Judge Gavel

Will a Religious Clause, Establishing How Trust Disputes are to be Settled, Hold Up in Court?

Courts of law normally handle disputes between citizens. Our American court system has evolved over the years to have its own method of procedures, evidence and tribunals. But what happens when a trust mandates that disputes are to be handled not by a secular state court but instead by a religious court? Is that legal? Moreover, what happens when complex tax laws become an issue? Can the IRS declare the imposition of a religious court as something contrary to rights under state law, causing adverse tax consequences?

Mikel v. Commissioner

These issues were recently decided in the Mikel v. Commissioner.

Israel and Erna Mikel made large gifts to an irrevocable trust totaling $3.62 million. The Mikels took advantage of something known as a “Crummey” withdrawal right, meaning that when a contribution is made to the trust, to the extent that a beneficiary has a limited window to withdraw his or her interest, then all or some part of the contribution to the trust is considered gift tax free.

The Mikels had an unusually large number of family members as beneficiaries – 60 in fact. Under the then current gift tax laws, $1.4 million could be contributed annually gift tax free to the trust using these “Crummey” powers. The trust was therefore able to accumulate many millions of dollars gift tax free.

Under the terms of the trust which were consistent with the federal tax law, each of the 60 beneficiaries had a limited period of time to withdraw their share of any contribution to the trust, subject to a cap based on the federal gift tax exclusion amount (then $12,000 per donee) at the time of the gift. The trust required the trustee to give notice to each beneficiary when any contribution was received by the trust, and the trustee gave these notices in a timely manner.

Bet Din

Instead of ending there, however, according to the terms of the trust any dispute that arose between the beneficiaries was to be arbitrated by a “Bet Din” before commencing a lawsuit. A “Bet Din” is a panel consisting of three men of Orthodox Jewish faith. Under the terms of the trust, the panel was directed to enforce the rights that the parties had under New York law, but the Halachah (Rabbinic Jewish law) was the primary gateway to the beneficiary’s rights.

These provisions read, in part, “It is the Grantor’s express intent that certain provisions of this Trust instrument be interpreted in accordance with Orthodox Jewish Law, or a “Halachah” including [that] by an Orthodox Jewish Bet Din convened by [Rabbinic Organization]…The Bet Din shall determine and resolve any issue arising as to the interpretation…or the application of Halacha… Grantor expressly directs and authorizes the Trustee to consult with the Bet Din concerning the resolution of such matters…

The IRS took issue with whether the withdrawal rights were valid under the gift tax rules, arguing that the mandatory use of a Jewish court constrained a beneficiary’s ability to compel the trustee to make a distribution. It is important to know that under the federal tax law, the right of a beneficiary to withdraw his or her share of a contribution to the trust under the limited time window must be absolute and not subject to any contingency. The IRS argued that this Bet Din requirement imposed a gatekeeper that could impinge the beneficiaries’ rights of withdrawal.

Terrorem Clause

Not only that, but the Mikel trust also contained an in terrorem clause (no challenge) that would result in a contesting beneficiary forfeiting his or her beneficial interests in the trust. The IRS argued that this provision undermined a beneficiary’s ability to challenge the trustee’s direction as to distributions. If the IRS won their arguments, then none of the contributions to the trust would have been free of gift tax.

As a side note – in terrorem clauses are unenforceable under Florida law. But this was a New York based trust.

The Tax Court rejected the IRS arguments, holding in favor of the taxpayers, accepting the Bet Din as not inhibiting the beneficiaries’ rights. The Court held that the Bet Din was there to interpret state law, and provided a means to resolve disputes outside of the Court system. Just because the resolution mechanism was not secular did not invalidate it.

I found this case interesting, and look forward to reading the outcomes of similar cases as they arise.

©2021 Craig R. Hersch .Learn more at floridaestateplanning.com

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