Potts and Reilly, L.L.P.., Austin, TX

Estate of Hurford v. Comr., T.C. Memo 2008-278, is a rags-to-riches story, where estates that were initially well positioned to achieve tax savings failed to achieve even the most basic estate tax savings. This case warns that a surviving spouse's poor choice regarding an attorney can significantly diminish an estate.

Mr. Hurford was an oil field worker who decided to go to college because he met a petroleum engineer who had a new car and clean clothes. Eventually, Mr. Hurford became an oil executive. He prospered in another family's oil company and died, in 1999, with significant assets. His wife, who “had devoted her life to family and friends, leaving the management of the finances to her husband,” just as suddenly had to take on the financial burden.

In early 2000, Mrs. Hurford was diagnosed with cancer. The attorney paid for by the oil company - a seasoned professional (who, though the opinion does not note this, is Board Certified by the Texas Board of Legal Specialization, a member of the American College of Trust and Estate Counsel, and a well-known speaker and writer) - was handling the administration of the husband's estate, including the funding of the marital and credit shelter trusts and advice on whether to make a QTIP election. That attorney recommended estate planning changes for Mrs. Hurford, including using up her lifetime gift tax exclusion (which she did), and creating family limited partnerships, one for farm and ranch properties, and the other for her financial assets. Then, according to one of the sons, Mrs. Hurford became dissatisfied with her attorney because “he did not relate well to the family and would often speak over their heads,” he was not completing the estate tax return or doing the survivor's estate planning fast enough, and he was too expensive. With her family's help, Mrs. Hurford hired a new attorney and fired the long-time attorney.

The new attorney's involvement resulted in disastrous consequences. Several FLPs were created, but these FLPs from the start did not function as a business, and were treated as Mrs. Hurford's bank account. The QTIP Trust and credit shelter trust established under Mr. Hurford's estate plan were distributed by Mrs. Hurford to herself, and subsequently she funded the FLPs with these assets. Mrs. Hurford sold her interest in the FLPs to two of her three children in exchange for a private annuity. This sale occurred before the FLPs were funded. The correct titling of assets did not occur after these transactions. The new attorney used old appraisals (when up-to-date ones were clearly needed for there to be a fair exchange for the sale of a private annuity) and the new attorney used his own undisclosed method for discounts for the FLPs and there were no appraisals. Gifts were not correctly reported or revealed. The new attorney did not correctly answer questions on the survivor's estate tax return about the ownership of interests in any partnerships, transfers under §§2035 through 2038, trusts in which the decedent held beneficial interests, and any trust for which a marital QTIP deduction had ever been claimed. The court's opinion highlighted the taint to the transactions caused by the sloppy work of the attorney. The court continually pointed out areas of sloppy work: proper names misspelled, page numbers in the table of contents were incorrect, references to entities were not correctly identified.

The Tax Court concluded that the private annuity and FLPs were shams. The court specifically found issue with the private annuity sale. The sale transferred Mrs. Hurford's FLP interest to only two of her three children. Testimony revealed that it was Mrs. Hurford's and two of her children's intent that the third child be a one-third owner if the FLP interests that Mrs. Hurford sold, but because that child had some personal issues it was not the intent to allow him control of the FLP interests. Instead of finding a solution by drafting the private annuity sale differently, Mrs. Hurford and all her children agreed that the third child had an ownership interest, but would not be listed as an owner on that portion of the FLPs. This action caused §2036 inclusion because the decedent retained control by the consent of the other children to include her third child. The court considered that private annuity to be nothing more than a will substitute and not a bone fide sale, and found §2038 inclusion because of Mrs. Hurford's continued involvement in the FLPs.

Even basic tax planning of utilizing both spouses' estate tax exemptions was foregone. Per the new attorney's recommendations, Mrs. Hurford ended the credit shelter trust and QTIP trust, and distributed these assets to herself, and subsequently contributed the assets to the FLPs. Had assets stayed in the credit shelter trust created at the husband's death (the survivor was allowed as trustee to invade principal only for “ascertainable standards” and so implemented would not have had a general power of appointment), the assets would not have been taxed in Mrs. Hurford's estate.

But the Hurfords cannot qualify for the exception [for the credit shelter trust] merely by stating it in the will and avoiding it in practice. Thelma [Mrs. Hurford] exercised a general power by 'distributing’ all of the Family Trust to herself and 'selling’ those assets in the private-annuity agreement, and so they became subject to her full control and individual ownership. Since Thelma used all the Family Trust's assets as her own in the private annuity, we disregard the fact they at one time could have been sheltered from any estate tax under the plan designed by [attorney no. 1].

The Hurfords sacrificed the tax savings of the credit shelter trust by engaging in more complex planning that was not properly implemented.

The Hurfords also incurred approximately $300,000 in fees to the new attorney. The judge held that the estate had “by a bare preponderance of the evidence,” proved a deduction of $45,000 in attorneys' fees.

Mrs. Hurford's executor (one of her children) avoided a §6662 negligence penalty, but only because the executor did not have enough sophistication in the estate tax area (though a highly competent psychiatrist in his professional life) to realize the new attorney was not providing the level of diligence necessary for complex estate planning.

Practice Point: Choose your advisors wisely. Do not be penny wise and pound foolish.

For more information, in the Tax Management Portfolios, see Wojnaroski, 805 T.M., Private Annuities and Self-Cancelling Installment Notes, and Lischer, 50 T.M., Incomplete Lifetime Transfers: Retained Powers under Sections 2036(a)(2) and 2038and in Tax Practice Series, see ¶6200, Pre-Death Transfers-Section 2035, 2036, 2037 and 2038.