On certification to the Superior Court, Appellate Division.
The opinion of the Court was delivered by O'hern, J. Chief Justice Wilentz and Justices Handler, Pollock, Garibaldi, Stein, and Coleman join in Justice O'Hern's opinion.
The opinion of the court was delivered by: O'hern
(This syllabus is not part of the opinion of the Court. It has been prepared by the Office of the Clerk for the convenience of the reader. It has been neither reviewed nor approved by the Supreme Court. Please note that, in the interests of brevity, portions of any opinion may not have been summarized).
LEONARD F. HILL, ET AL. V. ESTATE OF MARY LEA JOHNSON RICHARDS, ET AL.
Argued September 26, 1995 -- Decided December 14, 1995
O'HERN, J., writing for a unanimous Court.
Federal income tax law disregards the law of trust and estates in determining whether a distribution to beneficiaries is of income or principal. In order to avoid the tracing of income, the Internal Revenue Code (IRC) provides generally that, to the extent that a trust or estate has accumulated income during a tax year, any distributions from the trust during that tax year are treated as taxable income for federal income tax purposes.
Mary Lea Johnson Richards (Mary Lea) is one of several children of J. Seward Johnson, the founder of Johnson & Johnson Corporation (J & J). In 1944, J. Seward Johnson created a lifetime trust for the benefit of Mary Lea. As of her death on May 3, 1990, the value of the that trust had increased to over $70 million. Mary lea is survived by her husband, Martin Richards, six adult children from a prior marriage, one adult grandchild, and numerous minor grandchildren. By her will dated April 17, 1990, Mary Lea exercised her special power of appointment over the 1944 trust to resolve the beneficiaries respective claims to the trust property.
Richards and the six children entered a Stipulation and Compromise Agreement dated June 12, 1990 (the Agreement) that set forth the manner in which the principal and income of the 1944 trust were to be distributed. Under the Agreement, Richards was to receive approximately 47% of the trust balance, while the six children and grandchildren were to receive among them about 53%. Paragraph 16 of the Agreement specifically set forth the manner in which the income of the 1944 trust that accumulated after Mary Lea's death would be allocated. Essentially, the income would be divided among the beneficiaries in the same proportions established for the shares of the trust principal; therefore Richards was to receive approximately 47% of the 1944 trust's income, while the remaining 53% of that income was allocated among the other beneficiaries.
While awaiting approval of the Agreement by the Suffolk County Surrogate's Office, Richards and the six children requested the Trustees to make advance partial distributions of principal pursuant to the Agreement. In September 1990, the Trustees made the interim distributions as requested. In early February 1991, Richards, the six children and the adult grandchild executed an amendment to the Agreement (the Amendment) that provided that the parties agreed to take positions for tax purposes consistent with the terms of the Agreement, and to cooperate with each other in maintaining those positions. The Amendment, drafted by Richards' New York attorney, was filed in the Suffolk County Surrogate's Court on February 27, 1991. On February 15, 1991, Richards' attorney wrote a letter to the Trustees' counsel setting forth Richards' opinion, based on the explicit provisions of the Agreement and two IRS private letter rulings, that the advance principal distributions made in 1990 did not carry out income to the beneficiaries for income tax purposes. Accordingly, Richards urged that income tax due on the trust's 1990 income accumulated after Mary Lea's death be payable out of the trust.
In May 1991, the Trustees sought a private letter ruling from the IRS on whether the September 1990 distributions were deemed to carry out income for income tax purposes to the beneficiaries. In September 1991, New York Surrogate's Court approved the Agreement and Amendment and admitted the will to probate. In the fall of 1991, partly in reliance on assurances that a favorable IRS ruling would be forthcoming, the Trustees filed 1990 fiduciary income tax returns, paying the state and federal income taxes out of the trust.
On January 31, 1992, the IRS unexpectedly held that the 1990 distributions carried out income to the beneficiaries for income tax purposes. Following receipt of the IRS letter ruling, the Trustees filed amended fiduciary income tax returns for 1990, reflecting the trust's 1990 income of approximately $1.7 million as having been distributed to the beneficiaries as part of the 1990 distributions. The Trustees made application in these returns for refunds from both the federal and state governments to recover the 1990 income taxes that the Trustees had previously paid. The amended returns also showed that the trust's 1990 income was distributed to the beneficiaries in proportion to their respective size of the principal distribution each beneficiary received in 1990, not in proportion to each beneficiary's interest in the trust and not in proportion to the amount of the 1990 trust income that each beneficiary actually received in accordance with paragraph 16 of the Agreement. Thus, Richards was treated for tax purposes on the amended returns as having received over 91% of that income, while the other beneficiaries were treated on those returns as having received less than 9%.
On April 2, 1992, Richard filed an equitable adjustment motion before the Chancery Division, seeking reimbursement to him out of the other beneficiaries' respective shares of the 1944 trust of an amount equal to the income taxes he was required to pay on trust income that those beneficiaries received. On May 14, 1992, the Chancery Division denied Richards' motion on the grounds that his liability was consistent with the terms of the post-death Agreement between the beneficiaries as drafted by Richards' own counsel.
Following the Chancery Division's denial of Richards' equitable adjustment motion, the Trustees received approximately $550,000 in federal and state income tax refunds. The Trustees sought authorization to distribute these refunds to the beneficiaries in the proportions provided in paragraph 16 of the Agreement for the distribution of trust income. Richards made a cross-motion for distribution of the refunds in a manner consistent with that which the Trustees had used in amended 1990 fiduciary income tax returns, and which had in effect been upheld by the Chancery Division; 91% to him, 9% to the other beneficiaries. The Chancery Division granted the Trustees' motion and denied Richards' cross-motion.
Richards appealed, arguing that the results reached by the Chancery court were inconsistent and caused him a double injury. The Appellate Division concluded that the trial court properly denied Richards' motion to compel the beneficiaries to reimburse him for the taxes he paid on the partial distribution, but found, based on equitable considerations, that the 1990 tax refunds should have been allocated by the Trustees proportionate to the way in which the taxes were paid, rather than in accordance with the 1990 Agreement. Accordingly, the Appellate Division remanded the matter to the trial court for entry of an order directing the Trustees to redistribute the refunds in proportion to the taxes paid on partial distribution.
The Supreme Court granted certification.
HELD: Because the beneficiary who received the disproportionate advance distribution drafted the Agreement for the interim distribution, he was in the best position to foresee and foreclose the possibility of disproportionate tax treatment of the distributions. Therefore, it is unfair now to make a retroactive adjustment of the shares of other beneficiaries, some of whom received no interim distributions and many of whom may have placed their affairs in order in reliance on the court-approved final distribution of the trust assets.
1. The disparity between trust and estate accounting principals and federal taxation accounting principals can result in inequities to beneficiaries of trusts and estates. N.J.S.A.3B:19A-32 specifically authorizes adjustments to remedy inequitable results. In the circumstances of this case, however, the Court is not satisfied that the results are so inequitable as to call for an invocation of the doctrine of equitable adjustment. (pp. 13-16)
2. The inequitable circumstances in this case were, in part, the result of Richards' successful petition to the Trustees to make a distribution they otherwise might not have made. The Trustees did not breach any duty of impartiality in making the advanced distributions. Had Richards waited for the entire trust to be distributed, it is unlikely that the tax apportionment would have been the same. Thus, the Chancery court correctly assessed the equities here. Although the parties may not have fully foreseen the tax consequences of the advance distribution, it is clear that the interim or advance distribution was not at all proportionate to the final distribution. Moreover, when the parties made the final Amendment to the Agreement, Richards could have provided that, to the extent there should be any disproportionate income tax treatment of the distribution, adjustments would be made in the accounts of the beneficiaries. (pp. 16-19)
3. It is too late to make a retroactive adjustment of accounts. The Trustees have made final distribution of the trust assets and would have to recover the funds from other beneficiaries. Moreover, although Richards received a disproportionate share of the 1990 advanced distribution, he may have benefitted to the extent that he had an earlier use of the inheritance than others. (pp. 19-20)
Judgment of the Appellate Division is REVERSED and the judgment of the Chancery Division is REINSTATED.
CHIEF JUSTICE WILENTZ and JUSTICES HANDLER, POLLOCK, GARIBALDI, STEIN and COLEMAN join in ...