In a Tax Court filing from last week (Estate of Elwood H. Olsen, TC Memo 2014-58), we find how much tax can be owed if taxpayers do not administer trusts correctly. In the case, Mr. Olsen passed away in 2008 at the age of 92. In 1994, Mr. Olsen and his wife Grace each formed revocable living trusts (a very common estate planning tool). Each of these trusts had essentially identical terms and upon death, the trusts would be split into (1) a so-called marital trust that in turn would be divided into two separate and distinct trusts known as Marital Trust A and Marital Trust B and (2) a Family Trust.
On December 8, 1998, Mrs. Olsen passed. The final estate settlement allocated (1) $1 million to Marital Trust A, ; (2) $504,695 to Marital Trust B; and (3) $600,000 to the Family Trust. At that time, the maximum lifetime exclusion was $600,000 so that is why the family trust was allocated that amount. Also, the executor made a "QTIP" election on the two marital trusts. This election allowed the estate to reduce the estate value so that no tax would be due on Mrs. Olsen's death. However, upon Mr. Olsen's death, the trust assets would then be included in his estate.
As can sometimes happens with these facts and circumstances, Mr. Olsen did not create three separate trusts after the settlement of the estate. Rather, he simply kept all of the assets in one trust and throughout his life, made substantial charitable gifts and other transfers.
Upon his death, his personal representative elected not to include any of the trust assets in his estate return. The IRS audited the estate and assessed additional tax based upon their calculation of the value of Marital Trust A and B that should have been included. The IRS determined this value at $1,071,224 resulting in a deficiency of $482,051.
The Tax Court finally ruled that only $607,927.51of the Marital Trusts would be included, however, this still increased the tax by about $250,000 plus the estate probably spent another $100,000 or more on legal fees.
As advisors, we find too many other cases like this where clients have trusts and do not totally understand the mechanics involved in properly administering the terms and provisions of the trust. Since Mr. Olsen made several substantial charitable gifts during his life; the proper set up of the trusts and using the Marital Trusts to funds these gifts would most likely have reduced his estate and not caused an audit and court proceedings. This is a case where using a qualified trustee to handle the trusts along with Mr. Olsen would have been prudent.