New Michigan Law Avoids “Uncapping” in Family Transfers

Two years ago in March, I reported here on the Klooster v City of Charlevoix case, which addressed the issue of "uncapping" in a real estate transaction between family members. 1994 amendments to the Michigan Real Property Tax, placed a "cap" on the amount a taxing authority could increase the value of real property under consistent ownership. Under the 1994 rules, a taxing authority may raise the taxable value of real property no more than the lesser of 5% and a CPI calculation.

The principal change is new sub-paragraph (s) which provides a new exception for residential real property transferred to a relative who is related by blood or affinity to the first degree (i.e., children)

However, when there is a "transfer" of ownership in real property, the taxing authority may "uncap" the valuation for the "tax day" immediately following the transfer, raising the taxable value as high as the state determined State Equalized Value (SEV) of the property. This can be a considerable increase in taxes for the new owner.

The Klooster Court interpreted the transfer provisions of the statute, holding that where a father added his son as a "Joint Tenant with rights of Survivorship" while the father was alive and while the father remained a joint owner, there was no transfer. That seems to track with the plain language of the exceptions to "transfer" in the statute. In what was a surprise to many of us (most certainly to the City of Charlevoix and municipal entities around the state), the further held the death of the original joint owner (the father) was not a transfer. This lead to a new (for some of us at least) avenue of planning and caused us to re-think our planning strategies see, Some Family Cottage Strategies in Light of the Klooster Case; my follow up to the Klooster article.

Perhaps in response to Klooster and the uncertainty that surrounded its reasoning, and certainly to protect family interests in family-owned residential real estate, the Michigan Legislature passed, and Governor Snyder signed into law in December of 2012, a newer, clearer exception to the "transfer" for family-owned real property. House Enrolled Bill No. 4753, signed into law on December 27, 2012, amends Section 27a(7) of the Michigan General Property Tax Act (MCL 211.27a) to provide several new exceptions. Most are clarifications of existing exceptions.

The principal change is new sub-paragraph (s) which provides a new exception for residential real property transferred to a relative who is related by blood or affinity to the first degree (i.e., children). Notably, the exception does not limit itself to "cottage" or "vacation" property. Nor are the number of instances or parcels limited. Indeed, the Senate Fiscal Agency's "Bill Analysis" acknowledges that the exception is not limited to "homesteads," nor is there any limit to the number of times a single parcel could be transferred to first-degree relatives.

Caution!

It is important to note that this new transfer exception does not become effective until December 31, 2013! Thus, for owners dying before December 31, it may still be wise to consider the strategies discussed at the link above, at least temporarily. Still, this is a welcome change for owners of family real property, particularly in those instances of homesteads and family cottages that may have remained in the family for multiple generations. Like all legal changes, this development will require planners to consider whether old strategies remain viable and what, if any, new strategies may come into play.

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Congress Finally Gives us Answers on Estate and Gift Tax

To quote former President Gerald Ford, with respect to the Federal Estate and Gift Tax: "our long, national nightmare is over." Late on January 1, Congress enacted "The American Taxpayer Relief Act of 2012." I won't go into great detail about the act (there is a lot about it we still don't actually know and will have to wait for the analysis of people more capable than I am), but will point out the highlights of the Estate and Gift Tax provisions which are of considerable importance to Estate Planning.

The Act preserves the $5 million per person ($10 million per married couple) "unified" estate and gift tax exemption and indexes it for inflation.

The Act preserves the 2012 levels of a $5 million per person exemption, maintains the "unified"estate and gift structure (meaning the $5 million threshold applied to total transfers, whether by gift during lifetime or inheritance on death), and indexes them for inflation. The Act also makes the concept of "portability," which was added in the 2010 extension for the first time, a permanent part of the tax structure. What "portability" means is that for married couples, the $5 million credit can be allocated or "shared" between them at any time, including after death. This effectively eliminates–in most cases–the need for those "clunky," inconvenient, "AB Trusts" ("his and hers"), and all the allocations and adjustments we were constantly making in those plans. This should have the effect of greatly simplifying the planning process in all but a few instances. The only real, substantive change in the law is a (modest?) increase in the rate (which will only apply after the $5/10 million credit has been used up).

What does "permanent" mean?

Most importantly, the Act makes the current Estate and Gift tax laws permanent. One of my colleagues asked me, what does "permanent" mean? I think that is a fair question. In 2000, the so-called "Bush Tax Cuts" were implemented and because of internal machinations in Congress, were built around a 10-year "sunset." This meant that unless Congress acted during the 10-year period, the laws would automatically expire on December 31, 2010. In a demonstration of the "brinksmanship" for which our modern Congress has become so famous for, in late December of 2010, they "extended" the law for 2 more years.

For the first time in the past 12 years, planners will be able to tell clients what to expect in this area. As we move forward in 2013, I expect that many of our clients will be looking at much simpler estate planning devices.  I think that is a plus

But when they extended the general tax laws, they made unanticipated major changes to the Federal Estate and Gift tax. This was in every way a good change. But it was "temporary," because it was part of an extension, again due to expire recently on December 31, 2012. The new law does not have a "sunset" provision. This means that until Congress acts by legislation to change it, it is permanent. That is as "permanent" as any law gets these days.

My personal view, and what I have been able to glean from reading other sources, suggests that Congress has no appetite to make future major changes to this area, for a number of reasons. So, what we now have is some consistency and something on which we should be able to rely for the foreseeable future.

For the first time in the past 12 years, planners will be able to tell clients what to expect in this area. As we move forward in 2013, I expect that many of our clients will be looking at much simpler estate planning devices. I think that is a plus.

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SHOULD YOU BE DOING LARGE YEAR-END GIFTS IN 2012?

Unfortunately, before we can intelligently answer this question, some history is necessary. With the pending expiration of the so-called "Bush Era Tax Cuts," there is a significant amount of buzz about making large year end gifts to take advantage of the current high gift threshold. Historically, the current Federal Estate and Gift Law scheme dates back to the early 1980's when the "unified estate and gift tax exemption" and the "unlimited marital deduction" were created. A 1986 threshold of $600,000 was set as the amount exempt from federal estate and gift tax transferred by each person. This effectively meant with some careful planning, a married couple could pass $1.2 million to their heirs by lifetime gift or at death before a federal transfer tax was imposed. The amount was capped in 1986 at the $600,000 level. Many of us watched as inflation and growth took our parents' modest estates (often substantially below $600,000) and turned them millions. As we watched, many of us also felt strongly that the $600,000 threshold was no longer a reasonable measure of "modest" wealth and that Congress' failure to address an inflation factor in this threshold was a serious policy flaw.
In 2000, a "conservative" Congress enacted the "Bush Era" tax laws. In the context of the Federal Estate and Gift Tax, those laws made some major changes, but had some perplexing provisions. Inexplicably, they de-unified (if that is a word) the exemptions. They increased the $600,000 Estate Tax Exemption, incrementally over a series of years, to $3.5 million in 2009, and entirely eliminated the Federal Estate Tax (sometimes called the "death tax") in 2010. At the same time they increased the Federal Gift Exemption to $1 million and froze it there. Their plan was that in 2010 and later, there would be no transfer tax on death, the untaxed lifetime gifts would continue to be limited (to $1 million per person). I have never heard a sensible explanation for this "policy." There were some other "nightmarish" provisions in the new law, including a change to "carryover basis" for inherited capital assets.
The problem with their plan was that due to some internal rules, the conservative majority in Congress did not have the numbers to make the changes permanent. So this tax law had a 10-year lifetime, which was due to expire on December 31, 2010. Rather than deal with it, Congress (mostly) "punted" and extended this expiration deadline to December 31, 2012 – right around the proverbial corner!
However, they did some surprising and unexpected things regarding the Estate and Gift tax laws. It gave me some hope that perhaps there would be an end to the seemingly endless uncertainty involve in Estate and Gift Tax planning over the past decade. In late December, 2010, Congress re-instated the Federal Estate Tax (remember, it expired under the short-lived law in 2010), but increased the threshold to $5 million! They also re-unified the credit, increasing the Gift Tax Exemption, also, to $5 million. Then they indexed both of these exemptions for inflation (in 2012, they are slightly over $5 million). But wait – there's more. They also created a new (and long awaited) allocation rule called "portability" (portability means that we no longer had to have separate trusts in most instances for Husband and Wife).
But Alas, all of this is scheduled to end at midnight on December 31. And the aftermath will be all the way back to a $1 million per person unified exemption.
Now, to the question proposed in the title: Should you make large gifts? I like to think of what we have now as a window. At the moment, it is open wide and at its widest opening, there is room to fit $5 million of assets through it ($10 million for married couples). If nothing changes, Congress will close the window most of the way, leaving it open just enough to fit $1 million of assets through it. So, as I view it, there is little to be gained by making gifts of $1 million or less. We will always be able to get that much through the window. Where the gain comes is if we can put more than $1 million through the window, because once it's closed down, we will have forever gotten the excess amount through the window.
When planning year end strategies, we cannot make this analysis in a vacuum. There is always an argument for making gifts of appreciating assets, up to and even above the $1 million discussed above. We move not only the asset itself, but the future growth out of the estate. But we also have to be cognizant of the nature of the asset being moved and whether we can truly afford not to own it anymore. And, perhaps equally importantly, we need to ask whether we want to continue to own it. It has always seemed bad planning policy to me to let tax considerations override the desires of the client.

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The Michigan Property Tax Personal Residence Exemption

The Michigan General Property Tax Act authorizes municipal entities, including cities, townships, villages, schools, and municipal "authorities" to levy taxes real and personal property in Michigan. There are two principal exemptions from part of the taxes that routinely impact our clients. The most commonly invoked exemption is the "personal residence exemption" (a/k/a "homestead exemption). The second important exemption is the "qualified agricultural property" exemption (see, Navigating The Michigan General Property Tax Qualified Agricultural Property Exemption). Both exempt the subject property from the school tax. The mechanics of their application differs somewhat.

There is a lot of misinformation out there, much of it by word of mouth. This is an important exemption, as the school tax tends to be one of the highest taxes levied. So, understanding its applicability is worth a few moments' reading.

The personal residence exemption applies to property which is classified by the tax assessor as "residential property." Classification as "residential," does not by itself qualify the property for the exemption. The owner must demonstrate, to the satisfaction of the taxing authority (or – ultimately – the Michigan Department of Treasury), that the property for which they are seeking the exemption is their one, true personal residence.

Obtaining the Exemption

In order to qualify for the principal residence exemption, a homeowner must file an Affidavit of Personal Residence, (Form 2368), which may be obtained on line at the Michigan Government Website (www.michigan.gov/treasury). The affidavit must be filed – in most cases – not later than May 1 of the year the exemption is sought. The Affidavit is filed with the Local Assessor, not with the Treasury Department.

There are instances when a "late" filing can be sought by appearing before the tax board of review (which convenes in most municipalities in July and again in December). It probably makes sense to seek some professional assistance at that point, as there are rules and deadlines that must be carefully observed.

The greatest area of concern is when a residence is purchased after the May 1 deadline. In most instances, the prior homeowner has already filed the affidavit and qualified and the exemption will remain in effect until December 31, after which you may file to meet the May 1 deadline for the following year. The Affidavit need only be filed once and the exemption remains in effect as long as the residence continues to qualify for that owner.

Qualifying For the Exemption

This is the area where the most confusion (and frankly, a fair amount of "license" with the rules) usually arises. This exemption is intended to apply to one personal residence where a resident of Michigan intends to permanently use as their primary home. There are certain indicia that the Department of Treasury (or the local assessor) uses as "proof" of residency. The statutory provision makes clear that it is a matter of intent on the part of the owner. But proof of such intent is sometimes difficult. The authorities will look at things like voter registration address, address on Michigan Driver's License or other Michigan I.D., where the applicant has his or her mail sent, where bills are mailed and the address they use on official tax filing. None of these items alone will be determinative, but they will be used as evidence of intent.

The Michigan Department of Treasury publishes a pdf pamphlet called "Guidelines for Michigan Principal Residence Exemption Program." It is worth noting that in the guidelines, they specifically address the vacation home or cottage issue. Up until just recently, most lakefront vacation property in Michigan was appreciating much more rapidly than suburban or urban residential property. The tax pressure on owners of these properties was enough that many such owners have attempted to make them their personal residence in order to have the exemption apply to their higher value property. Some even attempted to claim both residences as their principal residence. About 10 years back, there was a strong push by taxing authorities to seek out these "transgressors."

The Guidelines make it clear that the state will view this as a matter of reality. In other words, you cannot simply change your driver's license, voter registration and other "indicators," and automatically have the property qualify. You have to demonstrate in a meaningful way that you indeed intend to reside in the property as your principal residence. While there are obviously grey areas (e.g., the "snowbirds," who may spend 6 or more months in a warmer climate), this means that you "live" there – you spend the bulk of your time there.

Multiple Exemptions

It is clear that a homeowner is only entitled to one principal residence exemption. You must be a resident of the State of Michigan and you may not have claimed a similar personal residence exemption in another state, country or territory. You cannot have dual residency, for purposes of the exemption.

What if you are husband and wife? State and Federal laws are nothing if not unclear about this distinction. The general approach is that we treat married couples as a single unit. However there are exceptions. For purposes of the principal residence exemption, if a husband and wife file a joint income tax return, they are entitle to one exemption for their "marital unit." However, if they file separately, they may each claim an exemption. Beware, however, that they will still have to demonstrate the "intent" reality discussed above. In most cases, unless the parties are separated, that will be pretty difficult to do.

Much will depend upon the diligence of the local taxing authorities on all of the above issues.

The Ownership Requirement

This requirement may be among the most elusive – and confusing. Like much legislation, the language is not necessarily consistent, nor clear. For example, the General Property Tax Act refers to the term "person." Yet they don't necessarily consistently apply their interpretation. For purposes of the principal residence exemption, "person" is interpreted as its plain meaning, a "human." A residence that has been transferred into a Limited Liability Company, a Partnership, or some other legal entity will cease to be qualified for the principal residence exemption. While this may seem harsh, it is the law in Michigan. Where we see this application cause the most problems is in the family farm arena, where we are often structuring land-holding entities and family limited liability companies and partnerships. Because there are other complex rules and programs affecting farmland, and because the farmstead and family home are often part of a larger tract of land, family estate and succession planning can become problematic and complex, and attention to detail is important in that context.

You do not, however, need to be a 100% owner of the property. The law says a partial owner may claim the exemption (again, subject to demonstrating that it is their one true personal residence). This means joint owners, and holders of life estates may still claim the exemption.

The law does not specify the amount of ownership. This opens the door to some creative tax and estate planning. For example, a child, parent or sibling could legally own a fractional interest (as little as a 1% joint tenancy interest), but reside in the home and claim the exemption. This, combined with the "uncapping" protections we learned about in the Klooster case (see, "Some Family Cottage Strategies In Light of The Klooster Case") may present some very enticing family property succession strategies.


A residence that has been transferred to a grantor-revocable trust also qualifies for the exemption.  In that case, the grantor (in most cases) is deemed the "person" who is the owner and entitled to the exemption.

Finally, note that you may claim the exemption if you are a Land Contract purchaser. This makes sense because Michigan Law sees such a purchaser as the "equitable" owner of the property, subject to the security interest of the Land Contract Vendor (the so-called "legal owner").

What Property is Covered?

This is another area which is sometimes susceptible to confusion. Adjacent land parcels are often arbitrarily separated by legal description (e.g., by the way they are acquired by deed) or by tax parcel identification code. They may be separated by roads, ditches, waterways, or other natural or man-made obstructions.

The exemption covers all contiguous property to the occupied residence, as long as it is: (1) classified residential, (2) is vacant, and (3) is not used for non-residential purposes. The Guidelines provide several examples of what qualifies as contiguous. Essentially, it is property which is "touching" the property the primary residence is on. A road, ditch, stream, etc., does not destroy contiguity. Another parcel owned by another that is in between does (there is some thought that the state views a corner-to –corner touching as not contiguous, though I fail to see the logic in that view) .

Separately described or deeded parcels or parcels with separate tax code parcel identification numbers, will all still qualify, as long as they satisfy the contiguity requirement. You need not combine parcels in order to have the exemption. You do, however, need to file separate exemption Affidavits for each separate tax code parcel.

The state is dead-serious about the 3 limitations above. If a contiguous parcel has a separate structure on it, it is not "vacant" and does not qualify for the exemption. If any business use is occurring on the contiguous parcel, at least a portion of it will not qualify. The most common example of this latter occurrence is vacant farmland, which is being farmed for rent. In most cases, it will or can be classified as qualified farmland, which will solve the problem. In other cases, it will be important to seek qualified professional assistance.


 

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Some Family Cottage Strategies in Light of the Klooster Case

Nothing triggers emotions more than the family cottage. You may have raised children who spent all their vacations there. You may have grown up there yourself. All the best memories are often there. Yet this family "heirloom" often becomes the most difficult asset to pass to the next generation; and sometimes the most contentious.

As an owner-family, one of the first questions I have clients consider is whether they should even go down that proverbial road? There is simply no legal "GPS" for finding the right mix of ownership and management of multiply-owned family recreational property. Much has been written about this subject over the years, including "Saving the Family Cottage," by Stuart Hollander, a Northern Michigan Attorney who lived and practiced in Leelanau County; and "The Cottage Rules" by Nikki Koski. These books purport to help "solve" the problems arising in trying to pass a cottage from one generation to the next. Yet they admit that it is more of an art than a science. In the end, I usually counsel my clients that their own family "chemistry" will make or break the succession, no matter how good or clever our written documents and plans may be. And, a continuing problem is how, even after passing to the second generation, successive generations will be treated. This article is not really a piece addressing whether the family cottage should be passed. Nor is it really a road map illustrating how it should be done. Rather, it addresses some of the pros and cons of different ownership methods and when they might be considered, in light of the real property taxation.

In 2010, the Michigan Supreme Court decided Klooster v City of Charlevoix, defining under what circumstances a "transfer" resulting in "uncapping" for purposes of the Michigan ad valorem real property tax. "Capping" refers to a limitation placed on the ability of the taxing municipality to raise the "taxable value" of real property as its fair market value increases. The intent of the act was to keep current owners from being unfairly taxed in relation to increase and development of surrounding properties, during their tenure of ownership. It imposes a formulaic limit on tax increases. However, when the ownership is transferred, this "cap" comes off and the taxing authority is free to make a one-time (for each transfer) adjustment to reflect fair market value in the hands of the new owner. The Klooster decision put an interesting (and for some of us, unexpected) twist on the meaning of "transfer" of ownership for purposes of the act. See, Michigan Buys Supreme Court Buys Us Another Generation on Real Property Taxes.

Before addressing the pros and cons, it is appropriate to review ownership options for family cottage properties. Over the years, some different methods of ownership by the next generation have been prevalent.

Joint Ownership

Perhaps the most common (and the most fraught with problems) is joint ownership of property. Michigan law observes several different types of joint ownership. Among non-married owners, the most common and often presumed type is as tenants-in-common. In tenancy-in-common, each owner owns an "undivided" fractional interest in the property. The interest can be sold, or transferred freely. In the event a problem arises in co-ownership, a tenant-in-common may ultimately petition the Circuit Court for an action to partition. The court may, alternatively, order a sale or physical division of the property. A second type of concurrent ownership is as joint-tenants. This type of ownership presumes that on your death, your interest passes, automatically, to the surviving owner. But during lifetime, between non-married owners, the interests may be sold or transferred freely. Such a transfer converts the joint tenancy to tenancy-in-common. A third type of joint ownership is known as joint tenancy with full rights of survivorship (JTWROS). Here, the decedent's interest also automatically passes to the survivor(s). However, these interests may not be transferred or sold without the concurrence of all joint owners. The JTWROS tenancy may not be severed, even by a court.

You may note that I have prefaced each of these with "among non-married owners." In Michigan, when a husband and wife take title to real property, it is presumed that they do so as tenants-by-the-entireties (a special type of JTWROS ownership reserved for married couples). It should be easy to see that, depending upon the makeup of owners and their ability to (and perhaps live) together, each of these owner methods may have potential significant disadvantages.

It is permissible, and in my view, strongly recommended, that the parties have a separate, recordable and enforceable written agreement providing for use, management and succession issues.

A separate, written agreement providing for use, management and succession issues is strongly recommended

Trusts

Another ownership method is a Trust. Most often, a parent-owner will create a Trust for ownership during their lifetime which provides for "rules" and management of the property following their death. Trusts can create complexities and difficulties that may have been completely anticipated by the client and/or drafter. Someone or some entity must act as the Trustee, with the significant responsibilities impose by both the Trust Agreement and the Michigan Trust Code. Tax reporting at both the federal and state level is required. The allocation of the taxable (and deductible) attributes is not always simple. There are annual reporting and accounting requirements, sometimes to more "remote" individuals who may have no current involvement, but have a possible future interest. Trusts are generally a cumbersome method for continuing ownership and often will direct another form of ownership upon the death of the original owners/trustors and transfer to the next generation. The "uncapping" circumstances for trusts are quite complex.

Entity Ownership - Limited Liability Company / Partnership

For numerous reasons, the Limited Liability Company (LLC) has become the real estate owning entity of choice in Michigan. It is an outgrowth of the Partnership, which was perhaps the preferred method before the LLC. The partnership's "achilles heel" was the unlimited liability every partner had on all partner activities. The LLC effectively created a Partnership with the same limited liability that a corporation traditionally had. And, over time, the Michigan LLC Statute has evolved as the most flexible and creative business entity tool available for planning.

The LLC has become the Real Estate Owning Entity of Choice in Michigan – but it has "uncapping" Issues.

With an entity format, the owners can have an agreement for management and succession of ownership for multiple generations. A manager(s) can be designated and "branches" among the family can be defined, for purposes of voting. A "buy and sell" agreement can be put in place, providing for valuation methods and payment methods, as well as limitations on sales and transfers. Accounts can be established for payment of expenses. And, because the entity is the owner of the real property, as "members" come and go, the ownership stays within the company. Because of this structure, the LLC is, in my view, a better practical and legal planning alternative to the Joint Property Agreement.

There are negatives. There is a cost to set up the LLC, and a (generally nominal) cost of annual maintenance. Like the Trust, federal and state tax reporting is required. The LLC is a "public" entity, in that it is on file in Lansing, with a register address and agent. Perhaps the most significant negative is the "uncapping" issue mentioned above.

How Klooster Applies

The Michigan Tax Tribunal has ruled that transfers of real property interests to a LLC will automatically cause uncapping. While a reading of the statute does not, in my view, intuitively suggest that result, the rulings of the Tribunal have the force of law in Michigan until a court having proper jurisdiction says otherwise. To the best of my knowledge, at the time of this writing, no court has done so. Nor is the Klooster result, in my opinion, the intuitive result of a reading of the statute. But the Michigan Supreme Court is the highest legal authority in the state and they have spoken.

If "uncapping is an issue, consider Joint Ownership with a written agreement; If it is not, go the route of the LLC

In summary, if "uncapping" is not a significant issue, you should strongly consider the formation of a LLC. Conversely, if "uncapping" is a significant issue, you should consider joint-ownership with a Property Agreement. However, before spending too much time on the "uncapping" issue, it is probably worth looking at whether the "uncapping" issue is as significant at one might think. Currently, most vacation property values are at a long-time low here in Michigan. Thus, the "jump" from current taxable value and fair market value (loosely, SEV in Michigan) may not be as significant as it first appears. Even though the "value" looks like a substantial number, it is worth doing the math to see what the actual increase in taxes might be. It may be that "uncapping" in the current environment is a "window" that should be taken advantage of. Remember that once the "uncapping" occurs, the "cap" starts over again for the succeeding owners.

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Why and When Is a Trust Accounting Report Required?

Clients often ask why we need to report or account to beneficiaries. This is a particularly perplexing concept when the beneficiaries are remote (i.e., they are not currently due to receive anything from the trust and may never receive, unless they outlive the current beneficiary(s)). A related question is to whom we must report and when?

When the grantor is still alive and is serving as his or her own trustee, there is no duty to report. This makes sense, as it would be a duty for the owner who retains total and complete control over the assets in the trust to report to him or herself. These very common estate planning trusts are known under the Internal Revenue Code as "Grantor-Revocable Trusts." The get this name from the section in the Internal Revenue Code which exempts them from filing or reporting separately on an income tax return. Instead, the grantor simply continues to report these items on their personal tax return. However, on the death of the grantor (and in some circumstances, when the grantor no longer is acting as trustee, if though they may be still living), the duty to report and file income tax returns arises.

Perhaps the most direct answer to why we must do this is that the law requires it. But what, exactly does that mean? Estates, whether Probate Estates or Trust Administration, are mainly governed by the law of the state where the grantor is/was a resident, or where they stipulated in the Trust Agreement which state law would govern. So we must look to the Statutes of the State. At the same time, in an effort to achieve some uniformity from state to state, there are "unofficial," but very influential and persuasive guidelines to Trust and Estate administration. State statutes often follow the guidance of these "national" guidelines.The Restatement of Trusts (now in its 3^rd iteration) is one such uniform nationally recognized guideline. The Restatement (Third) of Trusts states that A trustee has a duty to maintain clear, complete, and accurate books and records regarding the trust property and the administration of the trust, and, at reasonable intervals on request, to provide beneficiaries with reports or accountings. Following on this, Michigan's new Michigan Trust Code contains provisions requiring a Trustee to report to beneficiaries.

The Trustee of a Trust is a fiduciary. That means that they have a special duty to all of the trust beneficiaries, of fair and honest dealing, and of sensible management and investment of the trust's assets. This fiduciary duty also includes the duty to keep beneficiaries apprised of the status of the trust's assets and investments.

Who are the beneficiaries entitled to an account or report? That is a bit less clear. It is clear that the current beneficiaries are entitled. But what about more remote (or contingent) beneficiaries? The commentary to the new Michigan Trust Code says the language of the code "clarifies" this formerly unclear area. I am not so sure. The Code uses the new term (new to us in Michigan, anyway), "qualified beneficiaries." It defines "qualified beneficiary" in what I think is a rather confusing way. What is clear is that current beneficiaries are entitled to an accounting and that more remote beneficiaries may be entitled. The code requires a reporting to the current beneficiaries (current generally meaning that they have some current rights to trust assets, either in the form of income distributions or the right to distributions of some or all of the principal in the trust). It then goes on to say that other "qualified" beneficiaries are entitled to an accounting on request.


The Michigan Trust Code authorizes the maker (grantor) of the Trust to limit the duty of the Trustee to report to certain beneficiaries. However, a Probate Court can override this and order reporting anyway.

In my view, what this tells us is that a Trustee should keep detailed records, and prepare a report at least annually, to keep in its records. While that does not necessarily mean provide each beneficiary with an account, it puts the Trustee (or successors) in a position to provide that information upon an order of the Court. It may serve a secondary purpose of highlighting for the grantor and/or Trustee any problems that might be lurking out there in terms of trust accounting and record – keeping.

Finally, on all but "grantor revocable trusts," the Trustee will be required to file an annual income tax return with the IRS and with any state or states in which it earns reportable income. So it doesn't seem like a huge inconvenience for the tax preparer and/or Trustee to simply put together some kind of accounting report each year as and when the tax return is prepared.

The Michigan Trust Code does not specify a format for the report. It does give guidelines, suggesting that the report should be thorough and detailed enough to fully apprise the recipient of the nature and status of trust assets. This means it should probably have a method for recording items of income as well as how they affect the capital or income side of the trust accounts, as well as items of loss and expenditure, for the same reasons.

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Michigan Supreme Court Buys Us Another Generation on Real Property Taxes

Thursday, March 10, 2011, the Michigan Supreme Court, in Klooster v. City of Charlevoix, seems to have granted us another "generation" on Michigan Real Property Taxes. In 1994, so-called "Proposal A" placed a cap on the amount of increase in Michigan Real Property taxes a municipality could apply, regardless of how much the actual market value increased, as long as there was not a "transfer of ownership." The devil is always in the detail, and the Klooster case centered on the definition of "transfer of ownership," and the meaning of one of the exceptions laid out in the act.

The Act, which allows the municipality to remove the "cap" in the tax year following a change in ownership, has a rather involved definition of transfer of ownership. It also has a long list of exceptions to the rule allowing the cap to be removed. The Klooster decision focuses on the so-called "joint-tenancy" exception. That exception provides that the creation or termination of a joint tenancy by one who is an original owner does not result in an uncapping event, even though it is a change of ownership. The court defines "original owner" as one who has ownership immediately following the last "uncapping" transfer. The court further explains that death of a joint owner (joint with rights of survivorship) results in a "transfer" by operation of law. So an original owner who has created a joint tenancy with another and then dies, effects a transfer of ownership, but it is within the exception and therefore not an "uncapping" transfer.

There has been some question about this since the exception of the act. Some of us (particularly municipalities) felt that the intent of the act was to prevent an unfair increase in taxation while the same original owners and spouses were alive and owned the property, but the when the last original owner in a generation died or transferred out of ownership, an uncapping transfer occurred. The Klooster opinion makes clear that, as a matter of Michigan law (now anyway J ), we were incorrect. The court carefully dissects the language of the statute and concludes that the uncapping will occur on the next transfer. In other words, my dad and mom could add me as a joint with right of survivorship owner to real property and after both of their deaths (which would be a "transfer of ownership" by operation of law), an "uncapping event" would still not occur until the next transfer (either by deed or by my death) happens. This means the cap can stay on for my lifetime, if no transfer of ownership occurs.

Great care must be taken in planning. Once my parents die, for example, I may want to plan for my own succession. If I add a joint tenant who does not come within one of the "not a transfer" exceptions in the statute (e.g., adding children or siblings), an uncapping transfer occurs (adding a spouse or conveying to a grantor revocable trust would probably not be viewed as a subsequent uncapping event). Also, presumably, on my death, an uncapping transfer occurs. This opens much proverbial "food for thought" in real estate succession planning transactions.

It will also be interesting to see if the Legislature takes any action to change the statutory language the Court interpreted.

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