a timely manner. In re Estate of Lohm, 440 Pa. 268, 269 A.2d 451 (Pa. 1970) addresses the malpractice issues arising from the filing delay.
1. Smith v. St. Paul Fire and Marine Insurance Company. Rose Chaplin Heyer, a citizen of Louisiana, died on April 21, 1969, leaving two children, Edgar Smith and Hugh Smith of Arkansas. The Smiths employed attorney Dalton Barranger to handle their mother's estate, which included a home valued at $132,000 and stocks valued at date of death at $233,245.69. The Smiths sought to dispose of their mother's home, and a question arose as to whether the section 2032 alternative valuation date could apply, or whether this transaction would be treated as a distribution. The use of the alternative valuation date became important because the 1969 stock market was in a "state of decline."
The court carefully examined and interpreted the applicable Treasury regulations, noting the possibility of ambiguity. The IRS had changed its position as to whether a distribution of property would affect the use of the alternative distribution date. There was no judicial decision on point at the time the Smiths distributed their mother's property, but shortly thereafter Stoutz v. United States, 324 F.Supp. 197 (E.D.La 1970), had been filed, concluding that a distribution of property in Louisiana would terminate the one year valuation date. The Smith court determined that Barranger could not be blamed.
2. In re Estate of Lohm. Robert P. Lohm died testate on April 25, 1965. Ralph S. Kunst Jr., Lohm's nephew and the beneficiary of approximately 51 percent of the estate, was appointed co-executor. Attorney E.T. Adair also was appointed co-executor. Adair had been practicing law since 1911, but had very little experience in the administration of estates and no experience whatever with federal estate problems. Kunst was essentially a novice as to estates and taxation. The two co-executors retained attorney Alexander Rosenbaum, who was experienced in estate tax matters, to serve as an additional advisor for the estate. It appears that Adair and Rosenbaum were not beneficiaries of Lohm's estate and that the nonexecutor beneficiaries were entitled to 49 percent of Lohm's estate.
The Lohm estate sought to utilize the alternative valuation date in valuing securities for estate tax purposes. The value of the estate was $1 million. Securities constituted the bulk of the estate. The alternative valuation date is available only if the federal estate tax return is filed in a timely manner. The federal estate tax return was due 15 months from Lohm's death on April 25, 1965, i.e., on July 25, 1966, but Rosenbaum did not file the federal estate tax return until November 15, 1966, a four-month delay.
Lohm's estate was forced to use the nonalternative valuation date as a result of this filing delay. The delay presumably caused a higher estate tax valuation, increased basis for income tax purposes, and caused income tax losses that presumably could not be taken into account. Executor's fees are based on the value of the estate, and the higher value of the estate might conceivably have increased the fees that the executors would receive.
The estate's loss of the alternative valuation date did not lead to a malpractice action, but it did lead to a challenge to attorney fees and commissions before the probate court. Adair and Kunst filed their final account with the probate court on March 1, 1967, listing an attorney fee of $22,285.45 to Rosenbaum to be shared 60-40 by Adair and Rosenbaum. The executors claimed commissions of $21,838.78 each, or $43,677.56 in total. No counsel fee had been paid to Rosenbaum, and he requested $23,500 as payment for his services as co-counsel for the estate. Rosebaum's counsel fee claim came before the probate court.
The probate court determined that Adair, Kunst, and Rosenbaum were equally at fault for the loss of the alternative valuation date for the estate. The probate court determined that their negligence had cost the estate $35,821.56 plus interest, in additional to federal taxes, and Pennsylvania taxes. The probate court determined that the normal minimum executor fee for this estate would have been $30,000, but in view of the circumstances, the probate court awarded Adair and Kunst $15,000 jointly. The probate court determined the minimum attorney fee for an estate such as this would be approximately $23,500, but awarded a fee of $5,000 to Rosenbaum and directed that no portion would be paid to Adair.
The Pennsylvania Supreme Court addressed the standard of care applicable to persons at various skill levels in the context of Adair, Kunst, and Rosenbaum. This approach to the standard of care appears to be generally relevant in evaluating assertions made by professionals as to their expertise. Here, in the context of co-executors and their attorneys, the focus was the fiduciary relationship.
The Pennsylvania Supreme Court explained that the fiduciary's standard of care must be judged according to the standard of a person with special skill. It is reasonable to require Adair, as an attorney, to comply with a higher standard of care than Kunst. It is reasonable to require Adair to comply with a lower standard of care than Rosenbaum, as Rosenbaum had a great deal of experience with the types of tax problems that arose in this estate.
Pennsylvania courts can surcharge amounts to the fiduciary when the fiduciary negligently causes a loss to the estate. The courts can impose the surcharge by awarding an executor fee that is less than the customary minimum or by awarding the attorney fee that is less than the customary minimum. Adair and Kunst claimed that they had no knowledge of estate tax regulations, and relied on Rosenbaum. Here the court determined that Adair, Kunst, and Rosenbaum were equally and jointly at fault.
The Pennsylvania Supreme Court determined that Adair and Kunst, acting in their fiduciary capacity, were "guilty of supine negligence" that contributed to the tax loss suffered by Lohm's estate. The court expected the executors to ascertain when the federal estate tax was due, even if the executors might not have had the technical knowledge or skill to prepare the federal estate tax return. The court concluded that the executors failed to meet this standard of care. "We have difficulty in comprehending how, in this conscious age, an executor of an estate can with impunity be or remain ignorant of the time of filing tax returns or paying the taxes in the estate he is managing." The court continued that a missing tax return date "is not an error of law or of judgment for which the entire blame can be shifted to the expert."
As to Rosenbaum and Adair, the court concluded that "We don't find how distinction can be made, or should be attempted, between the lawyer who was negligent and the lawyer who was ignorant." The estate should be made whole before counsel fees are allowed to either lawyer. Adair and Rosenbaum received no counsel fees.
C. Property valuation
The Appellate Court of Illinois decided three estate tax malpractice decisions addressing the same estate tax issue--the failure to elect under the section 2032(a) "less than market value" farming valuation provisions. The first case took place in the Fifth District and the remaining two cases in the Fourth District, all between 1989 and 1993.
1. Gable v. Reznick. Charles A. Gable's principal asset was four parcels of property used for farming. Gable died on December 16, 1978, leaving his entire estate to his two children, James Gable and Charleen Meador, who became co-executors. Gable's children retained attorney John Reznick to provide legal services. Reznick failed to timely file Gable's federal estate tax return, causing the estate to lose section 2032A special use valuation. Reznick admitted his liability but disputed the magnitude of damages.
Gable and Meador, in their capacity as co-executors of the Charles A. Gable estate, filed suit on August 31, 1983. Reznick counterclaimed by filing a third-party complaint against Gable and Meador individually on October 3, 1985. Reznick asserted that the special valuation would be less if the heirs alter the use of the property. The Appellate Court affirmed the trial court's dismissal of Reznick's claim in Gable v. Reznick, 183 Ill.App.3d 171, 131 Ill.Dec. 769, 538 N.E.2d 1325 (Ill. 1989).The court held that Reznick's negligence caused the loss of the valuation adjustment, and that he was not entitled to benefit from his failure.
2. Rutkowski v. Hollis. The Rutkowskis owned farmland in Illinois through a closely-held corporation, Rutkowski Brothers, Inc. Alexander Rutkowski died, leaving his brother, Charles Rutkowski, as executor and a beneficiary of the estate. Charles Rutkowski sought the services of an attorney, Richard A. Hollis, in conjunction with Alexander Rutkowski's estate. Charles Rutkowski then died, and his wife, Mary Rutkowski, became Charles Rutkowski's executrix.
Mary Rutkowski contends that Hollis provided her late husband Charles with deficient tax advice regarding his role as executor of the estate his brother, Alexander, as to the special-use valuation provisions under federal law and Illinois law. Mary Rutkowski contends that Hollis negligently and carelessly failed to make this election, the negligence resulted in the estate paying excessive estate taxes in the amount of $250,000, and the excessive estate taxes reduced Charles's share of the estate proceeds.
Hollis defeated Rutkowski's claim by relying on the privity doctrine. Estate tax issues ultimately were not determinative. Hollis sought to dismiss Mary Rutkowski's complaint, asserting that her complaint failed to set forth facts establishing a duty that Hollis owed to Charles and that alternatively the claim did not establish a breach of that duty. The trial court granted this dismissal. The Appellate Court of Illinois affirmed with one dissent in Rutkowski v. Hollis, 235 Ill.App.3d 744, 175 Ill.Dec. 826, 600 N.E.2d 1284 (Ill. 1992).
A principal issue of the case concerned whether the claim was to be grounded in tort or by contract. The defendant argued that the claim was based on negligence and that Mary Rutkowski was seeking economic damages only. Mary Rutkowski asserted that she sought damages for "an intended beneficiary of the contract between Charles and Hollis" and argued that these actions are permitted where there was "an extra- contractional duty" to the persons whom the client intended to benefit from the agreement between the parties.
Mary Rutkowski's pleading adequately alleged that Hollis breached his duty to Charles, as executor of Alexander's estate, by failing to advise Charles about the estate taxes. This allegation, however, did not address a duty owed to Charles as a third-party beneficiary of the estate. Mary Rutkowski contended that she sought compensation for damages suffered by Charles in his capacity as a third-party beneficiary of the contract between Hollis and himself.
A client can maintain an action against an attorney based in negligence although no privity exists between the person and the attorney. The court held that an attorney retained by an executor owes no duty to the interests of the beneficiaries, and that Hollis's primary duty was to Charles as executor and not to Charles as beneficiary of Alexander's will. The complaint did not allege that Hollis owed Charles, as a third-party beneficiary, a duty that had been breached, and the breach of contract claim failed. The dissent pointed out that Hollis breached his duty by failing to make an election under section 2032(a) and a result of Hollis's negligence Charles Rutkowski suffered damage for the reason that his share, as beneficiary of the estate, was reduced.
3. Wilson v. Cherry. Clarence and Louella Adams died, and their daughter Dorothy A. Wilson became the executrix under their wills. Each owned an undivided half interest in a 1,193-acre farm in Illinois. Wilson hired attorney David A. Cherry to represent the executor in these estates. Cherry prepared and filed both federal and Illinois tax returns and Illinois inheritance tax returns, and the farm property was appraised at fair market value.
Wilson brought suit against Cherry, alleging that Cherry committed malpractice in failing to make a section 2032A election that would have resulted in less than market valuation for the estates. This valuation would have lowered valuation of farmland for federal estate purposes and for purposes of the Illinois inheritance tax returns. Cherry admitted his malpractice, and agreed to pay the two estates a total sum of $300,000 as reimbursement for the additional death taxes the two estates were required to pay because of the failure to use that option. Three issues remained between Wilson and Cherry and were before the courts:
1. whether the estates were entitled to damages for prejudgment interest, the loss of the use of the extra tax money;
2. whether the estates were entitled to damages for attorney fees incurred because of Cherry's error; and
3. whether the estates were entitled to damages for losses from a forced sale of the real estate in the estates required to pay taxes.
The trial court denied Wilson's claim for prejudgment interest, and the Appellate Court of Illinois affirmed, in Wilson v. Cherry, 244 Ill.App.3d 632, 184 Ill.Dec. 77, 612 N.E.2d 953 (Ill.1993). The appellate court denied the forced sale claim and did not address the issue of attorney fees.
D. Life insurance trusts
1. Stevenson v. Severs. Ms. Ferdinan B. Stevenson sought to benefit her four children on her death and retained a lawyer, Charles A. Severs III, and an insurance agent, Sam Radin of National Madison Group, Inc. Stevenson purchased two life insurance policies in 1986, each for half a million dollars. Severs set up a life insurance trust in 1986 to protect the insurance benefits for Stevenson's children.
Severs advised Stevenson that a life insurance trust should own the life insurance policy and that the life insurance trust should be the beneficiary of the two life insurance policies. Severs recommended against the estate being the owner and beneficiary of the life insurance. Inclusion of the life insurance policies in the estate would potentially increase the estate tax liability on the $1 million insurance proceeds.
Stevenson changed lawyers, and nine years later in 1995 Stevenson's new lawyer noticed that the life insurance policies listed Stevenson's estate, not the life insurance trust, as being the owner and beneficiary. The new lawyer directed the insurance agent to transfer the policies to the life insurance trust. At that point, the life insurance policies had become valuable and Stevenson paid $61,451 in gift taxes to transfer the policies to the life insurance trust.
Stevenson then brought suit against Severs, Radin, and National Madison Group, Inc. Stevenson was seeking three types of recovery:
1. reimbursement for the $61,451 gift tax amount;
2. $550,000 in potential future estate tax liability, computed by multiplying the $1 million life insurance policy by the 55 percent tax rate that her estate would incur under section 2035(a) if she died within three years after the transfer of the life insurance policies to the trust; and
3. $25,000 in remedial damages to the lawyer who discovered the problem.
The district court granted summary judgment to Severs, Radin, and National Madison Group, Inc. The district court found that Stevenson had already used the $10,000 per year gift exemption, and the $61,451 gift tax would be due in any event. Stevenson would have had to pay $170,901, comprising gift taxes on $161,156 in premium payments paid from 1990 to 1994 plus $9,645 for gifts given from 1986 to 1988 above and beyond her $10,000 per year exemption. The interpolated terminal reserve value of the policies at the date of the gift was $165,260.
The district court found that none of the defendants breached their duty to Stevenson as to advice, as they had no "duty to advise Stevenson on the potential gift tax liabilities of the trust arrangement...." Even if the defendants "had such a duty, they had not breached it." The U.S. Court of Appeals for the District of Columbia affirmed in Stevenson v. Severs, 82 AFTR2d Par. 98-6912 (D.C. Cir. 1998).
Next, the district court held that the $550,000 claim was unripe, and the appellate court affirmed. The transfer of the policies took place on September 29, 1995, so that the estate tax claim would be moot if Stevenson survived beyond September 29, 1998. The appellate court opinion was filed October 27, 1998, making this issue moot if Stevenson survived until that date.
Finally, the district court denied Stevenson's claim for the $25,000 reimbursement to correct the error, viewing the claim as for attorney fees. The appellate court disagreed, concluding that these amounts were costs to correct negligence.
E. Disclaimers
The manner in which an beneficiary can disclaim proceeds that the beneficiary otherwise receives can lead to malpractice claims. A wealthy widow sued her attorney for not informing her of the disclaimer possibilities in Linck v. Barokas & Martin, 666 P.2d 171 (Alaska 1983), A drafting error precluded the application of disclaimer in Estate of Callahan v. Allen, 97 Ohio App.3d 749, 647 N.E. 543 (Ohio 1994), but in Bucquet v. Livingston, 57 Cal.App. 914, 129 Cal.Rptr. 514 (1976), the beneficiary was able to use a disclaimer to diminish the attorney's drafting error.
1. Linck v. Barokas & Martin. A widow received all of her late husband's estate, valued at $3 million, pursuant to his will. Their children received nothing from their father's will, but they would have been beneficiaries in the event that their mother predeceased their father. Alaska law permitted the beneficiary to disclaim or renounce the inherited interest in the estate if the instrument renouncing the present interest is filed within six months of the decedent's death. Section 2818 permitted the use of a disclaimer for tax purposes if the disclaimer takes place within six months of the decedent's death.
Linck's disclaimer, if effective, would have enabled her disclaimed property to have passed directly to her children as if she had predeceased her husband. She would have escaped a second estate tax on her estate, and could have escaped gift tax by giving property to her children during her lifetime.
Barokas & Martin did not advise Linck of her right to disclaim her interest, and she brought suit, seeking $1 million. Barokas & Martin argued that the claim was premature as Linck incurred no actual present damage. The court in Linck v. Barokas & Martin, 666 P.2d 171 (Alaska 1983), reversed the dismissal of the claim, holding that Linck's children are harmed if the claim is proved because of the second estate tax and because of the delay in receiving the proceeds until their mother's death.
2. Bucquet v. Livingston. George and Ruby, husband and wife, engaged attorney David Livingston to prepare a trust for them that would minimize or avoid federal estate taxes and California inheritance taxes that would otherwise be payable on their death, but the trust contained a power of appointment, exacerbating taxability under section 2041. Ruby then sought to remedy the retention of the power of appointment by executing a document on March 21, 1969, characterized as a renunciation or as disclaimer over the revocation power. The document prevented the nonmarital half of George's trust from being included in her taxable estate.
Ruby assigned her life estate in the nonmarital half of the trust on the same date to make certain that none of that none of the property would be included in her taxable estate for federal estate tax purposes or California inheritance tax purposes. Ruby executed the assignment because a substantial period of time had elapsed since his George's death on July 27, 1964, and it was not initially unclear whether the renunciation would be effective as a release. It was subsequently determined that Ruby's renunciation was effective, the nonmarital half was not included in Ruby's estate, and the assets passed to the beneficiaries free and clear in Bucquet v. Livingston, 57 Cal.App. 914, 129 Cal. Rptr. 514 (1976). The court did not analyze section 2518.
3. Estate of Callahan v. Allen. Dennis J. Callahan died intestate on October 25, 1985, leaving his wife, children, and grandchildren. The estate retained attorney Craig A. Allen to handle the probate of the estate, and with Allen's advice, retained Edward Rambacher, a CPA, for the estate's tax matters. Allen and Rambacher determined that the estate could increase the section 2056(a) marital deduction and reduce the federal estate tax liability to zero if the decedent's children disclaimed 60 percent of their inheritance. Mr. Rambacher used a practice manual and filled out the blanks to prepare disclaimers for Callahan's children. The disclaimer directed the disclaimed property to the decedent's spouse.
The IRS determined on May 18, 1989, that the disclaimers expressly violated section 2518(b)(4)(A) by directing property to the decedent's spouse. The IRS then assessed an estate tax of $151,000. The estate retained a new attorney who advised the estate to settle the estate with the IRS by agreeing to pay $116,646.44 in taxes, $49,854.19 in interest, and $322 in penalties. The estate was not entitled to the marital deduction and had to pay Florida estate tax of $11,041.79 and Ohio tax of $1,770.11 plus interest of $643.64.
The estate filed suit against Allen on February 19, 1991. Allen argued that the statute of limitations applied and that estate waived any action against him in settling the dispute with the IRS without appeal. The trial court found that the estate's settlement with the IRS and its malpractice suit were not inconsistent, and the estate was not estopped from bringing the malpractice action. Allen then brought a third-party complaint against Rambacher for contribution and indemnity, but the trial court granted Rambacher's motion for summary judgment. The trial court granted judgment for $200,279.57, essentially the damages incurred by the estate.