Tax Apportionment Issues When Drafting for Blended Families
The following article was published by “ActionLine: A Publication of The Florida Bar Real Property, Probate & Trust Law Section.”
It is ironic that the estate of acclaimed author, Thomas L. Clancy, Jr. (the “Decedent”), would be embroiled in litigation due to the provisions of an “inartfully written will”. The case of Bandy v. Clancy highlights certain tax apportionment issues that should be considered when drafting estate planning documents for blended families.
Decedent was survived by his wife, Alexandra M. Clancy (“Mrs. Clancy”), a minor child of the marriage (“Daughter”), and four adult children from Decedent’s first marriage (“Older Children”).
The Decedent’s Will, which consists of a Last Will and Testament dated June 11, 2007 (the “Original Will”) and two codicils, provides that Decedent’s residuary estate should be divided into three shares as follows: (1) the marital share for the benefit of Mrs. Clancy (“Marital Share”); (2) the non-exempt family share for the benefit of Mrs. Clancy and Daughter (“Family Share”); and (3) the share for the benefit of the Older Children (“Older Children’s Share”).
The Original Will directs that the Marital Share should fund the Marital Trust. Following the funding of the Marital Trust, one-half of the balance of the residuary estate should fund the Family Share passing to the Family Trust, and the remaining one-half should fund the Older Children’s Share passing to trusts for the benefit of the Older Children.
For reasons beyond the scope of this article, the Family Trust, on the terms provided in the Original Will, did not qualify for the federal marital deduction. In a second codicil amending the Original Will (the “Second Codicil”), the terms of the Family Trust were amended to allow the trust to qualify for the marital deduction as qualified terminable interest property under Section 2056(b)(7) of the Code.
Additionally, the Second Codicil amended the Original Will to provide that notwithstanding any provision in the Will to the contrary, neither the personal representative of the Decedent’s estate nor the trustee shall have or exercise any authority, power or discretion over the Marital Share or Family Trust to cause Decedent’s estate to lose the benefit of the marital deduction (“Savings Clause”).
The terms of Decedent’s Original Will provide that all “estate, inheritance, legacy, succession, and transfer taxes (including any interest and any penalties thereon) lawfully payable with respect to all property included in” Decedent’s gross estate or taxable in consequence of Decedent’s death (the “estate tax”) shall be paid out of Decedent’s residuary estate, except that the Marital Share should not be charged with or reduced by any estate tax (“Tax Clause”).
The Second Codicil did not amend the Tax Clause even though the Family Share now qualified for the marital deduction.
Following Decedent’s death, a dispute arose regarding whether the Family Share was liable for any portion of the millions of dollars of federal estate tax charged to the Decedent’s residuary estate. As Decedent’s Will does not specify whether the Family Share should be funded from the Decedent’s residuary estate before or after payment of the federal estate tax and the Tax Clause did not expressly except the Family Share from liability, the Older Children argued that the Family Share should be funded from the residuary estate after payment of the federal estate tax. Conversely, Mrs. Clancy argued that the Family Share should not be reduced by the payment of the federal estate tax because the Decedent intended to maximize the amount of the marital deduction as evidenced by the provisions of the Savings Clause.
To support their position, the Older Children argued that the Tax Clause served as a clear direction against apportionment; therefore, the Maryland apportionment statute was inapplicable in resolving the conflict. Mrs. Clancy did not challenge this position. Accordingly, the construction of the Decedent’s Will was determinative in resolving the issue. Mrs. Clancy filed a petition for the construction of the Decedent’s Will.
As with Florida law, in construing the Decedent’s Will, the Maryland court looked to its “four corners” to discern the Decedent’s intent. In rendering its ruling, the Savings Clause was determined to be a valid “interpretive aid savings clause”. An interpretive aid savings clause is designed to clarify a testator’s intent in the event of an ambiguity.
The court concluded that the Savings Clause controlled over the Tax Clause for the following reasons: (1) by its express terms, the Decedent’s Will states that the Savings Clause would apply despite “[a]nything in [the] Will to the contrary notwithstanding”; and (2) the Savings Clause prohibited the personal representative of Decedent’s estate and the trustee from taking any action or exercising any authority that would reduce the effectiveness of the marital deduction.
Based on its construction of the Savings Clause and its conclusion that Decedent intended to maximize the marital deduction, the court rendered judgment in favor of Mrs. Clancy. As a result of the court’s decision, after payment of the estate tax apportioned against the Older Children’s Share, the trusts for the benefit of the Older Children would be funded with approximately $4 million less than the amount claimed by the Older Children during the litigation.
Although the court issued a judgement against the Older Children, upon closer inspection, the minor Daughter may be the most vulnerable beneficiary. For example, with respect to the Family Share funding the Family Trust, Mrs. Clancy was merely successful in delaying the imposition of the federal estate tax. Upon Mrs. Clancy’s death, the remaining principal of the Family Trust passing to Daughter will be subject to the federal estate tax. Further, Daughter’s remainder interest in the Family Trust is subject to Mrs. Clancy’s power to invade the principal. Therefore, in addition to being reduced by the federal estate tax, Daughter’s interest in the Family Trust would be reduced by principal distributions made to Mrs. Clancy during her life. On the other hand, the Older Children have immediate access to funds bequeathed to their separate trusts.
The litigation arising in Bandy v. Clancy serves as a reminder that tax apportionment provisions play a crucial role in a testator’s estate plan. The tax apportionment provisions must be analyzed and discussed in any instance in which the testator’s estate may be subject to the federal estate tax and the beneficiaries will not equally inherit the property subject to the tax. This instance arises frequently in blended family situations as the testator commonly desires to separate the interest of various family members to ensure that children of a prior marriage immediately benefit upon testator’s death or to avoid family disharmony triggered by the notice and reporting obligations to remainder beneficiaries when the surviving spouse is the lifetime beneficiary.
A poorly drafted tax apportionment provision may expose the drafting attorney to a malpractice claim. In Bandy v. Clancy, in addition to seeking construction of the Decedent’s Will, Mrs. Clancy petitioned the court for the removal of the personal representative for the specific purpose of pursuing a malpractice claim against the drafting attorney. As judgment was rendered in her favor, Mrs. Clancy malpractice claim was rendered moot.
Although the mere practice of law carries exposure to malpractice claims, the drafting attorney should consider taking the following actions to mitigate exposure to such claims when drafting tax apportionment provisions: (1) review all operative documents governing the transfer of property at testator’s death (i.e., the testator’s last will and testament, trusts created by the testator, and all amendments to the foregoing documents) to verify the consistency of directions for the payment of the tax; (2) include an express direction against apportionment in the governing instrument if the testator desires to “opt-out” of the Florida apportionment statute (i.e., the testator may desire the payment of the estate tax from the testator’s residuary estate); (3) evaluate the extent to which lifetime gifts reduce the available federal estate tax exemption and increase the estate tax exposure of beneficiaries inheriting at the testator’s death; (4) include an interpretive aid savings clause to document testator’s intent with respect to the payment of the tax; and (5) discuss with the testator (and document the discussion) of the impact of the tax apportionment provisions on the net value of the property received by beneficiaries under the governing instrument and beneficiaries inheriting property passing outside of the governing instrument.
 In a New York Times article, Tom Clancy, Best-Selling Master of Military Thrillers (October 2, 2013), author Julie Bosman describes Mr. Clancy’s book, “The Hunt for Red October”, as “one of the greatest genre novels ever written”. Many of Mr. Clancy’s books (The Hunt for Red October, Patriot Games, Clear and Present Danger, etc.) were made into Hollywood blockbuster movies.
 See decision of Chief Judge, Lewyn Scott Garrett of the Orphans’ Court for Baltimore City, Estate Number 101962, entered on August 21, 2015.
 449 Md. 577, 144 A.3d 802 (2016). The Maryland Court of Appeals upheld the decision of the Orphans’ Court.
 The marital deduction is only allowed in limited instances when the testator leaves his surviving spouse an interest in terminable interest in property – one such instance is when the interest qualifies as “qualified terminable interest property”. Under the terms of the Original Will, during her life, Mrs. Clancy was not the only beneficiary of the principal of the Family Trust. Discretionary distributions of trust principal could be made to Daughter. Further, Mrs. Clancy’s interest in the Family Trust terminated upon her remarriage. For these primary reasons, Mrs. Clancy’s interest did not meet the requirements of “qualified terminable interest property”. See Code §2056(b)(7) and Treasury Regulation §20.2056(b)-7. As used herein, the term “Code” refers to the Internal Revenue Code of 1986, as amended.
 The Second Codicil removed Daughter as a trust beneficiary during Mrs. Clancy’s life and deleted the divestment provisions that applied upon Mrs. Clancy’s remarriage.
 Decedent died in 2013 when the applicable exclusion amount under Code §2010(c)(3), as adjusted for inflation, was $5,250,000. Under Mrs. Clancy’s interpretation of the Second Codicil, the estate tax liability would be $11.8 million as opposed to $15.7 million under the Older Children’s interpretation of the Second Codicil.
 A marital deduction is only allowed for property passing to the surviving spouse. To the extent a portion of the Family Share was used to pay the estate tax, it would reduce the amount passing to the Family Trust. Only the net amount (after payment of estate tax) passing to the Family Trust is eligible for the marital deduction. See Code §2056(b)(4)(A).
 Generally, with apportionment, each recipient receiving property subject to the federal estate tax must pay its proportionate share of the tax.
 See §732.6005(1), Florida Statutes, providing that the intention of the testator as expressed in the will controls the legal effect of the testator’s dispositions.
 See Orphans’ Court analysis citing Gordon v. Posner, 142 Md. App. 399, 410 (2002) and Gideon V. Fleichmann, 193 Md. 203, 207 (1949).
 See Code §2044. If the Court would have sided with the Older Children, this would have meant that the Family Trust would be subject to the federal estate tax on two occasions – at Decedent’s death and at Mrs. Clancy’s death.
 If the beneficiaries inherit property subject to the estate tax equally, then the allocation of the estate tax is less likely to result in litigation as the estate tax liability is shared equally by them.
 Under Florida law, “qualified beneficiaries” of a trust include the current and remainder beneficiaries. See § 736.0103(16), Florida Statutes. A qualified beneficiary of a trust is entitled to notice and other reporting requirements under Florida law. See § 736.0813, Florida Statutes.
 Even though Bandy v. Clancy involved a dispute regarding the liability for payment of the federal estate tax, the same issues may arise with respect to the federal generation-skipping transfer tax. The tax provisions governing the payment of the estate tax and the GST tax are generally addressed in the same provision by the drafting attorney.