DocketNumber： No. 13779-02
Judges： "Holmes, Mark V."
Filed Date： 7/10/2007
Status： Non-Precedential
Modified Date： 11/21/2020
MEMORANDUM OPINION
HOLMES,
Kimberly Hicks was born on July 1, 1987. She lived with her parents, Clyde and Theresa, who were both guards at an Ohio women's prison. In April 1990, her mother was driving the family minivan when it collided with a Conrail locomotive engine, and then with a car driven by a man named Swank. The accident left Kimberly a quadriplegic, dependent on a ventilator to breathe, and in need of constant medical attention for the *185 rest of her life. Theresa Hicks and her other daughter both suffered only minor injuries.
The Hickses hired a lawyer, and the Probate Court for Union County (the county in central Ohio where the Hickses lived at the time of the accident and when the petition was filed) appointed Society National Bank as guardian for the estates of both Kimberly and her sister.*186 for her injuries.
Next to settle, in April 1993, was the Hickses' own car insurance carrier with whom they had filed a claim. This claim was also settled for $ 100,000. The probate court again approved the settlement, but this time authorized Society National to use the full amount for litigation expenses against Conrail.
This left Conrail, which faced the largest liability, fighting hard to avoid it. The Hickses and Society National's suit against Conrail sought damages for medical expenses, pain and suffering, and Clyde's loss of consortium from Kimberly. Conrail counterclaimed against Theresa, and she then counterclaimed against Conrail. Spurring the litigation from Clyde and Theresa's perspective were several problems that they faced. First, they needed enough money to meet their moral (and statutory) duty to provide for the ordinary expenses of their minor children. *187 been specially recognized by the Probate Court as Kimberly's guardian for "custody and maintenance," and so had a specific duty in that capacity to provide suitable maintenance for her care. *188 health insurance through their local Blue Cross/Blue Shield. It was paying for almost all of Kimberly's extraordinary medical expenses, and it had no lifetime cap, but the policy would continue only as long as either Clyde or Theresa remained employed by the State. They recognized that they might lose their coverage -- by having to leave their jobs at the prison, by the State's choosing to switch insurers, or by the insurer's changing the terms of the policy. More haunting was the possibility that one or both of them might not survive their daughter -- Clyde in particular was of an age and had physical problems of his own that made that fear reasonable. So the Hickses were rightly worried about all the future costs of caring for a very disabled child.
These worries made it very important that Kimberly be in a position to qualify for Medicaid when she became an adult or if the Hickses lost their insurance. Qualifying for Medicaid would mean that Kimberly would get the care she needed, but Medicaid is a program designed for the poor and its eligibility rules would force her to spend down any damages she won. And, though Medicaid provides adequate care, the Hickses reasonably thought it *189 would be less than perfect in meeting Kimberly's special needs.
The Hickses' ability to solve these problems and allay their worries was very uncertain. Conrail disputed its liability, blaming Theresa for the accident, and the Hickses' medical insurer intervened to protect its subrogation rights. Conrail even won summary judgment before trial, though the Hickses got that reversed on appeal. This pretrial maneuvering looked like it was headed to another round of appellate review, as both the Hickses and Conrail had petitioned the Ohio Supreme Court to take the case. But then, in early 1994, Conrail offered to settle all claims for $ 4,650,000. It had already negotiated separate settlement of Blue Cross/Blue Shield's subrogation claim, which relieved the Hickses from having to split the proposed settlement with their insurer. But Conrail's offer was a lump sum in exchange for a release -- there is nothing in the record that shows Conrail cared at all about how that lump sum would be split among the Hickses or their various causes of action.
This is where the Hickses' lawyers showed considerable professionalism -- instead of just taking a lump sum or negotiating an ordinary structured settlement, *190 they brought in a team of specialists, one of whom was Thomas Baxter. Baxter is an attorney with a practice at the intersection of health care, trust, and probate law. He focuses on the analysis and creation of trusts for the benefit of severely disabled adult children whose parents need help in navigating the complex and frequently changing rules governing eligibility for Medicaid. Baxter suggested to the Hickses that they create two trusts for Kimberly.
The first was the Kimberly Hicks Special Needs Trust. Baxter designed the Special Needs Trust to comply with
The second trust was the Kimberly Hicks Settlement Fund Management Trust, and was to be available to Kimberly for her "support, maintenance, health and education." This trust was to be funded in part by another $ 450,000 from the Conrail settlement. *192 indemnity contract" once she turned eighteen.
The Hickses and their lawyers did not have the final say about this. Local probate courts have jurisdiction under Ohio law to review and approve the settlement, allocation, and distribution of noneconomic compensatory damages in civil cases. See The *193 $ 1 million loan which Mr. Hicks is making to the Settlement Trust, although available for Kimberly's use and benefit during her lifetime, will not be an asset of her estate at her death. Since her estate will probably exceed $ 600,000, the savings on the $ 1 million which will not be included will be approximately $ 500,000.
The Probate Court reviewed the plan at a hearing in June 1994 and approved both the amount of the settlement and attorneys' fees, and the creation of the trusts. Society National drew up a plan to distribute the funds, which the Court approved about a month later. The plan allocated $ 1,415,000 to Clyde Hicks for loss of services and loss of consortium; $ 1,450,000 to Kimberly; and $ 100,000 to Theresa and Kimberly's sister for their comparatively minor injuries. (The remainder went to attorneys' fees and expenses.) Society National, in its capacity as trustee of the Management Trust, issued a promissory note to Clyde for $ 1 million. This had been contemplated by the terms of the Management Trust, under which proceeds from such a loan "shall become part of the trust property and shall be administered and distributed on the same terms as the property originally *194 contributed to the trust." With the trusts in place, the Probate Court was able to terminate Society National's role as guardian of Kimberly's estate -- a financial benefit to the estate because, under Ohio law, the fees and expenses of a guardianship are noticeably greater than those of a trust.
For several years, the trusts and loan worked as planned. Clyde received interest on schedule, and duly reported it on his income tax return each year. But then, in December 1998, Kimberly died. She was only eleven years old, and her estate needed no probate because her only assets were the property held in the two trusts. Society National's successor -- the Key Trust Company (which has its principal place of business in Ohio) -- became the administrator of her estate, and filed an estate tax return in September 1999. The estate listed the total amounts in both trusts -- including the assets bought with the contested $ 1 million -- under the Code provisions that regard certain trust assets to be part of a decedent's estate. See
The main issue in this case is how to treat the $ 1 million promissory note issued to Clyde bythe Management Trust. The estate urges us to accept the transaction as what the Hickses and their lawyers designed it to be -- a loan by Clyde of $ 1 million from his share of the Conrail settlement. The Commissioner argues that this "loan" was hardly bona fide and, even it were, urges us to apply the substance-over-form doctrine and disregard it as a sham.
We begin with the Code.
We think the Commissioner is underestimating the importance of the Probate Court in deciding to whom the $ 1 million belonged. The Hickses' lawyers were very careful in leaving the unallocated settlement funds with Society National until the beneficiaries were determined. This acknowledged the Probate Court's broad discretionary authority as "superior guardian" of a minor under Ohio law. That status means that the Probate Court has the power and authority to control the actions of the minor's guardian *197 and act directly to ensure that the minor's best interests are being considered.
The Commissioner's attack doesn't end with that quibble about possession of the settlement proceeds under Ohio law. He also argues that the allocation was a sham. This is itself a problem because the statute and regulation don't tell us to review the allocation. They tell us to review the bona fides of the loan. Decades ago, we held that the "bona fides of a loan are primarily established by the intention of the parties that repayment will be made pursuant to the terms of the agreement."
The Commissioner does make a good point by noting that the Probate Court specifically mentioned at the settlement hearing only $ 415,000 as compensation to Clyde. He concludes from this that the extra $ 1 million allocated to Clyde in the papers approved by the Probate Court transformed the allocation into nothing more than an "uncontested, nonadversarial, and entirely tax-motivated" proceeding of thesort we condemned in
We disagree at the outset with the Commissioner's unlinking of the $ 1 million repayment feature of the loan from its associated income stream. That income stream was Clyde's from the start, and it is plain error as a matter of economics to say in effect that it was valueless. Because the note was callable at Kimberly's death, we can estimate its present value as of the Probate Court's allocation by using her life expectancy at that time. That was the subject of considerable dispute, and the Commissioner argues that it ranged between 4 and 50 years. The annual payment to Clyde was fixed at $ 60,000. If one uses a discount rate of 10% to this income stream (at the time, longterm prime interest rates were between 7% and 8%), *200 in the note was likely worth between $ 190,000 and $ 590,000 on the day it was created; if one discounts at 8%, that worth jumps to a range of $ 200,000 to $ 730,000. These values only increase if one adds in the prospect of payment of the principal, or computes some nonzero probability of that payment being accelerated by Kimberly's need to qualify for Medicaid. (They also admittedly decrease with the probability that Kimberly would use the money before then.) This means that the allocation approved by the Probate Court is not simply an allocation of $ 1 million to Kimberly. As the Hickses suggest, there was a real risk that Clyde would predecease Kimberly. If he did, the present value of the note would become part of his taxable estate, and these rough calculations strongly hint that that value would not be negligible.
This strongly suggests that there was real economic substance here even if we look at the entirety of the allocation, including the loan. We do agree with the Commissioner that it's reasonable to assume that Kimberly's injuries would *201 shorten her life, but we find as a fact she was in no danger of imminent death at the time of the settlement, and so do not see the loan as an attempt to dodge the imminent imposition of the estate tax. Cf.
We also find that Clyde had plenty of motivation to seek a large portion of the settlement for himself. Remember that under Ohio law parents have a statutory obligation to provide continuing support to their minor children.
In deciding whether the allocation as a whole lacked substance, we return again to the important role of the Probate Court under Ohio law. Probate courts' decisions in this area are discretionary -- as the Hickses' personal injury lawyer credibly testified: "Some judges don't like special-needs trusts, because some judges think that *203 that money should go to the state, and that's just a strong philosophical belief. Some judges don't mind the loss-of-society claims; some judges do." And unless there is an abuse of discretion, an Ohio appellate court "will not substitute its judgment for that of the trial court."
In upholding the allocation of the settlement made by the State court in this case as having economic substance, we are not invoking a bright-line rule that our Court must always defer to settlement allocations reviewed by State courts -- we plainly don't in circumstances *204 like those we faced in
The Hickses' case -- though superficially similar in that the settling tortfeasor had no interest in the allocation of the settlement -- is different in important ways. The first, of course, is that states themselves have an interest (represented by state-court judges) in considering the impact of allocations in personal injury cases on the state's own Medicaid system. The field of long-term health-care planning, both for the disabled and the elderly, is rapidly growing and changing with a frequency that seems to rival tax law's. The policy decisions already made by Congress and the states in that area -- acknowledging the use of trusts and asset transfers in preparing to qualify for Medicaid benefits, but limiting them and, in cases like this, *205 subjecting them to state-court review -- strongly counsel us to not second-guess those courts in the guise of reallocating settlements years later in estate-tax cases.
A second factor making us reluctant to upset the allocation here is that the initial allocation of the settlement was not between taxable and nontaxable amounts. Unlike
And we finally return to Ohio's law expressly giving probate courts the authority to review intrafamily allocations of tort settlements when minors are involved. This reflects the all-too human likelihood that not all families will respond to the type of tragedy that the Hickses endured the way the Hickses endured it, by drawing *206 together to do the best for all the members of the family. Some families will be rent asunder in dividing large amounts of money, and some parents will inevitably be tempted to cheat their own children. But Ohio foresaw that threat and created courts to forestall it. Due regard for them again counsels us against upsetting the allocation of the settlement here.
Our hesitation echoes the Supreme Court's, which recently noted the potential importance of State-court approval in similar circumstances.
To be sure, [T]he risk that parties to a tort suit will allocate away the State's interest can be avoided either by obtaining the State's advance agreement to an allocation or, if necessary, by submitting the matter to a court for decision.
We view with some skepticism the Commissioner's fear that upholding the deductibility of the loan repayment here will trigger a massive recharacterization of settlement proceeds as intrafamily loans in the future. But we take cases one at a time, and here the facts persuade us that Clyde's loan had real substance -- it was concededly valid under Ohio law, and resulted in the creation of real interest income on which he really did pay tax. We are particularly persuaded by the evidence that the Hickses were trying very hard to comply with the complex Medicaid-eligibility rules in settling the trusts. As the Supreme Court said in a leading opinion on substance-over-form, where, as here, there is a genuine multiple-party transaction with economic substance which is compelled *208 or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by tax-avoidance features that have meaningless labels attached, the Government should honor the allocation of rights and duties effectuated by the parties * * *.
We therefore honor the allocation disputed here, and find that the $ 1 million loan was bona fide and for adequate and full consideration under The Commissioner has conceded in his posttrial brief the deductibility of administrative expenses incurred by the trusts in 2000, but contests all later expenses. The problem for the estate is that it neither secured the admission of a summary exhibit -- Exhibit 120-P -- nor elicited testimony from the Key Bank employee who testified about the estate's fees *209 and expenses after Kimberly died. That leaves those expenses unsubstantiated for the years 2001-2004, and so we must disallow them. The estate is quite right, however, about the expenses of this litigation; those expenses are governed by If the parties in an estate tax case are unable to agree under The parties are encouraged to reach a settlement on this issue, but in any event
1. Ohio family law distinguishes guardians with "custody and maintenance" from guardians of an "estate". A guardian with custody and maintenance has such duties as protecting his ward, providing her an adequate education if she is a minor, and supervising her medical care.
2. Ohio courts recognize parents' right to recover damages for physical injury to their minor child, terming such claims "loss of filial consortium." "Consortium" includes "services, society, companionship, comfort, love and solace."
3.
4.
5. The Management Trust agreement recited that the settlors of the Trust were Clyde and Theresa, even though all the other documents in the record showed it funded from another $ 450,000 of the Conrail settlement to be allocated to Kimberly. The parties did not discuss how it was that Kimberly's parents could be regarded as ever having possession of this $ 450,000. If this initial corpus came from Kimberly herself, it is conceivable that it might have counted as her own asset for purpose of Medicaid eligibility. See
6. Unless otherwise indicated, all section references are to the Internal Revenue Code, and the Rule references are to the Tax Court Rules of Practice and Procedure.↩
7. Federal Reserve Statistical Release H.15, Selected Interest Rates, Historical Data,
8. Any predeath interest accrued under the terms of the promissory note follows the loan (i.e., is payable to Clyde as the holder of the note) and thus is also deductible by the estate. See