January 7, 2015
Authored by: Luke Lantta
Accomplishing a settlor’s tax objectives can be a major factor in creating a trust. When a drafting error frustrates the settlor’s tax objectives, why shouldn’t the trust instrument be reformed to reflect the intent of the settlor? In O’Connell v. Houser, the Supreme Judicial Court of Massachusetts did just that – permitted reformation of a trust to embody the settlor’s intent and produce tax results that were consistent with the settlor’s objectives.
The George Houser Trust established two trusts for the benefit of George’s wife, Mary, and gave her a power of appointment over the marital trust. When Mary died in 1993, the remaining principal in the George Houser Trust was divided into two “share trusts,” one for each of the Housers’ sons. Each son had a limited testamentary power of appointment for any property remaining in his respective share upon his death “to such one or more of the Donor’s issue” or to trusts for their benefit. The George Houser Trust contained the following termination provision that provided that each share trust:
shall terminate whenever after the death of said child of the Donor [George] no issue of said child is living, or upon the expiration of twenty-one (21) years after the death of the last survivor of the Donor, the Donor’s wife MARY and all of the Donor’s issue by blood living at the Donor’s death, which ever shall first occur.
After George’s death and enactment of the GST tax, Mary established the Mary Houser Trust and exercised her power of appointment over the marital trust by appointing it to the trustees of the Mary Houser Trust. Mary directed that, upon her death, an amount equal to her GST exemption be held in a family trust created under Article Four of her trust. According to its terms, the family trust shall terminate:
(i) whenever after the death of the Donor [Mary] no issue of the Donor is living or (ii) upon expiration of twenty-one (21) years after the death of all of the Donor’s issue living on the date of the Donor’s death, whichever event shall first occur.
And therein lies the problem. One of the Housers’ children, Horace, died without having any children and exercised his power of appointment over his GST-exempt share by directing that the property be added to the GST-exempt family trust. The GST-exempt status of the property held in Horace’s grandfathered share trust may be lost if a power of appointment is exercised in a manner that may postpone or suspend the vesting, absolute ownership or power of alienation of an interest in property for a period, measured from the date of the creation of the trust, extending beyond any life in being at the date of the creation of the trust plus a period of 21 years.
Recall that the date of termination of the George Houser Trust was based upon death of the Donor’s issue by blood while the date of termination of the family trust was based merely upon the death of all of the Donor’s issue. Thus, the family trust could include the lives of adopted persons thereby potentially extending its termination date beyond the termination date of the George Houser Trust. The family trust needed to be reformed to make the measuring lives those of Mary’s blood issue. This was a perfectly appropriate modification of the family trust. Omission of the words “by blood” decoupled Mary’s estate plan from her husband’s and frustrated their planning objectives. Thus, the reformation was permitted.