Open for business - The Probate and Family courts are now hearing tax-related trust reformation cases

Issue January/February 2017 January 2017 By James E. Gallagher

Very often, families seek to preserve their assets for the benefit of future generations by including trusts in their estate plans. Well thought out trusts are often created with the intent of accomplishing specific tax objectives, but, no matter how much planning is done, issues may still arise that were unforeseen or simply overlooked.

Massachusetts has long been a jurisdiction that applied liberal rules for reformation of trusts that involve estate tax-planning issues. Traditionally, nearly all reformation cases were brought directly in the Supreme Judicial Court, because pursuant to established U.S. Supreme Court precedent, only decisions from the commonwealth's highest court were conclusive and binding on Federal authorities as to points of Massachusetts law. Commissioner v. Estate of Bosch, 387 U.S. 456 (1967). Thus, Bosch litigation, as it is known, was born. Therefore, for almost 50 years, trust reformation cases have been brought directly in and heard exclusively by the Supreme Judicial Court.

This process, however, was less than ideal. The SJC, as an appellate court, is not the most appropriate forum for bringing trust reformation cases. In order to hear these non-adversarial cases, the SJC had to divert scarce judicial resources from other important cases that would be relied on as precedent by all citizens of the commonwealth, rather than just the parties to the reformation. In short, the system was set up to force the highest court in the commonwealth to decide cases that impacted very few citizens.

This procedure was not all rosy for the parties involved either. Bringing an action directly in the SJC was not without its drawbacks, especially given that trust reformation cases were not a legal priority for the SJC when compared to other matters on its calendar - notably criminal matters. Also, despite the fact that the cases were nearly always non-adversarial, the SJC still required a full and complete record to establish that the parties seeking relief had "the requisite degree of proof that they are entitled to the relief they seek." Walker v. Walker, 433 Mass. 581, 582 n. 5 (2001). The assembly and production of such records can be costly, if not cost prohibitive.

In 2014, while observing trends in the commonwealth and around the country, the SJC set out to identify what, if anything, could be done to have other courts in the Commonwealth hear these cases. The SJC wanted to create a new cost effective and expedient way for these cases to be heard while still allowing the parties to obtain a ruling on trust reformation that would be binding on the Internal Revenue Service and other federal authorities. Justices from the SJC requested that a committee be appointed to examine, evaluate and make recommendations as to the trust reformation process. Attorneys with particular experience in these types of matters were selected to serve on the committee, and the committee's proposed recommendations were adopted by the SJC on October 1, 2014. See Amended Report of the SJC's Ad Hoc Committee on Bosch Litigation (the full report is available online at http://www.mass.gov/courts/case-legal-res/rules-of-court/sjc/report-of-sjcs-ad-hoc-committee-on-bosch-litigation.html).

Just one month after adopting the Amended Report, the SJC set forth its new plan for Bosch cases in its decision of O'Connell v. House, 470 Mass. 1004 (2014). Specifically, the SJC in O'Connell adopted the policy that cases which "involve no novel or unsettled issue of Massachusetts law, require only the application of settled Massachusetts legal principles and have no particular significance beyond the specific parties and the specific facts involved" are to be decided by the Probate and Family Court. The committee that prepared the Amended Report opined that it is not always necessary for federal purposes to have a decision from the state's highest court. Specifically, it is not necessary in cases where "the applicable principles of state law are settled, and the only job of the state court is to apply settled legal principles to a given set of unremarkable facts. …The role of this court could be more limited - to hear and decide only those [tax-related reformation] cases that raise a novel and unresolved issue of Massachusetts law or are significant for some other reason." Amended Report, p. 19-20.

Has the change had an impact? It is hard to say. As of yet, there are no reported cases in Massachusetts, and no pronouncements from the Internal Revenue Service indicating that it is unwilling to be bound by Probate and Family Court decisions. As long as that holds true, for the many cases that meet the test outlined in O'Connell, a quicker, more efficient path to reformation can be expected. At the very least, this will provide a reduction in potential stress and a diffusing of conflicts between settlors, beneficiaries and trustees, all of whom are concerned when tax issues threaten to diminish the effectiveness of an estate plan.

It should be noted that trust reformation at the Probate and Family Court level is not the only avenue available to parties seeking to change certain provisions of a trust when the purpose of those changes is not related to the estate tax. The new Uniform Trust Code (M.G.L. c. 203E, § 111) allows interested parties to enter into binding, non-judicial (no court involved) settlement agreements to resolve disputes over issues such as interpreting trusts, or determining the powers, authority or liability of the trustee. The settlement agreement will be valid as long as it does not violate a material purpose of the trust. Reforming a trust by means of the Uniform Trust Code could save interested parties a lot of time and money by avoiding litigation.

Parties may also pursue decanting as an option to effectuate a change in the provisions of an irrevocable trust. Decanting is a method used to distribute trust property from one irrevocable trust to another with different terms. If the original trust provides that a trustee can make distributions "to or for the benefit of" the beneficiary, the SJC has held that distributions to a new trust for the same beneficiary are permissible. Morse v. Kraft, 466 Mass. 92 (2013). This must be carefully done to ensure that the decanting itself will not create adverse tax consequences, but in the appropriate context, it is an option worth considering.

Regardless of how a family may have arrived at a crossroads with a trust instrument - whether through a drafting error, a change in the law, or a change in circumstance, families should be aware that there are many trust reformation options available that not only will effectuate the settlor's intent but also may avoid costly litigation.