Non-Residents of Massachusetts
Non-residents with estates exceeding $2 million and who own real or tangible property located in Massachusetts are subject to the estate tax. The issue for non-residents is that Massachusetts defines the taxable estate as all assets, wherever located (plus adjusted taxable gifts). This calculation uses a fractional approach, where the numerator of the fraction represents the value of real estate and tangible assets within the Commonwealth and the denominator is the total assets of the gross estate.
For those advising non-residents, a popular technique to avoid the estate tax is to move the real estate to a limited liability company (LLC), converting the asset from real property to intangible property and therefore falling outside of the estate tax regime. Nevertheless, planners should take caution as there is some uncertainty regarding whether the LLC would be legally recognized if it lacks a legitimate business purpose. Another consideration is if the LLC is structured as a single member LLC, it may be considered a property interest instead of an intangible under Massachusetts law due to its disregarded status, and thus would not fall outside of the estate tax regime.
Jones v. Jones
On September 6, 2023, the Appeals Court of Massachusetts decided the divorce case of Jones v. Jones, confronting the issue of whether gifts from the wife’s mother, including an irrevocable spendthrift trust, should be included in the marital assets for purposes of equitable division upon divorce. The Court concluded that the assets, including the spendthrift trust, should be included. Advisors should keep this case in mind as they advise clients who may one day be divorced in Massachusetts.
Facts
Husband and wife married in Michigan in August 1998, and were married for almost 19 years when the husband filed for divorce in Massachusetts in March 2017. The parties had two children (born in 1999 and 2001) and both spouses were employed outside of the home during the marriage and contributed equally to raising the children. During the marriage, the parties received a variety of financial gifts from wife’s mother which included, among other things: (i) a trust for the wife’s benefit (the Juliana Jones Irrevocable Trust, or “JJIT”), (ii) substantial funds that were deposited into a UBS CD ($300,000 which the parties had not added to or withdrawn from and which totaled $310,683.54 at time of trial), and (iii) a 99% interest in an LLC (PHR II) gifted to the wife that held title to the marital home and a one-third interest in real property in Michigan. The JJIT was formed as a GRAT remainder trust (to hold the proceeds of a 2015 GRAT established by wife’s mother) and funded with shares of Bank of Nova Scotia common stock.
In addition, the wife’s mother provided other gifts during the marriage enabling the parties to “fund frequent travel, summer camp and a lifestyle they would not otherwise been able to afford [without gifts from wife’s mother].” The parties contributed only minimally to retirement which the Court surmised was likely “due to [the] wife’s anticipated inheritance and the significant gifts the parties received during the marriage.”
Holding and Rationale
The Court held that the JJIT, the UBS CD account, and the LLC should all be considered part of the marital estate because the wife’s financial assets were “woven into the fabric of the marriage.” The Court felt it was equitable to include these assets due to the length of the marriage and the parties’ equal contribution during the marriage. The wife was able to retain the JJIT and PHR II, but was required to transfer to husband 60% of the UBS CD and make cash payments to him over a period of ten years (with the amount of such cash payments determined based on the value of the JJIT and PHR II as of the date of trial).
In determining that the JJIT should be included in the marital estate for purposes of equitable distribution, the Court determined that although the trust is discretionary, the wife had a “fixed and enforceable property right” in the trust, the wife was “entitled to the whole trust property”, and her share was not “susceptible to reduction.”
Given the Court’s conclusion regarding the JJIT being included in the marital estate, it is important for planners to understand the provisions of the trust, which included the following: (i) the trust was irrevocable, settled and funded by wife’s mother with the wife as the sole beneficiary, (ii) there was an independent trustee, (iii) the trust allowed for discretionary income and principal to wife for her best interests and welfare, (iv) the entire trust corpus was to be paid to wife after the mother’s death (terminating the JJIT), (v) the trustee had a power of postponement (allowing the trustee to postpone distributions for compelling reasons (which included the possibility of divorce and pending creditor claims, among other things), (vi) the trust was spendthrift, and (vii) the wife had a testamentary general power of appointment over the trust. It should be noted that the wife had never received a distribution from the trust.
The wife argued that because the trust was spendthrift and fully discretionary, her interest in the trust was merely speculative and, regardless, the trustee could always postpone a distribution to her because of the postponement provision. The Court disagreed and focused on the fact that upon the wife’s mother’s death, the entire corpus of the trust was to be mandatorily distributed to the wife, which gave her a vested and enforceable interest in the trust. The Court was unpersuaded by the argument that the trustee could postpone distributions to the wife because the wife still held a testamentary general power of appointment over the trust enabling her to control its disposition at her death. Importantly, the Court noted that the trustee had never actually postponed a distribution, and that the circumstances for a postponement might be temporary in nature or within the wife’s control, which limited the scope of the trustee’s power to postpone. The Court also stated that there was no evidence that the wife ever requested or would need to request a distribution in order to make any of the payments required to be made to the husband pursuant to the divorce judgment.
The Court distinguished this case from Pfannenstiehl (a prior Massachusetts case holding that a beneficiary’s interest in a discretionary trust was too speculative to be considered part of the marital estate) on the grounds that the trust in that case involved an open class of trust beneficiaries and no one beneficiary was entitled to any distribution.
Planning Tips
There are several lessons practitioners can glean from the Jones case. One key takeaway is that planners should be cautious about creating trusts with mandatory distribution provisions. A primary focus for the Court focus was the mandatory nature of the trust distribution at wife’s mother’s death – it was this mandatory distribution that created a vested enforceable interest in the trust. This vested interest could not be defeated by the postponement provision, especially because the wife held a general power of appointment.
Practitioners should also warn clients who would like to make gifts to his/her children and their spouses to enrich their lives about having those gifts be part of the “fabric of the marriage.” If clients would like to have the freedom to make gifts to their children, those clients should consider encouraging their children to sign a prenuptial or postnuptial agreement. This advice is important, even outside of Massachusetts because while trust beneficiaries may not live in Massachusetts today, they may live there at some point in the future.
Another focus for the Massachusetts courts seems to be on whether there is an open class of beneficiaries. The courts appear to be more willing to include the trust in the marital estate where the divorcing spouse is the sole beneficiary (as opposed to just one beneficiary among others as in Pfannenstiehl). Finally, planners should be cautioned about using ascertainable standards especially if maximum creditor protection is sought.
It remains to be seen whether the wife will appeal the Court’s decision, but in the meantime, planners must be mindful of the Jones case while planning for Massachusetts clients or those who may move to Massachusetts in the future.