Durable Powers of Attorney – No Implied Power to Make Gifts

Take-Away: We all know how important it is for our clients to have in place a Durable Power of Attorney for financial decision-making in anticipation of a future disability. It is important that the Durable Power of Attorney contains a specific delegation of powers to the principal’s agent. The law does not presume that a delegated power exists, especially when it comes to the agent’s ability to gift the principal’s assets.

Context: Many commentators these days suggest that it may be unwise to gift assets, if we are soon going to see the federal estate tax disappear. This suggestion is based on the repeal of the estate tax and the desire to obtain a step-up in the basis of assets held by the asset owner until his/her death. Consequently, we may not see as much activity in lifetime gifts as we have in prior years, although for very wealthy individuals it may still make sense for them to gift appreciating assets to remove the future appreciation from their taxable estates, so long as we have a the federal estate tax to contend with. For older clients with large estates, it may make even more sense for them to consider lifetime gifts, since their estates are more likely to have to contend with some form of the federal estate tax if it is phased out. Moreover, with gifted assets there is also a shift in the taxable income the gifted assets generate to a lower bracket taxpayer-donee, so a lifetime gifting program may still make some sense from an income tax perspective. If the older client becomes mentally incapacitated, the authority to make gifts of their assets will fall to their designated agent under their Durable Power of Attorney. Will the authority to make gifts be clearly stated in the client’s Durable Power of Attorney for financial affairs? Will the scope of the authority to make gifts be sufficient to assist the principal to implement their estate plan? Those are the questions.

Law: A Durable Power of Attorney is defined by the Estates and Protected Individuals Code (EPIC). MCL 700.5501 et. seq. The key is that the Power of Attorney must contain magic language “This power of attorney is not affected by the principal’s subsequent disability, incapacity, or by the lapse of time.” The attorney-in-fact (or the agent) possesses the authority, rights, responsibilities, and limitations provided by law, and as defined in the instrument. Unlike other fiduciaries that are identified in EPIC, there is no litany of default powers and authority that EPIC grants to the agent; rather, the delegation of powers, and their scope, is left to the principal who signs the Durable Power of Attorney.

Strictly Construed: The Durable Power of Attorney is governed by the law of agency, which means that a Durable Power of Attorney instrument will be strictly construed. Gruswatch v Niedzwiecki, No. 275188, 2008 Mich App LEXIS 831 (April 24, 2008.)
No Self-Dealing: Because a Durable Power of Attorney creates a fiduciary relationship between the agent and the principal, the agent lacks the authority to make gifts to himself. Nor can the agent create a joint tenancy between himself and the principal, unless authorized to do so. Smith v Onaway Cmty Fed Credit Union, No 246196, 2004 Mich App LEXIS 2785 (Oct 21, 2004)
IRS Position: The legal principle that a Durable Power of Attorney must be strictly construed surfaced about 15 to 20 years ago in a series of IRS private letters rulings and in some federal court decisions. The issue was whether an agent who acted under a Durable Power of Attorney could remove an asset from an principal’s taxable estate through lifetime gifts using the Durable Power of Attorney. Most of these cases focused on a generic delegation of authority given by the principal to the agent under the Durable Power of Attorney: e.g. ‘my agent shall have such authority to deal with my assets as I would have in dealing with the same assets.’ The position taken by the IRS, and adopted by the federal courts, was that the broad generic delegation of authority given to the agent did not specifically refer to the authority to make lifetime gifts. As a result, any gifts made by the agent under the Durable Power of Attorney on behalf of the principal were deemed voidable by the principal up until the moment of the principal’s death. The result was that the principal retained control over the gifted asset at the moment of his/her death, and thus the value of the gifted asset was nonetheless includable in the principal’s taxable estate under IRC 2038. This position came as a big surprise to many estates when significantly large values that the family thought had long ago been removed from the principal’s taxable estate through lifetime gifts in reliance upon a broadly phrased Durable Power of Attorney suddenly reappeared, thus causing a substantial and unexpected federal estate tax liability.
Attorney Response: In light of the position taken by the IRS and the federal courts, lawyers began to include in the litany of powers bestowed on the agent in a Durable Power of Attorney the ability to make gifts, including to the agent himself (in short, authorizing self-dealing in the fiduciary context.) Usually the grant of authority to make gifts authorized the agent to make annual exclusion gifts, or sometimes gifts to charities, more for income tax planning than for estate tax minimization. Sometimes the grant of authority went beyond the ability to make annual exclusion gifts to include prefunding 529 accounts, or to make large lifetime gifts that did not to exceed the principal’s then available lifetime federal estate and gift tax applicable exemption amount. Sometimes the ability to make gifts was conditioned on all similarly situated donees being gifted an equal amount, e.g. a gift to one child required a gift to all of the principal’s children. But the key response was to expressly grant in the Durable Power of Attorney to the agent the ability to make gifts using the principal’s assets in order to avoid the voidable gift argument that the IRS had successfully asserted in the past.

Current Issue: So why bring up this topic that has been well settled for more than a decade? Well, a federal case published last month tells us that the grant of the authority to make gifts in a Durable Power of Attorney will be literally interpreted, and a court will not impute a broader scope to the delegated gift-making authority to the agent.

Bad Facts: The case primarily dealt with a strategy that was pretty popular about 20 years ago to create a family limited partnership to hold the principal’s investment portfolio, and then transferring limited partnership units to the principal while claiming extreme valuation discounts associated with the limited partnership units held by the principal. In this case, the principal owned $10 million in cash and securities, who was in old age, and who was determined by her physicians to be incapacitated. Her son, acting under his mother’s Durable Power of Attorney, formed the limited partnership, named himself as its general partner with his brother, and a week prior to his mother’s death he transferred her $10 million in stock and cash to the limited partnership in exchange for a 99% limited partnership interest. 25% valuation discounts were applied to the 99% limited partnership interests held by the mother. The principal’s two sons each contributed assets (sort of) to the limited partnership: they each contributed a promissory note. Then, using the Durable Power of Attorney, the son transferred his mother’s 99% limited partnership interest to a Charitable Lead Annuity Trust (CLAT) in an attempt to remove the entire interest from his mother’s taxable estate; the lifetime annuity beneficiary of the CLAT was a family private foundation. Upon the mother’s death (one week later) the CLAT terminated and its assets were then transferred to trusts for the benefit of the mother’s two sons. This is one of those cases where it is easy to see why the family lost due to, as one Tax Court judge described it, “aggressive deathbed tax planning.”
Challenged Gift: This case was decided under California law, which is much like Michigan’s law. The legal principle is that an attorney-in-fact does not possess the authority to make gifts unless the authority is expressly provided in the power of attorney. In this case, the power of attorney included a grant of authority to make annual exclusion gifts, but note the scope of that delegation or grant of authority:

“.. to make gifts on the principal’s behalf, including, but not limited to, forgiveness of loans, to a class composed of the principal’s children, any such children’s issue, or any or all to the full extent of the federal annual gift tax exclusion under IRC 2503(b) or any successor statute.”

The Tax Court found that this grant of authority to make gifts was limited to annual exclusion gifts to the sons (and family members), and thus the grant of authority did not include the authority to gift the 99% limited partnership interests to the Charitable Lead Annuity Trust.

The principal’s estate claimed that other broad provisions of authority contained the Durable Power of Attorney and/or a claimed ratification of the acts taken by the agent were sufficient to overcome the limited scope of the gift-giving authority to the agent who funded the CLAT. The Tax Court disagreed with this argument. The result that the full 99% limited partnership interest was included in the principal’s taxable estate under IRC 2038(a)- about $10 million. Estate of Nancy H. Powell v. Commissioner, 148 T.C. No. 18 (May 18, 2017)

Conclusion: We regularly encourage clients to have in place Durable Powers of Attorney for financial decision-making, to avoid the need to have to petition a local probate court for the appointment of a conservator. We like the flexibility and privacy that a Durable Power of Attorney affords our clients. But close attention needs to be paid to the scope of the authority given by the principal to their agent under the Durable Power of Attorney. Most Durable Powers of Attorney contain gift-giving authority of some magnitude and scope. But as the Powell decision tells us, that grant of authority will be narrowly construed. If a principal has a private foundation, or the principal might benefit from a charitable gift annuity to their favorite charity, the agent’s ability to implement these future philanthropic transfers maybe be prohibited if not explicitly contemplated in the gift-giving authority. Similarly, if the principal has a series of cascading GRATs designed to shift wealth gift-tax free over a series of years, the agent’s ability to create and fund new GRATs may be denied if there is no authority included in the Durable Power of Attorney. The same for QPRTs or QTIP Trusts that might be created during the principal’s lifetime. Thus, when reviewing a client’s estate planning documents, you need to read their Durable Power of Attorney. While it is one thing to confirm that a client has in place a Durable Power of Attorney for financial decision-making, you will need to also make sure that the agent possesses sufficient authority to fully implement that client’s unique estate plan, especially if there are private foundations, or a variety to lifetime trusts in place to shift wealth.