Estate of Atkinson -- When Strict Liability in Tax Went Awry

Estate of Atkinson -- When Strict Liability in Tax Went Awry

Article posted in Charitable Remainder Trust, Treasury Decisions on 19 May 2014| comments
audience: National Publication | last updated: 20 May 2014


C. Scott Meyer presents an intriguing analysis of the Atkinson case, one that involved a poorly managed and maintained CRT.

By C. Scott Meyer, Originally published in Tax Notes


Charitable giving tax planners tend to view Estate of Atkinson v. Commissioner[1] as a chilling, but extreme outlier case.  The Eleventh Circuit held that mistakes in the administration of a charitable remainder trust (CRT) justified its retroactive disqualification as one.  The case is frightening because the court did not balk at the taxpayer’s protest that even a foot fault could be grounds for a CRT’s disqualification under the court’s rationale.  Fortunately, the government has shown no interest in disqualifying CRTs en masse, and Atkinson has been generally ignored as precedent.[2]

Given the increasing interest in strict liability[3] tax sanctions,[4] Atkinson merits reconsideration.  It involved the apparently self-interested misconduct of a CRT’s trustee.  Congress enacted section 4941 to deter and force correction[5] of that kind of self-dealing.  Still, the commissioner, the Tax Court, and the Eleventh Circuit all avoided mention of section 4941.  This silence is strange given that section 507 – also not cited – expressly prohibits the result reached in Atkinson absent the prior application of section 494, which, as noted, the Service did not apply.  Instead of deploying section 4941 to penalize the trustee and repair the charitable interest, the government pursued a strict liability tax sanction that the Eleventh Circuit inexplicably granted.  As a result, innocent charities suffered severe consequences from the loss of a tax exemption.  Section 507 makes that result the last resort.  Furthermore, section 4941 did not serve its intended function of curing other injuries to the charitable interest.  Frankly, Atkinson is far more persuasive as an argument against strict liability standards in the tax world than it is for them.

Statutory Framework

The Tax Reform Act of 1969 enacted sections 4941, 507, and 664 to strengthen federal oversight of charitable organizations.  The Joint Committee on Taxation report on TRA 1969 (JCT report) observed that Congress desired “more extensive and vigorous enforcement of the tax laws relating to exempt organizations” paid for in part by a tax on private foundations levied under section 4940.[6]

Section 4941, “Taxes on Self-Dealing,” imposes a 10% excise tax for each year in which an act of self-dealing between a foundation and a disqualified person occurs or begins with a prior act uncorrected.  Section 4946 defines a disqualified person for purposes of section 4941 as a person who is a substantial contributor or who is related to or affiliated with a substantial contributor.  A foundation manager if he has limited liability, is also a disqualified person, but the statute limits the liability of managers and gives them certain defenses to a section 4941 penalty; the trustee of a CRT is a foundation manager for this purpose.  A CRT beneficiary is not automatically a disqualified person, a fact that could be important in Atkinson.[7]

Section 4941(d)(1) defines self-dealing primarily using contract-based language.  It penalizes six transactions between the disqualified person and the foundation: (1) a sale or exchange; (2) a loan or extension of credit; (3) furnishing of goods, services, or facilities; (4) payment of compensation; (5) transfer of, or the use of, income or assets of the foundation; and (6) an agreement to make a payment to a governmental official.  That subsection uses neither act nor transaction, but the rest of section 4941 and the regulations use act and transaction interchangeably to describe the event constituting the self-dealing.

While a transfer of or the use of the foundation’s income or assets may not represent a formal contract, it has a solidly consensual aspect, and its inclusion within a list of contractual arrangements emphasizes agreement as opposed to some alternative paradigm.  A transfer requires an affirmative action – namely, acceptance – on the part of the transferee that conforms to the intent of the transferor; in other words, a meeting of the minds.  Even in the simple case of a person handing an object to another, the transfer is successful only if the transferee accepts the object.

The escalating penalty structure of section 4941 corresponds to its deterring intentional conduct, such as the drafting of an agreement.  Section 4941 imposes a three-tiered penalty structure.  When an initial self-dealing transaction is not corrected, the excise tax pyramids over time, making a failure to correct expensive.  The 10 percent excise tax is the first-tier sanction.  A second-tier 200 percent excise tax is imposed on the disqualified person for failure to correct the self-dealing before the commissioner sends a notice of deficiency.  The final tier of the penalty structure is the disqualification provision of section 507.[8]

Critically, section 507 provides that it is the exclusive method for terminating the status of an organization as a private foundation:

(a) General rule

Except as provided in subsection (b), the status of any organization as a private foundation shall be terminated only if –

  1. such organization notifies the Secretary (at such time and in such manner as the Secretary may by regulations prescribe) of its intent to accomplish such termination, or
  2. with respect to such organization, there have been either willful repeated acts (or failures to act), or a willful and flagrant act (or failure to act), giving rise to liability for tax under chapter 42, and
  3. the Secretary notifies such organization that, by reason of subparagraph (A), such organization is liable for the tax imposed by subsection (c),

and either such organization pays the tax imposed by subsection (c) (or any portion not abated under subsection (g)) or the entire amount of such tax is abated under subsection (g).

Subsection (b) provides an exception for a private foundation that voluntarily becomes a public charity or distributes all its net assets to public charities, but the exception is available only if subparagraph (2)(A) does not apply.  Thus, only the government can involuntarily terminate a private foundation’s status for willful and repeated, or a willful and flagrant, violation of section 4941 or some other provision of chapter 42.  A private foundation cannot voluntarily terminate if that conduct has occurred.

The statutory scheme makes it clear that a tax penalty should fall on the charitable fund only in extreme circumstances.  Section 6684 doubles the 200 percent second-tier section 4941 penalty when the violation of section 4941 is either willful and repeated, or willful and flagrant; the same language appears in section 507.  The cumulative penalty imposed on a disqualified person for uncorrected self-dealing, with interest imposed, and with failure to file and other penalties added, can be extraordinary – potentially greater than the amount in the underlying transaction.  Only after the maximum individual penalty applies does section 507 provide for the possibility of a penalty paid from the charitable interest.  Even then, subsection (g) creates two alternative grounds for abating the section 507 penalty, both of which are aimed at removing the misbehaving individual(s) from control of the charitable fund.

Section 664 acts as the prime gatekeeper to a charitable deduction under sections 170, 2054, and 2522 for transfers to trusts with both charitable and non-charitable beneficiaries.  Sections 664 and 642(c) permit a deduction for a charitable remainder interest in trust only if the non-charitable interest is precisely defined.  Section 664(a) authorizes Treasury to promulgate regulations to govern CRTs, and the interpretive heavy lifting occurs there.

Section 4947(a)(2)(A) provides that section 4941 does not apply to “any amounts payable under the terms of a split-interest[9] trust to income beneficiaries” (emphasis added).  This sentence creates a narrow exception to section 4941 to permit a CRT to make statutorily defined distributions – the annuity or unitrust amount – to a beneficiary; any other transaction involving a disqualified person falls within the scope of the penalty.  Accordingly, the section 664 regulations give considerable attention to the terms that a CRT must contain, particularly the provisions governing timing, characterization, and treatment of income distributions, but they otherwise leave the governing of antiabuse provisions to section 4941.  Reg. section 1.664-1(a)(4), however, does say:  “In order for a trust to be a charitable remainder trust, it must meet the definition of and function exclusively as a charitable remainder trust from the creation of the trust.”  The Atkinson opinions rest on that sentence.

Atkinson Facts

In 1991 at age 95, Ms. Melvine Atkinson (Melvine) transferred $4 million to a CRT for her benefit and somewhat less than $1 million into an irrevocable trust designed to pay estate debts and taxes.  The attorney (the fiduciary) who developed that plan became the trustee of both trusts and executor of her will.  Melvine named four individuals to be the successor life beneficiaries of her CRT on her demise.  One of the successor beneficiaries, Mary Birchfield (Mary), acted as Melvine’s caretaker from 1984 until Melvine’s death in 1993.  For unexplained reasons, the CRT did not make the seven annuity payments due to Melvine during her life.

Typically, the entire date-of-death value of a CRT with a reserved life interest is included in the donor’s federal gross estate,[10] while a charitable deduction is allowed for the value of the charitable remainder.  If the CRT does not terminate at the donor’s death, the value of the charitable remainder will be less than the amount included in the federal gross estate and federal estate tax will apply to the difference, which will equal the value of the successor life interests.  Rev. Rul. 82-128 provides that for a successor non-charitable interest, a CRT governing instrument must condition the enjoyment of a successor interest on the payment of any death tax from other sources.  The Atkinson CRT contained a provision to that effect.

Although Melvine’s estate plan presumably contemplated that her irrevocable trust would pay those taxes, the trust and her probate estate became inadequate to pay them.[11]  When the fiduciary communicated that, the three successor beneficiaries other than Mary renounced their interests.  Had Mary forfeited her successor interest, the charitable remainder interest would have accelerated and probably no federal estate tax would have been due.[12]

Mary, however, claimed that Melvine gave her a notarized document exempting her from paying estate taxes.  Under pressure, the fiduciary distributed more than $700,000 from the CRT to Mary without satisfying the death taxes.  The audit of the estate’s federal estate tax return revealed that a significant portion of the federal estate tax would have to be paid from the CRT.  The auditor denied the federal estate tax deduction, a position upheld by the Tax Court and the Eleventh Circuit.

After all appeals were exhausted, the estate tax assessment on an already insolvent estate led to collection actions.  The Tax Court opinion that reviewed the collection proceedings shed light on the estate’s insolvency.  The fiduciary had not filed fiduciary income tax returns for the estate, had made “questionable investments,” had expended estate funds for class action suits, and conducted expensive litigation resisting the federal estate tax.  The IRS claimed that the fiduciary’s fees were excessive.  Overall, the assets in the federal gross estate shriveled from $7 million to $500,000.[13]

The opinions do not reveal what first caught the auditor’s eye.  Melvine’s federal estate tax return reported a large receivable from the CRT for the unpaid annuity.  But one would think that most beneficiaries forfeiting substantial inheritances would also catch the auditor’s attention.  Whatever may have initiated the audit, the commissioner made the missing annuity payments the centerpiece of the case and continued with that argument long after more serious problems became obvious.

Atkinson Holding and Rationale

Footnote 1 of the Eleventh Circuit’s opinion goes straight to the bottom line:  ‘‘We decide that the trust was not a CRAT [charitable remainder annuity trust] because of its failure to pay Atkinson a lifetime annuity.’’  The court’s analysis of why Melvine’s trust was not a CRAT is so brief that some of the logical steps must be inferred.  As noted above, reg. section 1.664-1(a)(4) requires that a CRT function exclusively as a CRT.  The terms of Melvine’s CRT required the payment of a quarterly annuity and it did not do that.  The failure to make those payments meant that her trust did not function exclusively as a CRT.  That failure led to the conclusion that her trust was not a CRT, at least as of Melvine’s demise.  Because her trust was not a CRT, section 2055 did not permit a charitable estate tax deduction for the charitable remainder interest.[14]

The court tacitly acknowledged that its conclusion did not rigorously follow from the relevant regulation.  It approvingly quoted the argument of the IRS that ‘‘the intent of Congress in enacting [the CRAT rules] could be defeated by the creation of CRATs that have their documents in order but that fail to function as CRATs after their creation.’’  The argument that the regulation must be read as urged by the Service to avoid an absurd result surely implies that the text does not expressly exhibit the desired reading.  Further, the argument that this regulation must be so interpreted to avoid disaster implies that no other remedy is at hand, making the failure to mention section 4941 at least awkward.

In context, reg. section 1.664-1(a)(4) points in quite a different direction than the interpretation given by the court.  Read carefully, subparagraphs (a)(4) and (a)(5), and the examples in subparagraph (a)(6) that illustrated those subparagraphs, all relate to events that might or do occur before the CRT takes exclusive possession of a transfer.  The first sentence of reg. section 1.664-1(a)(4) establishes the general principle that a transfer to a CRT cannot include any restriction or limitation not expressly permitted by section 664.  Subparagraph (a)(4) then exempts a transfer to a CRT through a revocable living trust (which will have terms not permitted by section 664).  Subparagraph (a)(5) exempts a transfer to a CRT through an estate (which will similarly be governed by legal requirements not permitted by section 664).  Nothing in subparagraphs (a)(4), (a)(5), or (a)(6), however, suggests that disqualification can occur retroactively.

It is helpful to remember that an irrevocable transfer in trust to A for life, with a pour-over remainder to a purported CRT for B for life, with the final remainder directed to charity, is a current transfer of a vested future interest to the purported CRT.  The purported CRT is a valid trust because a transfer of property has occurred even if possession is deferred.[15]  Because the purported CRT may contain all of the necessary terms to meet the definition of a CRT, the first sentence of reg. section 1.664-1(a)(4) is needed to disallow the transaction because the purported CRT cannot operate as one from day one.  Read this way, Melvine’s CRT did not fail the regulation.

In any event, the Eleventh Circuit’s interpretation of reg. section 1.664-1(a)(4) is moot unless there is some theory for avoiding the dictate of section 507.  The court’s opinion unambiguously grounds the denial of an estate tax deduction on the status of Melvine’s CRT.  As noted, section 4947(a)(2) makes section 507 applicable to CRTs.  Section 507 states that it is the only section that controls whether a private foundation’s status can be terminated.

There is no obvious path around section 507.  By the court’s admission, Melvine’s CRT contained all necessary terms at the start, so there is no argument that the CRT failed the definitional requirement.  Section 507(c) and (d)(1)(A) disallow all tax benefits under chapters 1, 11, and 12 to a substantial contributor in the event that a foundation’s status is terminated, a remedy that accomplishes all the commissioner sought in Atkinson and more, so there is no revenue policy at stake in avoiding section 507.

One could argue that reg. section 1.664-1(a)(4) causes a retroactive disqualification that can be distinguished from a termination under section 507.  Ironically, the fiduciary forced the court to forgo that theory.  He argued that Melvine’s CRT never qualified as one, at least for estate tax purposes, because none of the successor life interests ever qualified.  The court responded that the CRT came into effect at the initial funding and that proper administration was required to preserve its status.  Termination is the only meaningful term to describe the transition from qualified to unqualified status, and section 507 disallows termination absent pre-conditions unmet in Atkinson.

The suggestion that reg. section 1.664-1(a)(4) produces a disqualification ab initio that escapes section 507 entrains a far more absurd result than the specter the IRS raised in its brief.  Section 4947, and therefore section 4941, applies only if a charitable deduction was allowed under some provision of the code.[16]  If disqualification eliminates all deductions ab initio, no penalty is available to apply to the misconduct of a trustee.  The regulations under section 507 expressly avoid that result in the event of termination, but the question here is whether retroactive disqualification under reg. section 1.664-1(a)(4) somehow escapes the reach of section 507.  Any retroactive theory would give a misbehaving fiduciary an incentive to cause disqualification to avoid a personal penalty under section 4941, surely an unpalatable outcome.

Application of Section 4941 to Atkinson

Note that because the Atkinson opinions do not address the potential application of section 4941, the fiduciary’s perspective on the facts has not been heard.  My observations are purely conjectural.  Still, the facts appear to make a prima facie case for the application of section 4941.

The first requirement is the involvement of a disqualified person.  Mary was not related to Mel-vine, and as a result was not a disqualified person.  However, if Mary had been Melvine’s daughter, the distribution to her when the payment of the federal estate tax was not assured would have violated the terms of the CRT and therefore lost protection under section 4947 and constituted a transfer to a disqualified person penalized by section 4941.  More importantly, the escalating enforcement scheme for correction would have forced Mary to return the distribution to the CRT.  The first-tier penalty, initially set in 1969 at 5 percent, was intended to be essentially a demonstrative wrist-slap; the primary objective is the protection of charity by the reversal of the prohibited transaction.

As the trustee, the fiduciary was a disqualified person because he was the foundation manager.   While section 4941 requires a transfer to or for the benefit of the disqualified person, the benefit need not pass directly from the private foundation.  Section 4941(d) provides that the relevant transaction can be direct or indirect.  As reg. section 53.4941(d)-2(f)(1) illustrates, self-dealing occurs when a private foundation buys or sells stock “in an attempt to manipulate the price” of the stock to the advantage of the disqualified person.  The disqualified person self-deals indirectly even though he conducts no transaction directly with the foundation.  If the transfer to Mary conferred a benefit on the fiduciary, an indirect act of self-dealing occurred.

From Mary’s perspective, the fiduciary was the architect of an estate plan that failed catastrophically after only a couple of years.  In light of the Tax Court’s later collection opinion, one suspects that the fiduciary’s actions were at least part of the insolvency problem.  As the Tax Court noted in the earlier proceeding, Mary became hostile to the fiduciary when he refused to pay her the annuity.[17]  Whether Mary actually uttered the words “malpractice” or “surcharge,” the fiduciary should have known that personal liability was an objectively realistic possibility.[18]

Section 4941 provides some protection for trustees acting solely in that capacity.  Acting solely as a trustee, the fiduciary arguably could have relied on the state court approvals he obtained as a defense to a penalty for the payment to Mary.  But the section 4941 regulations note that a foundation manager may also act in an individual capacity, in which case the manager is treated as both an ordinary disqualified person and as a manager.  A trier of fact could, and hypothetically would, conclude that the fiduciary paid Mary to forestall her action against him personally.  Once a potential personal benefit to the fiduciary is involved, he did not act solely as a trustee.

As noted in the JCT report, Congress intended that the IRS use section 4941 to police fiduciary misconduct.  Had the Service invoked section 4941 early in Atkinson, the case’s future would have been different.  The fiduciary would have had personal liability to restore the distribution to the CRT.  Any use of CRT funds for litigation expenses would have been additional self-dealing transactions.  Either under section 507 or because the charitable interest accelerated, the IRS would have had grounds to preclude the payment of additional expenses and compensation from CRT funds.  Moreover, section 507 contains a cross-reference to section 6104(c).  That section directs the secretary to notify the appropriate state officer, typically the state attorney general, of the mailing of a notice of deficiency under section 507, and it permits tax return information to be given to the state officer for the purpose of administering the state’s charitable laws.  Generally, state laws authorize the attorney general to remove trustees of charitable trusts for misconduct.  The carrot for state involvement is that effective regulatory action by the state can be grounds for completely abating the section 507 tax on the charity.  Had the IRS complied with section 6104(c), it is unlikely that the case would have dragged to 2007, when the Tax Court rendered its collection opinion.

If the IRS thought it necessary, section 4941 could have applied even to the failure to make annuity payments.  In TRA 1969, Congress determined that it was inappropriate for private foundations to simply accumulate funds.  Suppose Melvine did not cash annuity checks given to her.  After seven uncashed checks, the government could have argued that Melvine’s failure to cash them was intentional.  As a result of not cashing checks, wealth would increase in a tax-sheltered vehicle.  Misers by definition enjoy increasing the assets they control, and many individuals will go to great lengths to avoid taxes.  Both are intangible but quite real benefits.  An intentional failure to accept a distribution produces the very result Congress had intended to prohibit and section 4941 should apply.

However, the Tax Court disbelieved the fiduciary’s claim that he wrote checks that Melvine did not cash.  The fiduciary could produce no uncashed checks, and no annuity checks could be found in the check register. Its issued checks were in proper numerical sequence.  Melvine was in her mid-90s and presumably had no close relatives.  It would not be unusual for Mary as her personal attendant to take an interest in Melvine’s estate plan, and Mary certainly claimed after Melvine’s demise to have spoken with Melvine about her estate.  There is no obvious tax reason for the fiduciary to have drafted Melvine’s administrative trust to be irrevocable.  One speculates that perhaps the fiduciary wanted to keep a tight rein on Melvine’s assets.  Section 4941 would apply, although proof might be difficult, if the fiduciary intentionally failed to make annuity payments to keep Melvine’s assets from the reach of potential interlopers.

Ironically, the Eleventh Circuit cited congressional intent for its agreement with the fiduciary’s complaint that its decision treated administrative mistakes with the same harshness as grave misconduct.[19]  Congress enacted section 4941 precisely because it found that equation unworkable.  In describing the reasons for the passage of section 4941, the JCT report said:

In many cases the sanctions [termination of charitable status, exactly the remedy supplied in Atkinson] are so great in comparison to the offense involved, that they cause reluctance in enforcement, especially in view of the element of subjectivity in applying arm’s-length standards.  Where the Internal Revenue Service does seek to apply sanctions in such circumstances, the same factors encourage extensive litigation and a noticeable reluctance by the courts to uphold severe sanctions.[20]

The later history of the Atkinson matter supports the congressional belief that strict sanctions produce extensive litigation.  Fifteen years after Melvine’s demise, it appears that almost none of Melvine’s estate passed to charity and huge amounts were spent on attorney fees.

A Brief and Speculative Sidebar

Section 4941 provides an appropriate remedy for any administrative error tainted by a personal motive.  Even if the IRS believes it needs a penalty for disinterested mistakes, draconian disqualification of a CRT is not the appropriate response.  Section 4947 makes section 4945 applicable to CRTs.  Although the wisdom of widely implementing the following suggestion is dubious, section 4945 could penalize some types of sufficiently careless errors.  Section 4945(d) defines taxable expenditures by a private foundation to include any amount paid or incurred for specified prohibited purposes.  One can distinguish between the obligation to make an annuity payment and the obligation created after an annuity payment is not made. The person who benefits from that second obligation is the CRT itself, and the failure to make the distribution in effect becomes a grant to itself to the extent of the time value of money.  Section 4945(d)(4) characterizes that grant as a taxable expenditure.  Similarly, if a mistaken double payment is made to an unrelated vendor, for example, the overpayment does not advance a charitable purpose and is by definition a taxable expenditure if the CRT does not recover it.  Subject to some conditions, section 4945 not only provides a penalty for making a taxable expenditure, but it also implements the prophylactic strategy of imposing a duty to correct that is enforced by additional penalties for failure to correct.  Chapter 42 is broad enough to penalize, and force correction of, simple sloppiness when necessary.  Further, section 4945 applies without regard to self-dealing, so it sidesteps potentially contentious disputes over personal liability for nonculpable acts.

The Strict Liability Holy Grail

Atkinson is a strange case.  It strains belief that in a decade-long tax litigation, no one on the government’s side noticed sections 4941 and 507.  The problem may have been that the fiduciary was too obviously at fault.

Treasury interpreted TRA 1969 as authority for it to create strict liability tax sanctions.  Although discussion of that point is beyond the scope of this article, an illustrative example from the regulations would be helpful.  Suppose John lends money to Sue and Sue gives John a note.  Harry, Sue’s vindictive ex-husband, buys the note from John and contributes it to a private foundation to which Sue’s grandfather was a substantial contributor.  The last sentence of reg. section 53.4941(d)-2(c)(1) provides that Sue committed self-dealing.

The commissioner has argued for strict liability in the courts:  “This, respondent asserts, should be especially true in a case involving a section 4941(a)(1) excise tax, which tax imposes a type of strict liability on disqualified persons for acts of self-dealing with private foundations.”[21]  In Adams v. Commissioner,[22] the court described the section 4941 regulations as a strict standard, and it refused to engage the petitioner’s argument that he was not at fault because unrelated parties caused the penalized facts to occur.  Madden v. Commissioner[23] is bracing because the taxpayer conceded liability under section 4941 for unambiguously pure mistakes made by employees, mistakes which were corrected within days.

A successful prosecution against the fiduciary under section 4941 would have produced only a pedestrian opinion sanctioning culpable wrongdoing.  Instead, the IRS saw Atkinson as an opportunity to establish an extremely harsh penalty – disqualification of a CRT – for violating a strict liability standard.  The Tax Court, at least, held as an alternative ground for disallowance that the CRT’s assets would be required to pay the estate tax.  On that basis, most trust and estate practitioners would view loss of the estate tax deduction as an understandable response to a major and critical tax failure, irrespective of the particular theory relied on.  The Eleventh Circuit nevertheless relied solely on the failure to make the annuity payments, and the tenor of the opinion – “since the CRAT regulations were not scrupulously followed,” “strict adherence to the Code” – implies that missing even a single annuity payment justifies disqualification.

Despite Treasury’s spin on the statute, Congress’s message in 1969 was much the same as Justice Benjamin N. Cardozo’s famous assault on self-dealing, minus the rhetorical flourishes.  The JCT report states the clear congressional policy objectives for section 4941: “Congress [believes] that the highest fiduciary standards require complete elimination of all self-dealing rather than arm’s-length standards.”[24]  Congress realized that the previous arm’s-length standard for transactions between donors and private foundations tended to legitimize transactions between donors and foundations.  Accordingly, it gave section 4941 the caption “Taxes on Self-Dealing.”  The self-dealing reference was likely chosen to repudiate the belief that payment of adequate consideration legitimated private access to public goods and appealed to donors’ notions of right and wrong as a basis for observing the new prohibition.  “Improper’’ may be a tame synonym for “wrong,” but that is the basic meaning, and the word “improper” and its cognates appears 12 times in the portion of the JCT report covering chapter 42.  On three occasions, the JCT report describes chapter 42 as responding to temptations.  As evidenced by the graduated penalty scheme, Congress expected section 4941 to persuade disqualified persons more by clarifying the wrong of the act than by the severity of the punishment.  In short, Congress’s aim was to reinforce a social norm. Treasury’s agenda to create a strict liability tax penalty has subverted the intended purpose.

Justice Oliver Wendell Holmes’s adage that a “law which punished conduct which would not be blameworthy in the average member of the community would be too severe for that community to bear” counsels consideration of the effect of a severe, strict liability penalty on the legitimacy of the tax law itself.  Atkinson serves as a salutary warning that even the desire for a strict liability tax weapon may be misguided.  We lose much if tax punishment is seen as visited by angry fate rather than flowing as the just consequence of wrongdoing.

[1] 309 F.3d 1290 (11th Cir. 2002), aff’d, 115 T.C. No. 3.

[2] At the time of this article, only three opinions have cited Atkinson, and none have cited it for any point relevant here.

[3] The meaning of strict liability is debated even in the tort context, and importing the phrase into the tax realm will further muddy the concept.  Still, aspects of the opinion are best conveyed by describing it as setting a strict liability standard.  The court’s basis for disqualifying the CRT was its failure to make required annuity payments.  The court did not consider why the failure occurred.  It did not mention the trustee’s duty of care or negligence.  The court’s logic allows no space to raise questions of reasonable cause, lack of knowledge, or other customary tax defenses or mitigating circumstances. 

[4] For example, section 4965(b)(1)(B) provides a heightened penalty for a charity that participates in a transaction that it knew, or had reason to know, was a prohibited tax shelter.  The implication is that the lesser penalty in section 4965(b)(1)(A) applies even if the charity did not know, and had no reason to know, that the transaction was a tax shelter.  The regulations take some of the edge off the potential harshness of the statutory language.

[5] Section 4941(e)(3) provides that “the terms ‘correction’ and ‘correct’ mean, with respect to any act of self-dealing, undoing the transaction to the extent possible, but in any case placing the private foundation in a financial position not worse than that in which it would be if the disqualified person were dealing under the highest fiduciary standards.”

[6] Staff of the Joint Committee on Internal Revenue Taxation, “General Explanation of the Tax Reform Act of 1969,” at 29 (Dec. 3, 1970) (hereinafter, Joint Committee report).

[7] Beneficiaries of a CRT should, as a matter of common sense, be treated as disqualified persons, but Congressional action would be required to amend section 4946.  One of the lessons from Atkinson is that Treasury by regulation or rule should provide for a rebuttable presumption of self-dealing by the trustee in some cases.  If a beneficiary obtains a benefit from the CRT not authorized by the terms of the instrument, the benefit presumably occurs because of pressure brought by the beneficiary, and the trustee presumptively acts to obtain the personal benefit of relief from that pressure.

[8] Section 4947 makes sections 507 and 4941 applicable to CRTs as well as to private foundations.

[9] A CRT is a split-interest trust.

[10] Reg. section 20.2036-1(c)(2) provides a method for computing the inclusion, which generally follows capitalization of income concepts.

[11] The insolvency aspect of Atkinson during the period shortly following Melvine’s demise is unclear.  The Eleventh Circuit opinion recites that the irrevocable trust contained nearly $1.5 million at Melvine’s demise and was intended to pay estate taxes.  Still, the fiduciary told the successor annuity beneficiaries that they were required to pay estate taxes on their interest.  The later history of the case mentioned below provides some strong hints as to how the insolvency may have arisen.

[12] That conclusion assumes that Melvine’s estate and the remainder interest in the smaller irrevocable trust also passed to charity, a fact not given in the opinions but one that seems likely from the overall estate design.

[13] Estate of Atkinson v. Commissioner, T.C. memo. 2007-89.

[14] It is interesting, but of no particular probative value, that while reg. section 20.2055-2(e)(2)(v) cross-references the section 664 regulations specifically applicable to charitable remainder annuity trusts and charitable remainder unitrusts, respectively, it does not reference the section 664 regulation containing the crucial sentence at reg. section 1.664-1(a)(4).

[15] Example 5 of reg. section 1.664-1(a)(6) is especially clear that the CRT is created upon the transfer (which occurs at death in that example) and that this date precedes the date the CRT is funded.

[16] Wisely, reg. section 1.664-1(a)(1)(iii)(a) provides that a CRT is a trust for which a deduction is allowable under a list of code sections which is nearly identical to the one in section 4947.  Thus, while the provisions of section 4947 require that a deduction actually be taken for section 4941 to apply, Melvine’s trust immediately became a CRT upon funding – yet another reason why retroactive ab initio disqualification is incorrect. 

[17] 115 T.C. No. 3, at 28.

[18] Interestingly, at about the time of Melvine’s death, Florida law relaxed the privity requirement in legal malpractice in estate planning matters, permitting beneficiaries to sue estate planning attorneys.  See Espinosa v. Sparber, 612 So.2d 1378 (Fla. 1993); Greenberg v. Mahoney Adams & Criser, P.A., 614 So.2d 604, 605 (Fla. Dist. Ct. App. 1st Dist. 1993); Winston v. Brogan, 844 F.Supp. 753 (S. D. Fla. 1994).

[19] Despite the certain charitable donation in this case, the countervailing congressional concerns surrounding the deductibility of charitable remainders in general counsel strict adherence to the Code, and, barring such adherence, mandate a complete denial of the charitable deduction.”  309 F.3d 1290 at 1296.

[20] Joint Committee Report, supra note 6, at 30.  Bracketed text added by author.

[21] Dupont v. Commissioner, 74 T.C. 498, at 503 (1980).

[22] 70 T.C. 373, at 384 (1978).

[23] T.C. Memo. 1997-395.

[24] JCT report, at 30.

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