Foresight -- Devoted to Estate and Tax Planning
2nd Quarter, 1997 -- Vol. 3, No. 2
© 1997 De Maio & De Maio

IN THIS ISSUE:

Feature Article:

Recent Developments:

The Lighter Side:


Feature Article

The New Jersey Prudent Investor Act

By Andrew J. De Maio, Esq.

Trustees, by tradition, have invested conservatively. The legal rules governing trustee investments have discouraged or prohibited investment in assets that might decline in value. These long-standing rules have encouraged the use of "safe" fixed-income investments. The exclusive use of ultra-safe investments such as Treasury bonds virtually ensures that trust principal will not be lost due to default or to significant market fluctuations. But a portfolio invested entirely in fixed-income securities is exposed to another risk: inflation. Such a portfolio rarely keeps pace with the constant decline in the true value of a dollar. Over time, the equity market averages have consistently outperformed investments that produce only a steady stream of income. The legal restrictions on trustees have discouraged or prevented the use of growth-oriented, long-term investment strategies.

State legislatures have responded to this anomaly by revising and updating laws governing trustee investments. New Jersey, on March 7, 1997, joined in by enacting the "Prudent Investor Act," P.L. 1997, Chapter 26. The Act, based on the Uniform Prudent Investor Act adopted by the National Conference of Commissioners on Uniform State Laws, overhauls the legal standards governing investments by fiduciaries of New Jersey trusts and estates.


The "prudent investor" standard

The general rule is stated simply in Section 3 of the new law: "a fiduciary shall invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements and other circumstances of the trust." The law lists eight examples of factors that should be considered, and permits the consideration of other relevant circumstances. In accord with modern portfolio theory, the law provides that no single investment is judged in isolation. Rather, it calls for an evaluation of the prudence of the entire portfolio as a whole. Thus, no particular investment is inherently imprudent. High-risk securities formerly off limits to trustees may be proper within the context of a well-planned portfolio.

Prior to the new legislation, trustees were often judged harshly when an investment performed poorly. Under the new prudent investor standard, the conduct of the trustee, and not the investment outcome, is what matters. If the fiduciary takes the proper steps to construct and maintain an adequate portfolio, he or she will not be held responsible if the assets decline in value or do not perform as well as expected.


Diversification of investments

The new law requires that a trustee diversify the investments of a trust unless the purposes of the trust are better served without diversification. Under what circumstances is diversification not required? An example is a qualified personal residence trust designed specifically to own a home, and exclude it from the taxable estate of the person creating the trust. The tax regulations governing such a trust prohibit it from owning any asset other than the residence.


Delegation of investment decisions

In the past, trustees have been prohibited from delegating investment authority to others. The new law permits delegation of investment and management functions to an agent, but requires the trustee to act prudently in selecting the agent, in limiting the agent's authority, and in monitoring performance.

Nevertheless, New Jersey's version of the law discourages delegation of investment authority in two ways. First, it requires that the trustee give advance written notice to the income beneficiary or beneficiaries each time a delegation of investment and management functions is proposed. The notice must identify the agent to whom investment authority is being given.

The second disincentive to delegation is an economic one. If a trustee delegates investment decisions, the amount of compensation must be reduced to reflect the the costs of the delegation and the trustee's diminished responsibilities.


Effective date; Modification of the Rules

The New Jersey Prudent Investor Act takes effect on June 5, 1997. The new standards of investor conduct apply to executors, trustees, guardians, conservators, and "every other individual or corporation charged with the duty of administering a trust estate." The law applies to existing trusts and estates as well as those created after the date of enactment.

The prudent investor rule, according to section 2 of the new law, "may be expanded, restricted, eliminated, or otherwise altered by express provisions of the trust instrument." Thus, the will or other instrument creating a trust may provide that some or all of the new provisions shall not apply.


Implications for planning

Trustees of existing trusts need to be aware of the new investment standards, and comply with the new requirements. For example, trustees should:

For drafters of new wills and trust agreements, there is more flexibility. Creators of new trusts should consider:

Final thoughts

The Prudent Investor Act is a welcome addition. It should permit fiduciaries to implement sensible, long-term investment strategies, unencumbered by traditional concepts that have become outmoded. But the new law imposes additional responsibilities on investment managers. Fiduciaries need to be aware of and comply with these new obligations. Those creating new trusts should foresee the new opportunities and potential pitfalls created by the new law, and plan accordingly.

 


RECENT DEVELOPMENTS

Revocation of Codicil Does Not Revive Provisions in Will
In re Estate of Lagreca, N.J. Superior Court, App. Div. (Jan. 28, 1997)

Katey Lagreca had three children. Her 1982 will left most of her estate to her son John and named him as the sole executor. In 1987 she signed a codicil that left the residuary estate to her children equally, and named her daughter Diane as executor. Later that year, Mrs. Lagreca destroyed the codicil with the intention of revoking it. She died on September 18, 1987.

A dispute arose over the disposition of the estate. John claimed that the destruction of the codicil left intact the 1982 will, which gave the estate to him and named him as executor. Diane argued that the codicil had revoked those provisions of the will. Even though the codicil had been revoked, Mrs. Lagreca had not re-executed the old will. This, according to Diane, left a void, and the residuary estate should be distributed under the law of intestacy, as if there were no valid will. Under New Jersey's intestacy statute, the estate would pass in equal shares to the three children.

The Court agreed with Diane. By signing the codicil in 1987, Mrs. Lagreca had revoked the inconsistent parts of the 1982 will. The applicable section of the New Jersey probate code, N.J.S.A. 3B:3-15, provides that "[a] revoked will or codicil shall not be revived except by reexecution or by a duly executed codicil expressing an intention to revive it." Neither was present in this case. Thus, the residuary estate was to be divided among the three children equally, pursuant to the intestacy law. Since there was no valid provision appointing an executor, any of the children was permitted to apply for appointment as administrator of the estate.

Comment: Ironically, the court's decision results in a distribution of the residuary estate that is identical to the codicil that Mrs. Lagreca had revoked. John argued that this could not possibly have been his mother's intent. But the Court held: "in the area of wills, the Court must scrupulously follow statutory law." That meant that the estate must be distributed under the law of intestacy. It was merely coincidence that the intestacy law provided for the same distribution as the revoked codicil.

Perhaps Mrs. Lagreca thought that destroying the codicil would reinstate the 1982 will. The doctrine of "probable intent" dictates that a court should seek to implement the testator's intention, as revealed by the will and surrounding circumstances. But that doctrine applies only in interpreting a will, not in determining whether it is valid.



Court Must Decide Who Pays Tax on Real Estate Gift
In Re Estate of Baker, N.J. Superior Court, Appellate Division (Feb. 4, 1997)

Mabel M. Baker signed her Will in June, 1994. In it, she left her Medford, N.J home to her grandnephew, Michael Alcott. In another section of the Will, she directed that all estate and inheritance taxes be paid from the general funds of the estate, so that the named beneficiaries "would receive the full legacies or devises given to them." If Baker had owned the home at the time of her death, the 15% New Jersey inheritance tax on the residence would clearly have been payable from other funds of the estate, and Michael would have received it tax-free. But sixteen days after signing her Will, Baker signed a deed transferring ownership of the home to Michael and his wife Louise.

Baker died in May, 1995 at the age of 99. The executors of her estate argued that the inheritance tax on the residence should be paid by Michael and Louise. The tax allocation clause in the Will, they contended, applied only to property passing under the Will, and not to the transfer by gift.

Michael pointed to Baker's intent, as expressed in the Will, that the property pass to him tax-free. He sought to present additional evidence concerning his great-aunt's intent.

Reversing the decision of the trial court, the Appellate Division held that the Will was ambiguous, and that a hearing should be held to determine Baker's intention. The case was remanded to the Probate Part for a trial.

Note: Inheritance tax was imposed on the real estate, even though it was not owned by Baker at the time of her death, under N.J.S. 54:34-1c, which taxes property transferred by gift in contemplation of death, within 3 years before the date of death.



Transfers of Annuities under Power of Attorney Upheld
Estate of Neff v. Commissioner, T.C. Memo 1997-186 (April 21, 1997)

The issue in this case was whether transfers of 19 annuities made one month before Rosa Neff's death were complete, valid gifts. The IRS contended that the gifts were not complete (and therefore the annuities were included in Neff's estate) because the transfer was not made by Neff, but by three of her relatives pursuant to a power of attorney signed by her. Neff was 97 years of age and was ill at the time of the transfers. The power of attorney authorized the transfer of all types of assets, but did not specifically address the making of gifts.

As reported in a prior issue, the IRS has successfully challenged the effectiveness of gifts in circumstances such as these. In this case, however, the IRS attack was rejected by the U.S. Tax Court. The Court held that the power of attorney was effective under state (Oklahoma) law to authorize the gifts. After considering the testimony of Neff's relatives and advisors, the Court was persuaded that she intended to make the gifts in question.

Comment: It is likely that the IRS will continue to challenge similar transactions. The best way to head off a problem in this area is to state specifically in the power of attorney whether gifts are authorized.



Estate Tax Changes Considered Likely

Some members of Congress would like to eliminate the estate and gift tax laws in their entirety. Because of budgetary constraints and political considerations, an outright repeal in the near future is unlikely. But there is widespread support for legislation easing the estate tax burden on American families. These proposals are among those most likely to succeed:

Foresight will follow the progress of these bills and report on the legislation when enacted.



Government Calls Foul on NBA Referees

The National Basketball Association reimburses its referees for first-class airline tickets on flights longer than two hours. Under the refs' collective bargaining agreement, officials are permitted to downgrade to lower-cost tickets, and keep the cost savings. However, they are required to report the cash received as income.

The U.S. Justice Department has obtained indictments against two referees, claiming that they failed to report the income and obtained false documents to conceal the downgrading arrangements. The indictments charge that the referees obtained bogus receipts for first-class travel and submitted them to the NBA so that the income would not appear on W-2 forms filed with the IRS. If convicted, the officials could be fined $250,000 and imprisoned for three years on each count.

 

THE LIGHTER SIDE:

Will Trivia

The last will of Bimla Rishi of Dehli, India, dated February 9, 1995, consists of only four Hindi characters. The translation: "All to son."

In contrast, the will of Frederica Evelyn Stilwell Cook consisted of four bound volumes containing 95,940 words. It was admitted to probate in 1925 in London, England.

J. Paul Getty added 21 codicils (amendments) to his will, dated September 22, 1958. The first was dated June 18, 1960. The last was made March 11, 1976, three months before Getty's death.

The April 5, 1993 Last Will and Testament of tobacco heiress Doris Duke directed the payment of $100,000 to a trust for the benefit of her dog.



FORESIGHT is a publication of De Maio & De Maio, Attorneys at Law. It is not intended as and does not constitute legal advice, nor does it create an attorney-client relationship. The information contained in this publication should not be acted upon without first obtaining the advice of a professional advisor.

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